December 2019

ASIAN DEVELOPMENT FUND (ADF)

ADF 13 REPLENISHMENT MEETING 11–12 February 2020 Manila, Philippines

Update on ADF 13 Resource Allocation Framework

This document is being disclosed to the public in accordance with ADB’s Access to Information Policy.

ABBREVIATIONS

ADB ADF

– –

Asian Development Bank Asian Development Fund

COL – concessional ordinary capital resources lending DRF – disaster response facility DRR – disaster risk reduction DMC – developing member country DSA – debt sustainability assessment EVI – Economic Vulnerability Index FCAS – fragile and conflict-affected situation IDA – International Development Association OCR – ordinary capital resources PBA – performance-based allocation PSW – private sector window SIDS

–

small islands developing states

NOTE

In this report, “$” refers to United States dollars, unless otherwise stated.

In preparing any country program or strategy, financing any project, or by making any designation of or reference to a particular territory or geographic area in this document, the Asian Development Bank does not intend to make any judgments as to the legal or other status of any territory or area.

CONTENTS

Page

EXECUTIVE SUMMARY I

I. INTRODUCTION 1

II. OUTLINE OF THE PROPOSED ADF 13 FRAMEWORK 1

III. INTRODUCING A PREMIUM FOR ADF GRANT-ELIGIBLE SMALL ISLAND DEVELOPING STATES 3

IV. REVISING THE ALLOCATION FRAMEWORK FOR CONCESSIONAL ORDINARY CAPITAL RESOURCES LENDING 5

V. PROJECTED FUNDING FOR ADF 13 GRANT OPERATIONS 8

VI. ISSUES FOR DONORS CONSIDERATION 9

ASSESSMENT OF VULNERABILITY, RESILIENCE, AND FRAGILITY INDICES 10

INTEGRATING VULNERABILITY INDICES IN THE PERFORMANCE-BASED ALLOCATION FRAMEWORK 14

EXECUTIVE SUMMARY This paper presents an update on the proposed resource allocation framework for the Asian Development Fund (ADF) 13. It discusses the proposed introduction of a small island developing states (SIDS) Premium and a new concessional ordinary capital resources lending (COL) allocation framework. It also discusses an alternative funding scenario based on a proposed carry-over of unutilized resources from ADF 12 to ADF 13, and a resulting lower donor contribution under ADF 13 than under ADF 12. At the first ADF 13 Replenishment Meeting on 5–7 November 2019, ADF deputies expressed broad support for the continuation of a hybrid resource allocation framework for ADF grants consisting of country allocations and thematic components. Donors generally supported the proposed introduction of the Economic Vulnerability Premium. Donors also commented on (i) integration of fragility and vulnerability measures in the performance-based allocation (PBA) formula, (ii) perceived lack of granularity of the proposed premium, and (iii) allocating the premium to the ADF grant-eligible countries. To improve the efficiency of the country allocation system, donors agreed on de-linking the allocation of ADF grants and COL. Donors also suggested to retain the PBA system and requested more details on the proposed allocation of COL at the second ADF 13 Replenishment Meeting. Some donors also enquired about the proposed mechanism for continued donor input in the allocation of COL. Several donors requested to include in the proposed financing scenarios for ADF 13 a carry-over of unutilized resources of the Disaster Response Facility (DRF) and the debt distress reserve under ADF 12 to ADF 13 in order to reduce donor contributions. Introducing the SIDS Premium for ADF grant-eligible small island developing states. The ADB Strategy 2030 recognizes SIDS as requiring special attention on account of their unique development challenges. Income-based measures do not capture the vulnerability of SIDS, which is aggravated by high exposure to climate change and disasters caused by natural events. Most SIDS have very small PBAs mainly due to their small population. These allocations are not sufficient to meet the country needs for key development programs. A premium for SIDS is proposed to be introduced under ADF 13 to replace the base allocation and provide tailored support to ADF grant-eligible SIDS based on their degree of vulnerability.1 The allocation of the premium is proposed to be limited to the grant eligible SIDS because other ADF grant-eligible countries benefit from much larger PBAs. An assessment of relevant indices concludes that the Economic Vulnerability Index (EVI) is the most suitable index for use in the ADF resource allocation framework to develop a supplementary allocation for ADF grant-eligible SIDS, based on its country coverage, data availability, simplicity, and comprehensiveness. Indices categorized as reflecting countries’ fragility tend to reflect a wide range of indicators related to political, economic, and social aspects and do not sufficiently cover ADF 13 grant-eligible SIDS. It is not feasible to integrate existing fragility indices in the ADF 13 resource allocation framework. Simulations indicate that integrating vulnerability indices in the PBA formula cannot fully address shortcomings of the PBA system. While several SIDS receive significantly higher allocations in line with allocations under ADF 12, allocations for SIDS with small population remain very small. Variation in the resource allocations between SIDS is very high. Introduction

1 The SIDS Premium is replacing the Economic Vulnerability Premium which was proposed at the first ADF 13 Replenishment Meeting.

