PCDForum Article #14,   Release Date July 10, 1995

by Frances F. Korten

In response to mounting worldwide evidence of environmental deterioration, world
leaders have called on the multilateral development banks to step up lending for
environmental projects.

The banks have welcomed the new mandate, partly out of concern for the
environment and partly because they are seeking justifications for increased
lending to meet developing countries’ fiscal needs. The multilateral banks have
used new loans to provide the hard currency those countries need to repay past
loans and maintain their imports. Environmental lending would appear to at once
meet both fiscal and environmental needs. However, a closer look casts doubt on
the wisdom of combining the two agendas.

The Philippines provides a useful example. Its economy has been fiscally
stressed. In 1992, servicing its $32 billion external debt consumed some 28
percent of its exports, while imports exceeded exports by $1.4 billion. It is
also environmentally distressed. Due to rapid deforestation, conservationist
Norman Myers named the Philippines one of the world’s 10 "hot spots,"
where biodiversity is most severely threatened. Finally, it has been a major
recipient of official environmental loans, concentrated primarily in forestry
projects. Between 1988 and 1992 the Asian Development Bank (ADB), the World
Bank, and the Japanese government lent $731 million for forestry projects–more
than 10 times the $60 million of international lending provided for forestry
projects during the previous 12 years.

From the fiscal perspective, massive environmental lending for Philippine
forestry projects is nearly ideal, because most of the actual costs are local.
Therefore the foreign currency that is borrowed can be used to repay foreign
debt and finance imports, while project costs are covered with local currency.
An examination of the loans from an environmental perspective, however, reveals
that in the design of these projects, the banks have placed fiscal needs ahead
of environmental ones to such an extent that the environment may be a net loser.

An indicator of the fiscal emphasis is found in the extent to which loan size
exceeds any reasonable estimate of the capacity of implementing agencies to use
the funds effectively. The first of the environmental loans to the Philippine
forestry sector was for $240 million–half from the ADB and half from the
Japanese government. Its stated purpose was to reforest lands denuded by a
combination of logging and slash-and-burn agriculture. The project design called
for the Department of Environment and Natural Resources to contract with private
groups to reforest 358,000 hectares over five years. According to a German
study, over the previous 71 years this Department had successfully reforested a
total of only 70,000 hectares. The project called on it to reforest an average
of 71,600 hectares each year.

To its credit, the Department actually met and even exceeded the loan-funded
program’s contracting targets. It did so, however, by sacrificing the program’s
potential effectiveness. Department planners had expected to contract primarily
with well established groups or families living close to the reforestation sites
who would have a direct interest in the long-term environmental and economic
benefits the trees would bring them a condition shown to be critical to the
success of reforestation efforts throughout Asia. To meet the high targets set
by the lenders, Department personnel were forced to contract with many urban
groups that hastily formed to gain short-term profit from the contracts.
Independent evaluations studies revealed that under such circumstances the
residents in replanted areas had little or no commitment to protect the trees.
In several cases where the laborers’ wages were delayed, they burned the trees.

The scale of the project so far exceeded the Department’s supervisory capacity
that despite earnest watchdog attempts by senior management, evidence of
corruption abounded. Spot checks identified a disturbing number of cases of
contracts with phantom parties, contractors who were not paid the amounts
stipulated on their receipts, and others who were never paid at all.

Another consequence of the unrealistic targets was the use of a single variety
of seedlings. Planners had expected contractors to plant a variety of tree
species suited to the local environment. But to meet deadlines, contractors
commonly used readily available Gmelina arborea seedings, a fast growing tree
with a natural life span of only fifteen years in the marginal soils of
reforestation sites. While good for paper pulp, its short life makes it a poor
choice for conservation purposes.

A commonly neglected feature of environmental loans is that the borrowing
country is borrowing foreign exchange, which must eventually be repaid in
foreign exchange. If the borrowed foreign exchange is being used to repay
previous loans and finance current imports, it is appropriate to ask two
commonly neglected questions: 1) are the imports moving the economy toward
increased equity and sustainability; and 2) how will the additional foreign debt
eventually be repaid?

The answers in the Philippine case are not reassuring. In addition to its
already substantial debt service burden, a substantial portion of the
Philippine’s foreign exchange shortage could be traced to its highly
oil-inefficient economy, which boasted the lowest price of petroleum in the
region (lower even than oil-producing Indonesia); and to the import of
substantial quantities of luxury goods to stock the shelves of air-conditioned
mega-shopping malls that were springing up around the country.

With regard to loan repayment, it is fairly typical of environmental loans such
as the Philippine reforestation projects that the loan-funded activities are not
expected to generate foreign exchange. There is, however, no point in the
project design and approval process at which anyone asks from where the foreign
exchange for repayment will be obtained or with what environmental consequences.

In the Philippines, the need for export income to pay outstanding foreign debts
was one of the most common justifications put forward for the unrestrained
logging that contributed to the deforestation the ADB loan was intended to
correct. However, with the forests now nearly gone, timber exports are no longer
a foreign exchange earner and the country has turned to other sectors for export
earnings. Many have their own environmentally devastating consequences. Gold and
copper mining, which seriously contaminates soil and water, produces several the
country’s top 10 exports. And the country subsidizes prawn farming for its
export potential, despite the fact that pawn farms destroy protective coastal
mangroves and commonly create salt water contamination of underground freshwater
aquifers. The pressure to repay the environmental loans will likely accelerate
such environmentally damaging export promotion.

The Philippine experience exposes the fallacy of addressing the very real
environmental needs of indebted countries through massive international loan
funding. A more appropriate approach to assisting low income countries with
environmental problems would:

  • Recognize that many environmental problems result from social and
    institutional conditions that are not readily corrected by large infusions of
    foreign funds;
  • Build institutional capacities both within and outside the government to
    implement low-cost, effective environmental programs and keep assistance at
    levels that can be used efficiently;
  • Provide assistance primarily in grant form, so as not to exacerbate
  • Acknowledge the damaging environmental consequences of many developing
    country exports;
  • Reduce export pressures by encouraging trade deficit countries to limit
    non-essential imports, especially for military hardware and luxury consumer
  • Provide debt relief in return for reduced foreign borrowing.

Under their current structure, multilateral banks will best serve the
environmental cause by providing hard currency loans only to environmentally
beneficial projects that generate the foreign exchange required for repayment.
Since most environmental projects are not foreign exchange earners, their
financing generally will need to come from agencies that can provide grants.
Increasing the foreign borrowing of indebted countries in the name of
environment protection will only accelerate the very damage the proponents of
environmental lending seek to reverse.

Frances F. Korten is a Ford Foundation program officer. The column is
distributed by the PCDForum based on her article "Questioning the Call for
Environmental Loans: A Critical Examination of Forestry Lending in the
Philippines, World Development, July 1994. The views expressed are the author’s

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