House of Commons - Aid under Pressure - International Development Committee

Aid under Pressure - International Development Committee Contents

3 Responding to the crisis

DFID's response

24. The World Bank has identified three priority areas which it believes should be the focus of efforts to prevent the global financial crisis eroding progress made in reducing global poverty. First, "attention must be directed to protecting the poor through targeted social spending, including expanded safety nets" to support the poorest people through the crisis. Secondly, investment in infrastructure must be maintained as this "will be crucial to restoring growth following the crisis." Finally it argues for a "concerted effort […] to support the private sector especially SMEs [small and medium sized enterprises], which are essential to a resumption of growth and job creation in developing countries."[49]DFID has taken steps to address all three of these areas in its response to the impact of the recession in developing countries. We discuss each element below.

SOCIAL PROTECTION

25. The Institute of Development Studies defines social protection as "a group of policy initiatives that transfer income or assets to the poor. They protect vulnerable people against livelihood risks, and seek to enhance the social status and rights of the marginalised." These can take several different forms; for example, direct cash transfers, or in kind transfers (such as free school meals), and can be conditional either on household income or another requirement such as a child's school attendance. Social protection programmes may also concentrate on the provision of social services or social funds.[50]

26. Social protection programmes have been shown to have helped reduce poverty levels in previous economic crises. The Government of Indonesia introduced a National Safety Net Programme in 1997 after the Asian financial crisis caused poverty levels to double in a year. As a result of this programme the poverty rate reduced from 33% in 1998 to 12% in 2002. The evidence suggests that it was unlikely that the country would have recovered as quickly had it not been for this programme.[51]

27. Dr McCulloch of IDS argued that social protection policies not only provided help for the poorest but would also inject demand into the economy. This method of increasing demand for goods and services was particularly effective as it "does not leak out in the form of imports, because poor communities in Kenya are not buying iPods; they are just buying locally-produced food and locally-produced services".[52]

28. The Secretary of State told us that DFID planned to increase its bilateral expenditure on social protection by £100 million over the next two years, as part of its response to the crisis.[53] Amongst the partner countries which will benefit is Ethiopia which will receive an additional £15 million for social protection.[54] We were concerned that this additional expenditure on social safety nets would mean that spending on other essential programmes would be affected. When we put this to the Secretary of State he was clear that the funding had been found from DFID's contingency budget and unallocated resources from within bilateral programmes and that no existing programmes had been cut or reduced to date.[55]

29. While we accept that the Department needs to keep some funds in reserve to allow it to respond to unforeseen circumstances we are surprised that such a substantial increase in funding was possible from unallocated resources. Given the need for DFID to use its resources as effectively as possible we would expect DFID to have already identified spending priorities for a large proportion of that money.

30. The reallocation of £100 million within DFID's bilateral programmes to fund social protection programmes is in addition to the £200 million that the Department has pledged to the Rapid Social Response Fund, which will be hosted by the World Bank as part of its Vulnerability Fund.[56] Rachel Turner told us that in past crises:

She argued that the current reaction by multilateral development banks was "very different to the past " with the World Bank, the African Development Bank, the Asian Development Bank and the Inter-American Development Bank expected to invest a total of $12 billion in social protection,between 2009 and 2011.[58]

31. Witnesses were positive about DFID's decision to fund social protection as part of its response to the crisis. Eckhard Deutscher, Chair of the OECD Development Assistance Committee (DAC), told us that it was necessary "now more than ever" to focus on developing social safety nets in poor countries and Maciej Popowski of the European Commission believed DFID's response was "definitely in the right direction."[59]

32. Dr McCulloch suggested that DFID should use the heightened international focus on social protection programmes to increase the level of coverage offered by existing programmes in Africa. He told us that he was "really struck by the fact that social protection efforts throughout Africa are very piecemeal, many of them DFID funded". Many programmes were "lacking in comprehensive coverage in a continent which has particular need at this time for more effective social protection."[60] This view was echoed in a piece of IDS research which concluded that the "crisis can represent a window of opportunity and […] it is important to seize these moments for progressive social protection initiatives."[61] However, Dr McCulloch expressed a note of caution: the large sums for social protection from donors could "actually undermine the ability to generate domestic political demand throughout the developing world" for partner country governments to supply these services, which could result in a loss of country ownership and disenfranchise local people.[62]

33. We commend DFID's focus on funding social protection programmes which have been shown to play a vital role in protecting the poorest people in the poorest countries from the worst effects of economic crises. However, DFID must work closely with partner governments to ensure coverage of these programmes is sufficient to reach those with the greatest need.