ii

of a SIDS Premium based on the EVI generates sizable allocations for all ADF grant-eligible SIDS, while taking into account their degree of vulnerability. Revising the allocation framework for concessional ordinary capital resources lending. The proposed COL allocation is based on PBA and adjusted by country demand to flexibly respond to country needs. The total COL allocation for an eligible country under ADF 13 is proposed to be the sum of the allocation from a PBA-based component and the allocation from a demand-based component. The demand-based component of the COL allocation framework will be calculated based on a 5-year time horizon as an average of 2 years’ historical commitments and 3 years’ pipeline following the work program and budget framework process. ADF donors will continue to agree on the indicative total amount of COL from ADB’s OCR balance sheet during the ADF 13 period in the ADF 13 donors’ report. Updates on the overall, and annual COL allocations and commitments will be provided at the annual donor consultation meetings and the ADF 13 mid-term review. An overall indicative amount of $13.7 billion COL from ADB’s OCR balance sheet is expected to be make available during ADF 13. Proposed funding scenario including lower donor contributions. The paper proposes an ADF funding scenario for overall ADF 13 grant size of $3,303 million based on a proposed carry-over of $337 million and donor contributions amounting to $2,474 million, which is lower than the donor contributions of $2,594 million under ADF 12. The details of the financing framework will be discussed in a forthcoming paper, “ADF 13 Financing Framework Update”. Donors’ endorsement is sought for: (i) the proposed SIDS Premium for ADF grant-eligible SIDS under ADF 13 to replace the

base allocation, and (ii) the proposed COL resource allocation framework.

I. INTRODUCTION 1. This paper presents an update on the proposed resource allocation framework for the Asian Development Fund (ADF) 13. It discusses the proposed introduction of a small island developing states (SIDS) Premium;1 new concessional ordinary capital resources lending (COL) allocation framework; and an alternative funding scenario that includes a carry-over of unutilized resources from ADF 12 to ADF 13, and a lower donor contribution under ADF 13 than under ADF 12. 2. At the first ADF 13 Replenishment Meeting on 5–7 November 2019, ADF deputies expressed broad support for the continuation of a hybrid resource allocation framework for ADF grants consisting of country allocations and thematic components. Donors generally supported the proposed introduction of the Economic Vulnerability Premium. Donors also commented on (i) integration of fragility and vulnerability measures in the performance-based allocation (PBA) formula, (ii) perceived lack of granularity of the proposed premium, and (iii) allocating the premium to all ADF grant-eligible countries. 3. To improve the efficiency of the country allocation system, donors agreed on de-linking allocation of ADF grants and COL. Donors also suggested to retain the PBA system and requested more details on the proposed allocation of COL at the second ADF 13 Replenishment Meeting. Some donors also enquired about the proposed mechanism for continued donor input in the allocation of COL. 4. Several donors requested to include in the proposed financing scenarios for ADF 13 a carry-over of unutilized resources of the disaster response facility (DRF) and the debt distress reserve under ADF 12 to ADF 13 in order to reduce donor contributions.

II. OUTLINE OF THE PROPOSED ADF 13 FRAMEWORK 5. The proposed ADF 13 resource allocation framework will continue to adopt a hybrid system as the ADF 12 framework, consisting of country- and theme-based components. It will retain the country classification system and debt sustainability assessment to determine country eligibility for grant, PBA formula, special support for Afghanistan, DRF, and debt distress reserve. 6. The proposed ADF 13 framework proposes the following revisions of the existing ADF 12 framework to improve the implementation efficiency and effectiveness of resource allocation: (i) discontinuing the base allocation for all concessional assistance countries and introducing a more efficient SIDS Premium for SIDS eligible for ADF grants; (ii) expanding the thematic use of ADF grants to gender equality and climate change adaptation; (iii) introducing a single thematic pool applicable for group A countries and very selectively for group B countries, addressing thematic priorities in gender equality, climate change adaptation and disaster risk reduction, and regional cooperation and integration including regional public goods;

1 The SIDS Premium is replacing the Economic Vulnerability Premium which was proposed at the first ADF 13 Replenishment Meeting.

2

(iv) aligning with the International Development Agency (IDA) on the Sustainable Development Finance Policy (SDFP) assessments and incentive system, replacing the static 20% discount on ADF grants with an interactive incentive scheme;

(v) rewarding improvements in public financial management policies with preferential access to the thematic pool to reinforce the performance-based incentive system; (vi) piloting a Private Sector Window (PSW) for group A countries to help expand private sector operations in frontier markets and new sectors; (vii) separating the allocation mechanism for ADF and COL. The proposed COL allocation is based on PBA and adjusted by country demand (including historical commitments and future pipeline) to flexibly respond to country needs; and (viii) converting the biennial allocation to 4-year allocation with annual updates to improve the efficiency of the allocation process.2 Figure 1 illustrates the proposed ADF 13 framework.

Figure 1: Proposed ADF 13 Grant Framework

ADF = Asian Development Fund, RCI = regional and cooperation integration, RPGs = regional public goods, SDG = Sustainable Development Goals. Source: Asian Development Bank.

