World Bank Anticorruption Drive Blunted as China Threatens to Halt Loans

World Bank president Paul Wolfowitz's war to reform the world's most important antipoverty institution faces a new and potentially crippling challenge — even while the former No. 2 man at the Pentagon is declaring victory.

The claim of triumph came last week when the bank's 24-member board of directors embraced a watered-down version of Wolfowitz's strategy to link lending by the world's foremost development institution to a country’s governance and corruption record.

But even before that vote was taken, the bank had received a warning from China, the agency’s second-biggest customer, that it might halt future borrowings if Wolfowitz doesn’t rein in its anticorruption investigative practices.

Making loans to developing countries is central to the bank’s very reason for existence — so the threat to quit borrowing is a blow at its mission, and to the job security of some 26,000 World Bank bureaucrats, staffers and consultants around the world.

A spokesman for the bank vehemently denied that China, which has more than $21 billion in outstanding World Bank loans and development credits, has made such a threat. But a copy of an internal bank e-mail referring to the possibility was obtained by FOX News.

FOX News has also learned that a team of World Bank officials has been secretly dispatched to Beijing to begin negotiations Monday with Chinese officials to head off the crisis. The e-mail floats the idea of creating a “mutually acceptable framework” with China that could amount to a separate side deal as part of that effort.

“MOF [China’s Ministry of Finance ] is very concerned,” warns the March 12 e-mail — written by the bank’s China manager, Hsiao-Yun Elaine Sun, and dispatched to 24 staffers in Washington and Asia.

“They foresee potential disagreements as to the scope, level and approach of the bank’s involvement on specific [corruption] cases," she writes. "… Our MOF counterpart is so worried and is considering to [sic] suspend the lending program discussions next year. … MOF is talking about not adding new projects to the pipeline in order to avoid getting into a confrontational situation with the bank.”

Click here to read the internal bank e-mail.

Click here to view a key that identifies the acronyms and staffers in the e-mail.

In the internal e-mail, Chinese officials complain that the bank “may have gone beyond its mandate” in the “sanctions” component of Wolfowitz’s anticorruption strategy — essentially, in how it goes about probing development projects and blacklisting companies or individuals that have been found by the bank to be corrupt.

While the memo doesn’t spell out what the government is upset about, the largest percentage (24 percent) of the bank’s hundreds of pending corruption cases are now focused on its East Asia-Pacific region, which includes China. And according to Transparency International, a private anti-corruption reform group, India and China lead its rankings of the world’s top nations where bribery is concerned.

FOX News has further learned that two more Asian countries have echoed the Chinese threat, raising the question of whether Wolfowitz’s anti-graft strategy — now entering its fourth revision — will be diluted even further before it goes back to the board in April.

Wolfowitz, who moved from the Pentagon to the bank in 2005, has been silent about the latest crisis. Last week he hailed unanimous approval by his board of the latest version of his anticorruption strategy as a step forward for the goals of the bank, which doles out roughly $20 billion annually for 2,000 projects in poor and developing nations.

But in reality, the Bush administration’s appointee caved in on several key clauses in the plan after suffering a massive backlash against his.

The rebellion against Wolfowitz is led by some of the bank’s biggest borrowers — including China, India, Indonesia and Mexico, which have received a total of $68 billion in outstanding bank loans and development credits. (India, with about $29 billion outstanding, is the Bank’s biggest customer.) Some of those governments recently warned the bank’s executive to tone down any anticorruption strategy that would intrude in their country’s internal affairs.

The confrontations come at a particularly vulnerable time for Wolfowitz, who earlier this month kicked off a yearlong drive to get donors to replenish the bank’s coffers by as much as $25 billion, a fundraising process that occurs every three years.

He is appealing to governments that have been critical of his tenure — as well as his anticorruption scheme — not to let it influence their financial support.

But clearly, big borrowers from the bank sense the institution’s vulnerability. They are aided in their aggressive response by a new factor in development aid: the private sector.

In a globalized economy, where they have reaped huge rewards for their industrialization — China alone has foreign currency reserves of more than $1 trillion —- the strongest of developing nations can increasingly obtain funds from private sector lenders who impose fewer conditions-and ask fewer questions — than the World Bank.

So awash is the world in private capital that the bank has even had to cut its loan rates to compete.

“The bank is making a huge effort to compete with the markets by lowering its fees to the point of losing money,” said Adam Lerrick, an economist with Carnegie Mellon University. An analysis conducted by Lerrick for the American Enterprise Institute shows the bank loses between $100 million and $500 million per year on its loans — though accounting maneuvers paint a rosier picture of the financials.

“The bank is desperate to keep its best clients,” Lerrick said. “Its status and power are at stake.”

China, for example, could easily repay its billions of dollars of outstanding loans tomorrow, Lerrick said. But the terms of borrowing have become so cushy — on some of those loans, for example, Britain even pays all the interest — that Lerrick said China “is happy to take the subsidy.”

