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The Inter-American Development Bank (IADB) has approved the inclusion of a local currency conversion clause for pending disbursements of a US$300mn loan to Mexico to support decentralisation and strengthen state and municipal governments.

This is the first time the IADB offers such an option in a loan. Recent research suggests that by lending in local currency multilateral institutions can help borrowing countries avoid exposure to currency fluctuations and foster the development of financial markets. Lessons learned from this experience may shape future IADB operations.

“This pioneering instrument is being watched closely by many Latin American and Caribbean countries that view it as a potential tool to expand and deepen their own capital markets,” IADB president Enrique Iglesias says.

The local currency conversion clause will be added to a loan approved in 2001for the first phase of Mexico’s Fortem programme. This nine-year initiative supports decentralisation by helping states and municipalities modernise their administration and improve their financial standing.

As an incentive for Mexican sub-national governments to undertake reforms and adopt best practices such as transparency in budgeting and spending, the programme offers financing for investments in infrastructure and social projects.

The option will allow the IADB to make disbursements in Mexican pesos to the Banobras federal development bank. In turn, Banobras will be able to offer sub-national governments long-term, fixed-rate loans in local currency.
Banobras expects that the state of Jalisco, a committed participant in Fortem, will be the first beneficiary of the currency conversion clause. The state has used the decentralisation programme to strengthen its administration practices such as budgeting, investment planning, accounting and transparency.

Through its commitment to Fortem Jalisco has improved its management and achieved a solid financial performance, obtaining higher credit ratings and setting an example for other states.