2 Commitments are subject to available resources.

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III. INTRODUCING A PREMIUM FOR ADF GRANT-ELIGIBLE SMALL ISLAND DEVELOPING STATES

A. Background on Resource Allocations for Small Island Developing States 7. Limitations of performance-based allocation system for small island developing states. The ADB Strategy 2030 recognizes SIDS as requiring special attention on account of their unique development challenges.3 The PBAs for SIDS, however, are generally very small mainly due to their small population size and not sufficient to meet the country needs for key development programs.4 Seven SIDS among the 12 ADF grant-eligible countries have PBA shares of less than 2%. The PBA system has to be modified to increase allocations for SIDS, ensure sufficient financing, and build resilience and address the causes of vulnerability. 8. Base allocation has generated improved allocations for small island developing states, but also benefits countries with large performance-based allocations. A base allocation of $6 million per year was introduced in 2017 under ADF 12. The base allocation was increased to $13 million per year for 2019–2020. The increased base allocation has helped to ensure sufficient long-term financing and capacity development assistance in order to continue building resilience and addressing the causes of vulnerability for SIDS. The base allocation, however, has a uniform amount for all eligible countries despite large countries receiving substantial PBAs, which makes it less efficient to support SIDS. 9. It is proposed to integrate a supplementary allocation for ADF grant-eligible SIDS in the ADF 13 resource allocation framework to replace the base allocation and provide tailored support based on the degree of vulnerability of eligible SIDS. Two options based on vulnerability indices have been explored: (i) integrating vulnerability indices in the PBA formula, and (ii) determining the size of a SIDS Premium based on vulnerability indices. The ADF 12 allocation for ADF grant-eligible SIDS serves as benchmark to evaluate the two options for a supplementary allocation for SIDS to generate an adequate country allocation under ADF 13. B. Review of Vulnerability and Fragility Indices 10. Vulnerability and fragility indices can be integrated in the ADF resource allocation framework to improve resource allocations for small island developing states. Several vulnerability-, resilience-, and fragility-related indices are publicly available and regularly updated by international organizations. The indices are broadly categorized into three groups, namely, (i) vulnerability including economic and environmental aspects, (ii) resilience based on human capital, and (iii) fragility covering a wide range of dimensions including political and social aspects. Appendix 1 provides additional details on the indices. 11. Fragility indices. Indices categorized as representing countries’ fragility do not sufficiently cover SIDS. The indices tend to reflect a wide range of indicators related to political, economic and social aspects as well as experts’ qualitative analyses in some cases, which increases the complexity of their methodologies. It is therefore not feasible to integrate existing fragility indices in the ADF resource allocation framework.

3 ADB. 2019. A Framework for Addressing the Financing Needs of Small Island Developing States. Paper prepared for

the first ADF 13 Replenishment Meeting. Manila. 5-7 November 2019. 4 The PBA formula consists of the composite country performance rating, per capita gross national income and

population.

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12. Vulnerability Indices. Among the three selected vulnerability indices, only the Economic Vulnerability Index (EVI) covers all ADF grant recipient countries. The Climate Risk Index does not cover Nauru and the World Risk Index does not cover four SIDS (Marshall Islands, Federated States of Micronesia, Nauru, and Tuvalu). The Climate Risk Index country ranking is narrowly focused on disasters and tends to change drastically according to whether actual disasters occurred each year. The World Risk Index consists of 27 indicators, which makes calculation complex and prone to issues of data collection. In summary, neither the Climate Risk Index nor the World Risk Index is deemed to properly reflect the structural vulnerability of SIDS. 13. The Economic Vulnerability Index covers all ADF grant-eligible countries. It has eight variables divided into two groups, namely, exposure and shock index. The exposure index represents its structural vulnerability from four aspects (i.e., population size, remoteness from global and regional markets, economic structure, and environmental situation).5 The shock index indicates the level of external shocks actually caused in the past 20 years from two aspects (i.e., trade and natural shocks). The relationship between the two indices can be seen as theoretical vulnerability and actual effects – both are essential and none of them can be negligible. The weight of each variable is set in an equitable manner, distributing 50% for both exposure and shock indices and equal proportions among the sub-indices. The EVI is considered to be the most suitable vulnerability index for use in the ADF resource allocation framework to develop a supplementary allocation for ADF grant-eligible SIDS, based on its country coverage, data availability, simplicity, and comprehensiveness. C. Options for Integrating Vulnerability Indices in the ADF 13 Resource Allocation

Framework for Small Island Developing States 14. Integrating vulnerability indices in the performance-based allocation formula cannot fully address shortcomings of the performance-based allocation system. Simulations of the PBA formula including vulnerability indices show that several SIDS receive higher allocations than under ADF 12, while allocations for SIDS with small population remain very small (Appendix 2). 6 The variation in the resource allocations between SIDS is wide generating inadequate differences in country allocations. The simulations also demonstrate that vulnerability of SIDS is fundamentally different from vulnerability of Afghanistan as the single other remaining fragile and conflict affected situations (FCAS) country among ADF grant-eligible countries. In summary, integrating vulnerability indices in the PBA formula does not generate adequate resource allocations for SIDS. 15. Experiences from IDA and the African Development Bank in exploring the integration of fragility and vulnerability indices in the PBA system suggest considerable challenges, deriving from limited data availability, complexity of the model, and high transaction costs in developing the indices (Appendix 2). 16. Small Island Developing States Premium proposed to be introduced in ADF 13 resource allocation framework. A SIDS Premium is proposed to be introduced for ADF grant-eligible SIDS under ADF 13 to replace the base allocation and provide tailored support based on the degree of vulnerability of countries. The SIDS Premium is proposed to be based on EVI. SIDS will be divided into groups based on their EVI scores. EVI scores range from 0 to 100, with a

5 United Nations. 2018. Handbook on the Least Developed Country Category: Inclusion, Graduation and Special

Support Measures Third Edition. 6 The simulations are based on the revised funding scenario for ADF 13 in section V.