INFRASTRUCTURE

34. Investing in infrastructure is a particularly effective policy response to the recession because it serves a dual purpose. Firstly, as the Chairman of the OECD DAC emphasised, it makes an important contribution to economic growth and lays the foundation for future growth after the recession has run its course.[63] Secondly, it lessens the immediate impact of the downturn by creating jobs. As Mr Popowski of the European Commission explained: "If we invest in infrastructure we are automatically creating ways […] of cushioning the impact of the crisis on the real economy because we would spur job creation and promote growth.[64] Dr McCulloch echoed this view and emphasised the role that such investments could play in stimulating the local economy: "we know from experience that infrastructure expenditure is a very good way of getting money into people's pockets".[65]

35. Poor infrastructure has been identified as one of the main barriers that restricts African countries' ability to trade with the rest of the world. Poor road systems are particular barriers to trade for landlocked countries which are dependent on transport links in neighbouring countries as well as their own. The Democratic Republic of Congo, which is almost 10 times the size of the UK, has just 1,400 miles of paved road and no well- maintained road which runs the length of the country.[66]

36. DFID recently announced £100 million of support for regional infrastructure and trade. This funding will be used to support the North-South Corridor initiative in Africa which aims to remove the bottlenecks that currently exist along main trading routes by speeding up border crossings, and improving railways, roads and ports across east and southern Africa.[67] The North-South Corridor is a $1.2 billion project which will link the "copper belt" of Zambia and the Democratic Republic of Congo to ports in Southern Africa and pass through eight countries: Botswana, South Africa, Zimbabwe, Zambia, Malawi, Mozambique, Tanzania and the Democratic Republic of Congo.[68] Announcing this project, Gareth Thomas, Minister for International Development and Trade, said that the investment could be worth "tens of millions of pounds a year to the African economy and generate strong investment opportunities."[69]

37. Donor investment in infrastructure not only provides developing countries with a source of employment but will also enable them to emerge from this recession with a stronger economy. We welcome DFID's decision to provide significant funds for infrastructure projects as part of its response to the downturn. The scale of the North-South Corridor project in Africa gives it huge potential to boost trade and economic development in the continent. We request the Department, in its response to this Report, to provide an update on progress with the project.

SUPPORT FOR BUSINESSES

38. A recent meeting of the World Trade Organisation (WTO) announced that the shortfall in trade credit was now $100 billion and that the cost of trade credit for developing countries had become prohibitively high.[70] Urgent action to restore trade finance liquidity was therefore identified as one of the priorities for the G20.[71] The World Bank has responded to the difficulties faced by small and medium-sized enterprises (SMEs) by setting up the Global Trade Liquidity Programme (GTLP). The Secretary of State told us that the motivation for the GTLP arose from the fact that the market in trade finance, on which 90% of global trade relies, was seen to be failing.[72] DFID plans to increase its support for SMEs through a £300 million contribution to the GTLP (to be made through CDC Group).[73]

39. This Programme is intended to help address the trade finance shortage in developing countries by making additional funds available through international banks specialising in trade finance in these regions. The GTLP is due to become operational in May. Under its first phase businesses will be assisted in Angola, Ghana, Kenya, Malawi, Mauritius, Mozambique, Nigeria, Seychelles and Zambia. DFID says that the initial sum committed could help fund between £2 billion and £3 billion of trade over the next two years, by helping small and medium firms to import and export products. The GTLP will be based on a commitment of $1 billion from IFC, a member of the World Bank Group. The IFC is seeking a further $3-4 billion from donors. It is expected to support at least $30 billion of trade over three years.[74] The Secretary of State told us that getting the GTLP up and running quickly "will make a significant difference to what would otherwise be very, very serious consequences as a result of the loss of trade finance in developing countries."[75]

40. We fully support DFID's decision to fund the Global Trade Liquidity Programme. Ensuring the availability of trade finance is an important part of supporting small and medium-sized businesses in poor countries and thereby sustaining economic development. It is vital that the aim for the Programme to be operational in May is achieved. We request that DFID, in its response to this Report, provides us with an update on the amount of funding which has been disbursed, and to which countries.

