The Future of UK Development Co-operation: Phase 1: Development Finance - International Development Committee Contents

3  Development finance challenges

22. The global policy context for development finance is changing, and the UK is actively engaged in a number of different debates on the future of development finance.[45] The aim of developing countries taking on the responsibility of funding their own services is increasingly being realised. For example countries such as Vietnam have relied less on external aid and more on other capital flows as they have grown and developed.[46] A recent World Bank report on development finance reviewed some of these key changes, and concluded that the ability to finance a post-2015 development framework depended on global development cooperation, good policies, and "credible institutions to increase the impact of scarce resources and to leverage additional resources from both domestic and foreign, public and private sources".[47] In this Chapter, we consider changes in the sources of development finance and the emergence of new financial instruments, in order to examine how DFID might best contribute to this global development cooperation, and how it can remain relevant and effective in responding to the changing needs of developing countries.

Changes in development finance

23. The nature of capital flows to developing countries and the role of development assistance are changing rapidly. As recently as the year 2000, development assistance was overwhelmingly provided by traditional bilateral and multilateral donors, but today it is being supplemented by other forms of development assistance. These other sources include non-DAC donors (such as China), climate finance funds, social impact investors,[48] philanthropists and global funds, as well as other less concessional flows.[49] Other capital flows such as foreign direct investment, portfolio bond and equity flows and remittances have increased,[50] and developing countries are increasingly able to access other non-concessional sources of finance. For example, Richard Manning referred to the issuing of bonds by African countries:

Ghana, a country which was desperately marginalised in the 1980s, famously launched a Eurobond in 2008. Other poor African countries, many of them recipients of debt cancellation and HIPC, have been doing the same in the recent past, so we are definitely in a different world.[51]

Figures a, b and c show financial flows to developing countries Figure a, 'International Capital Flows to Developing Countries, 2012(in US$ billions and as a % of total flows)[52]:

Note: FDI inflows are net of disinvestments by non-residents. Debt Inflows are debt disbursements net of repayments. Official flows include bilateral and multilateral lending and are not equivalent to ODA. Data on official capital inflows are "debt enhancing official assistance", and thus not the same as ODA, which is concessional in character with a grant element.
Figure b: International financial flows to developing countries[53]

Figure c: Trends in development assistance flows, for 2000 and 2009 (US billion)

Source: ODI, The age of choice: developing countries in the new aid landscape, 2013, R Greenhill, A Prizzon and A Rogerson

Figure d shows the declining importance of ODA to middle income countries.Figure d, Financial flows to middle income countries, % of national income

Source: World Development Indicators[54]

24. The range and impact of these new sources of finance have been evaluated in a number of research papers.[55] An ODI analysis found that recipient countries welcomed the increased choice, ownership, alignment and speed of new finance sources. But it also suggested that the increased choice of finance options open to recipients may make it more difficult for traditional donors to influence policy and that donors may need to be clearer about their own 'niche' in relation to competition from other finance providers.[56] Although aid is an increasingly small share of total capital flows into developing countries, it can still be substantial for specific countries. A recent analysis by Development Initiatives concluded that ODA remains the main international source for countries with government spending of less than $500[57] per person per year,[58] and the World Bank notes that "ODA is expected to remain a critical input to achieve the new development agenda".[59] The Development Initiatives report comments that "Aid continues to be of great significance to some of the poorest people and countries … In these countries, ODA continues to fund investments to get girls into school; increase access to treatment for HIV/AIDS, malaria and TB; provide water and sanitation; and support social protection schemes. Overall, ODA remains the largest international resource flow for 43 countries.[60]

25. Witnesses agreed that, despite the availability of new sources and types of finance, aid could still play a critical role in the coming years. Professor Stephany Griffith-Jones, of Columbia University, told us that "aid and concessional flows still have a very important role to play, even though the landscape is changing very rapidly"[61] and Jonathan Glennie that "a lot of new money is much faster money ... but may not have that focus on institution building or on social and environmental impact that has been such an important part of the last 10 years of aid effectiveness".[62] Matthew Martin, Director, Development Finance International, agreed, saying that "sometimes people exaggerate the scale of the change ... of course there is foreign investment, remittances and all the other things out there. If you actually look at the key countries DFID aid is intended to help, the key source of net financing ... is concessional flows".[63] Figure e shows the importance of ODA for the lowest income countries.Figure e; Financial flows to low income countries, % of national income