5

higher score indicating higher vulnerability. Table 1 reports the methodology of classifying SIDS by their EVI scores and the proposed amounts for the SIDS Premium based on their classification. The highest group comprises scores 70–80, and countries are allocated an amount of $55 million per cycle, while the lowest group comprises scores 40–50 with an allocation of $40 million.7

Table 1: Proposed SIDS Premium for ADF 13

EVI Score Country (ADF Grant-Eligible SIDS) Premium ($ million)

70-80 Kiribati 55

60-70 Marshall Islands 50

50-60 Federated States of Micronesia, Maldives, Nauru, Solomon Islands, Tonga and Tuvalu

45

40-50 Samoaa and Vanuatu 40 ADF = Asian Development Fund, EVI = economic vulnerability index, SIDS = small island developing states.

Note: a Samoa’s score of 39.7 was rounded to 40.

Source: Asian Development Bank.

D. Conclusions 17. Introducing the SIDS Premium generates sizable allocations for all ADF grant-eligible SIDS comparable to allocations under ADF 12, while taking into account their degree of vulnerability. The allocation of the premium is proposed to be limited to the ADF grant-eligible SIDS because other ADF grant-eligible countries benefit from much larger PBAs. The overall proposed envelope for the SIDS Premium under ADF 13 will be largely guided by the overall base allocation amount for ADF grant-eligible countries under ADF 12 to ensure an adequate allocation to meet the country needs for key development programs.

IV. REVISING THE ALLOCATION FRAMEWORK FOR CONCESSIONAL ORDINARY CAPITAL RESOURCES LENDING

18. The combination of concessional lending operations with the OCR balance sheet on 1 January 2017 changed the general conditions for allocating concessional resources to eligible countries. ADF became a grant-only facility, while COL funding shifted from ADF donors to the OCR balance sheet. The OCR equity increased to about $48 billion from about $17 billion, which enabled ADB to substantially scale up overall lending since 2017. Overall COL allocations under ADF 12 increased by 43% to $13.2 billion from $9.3 billion under ADF XI.8 19. Increasing limitations of the performance-based allocation system after the combination of concessional lending operations with the OCR balance sheet. COL allocations that are entirely based on the PBA formula do not take into account overall country demand, changing country needs and greater absorptive capacity of some group B countries. This limitation of the PBA allocation system has increased in significance following the substantial scale-up of COL allocations after the combination of concessional lending operations with the OCR balance sheet. The effective commitment of higher available amounts of COL resources

7 The proposed range of the premium of $40 million - $55 million per cycle corresponds to a range of $10 million- $14

million per year. This compares to the IDA annual base allocation of around $20 million under IDA18 and IDA 19. 8 While country allocations to concessional assistance-only countries increased by 59%, country allocations to OCR

blend countries increased by 45%. ADB. 2016. ADF 12 Donors’ Report: Scaling Up for Inclusive and Sustainable Development in Asia and the Pacific. Manila.

6

argues for paying increasing attention to country demand and absorptive capacity in the allocation process. 20. Allocations based on performance and country demand. The total COL allocation for an eligible country under ADF 13 is proposed to be the sum of the allocation from a PBA-based component and the allocation from a demand-based component. Country demand for COL is measured by a multi-year average of historical annual commitments and future annual pipelines. 21. Performance- based allocation component. Country allocations based on PBA will be calculated by applying the PBA formula for eligible countries on half of the overall resource envelope for COL.9 To simplify the overall allocation framework, the soft cap will be removed from the PBA-based component. 10 The special allocation for Myanmar will be discontinued and replaced by allocations based on actual and planned commitments under the demand-based component. 22. Demand-based component. Annual country allocations for the demand-based component of the COL allocation framework will be calculated based on a 5-year time horizon as an average of 2 years’ historical commitments and 3 years’ pipeline following the work program and budget framework process.11 Calculation of a multi-year average will minimize fluctuation across annual commitments for countries. By relating country allocations to past commitments, countries’ absorptive capacity will be better taken into consideration than under the PBA-based component. Flexible response to country demand will increase absorption of available COL resources. An overall indicative amount of $13,727 million of COL from ADB’s OCR balance sheet is expected to be made available during ADF 13.

9 Countries at moderate risk of debt distress (ADF blend countries) will receive a blend of ADF grants and COL which

will be allocated separately. The grant PBA will be applied with 50% of their PBA share, and COL will be allocated based on a combination of PBA and country demand.