Outcomes of the G20 London Summit

41. The G20 meeting held in London on 2 April set out to provide a strong multilateral response to the downturn, including the challenges that it posed for the developing world. The main outcome of the meeting was a $1.1 trillion programme aimed at restoring credit, growth and jobs to the world economy. This included:

A trebling of resources available to the International Monetary Fund (IMF) to $750 billion, an increase of $500 billion, as well as commitments to support a new special drawing rights allocation (SDR) of $250 billion; [76]
Support for a minimum increase of $100 billion of additional lending by the Multilateral Development Banks (MDBs);
A promise to ensure $250 billion of support for trade finance;
An agreement to use the sale of part of the IMF gold reserve to fund concessional financing for the poorest countries.[77]

42. Although these announcements are welcome, significant uncertainty remains about how they will be delivered. Of the $500 billion of external resources pledged for the IMF "only a $40 billion loan from China, still not confirmed by the Chinese government, was an unknown before the summit." $200 billion consists of two $100 billion agreements already made by Japan and the EU.[78] The UK has provided $15 billion to the IMF as part of the EU contribution.[79] Another $114.5 billion has since been offered by a combination of Canada, Norway and the USA. This still leaves $145.5 billion to be found.[80]

43. The funding commitments made at the G20 London Summit are very welcome. However, uncertainty and lack of clarity remain on the detail of how the pledges will be delivered. We recommend that the UK Government maintain pressure on G20 partners to honour their commitments and on the international financial institutions to ensure that the benefits of these commitments are felt by poor countries at the earliest opportunity.

FUNDING FOR THE IMF

44. The main purpose of the IMF is to assist countries in addressing balance of payments deficits—it does not provide countries with aid. We were told by the President of the World Bank that, while the work of the IMF is important, providing additional funding to the IMF was no substitute for supporting infrastructure and social protection spending. Poor countries urgently needed this to help them through the economic downturn. Kevin Watkins, director of UNESCO's Education for All Global Monitoring Group, echoed this view: "While the IMF has a key role to play in the financial crisis […] poverty reduction is not the IMF's core business—and it doesn't do it well."[81] DFID officials agreed that "the role of the IMF for middle-income countries is where these really big numbers are", suggesting that IMF support for developing countries will be more limited.[82]

45. Other commentators have been critical about the prospect of the IMF playing an increased role in developing countries. In previous crises, including the Asian financial crisis, the IMF "imposed stringent conditions on many countries that came to it for help, forcing them to target unrealistically low inflation rates and implement […] pro-cyclical policies—spending cuts and interest rate rises that can exacerbate a downturn." Concerns have been raised that similar conditions could be imposed on developing countries seeking IMF assistance during the current downturn.[83]

46. A recent report by the Global Campaign for Education (GCE) argued that no real progress had been made in changing the conditionality attached to IMF loans, and was particularly concerned that this would impact upon developing countries' abilities to fund basic social services, especially education.[84] In the run up to the London summit, the IMF announced that changes to its concessionary lending were on track and that conditionality for low-income countries (LICs) had changed.[85] However, the GCE asserts that the changes are only structural and relate to how the money is delivered; they do not change the economic conditions countries must meet to receive support.[86] The World Bank has voiced similar concerns, arguing that its sister organisation often puts too many conditions on countries asking for help.[87] Hugh Brendenkamp, IMF Deputy Director of Strategy, Policy and Review, has denied that the IMF is preventing LICs investing in basic social services: "The IMF has called for more aid to prevent low income countries from having to cut expenditure at we go into recession."[88]