The anticorruption battle between Wolfowitz and his board began soon after he assumed the bank’s presidency 21 months ago — and made a dramatic gesture. Wolfowitz temporarily halted approximately $1 billion in loans to a half-dozen governments (including Bangladesh, Congo, India and Kenya) as an indication of his seriousness at the anti-graft issue.

Wolfowitz’s opponents immediately complained that the bank’s prime mandate — helping the poor — would suffer from the emphasis on corruption-fighting. Moreover, even some of his allies in principle objected to the bare-knuckle tactics.

The fury boiled over in Singapore last September, during the bank’s annual meeting, when a British government official launched a rare public attack of Wolfowitz, followed by a temporary halt of U.K. funding to the bank. In a compromise measure, the board won the power to oversee and implement the president’s anticorruption strategy.

But under World Bank rules Wolfowitz still kept another presidential power, to bring any and all loans to the board for approval — or not to. The result: He still has power to pursue some anticorruption sanctions even if the board objects. The president and the board have been fighting behind closed doors ever since, even as Wolfowitz declared that both sides were actually united on their goals.

Under the latest compromise, the bank will remain engaged with even the most corrupt of its borrowers, and Wolfowitz has agreed that the bank will no longer halt funding to corrupt governments without seeking the “support” of the board — whose membership is heavily made up of borrowing countries.

Moreover, Wolfowitz has tempered one of his other controversial measures — an attempt to bypass corrupt regimes by developing relations with what he calls “champions of reform” — such as media, nongovernmental organizations (NGOs), national parliaments and the private sector.

That proposal in particular drew wrath from China, where the government is especially sensitive about maintaining its monopoly on power. The bank has now agreed not to deal with any such groups and institutions if the central government of a country objects — essentially undercutting the idea.

But buried deep inside the newly approved anticorruption paper is still a commitment by the bank to be more transparent and disclose more information to the public.

The global pushback against Wolfowitz was evident in a series of “consultations” on its anticorruption strategy that the bank just completed in 47 nations — the largest opinion-outreach program in the bank’s history.

More than 3,200 people participated in these sessions that ran from November 2006 to February 2007. Many of the responses came from national administrations, ministries and parliaments in the world’s most corrupt and authoritarian capitals. And much of the response was negative, and sometimes specifically directed against Wolfowitz himself.

Click here for a summary of the feedback reports and Wolfowitz's frustration.

Holding the global consultations was itself part of an effort by Wolfowitz to appease his board members, many of whom were angry when he temporarily blocked that $1 billion in loans.

In a speech in Belgium on March 14, Wolfowitz mentioned no opposition to the bank when reciting the “major messages” he learned from the consultations. But a detailed analysis by FOX News of the dozens of consultation reports, as well as interviews with bank insiders, reveals antagonism and vitriol from all continents aimed at the bank.

Some of the rhetoric is overwrought and fueled by self-interest — generally, the more corrupt a country’s reputation, the louder the complaints — but many of the criticisms also strike home.

Among 35 developing countries in the survey, nearly half the governments complain that the bank itself is failing to be transparent and communicative about its projects, policies and dealings.

Officials from eight governments — Burkina, Cambodia, China, El Salvador, Rwanda, Lao PDR, Mexico and Morocco — complain that the bank itself has governance problems, is mismanaged in the field or is engaged in practices that contribute to corruption.

“While the World Bank, as the world’s largest multilateral development institution, is facing the daunting task of improving its own governance,” said Chinese government officials back in January, “is it suitable for it to judge measurement of the level of governance of member countries?”

The bank should “not adopt a confrontational approach” with governments, warned Egyptian officials. Do not “moralize and stigmatize” developing countries, fretted the French.

“How can the World Bank talk about governance when its President broke international legality with the Iraq war?” exclaimed government officials in Mexico. “The World Bank needs to democratize its relationship with countries.”

One recurring theme in the reports is that the bank lacks any solid metrics for measuring a country’s governance and corruption. In fact, some governments argue there’s not even clear proof that less corruption and better governance means less poverty and higher economic growth.

“Cambodia has been growing at around 7 percent to 8 percent per annum in the past 10 years,” boasted that government’s officials. “While the bank is making the case that good governance and growth are interlinked, this seems to go against the Cambodia story. … The theory must be flawed or the [Cambodia’s low good-governance] ratings are baseless.”

Amid the criticism, there was some praise.

“The private sector was very encouraged when the Bank took firm action on corruption in its projects in Cambodia,” said Cambodian business leaders. “Before that, they have [sic] given up hope that anyone in this country cared enough to take any action against corruption, and that corruption would ever decline.”

But caring is one thing, while replenishing the World Bank coffers — and keeping major customers like China from abandoning the ship — is the challenge that looms right now.