10 The PBA shares of group B countries under ADF 12 are reduced when allocation shares exceed the 14% threshold (or soft cap) to ensure that sufficient concessional funds remain for all eligible countries. A country with a PBA share greater than the threshold will retain half of the amount above the threshold. For example, a country with an initial PBA share of 16% would receive a 15% modified PBA share; a country with an initial PBA share of 20% would receive 17%.

11 The work program and budget framework defines the parameters and main thrusts of ADB’s operations, and provides the framework for preparation of the budget for the upcoming year.

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Figure 2: Proposed COL Allocation Framework for ADF 13 based on Performance-based

Allocation Component and Demand Component

50% 50%

23. Annual updates of country allocations will be carried out over the 4-year allocation period of ADF 13 for the PBA-based and demand-based component. For the first year of ADF 13, a 4-year country allocation will be calculated. It will be updated in the second year of the ADF 13 cycle for the remaining 3 years’ allocation, and accordingly for the remaining 2 years of ADF 13. ADF donors under ADF 13 will continue to agree on the indicative total amount of COL in the ADF 13 donor report. Updates on the overall and annual COL allocations under ADF 13 and commitment levels will be provided at the annual donor consultation meetings and the ADF 13 mid-term review.

24. COL allocations for group B countries will be prioritized in areas such as disaster risk reduction, adaptation to climate change, environmental sustainability, regional projects (regional cooperation and integration and regional public goods such as regional health security and ocean health), gender equality, social sectors, food security, and public sector management. COL allocations will be discussed and reported as part of the work program and budget framework process.

Estimated available COL resources for ADF13

Available resources for performance-based allocation (50%)

Available resources for demand-based allocation (50%)

Determining individual country allocations through performance-

based allocation formula

Total allocations for individual countries

Determining individual country allocations based on demand

(average of 2 years’ past commitments and 3 years pipeline)

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V. PROJECTED FUNDING FOR ADF 13 GRANT OPERATIONS

25. Three indicative funding scenarios for ADF 13 were proposed at the first ADF 13 Replenishment Meeting on 5-7 November 2019. Several ADF donors suggested an alternative funding scenario including a carry-over of unutilized resources under the DRF and debt distress reserve from ADF 12 to ADF 13 (currently $437 million), and a lower donor contribution than under ADF 12.12 26. Proposed funding scenario with reduced donor contributions for ADF 13. The proposed scenario with $3,303 million is presented in Table 2. It has been derived through a carry-over of $337 million and by retaining an amount of $100 million of unutilized resources under the DRF in case of disasters taking place in 2020. Any unutilized resources at the end of 2020 will be carried over to ADF 13 and added to the PBA. The proposed scenario would result in donor contributions’ amount of $2,474 million, compared with donor contributions of $2,594 million under ADF 12. The details of the financing framework will be discussed in a forthcoming paper, “ADF 13 Financing Framework Update”. 27. The overall proposed grant amount for ADF 13 is $3,303 million. A strong replenishment of ADF 13 is critical for ADB to continue supporting sustainable development in the poorest and most vulnerable countries of Asia and the Pacific in order to consolidate development gains and enhance the chances of achieving the Sustainable Development Goals by 2030. The proposed funding scenario with an overall grant amount of $3,303 million includes: (i) higher share for country allocation at 62% of total ADF 13 grants (59% under ADF 12), (ii) higher share of PBA at 34% of total ADF 13 grants (30% under ADF 12),13 (iii) full amount of SIDS Premium is allocated to ADF grant-eligible countries at high and half

amount of SIDS Premium is allocated to ADF grant-eligible countries at moderate risk of debt distress,

(iv) lower share of thematic pool at 21% of total ADF 13 grants (26% under ADF 12), (v) PSW at 2% of total ADF 13 grants, (vi) DRF with expanded scope and country coverage at 8% of total ADF 13 grants (8% under

ADF 12), and (vii) debt distress reserve at 7% of total ADF 13 grants (7% remaining amount under ADF 12).

12 For ADF 12, unutilized resources under the DRF amount to $216 million, and under the debt distress reserve to $221

million. 13 The indicative PBA allocation exceeds the joint indicative allocation for special allocation for Afghanistan and SIDS

Premium.

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Table 2: Projected ADF Funding and Indicative Allocations during ADF 13  ($ million) 

Item

ADF 12 ADF 13

Actual Allocation Proposed Scenario

Amount % Amount %

Country allocation 1,783 59% 2,048 62% Of which: Performance-Based Allocation 887 30% 1,130 34% Special Support to Afghanistan 521 17% 506 15% Base Allocation 376 13% SIDS Premium 0% 413 12% Set-asides/Thematic pool 775 26% 694 21% Pilot Private Sector Window 0% 66 2% Disaster Response Facility 225 8% 264 8% Reserve for changes in debt distress 221 7% 231 7% Total ADF Grants 3,005 100% 3,303 100%

Memorandum Items Bhutan 40 Lao PDR 138 Potential Maximum SDFP Discount Total 3,183 3,303 100%

ADF =Asian Development Fund, Lao PDR = Lao People’s Democratic Republic, SDFP = Sustainable Development Finance Policy. Source: Asian Development Bank.