47. The Secretary of State defended the G20's decision to focus on the refinancing of the IMF, arguing that developing countries would benefit. He said that the view that refinancing the IMF would not help developing countries was a fallacy and that "the poorest people in the world would have suffered more if the financial crisis had led to the collapse of the banks". He made "no apology for the actions that were taken in the United Kingdom, in the United States and elsewhere in securing stability of the global financial architecture."[89] Mr Alexander believed that refinancing the Fund would allow it to cope with the "very significant calls" on its reserves which were expected in the coming months. This would mean that the World Bank, whose main remit is poverty reduction, would not have to use its resources for "crisis management" as it had in previous balance of payment crises when there had "simply not been adequate capital within the Fund to be able to deal with it independently".[90]

48. Rachel Turner highlighted changes to the IMF's relationship with developing countries that had come out of the London Summit. One key change is the doubling of access limits for low-income countries from 75% to 150% of their quota access levels.This would apply to both the Exogenous Shocks Facility and the IMF's Poverty Reduction and Growth Facility. Previously IMF funds which could have been made available to low-income countries had remained unused because of the "binding constraint" of those countries having reached the ceiling of permitted funding levels.[91] While this change had not yet been agreed by the IMF board, DFID was "fairly confident" that the proposals would get through.[92]

49. We were told that discussions were also under way to improve the concessionality of IMF financing. Currently IMF loans are 30% below market rate compared to the 60% discount offered by the World Bank's International Development Association.[93] This increase in the concessionality of IMF lending is to be partially financed by the sale of a proportion of the IMF's gold reserves. However, DFID was unable to tell us how much income was expected to be raised from this sale as this was a decision that the IMF board was yet to take. "It is quite a complicated equation. There is a set of options that have been worked up for the board and decisions will be taken. We do not have the answer yet".[94]

50. We agree with the Secretary of State that it was in everyone's interest for the IMF to be recapitalised. But this, in itself, is not enough to support developing countries through the downturn. The UK needs to continue to engage with the IMF to ensure that this additional money is rapidly made available to poor countries which need it. Increasing access limits is an important first step. DFID must also ensure that the conditions attached to IMF loans are reduced and that they are consistent with the aim of reducing poverty and promoting growth in the world's poorest countries. The sale of IMF gold reserves seems a sensible way to increase the concessionality of the rate at which IMF loans are made. We request that DFID, in response to this Report, provides us with more details on progress with the sale.

FUNDING FOR THE MULTILATERAL DEVELOPMENT BANKS

51. The headline figure of a $100 billion increase in lending by the multilateral development banks (MDBs) sounds impressive. The MDBs had planned to make loans worth $200 billion over the next five years: this additional lending therefore represents a substantial and welcome increase. However when we questioned DFID about these increases we discovered that they were being achieved without any additional commitment of resources by donor governments. This is because "the additional £100 billion is made up of the multilateral development banks doing more with their existing balance sheets."[95] An additional $60 billion of capacity has been found on the World Bank balance sheet, with the balance coming from the regional development banks.[96]

52. The Secretary of State assured us that the MDBs were not over-stretching their resources and that nothing was being done that would compromise the credit-worthiness of the Banks.[97] This suggested to us that the Banks must have been over-cautious in the past. Mr Alexander agreed with this assessment:

He believed that now was the time for the World Bank in particular to step in and use the strength of its existing reserves to provide the resources which developing countries need.[99]

53. We agree that the multilateral development banks, and particularly the World Bank, should make the most effective use of the funds they already have on their balance sheets to maximise poverty reduction outcomes. At a time when other donors are having to take hard decisions on spending, it is clearly welcome that the Banks can increase their lending by $100 billion. DFID has pressed for this and we are pleased that it has won the argument. It should now maintain its engagement with the Banks to ensure funds are disbursed rapidly to poor countries most affected by the downturn.