Source: World Development Indicators[64]

DFID's current approach

26. Around 87% of UK ODA is spent by DFID, with the other main UK providers of ODA being the Foreign and Commonwealth Office and the Department of Energy and Climate Change which each account for a further 3%.[65] In 2012-13 DFID spent just under half of its development budget through core contributions to multilateral organisations, around a quarter as bilateral spend through multilateral organisations, and the remainder through UK bilateral programmes.[66] DFID currently has bilateral programmes in 28 countries in Africa, Asia and the Middle East, where it provides aid via grants (general budget support, sector budget support and funding of specific projects and programmes) and technical assistance.[67]

27. DFID's Global Partnerships Department is responsible for broader international relationships and is for example developing joint programmes with emerging powers, particularly China, Brazil, India, South Africa and the Gulf.[68] DFID does not currently provide bilateral concessional loans, but the multilaterals to which it contributes use both loans and grants, as well as a range of other instruments such as equities and guarantees. DFID is also increasingly working with the private sector through bodies such as CDC and the Private Sector Infrastructure Group (PIDG) and a range of challenge funds such as the Africa Enterprise Challenge Fund and Impact Investment.

Approach of other national donors

28. In 2012, the UK was the second largest OECD DAC donor in volume terms, spending £8.7 billion on ODA. The largest provider was the USA, and other major donors were Germany, France and Japan.[69] In order to learn about the approach of other national donors, the Committee has held informal discussions with representatives from the Japan International Cooperation Agency (JICA) and Agence Francaise de Developpement (AFD, the French development bank), and received oral evidence from the German Federal Ministry for Economic Cooperation and Development and KfW Entwicklungsbank (the German development bank).


29. Japan provides the majority of its ODA as loans, but it also provides grants and technical assistance. In 2012, Japan's net ODA amounted to £6.6 billion (0.17% GNI).[70] In response to some of the changes in the development landscape, Japan has been moving towards a greater integration of its development assistance schemes,[71] and JICA was formed in its current structure in October 2008. International development policy is determined by the Japan Foreign Ministry, and also by the Finance and the Environment Ministries. JICA is an independent Government agency which supports the policy formation process and implements projects and programmes.

30. JICA has typically provided funding to the public sector, but has recently also restarted private sector financing. It provides loans and private sector investment finance through a Finance and Investment Account, which is separate from the general account used for aid. JICA can offer developing countries repayment periods of 30-40 years which would not be available on the market, and also offer repayment terms which help maintain debt sustainability. JICA's capital is mainly funded by the Government of Japan which may, when it finds necessary, make additional capital contributions to the Agency. JICA has received a Government of Japan contribution every year since 1965. JICA also raises money from the markets. Since its reorganisation in 2008, JICA has been issuing bonds to institutional investors and has recently issued bonds to the retail market.[72]


Germany's ODA in 2012 was £8.3 billion, representing 0.38% GNI.[73] OECD reports that Germany remains committed to the EU target of giving 0.7% of GNI as ODA by 2015.[74] Germany has recently negotiated a coalition treaty. There is reference to 0.7% in the coalition treaty: there is a commitment to reaching 0.7% and therefore there is a need to increase resources on an annual basis—this commitment would put Germany on a sustainable financial path to reach the 0.7%. However, there is no agreed budget at the moment. The preliminary numbers suggest there would be an additional €2 billion in aid over the next four years, but this would not be enough to reach 0.7% (but rather something below 0.6%). The German Federal Ministry for Economic Cooperation and Development sets the political framework for development cooperation, GIZ deals with technical assistance and KfW Entwicklungsbank (the KfW development bank, an integral, but small, part of KfW Bankengruppe) deals with financial cooperation.