VI. ISSUES FOR DONORS CONSIDERATION

28. Donors’ endorsement is sought for: (i) the proposed SIDS Premium for ADF grant-eligible SIDS under ADF 13 to replace the

base allocation, and

(ii) the proposed COL resource allocation framework,

10 Appendix 1

ASSESSMENT OF VULNERABILITY, RESILIENCE, AND FRAGILITY INDICES

1. Several vulnerability-, resilience-, and fragility-related indices are publicly available and regularly updated by international organizations. Vulnerability and fragility indices can be used in the resource allocation framework for ADF to increase resource allocations for fragile and conflict affected situation (FCAS) countries and small island developing states (SIDS). The indices are broadly categorized into three groups, namely, (i) vulnerability including economic and environmental aspects, (ii) resilience based on human capital, and (iii) fragility covering a wide range of dimensions including political and social aspects. Table A1 presents a list of selected vulnerability, resilience- and fragility-related indices and evaluates their suitability for the ADF 13 resource allocation framework.

Table A1: List of Vulnerability, Resilience and Fragility Indices

Type Index Organization Characteristic Feasibility

Vulnerability (including economic and environmental aspects)

Economic Vulnerability Index (EVI)

United Nation Committee for Development Policy (UNCDP)

- EVI is updated every three years (latest in 2018).

- EVI is composed of two sub-indices (exposure index and shock index) with eight variables.

- EVI scores are relatively stable as some of the variables do not significantly change over time.

- EVI covers all the ADF grant-eligible countries.

- EVI comprehensively reflects structural vulnerability of small island development states (SIDS).

Climate Risk Index (CRI)

Germanwatch (Germany)

- CRI is updated every year (latest in 2019).

- CRI scores are calculated based on the number of deaths and sum of losses caused by extreme weather events.

- CRI scores tend to change drastically according to the actual natural disasters.

- CRI does not cover Nauru.

- CRI is narrowly focused on natural disasters.

World Risk Index (WRI)

Bundnis Entwicklung Hilft and Ruhr University Bochum (Germany)

- WRI is updated every year (latest in 2019).

- WRI is composed of 27 indicators covering a wide range of developmental issues (poverty, infrastructure, health, education, gender, ecosystem, corruption, etc.).

- WRI does not cover Marshall Islands, Nauru and Tuvalu.

- The scope of WRI is broad and complex.

Resilience (including human capital aspect)

Human Assets Index (HAI)

UN Committee for Development Policy (UNCDP)

- HAI is updated every three years (latest in 2018).

- HAI is composed of two sub-indices (health index and education index) with five variables.

- EVI covers all the ADF grant-eligible countries.

- SIDS tend to be scored as less

Appendix 1 11

Type Index Organization Characteristic Feasibility

vulnerable by HAI.

Human Development Index (HDI)

United Nation Development Programme (UNDP)

- HDI is updated every year (latest in 2018).

- HDI reflects life expectancy, years of schooling and GNI per capita.

- HDI does not cover Nauru and Tuvalu.

- HDI is less comprehensive than HAI.

- Gross national income (GNI) per capita is already used in the PBA formula.

Multidimensional Poverty Index (MPI)

UNDP and Oxford Poverty and Human Development Initiative (OPHI)

- MPI is updated every year (latest in 2019).

- MPI reflects health, education and standard of living with ten variables.

- MPI uses micro data from household surveys.

- MPI does not cover Kiribati, Marshall Islands, Federated States of Micronesia, Nauru, Samoa, Solomon Islands, Tonga and Tuvalu.

Fragility (including a wide range of political, economic and social aspects)

Fragile States Index (FSI)

Fund for Peace (US)

- FSI is updated every year (latest in 2019).

- FSI consists of four categories of indicators (cohesion indicators, economic indicators, political indicators, and social and cross-cutting indicators).

- FSI does not cover Kiribati, Marshall Islands, Nauru, Tonga and Vanuatu.

- The indicators partly depend on experts’ qualitative analyses.

Country Indicators for Foreign Policy (CIFP)

Carleton University (Canada)

- CIFP reflects three dimensions of countries (authority, legitimacy, and capacity).

- The indicators include conflict intensity, government effectiveness, political stability, level of democracy, GDP per capita, education and life expectancy.

- The frequency of updating is uncertain.

- CIFP does not cover Marshall Islands, Nauru and Tuvalu.

Global Conflict Risk Index (GCRI)

European Commission

- GCRI uses a methodology that isolates three dimensions of conflict: the risk of confrontation, the risk of internal conflicts over government control, and the risk of internal conflict

- The frequency of updating is uncertain.

- GCRI does not cover Kiribati, Marshall Islands, Nauru,

12 Appendix 1

Type Index Organization Characteristic Feasibility

over issues apart from government power itself.

Samoa, Tonga and Vanuatu.

Global Peace Index (GPI)

Institute for Economics and Peace (Australia)

- GPI is updated every year (latest in 2019).

- GPI reflects ongoing domestic and international conflict, societal safety and security, and militarization with 23 indicators.