REFORM OF THE INTERNATIONAL FINANCIAL INSTITUTIONS

54. There was a high degree of consensus between DFID and commentators before the summit on the need for the G20 negotiations to lead to further reform of the international financial institutions (IFIs), particularly the World Bank and the IMF.[100] They need reform both to improve the speed and level of funding, and to provide developing countries with a greater say in the institutions' internal decision-making processes. The Secretary of State emphasised that the World Bank needed to "make more funding available more quickly".[101] This concern was echoed by Dr McCulloch who told us that a report by the Brookings Institute had found that:

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55. Dr Gottschalk, a research fellow at IDS, gave us an example of the delays which occur in disbursal of funds. The IMF's Exogenous Shocks Facility (ESF) was set up in 2005, but did not deliver its first loans until December 2008 when funding was made available to help Malawi cope with the effect of food and fertiliser price rises and to assist the Kyrgyz Republic to deal with commodity price shocks. Dr Gottschalk described these loans as being "too few" and arriving "too late" and argued that they were still being used to address past shocks while a new crisis was happening.[103]

56. Some progress has already been made on this issue. The World Bank has created a Fast Track Facility to speed access to $2 billion of the $42 billion made available to the poorest countries following the 15th replenishment of the International Development Association.[104] The Secretary of State told us back in January that the Bank had already improved the speed with which it responded to need: "if you look at the Bank's response to the global food crisis last year, it acted with urgency uncharacteristic of the institution in the past."[105]

57. We are glad that the World Bank is becoming a more agile institution which can respond more rapidly to the needs of developing countries. However, much progress remains to be made by the international financial institutions (IFIs) to ensure that the gap between approving funds and disbursing them is as short as possible. DFID has played a leading role to date in pushing for these changes and it is the largest contributor to the World Bank's International Development Association. It is entitled to continue to press the IFIs to improve their performance in this regard.

58. The second area where there was general agreement on the need for reform of the IFIs was on their governance, and particularly the level of involvement of developing countries in decision-making processes. At the last Autumn Meetings of the Bank and the IMF in 2008, agreement was reached on the establishment of a merit-based process for the selection of the President of the World Bank and the Managing Director the IMF, which have previously been US and European appointees respectively.[106] The World Bank Governors also agreed to increase the voting share of developing countries to 44% and to create an additional chair to represent Sub-Saharan Africa on the board.[107]

59. Witnesses were unanimous in their belief that these reforms, although welcome, were far from sufficient. Maciej Popowski of the EC told us that an additional African seat on the World Bank board would "not do the trick. It is a good start but we need to go further than that."[108] Eckhard Deutscher of the OECD DAC described the decision as "more [of] a symbolic step."[109] He argued for much more radical change and quoted Horst Koehler, a former director of the IMF, who suggested that European countries should consider being represented by one chair. "The Europeans, without losing their voice and influence, should have a look at how we can have a more efficient governance structure in both institutions".[110]

60. Mr Deutscher emphasised that the real issue which needed to be addressed was the allocation of shares within the Bank and the Fund, which determine how much weight a country carried in the voting process.[111] The recent Manuel Report[112] on IMF reform reiterated the importance of accelerating the process of reforming the quota system to increase the voice of developing countries in decision-making.[113] As Dr McCulloch highlighted, this will be a difficult issue to resolve:

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61. Dr McCulloch also stressed the importance of decentralising World Bank staff to ensure that they spent more time engaging with officials and civil society in the country in which they operate. He said that, while some progress had been made, much more could be done. He advocated changing the Bank's internal incentive and reward mechanisms to encourage staff to engage more effectively with developing countries.[115]

62. The World Bank recently announced the membership of the Zedillo Commission,[116] which will review its internal governance structure. Douglas Alexander said that the reform package which this Commission produces must address the issues of voting rights, decentralisation and the relationship between the Bank's shareholders and managers.[117]

63. The G20 communiqué acknowledged the need to reform the IFIs but the specific commitments made are simply to implement reforms already agreed in October 2008 and to hold future meetings on reforms in 2010 and 2011.[118] Oxfam and ActionAid have argued that it was a mistake to make such large increases in the resources of the IFIs, especially the IMF, before governance reforms had been implemented.[119] Mr Boutros-Ghali, who chairs the IMF's steering committee, has warned that governments are already showing "reluctance" to follow through on promises they made at the G20 to reform the IMF.[120]

64. As we said in our 2008 report on DFID and the World Bank, "adequate representation of developing countries in World Bank decision-making is not only a question of fairness, it is one of effectiveness: greater ownership by developing countries will lead to more effective Bank programmes." We emphasised the strong role which we believed the UK should play in pressing for reform.[121] The Secretary of State stressed that the UK remained committed to this:

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65. If developing countries are going to be properly represented in decisions on how the global community responds to the current economic crisis, reform of the international financial institutions (IFIs) needs to take place without further delay. The UK Government clearly understands the need for reform and we accept that it is not prepared simply to "write a cheque and walk away". But the timescale set out at the London summit, with no new reforms to be agreed, let alone implemented, until next year at the earliest, fails to respond to the urgent need. We reiterate our view that DFID, as one of the highest donors to the World Bank, must continue to use its leverage at every opportunity to press for swifter reform of the IFIs, particularly in relation to the representation of developing countries on the World Bank board.

Vulnerability Fund

66. Many hoped that the G20 summit would result in additional funding pledges to meet the specific difficulties that the recession poses for developing countries. There has been no shortage of ideas for how this could be done. Ban Ki-moon, the UN Secretary-General, called on the G20 to announce a $1,000 billion stimulus package for developing countries threatened by the global financial crisis.[123] Another suggestion was that, rather than set an absolute amount of money that should be raised to support developing countries, a proportion of each national and international stimulus package should be used to support developing countries. President Zoellick has recommended that each developed country allocate 0.7% of its stimulus package to the World Bank's Vulnerability Fund.[124] (This figure was chosen because it is the same as the percentage of GNI which donor countries have pledged to provide in official development assistance by 2015.) According to the G20 communiqué, the total global stimulus package was worth $5 trillion. Had 0.7% of this amount been pledged to the Vulnerability Fund this would have raised an additional $35 billion for developing countries. However, the Secretary of State told us that this proposal did not "find favour" at the London summit.[125]

67. The Vulnerability Fund is an umbrella fund that channels resources through the Bank, the UN and other development banks to help countries which do not have sufficient resources to cope with the crisis. Assistance will be provided in the Bank's three priority areas described above: social safety net programmes; infrastructure projects; and the Global Trade Liquidity Programme.

68. We asked the Secretary of State whether DFID regarded the commitments it has made to these funds as the UK's response to the World Bank President's call for 0.7% of stimulus packages to be devoted to the Vulnerability Fund. We did not get a direct response to the this question. Mr Alexander told us that he did not think that Mr Zoellick's suggestion was "the most effective response the G20 could have taken".[126] He argued that the proposal:

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He also expressed concern that having two 0.7% figures could dilute the clarity around the longstanding commitment made by developed countries to allocate 0.7% of Gross National Income (GNI) to poor countries by 2015.[128] In the next chapter we shall review the progress that donors have made towards reaching this target.

69. We welcome the creation of the World Bank's Vulnerability Fund—developing countries need large and dedicated sums to support them through the downturn. We do, however, agree with the Secretary of State that setting a target of dedicating 0.7% of stimulus packages to this new Fund could cause confusion and undermine international resolve to achieve the long-standing and much more ambitious commitment to allocate 0.7% of Gross National Income to official development assistance by 2015. Nevertheless, we believe that the premise which underlies the World Bank President's proposal is valid: if rich countries can find substantial sums to boost their own economies, they should recognise the pressing need in poor countries and identify dedicated sums, additional to existing pledges, to assist them. We invite the Secretary of State, in response to this Report, to indicate how the UK is responding to the World Bank President's proposal.

49 World Bank, Swimming against the tide, March 2009, p 1 Back

50 Davies, M. and McGregor J.A., "Social Protection Responses to the Financial Crisis", IDS In Focus Policy Briefing 7.4, March 2009 Back

51 Davies, M. and McGregor J.A., "Social Protection Responses to the Financial Crisis", IDS In Focus Policy Briefing 7.4, March 2009 Back

52 Q 107 [Dr McCulloch] Back

53 Q 247 Back

54 Ev 84 Back

55 Qq 247-248 Back

56 "Douglas Alexander pledges £200 million for rapid response global safety net", DFID Press Release, 15 March 2009 Back

57 Q 248 [Ms Turner] Back

58 Q 248 [Ms Turner] Back

59 Q 185 and Q 213 Back

60 Q 89 Back