- GPI does not cover Kiribati, Marshall Islands, Nauru, Samoa, Tonga and Vanuatu.

State Fragility Index (SFI)

Center for Systemic Peace (US)

- SFI is updated every three years (latest in 2017).

- SFI consists of eight indicators such as state effectiveness and legitimacy in the areas of security, politics, economy, and social welfare.

- SFI does not cover Kiribati, Maldives, Marshall Islands, Federated States of Micronesia, Nauru, Samoa, Tonga and Vanuatu.

Source: Asian Development Bank.

2. Limited country coverage. One major constraint of using vulnerability and fragility indices as part of the ADF resource allocation systems is limited country coverage. Most indices in table A1 do not fully cover the ADF grant-eligible SIDS. 3. Fragility Indices. None of the indices categorized as representing countries’ fragility sufficiently cover the ADF grant-eligible SIDS. Fragility indices tend to reflect a wide range of indicators related to political, economic and social aspects as well as experts’ qualitative analyses in some cases, which increases the complexity of their methodologies. It is therefore not feasible to integrate existing fragility indices in the ADF resource allocation framework. 4. Vulnerability Indices. Among the three vulnerability indices, only the Economic Vulnerability Index (EVI) covers all the ADF grant-eligible countries. The Climate Risk Index does not cover Nauru and the World Risk Index does not cover four SIDS (Marshall Islands, Federated States of Micronesia, Nauru, and Tuvalu). The Climate Risk Index covers 182 countries and is updated every year by Germanwatch, a non-profit organization in Germany. The scores are calculated based on the number of deaths and sum of losses caused by extreme weather events. The Climate Risk Index country ranking is narrowly focused on disasters and tends to change drastically according to whether actual disasters occurred each year. The World Risk Index covers 172 countries and is updated every year. The scores are calculated based on (i) exposure to earthquakes, cyclones, floods, drought, and sea-level rise; (ii) susceptibility depending on infrastructure, food supply, and economic framework conditions; (iii) coping capacities depending on governance, healthcare, social and material security; and (iv) adaptive capacities related to coming natural events, climate change, and other challenges. The index consists of 27 indicators which makes calculation complex and prone to the issue of data collection. In summary, neither the Climate Risk Index nor World Risk Index are deemed to properly reflect the structural vulnerability of ADF grant-eligible SIDS. 5. Economic Vulnerability Index considered most suitable vulnerability index for use in ADF resource allocation framework to develop a supplementary allocation for ADF

Appendix 1 13

grant-eligible SIDS. The EVI was created by the United Nation’s Committee for Development Policy and is updated every three years (latest update in 2018). It covers 145 developing countries worldwide, including all 10 ADF grant-eligible SIDS, and measures the structural vulnerability of countries to economic and environmental shocks. The EVI, in addition to income per capita and the Human Asset Index, is one of three complementary criteria that a country must meet to be designated as a Least Developed Country. The EVI is composed of two sub-indices with eight variables in total with different weights, namely, population (1/8), remoteness from world market (1/8), merchandise export concentration (1/16), share of agriculture, forestry and fishing in GDP (1/16), share of population in low elevated costal zones (1/8), instability of exports of goods and services (1/4), victims of natural disasters (1/8), and instability of agricultural production (1/8). These factors comprehensively reflect the vulnerability of ADF grant-eligible SIDS. The EVI is considered to be the most suitable vulnerability index for use in the ADF resource allocation framework to develop a supplementary allocation for ADF grant-eligible SIDS, based on its country coverage, data availability, simplicity and comprehensiveness 6. Trends of Economic Vulnerability Index. The EVI scores are relatively stable as some of the parameters (e.g., remoteness from world market and share of population in low elevated costal zones) do not significantly change over time. This means that update of scores would not cause significant fluctuations in resource allocation from one ADF cycle to the other. Table A2 indicates trends of the EVI scores for ADF grant-recipient countries (five countries were not covered in 2012).

Table A2: Trends in the Economic Vulnerability Index

Country EVI (2018) EVI (2015) EVI (2012)

Afghanistan 39.3 35.1 38.8 Kiribati 73.7 71.5 82.0 Kyrgyz Republic 31.3 29.6 - Maldives 50.9 49.9 55.2 Marshall Islands 66.1 62.3 - Micronesia, Fed. States of 58.6 55.2 - Nauru 58.3 67.9 - Samoa 39.7 44.0 51.1 Solomon Islands 51.9 50.8 55.2 Tajikistan 35.9 36.8 - Tonga 56.0 55.5 59.6 Tuvalu 56.0 54.0 63.9 Vanuatu 47.0 47.7 46.8

Source: Asian Development Bank.

14 Appendix 2

INTEGRATING VULNERABILITY INDICES IN THE PERFORMANCE-BASED ALLOCATION FRAMEWORK

1. Vulnerability indices can be integrated in the ADF resource allocation framework by including the indices in the performance-based allocation formula. The PBA formula is augmented by a Vulnerability Index (VI). Four specifications of the VI have been developed with either EVI or a weighted average of the EVI and the Human Assets Index (HAI).1 The VI is included in the PBA formula with an exponent of 1 and 2. For each country, the country share of the allocated ADF grants (Si) is determined by the formula below, wherein CCPR denotes the

composite country performance rating, PCI denotes per capita income, POP denotes population, and VI denotes vulnerability index.

Si = CCPRi 2.00

× PCi -0.25 × POPi

0.60 × VIi

1.00 or 2.00 × C

The scaling factor, C, is a constant term where

C = 1 ÷ Σi( CCPRi 2.00

× PCi -0.25

× POPi 0.60

× VIi 1.00 or 2.00

) The following specifications of VI are applied:

Scenario (1): VI1.00

= 1.00 × EVI

Scenario (2): VI1.00

= 0.50 × EVI + 0.50 × HAI

Scenario (3): VI2.00

= 1.00 × EVI2.00

Scenario (4): VI2.00

= (0.50 × EVI + 0.50 × HAI)2.00

Scenarios 3 and 4 assign the high weight of 2 to vulnerability in the PBA formula equivalent to the weight for country performance. 2. Simulation results. Figure 1 reports simulation results for different specifications of the vulnerability index.2 Simulation results were compared to country allocations under ADF 12. Several SIDS receive higher allocations than under ADF 12 by including a vulnerability index based on EVI in the PBA formula (scenarios 1 and 3), while SIDS with small population receive substantially less allocations. Some of the SIDS with small population such as Marshall Islands, Nauru and Tuvalu have very low allocations. The variation in the resource allocations between SIDS is very wide. Afghanistan does not benefit from including a vulnerability index based on EVI. 3. Adding the HAI in the vulnerability index (scenarios 2 and 4) lowers allocations for SIDS, which have comparatively high scores of the HAI. Among SIDS and FCAS, only Afghanistan benefits from the inclusion of the HAI, receiving higher resource allocations compared with ADF 12. Integrating the HAI in the PBA formula therefore increases the allocation for Afghanistan, while lowering the allocations for SIDS.

1 The Human Assets Index (HAI) is considered to be the most appropriate index to represent DMCs’ human capital and

resilience to withstand disaster. The HAI consists of five variables that are divided into two groups, namely, health index and education index.

2 The simulation results are based on the revised funding scenario for ADF 13 in section V.

Appendix 2 15

ADF = Asian Development Fund, EVI = Economic Vulnerability Index, HAI = Human Assets Index, VI = Vulnerability Index. Source: Asian Development Bank.

4. Conclusions of simulations. The simulation results indicate that vulnerability of SIDS is fundamentally different from vulnerability of Afghanistan as the single other remaining FCAS among ADF grant-eligible countries. No vulnerability index included in the PBA formula allocates sufficient resources to both SIDS and Afghanistan compared with ADF 12. Integration of vulnerability indices into the PBA formula by itself (i) does not ensure sufficient resource allocations to all ADF grant-eligible SIDS; (ii) creates a wide range of country allocations among SIDS; and (iii) cannot replace the special support to Afghanistan. Experience of other International Financial Institutions 5. Experiences from the International Development Association (IDA) and the African Development Bank suggest the considerable difficulty of integrating fragility and vulnerability indices into the PBA formula, deriving from limited data availability, complexity of the model and high transaction costs of developing the indices. 6. The World Bank once considered an allocation approach that would link IDA’s allocations to a country’s structural vulnerability and tested modification of Country Performance Rating (CPR) by integrating the EVI and the HAI. This approach was found to be less feasible due to several issues such as reduction of performance-orientation of the PBA system, fluctuation of indices, and rather long interval of updates, among others.3 In order to address the vulnerability of small states member countries without direct inclusion of fragility and vulnerability indices in

3 World Bank. 2010. IDA’s Performance Based Allocation System: Review of Current System and Key Issues for

IDA16.

-100%

-50%

0%

+50%

+100%

+150%

+200%

+250%

Figure1: Simulated Country Allocations in comparison with ADF 12

Scenario (1): VI= EVI Scenario (2): VI=0.5*EVI+0.5*HAI

Scenario (3): VI=EVI^2 Scenario (4): VI=(0.5*EVI+0.5*HAI)^2

16 Appendix 2

the PBA formula, IDA provides these countries with exceptional treatment in terms of IDA eligibility and increased minimum base allocation, among others. 7. Similarly, the African Development Bank tested the feasibility of integrating fragility and vulnerability indices into the PBA formula in the process of the 15th replenishment of the African Development Fund. A new PBA formula was proposed by introducing Vulnerability Index (VI) and Human Needs Index (HNI). The Vulnerability Index represented different vulnerability aspects such as economy, climate change and internal violence. Likewise, the Human Needs Index reflected health, education as well as demographic pressure. The indices were built on the existing indicators such as the EVI and the HAI but customized to the African Development Fund context. This approach was found to pose an operational risk and high transaction costs due to the required data collection requirements for a large number of indicators from different information sources.4 It has therefore been proposed to maintain the basic structure of the PBA formula but make some minor modifications on discount rates and exponents of certain variables to allocate more resources to countries with higher fragility and vulnerability.

4 AfDB. 2019. ADF15 Technical Note on Introducing a Vulnerability Component in the ADF Allocation Framework.