KfW provides financing to governments, public enterprises and commercial banks engaged in microfinance and the promotion of small and medium enterprises in developing countries, and provides different instruments according to the sector, the nature of the projects and the needs of its partner countries. It provides loans close to market terms using its own resources (promotional loans); soft loans that blend KfW resources with support from the federal government's aid budget (development loans); and highly subsidised loans and grants from the federal aid budget. KfW lends mainly to the public sector, but sometimes also to the private sector, via financial intermediaries such as its DEG subsidiary.[75]

32. Germany used to provide the majority of its ODA as grants, but is now increasingly providing loans. Dorothee Fiedler, Deputy Director General at the German Federal Ministry for Economic Cooperation and Development, explained that this was because of the increasing wealth of many of its partner countries; the German Government considered that loans could be much more efficient and effective, and that it was possible to get more developing country ownership from loans.[76] Dorothee Fiedler told us that there had been a big increase in the amount of funding provided by KfW to developing countries, because of its ability to raise money from the market. She also said that developing countries came to KfW for its special expertise, not just its money, and that this technical expertise was a particular feature of a development bank, rather than a bank which just gave out grants or loans.[77] Marc Engelhardt, Director of Development and Climate, KfW Development Bank, said that a really big advantage of a development bank was its holistic assessment of projects, and the bringing together of banking and development perspectives in one institution which enabled it to share a wide range of expertise.[78]


33. In 2012, France's ODA amounted to £7.6 billion (0.46% GNI),[79] and it has reiterated its commitment to reach the 0.7% target by 2015.[80] However, according to the OECD, French ODA as % of GNI is 0.46%. At present, the commitment to spend the equivalent of 0.7% of the French GNI on ODA is not part of the national budget for 2014 which is being negotiated at present. A report of the French Court of Audit[81]published in June 2012 suggests that, based on the assumption that France's GNI will amount to €2,489 billion in 2015, an increase of €8.76 billion from current levels (2011) would be necessary between 2012-2015 to reach the 0.7% objective. This would represent an annual increase of 20% in each of the four years, which has been achieved in the past thanks to debt cancellation, but looks unlikely in the years to come. Coordination Sud[82] (the French equivalent of BOND) published a report in September 2013 highlighting that ODA allocations are 3.1% lower in the 2014 budget proposal compared to 2013. On 11 December 2013, the French Development Minister presented a legislative proposal for a law programming and guiding policy priorities of development cooperation to be debated in Parliament early 2014. The commitment to spending 0.7% of GNI on ODA is not among the priorities in this proposal and civil society has criticised the fact that this commitment is only lightly referred to in the text. Around 31% of French ODA is provided through Agence Francaise de Developpement (AFD), France's development bank, which is owned by and pays dividends to the French Government. It operates under the remit of the French Ministry of Foreign Affairs, the Ministry of Finance, and the Ministry of Overseas Territories. AFD is licensed and regulated by the French Banking Authority and conforms to national and international banking regulations. AFD's ability to raise low-cost funding from financial markets and to design innovative co-financing arrangements allows loan recipients to benefit from AFD's leverage, achieving an economic return on their investments that exceeds the cost of their debt. AFD also processes some grants on behalf of the French Ministry of Foreign Affairs, but these are relatively few. These grants are funded by the interest payments received from AFD loans. AFD currently provides very little technical assistance.

34. AFD provides sovereign loans to countries with low levels of debt that are in a position to borrow. It also provides non-sovereign loans to state-owned companies, local authorities, public establishments, NGOs and the private sector. It allocates both market-rate loans (non-concessional loans) and subsidised loans (concessional loans). The subsidised element of concessional loans is provided by the French Government. Market-rate loans provide a response to a lack of liquidity and an urgent need for credit, and are destined for countries with low levels of debt and profitable projects to finance. AFD also provides equity, guarantees and subsidies. AFD has a branch, PROPARCO, which operates private sector financing, through loans and taking equity stakes in businesses in developing countries.[83]

35. We are disappointed that neither Germany nor France appear to have backed up their stated commitments to achieve the 0.7% GNI aid target by 2015 with the necessary allocations in their forward budgets.

DFID's future strategy

36. The World Bank argues that aid has helped low-income countries to accelerate economic growth and lift people from extreme poverty, and that it will continue to be an important source of development financing for many countries. But with heavy fiscal pressures on major donors, constraints on the multilateral development banks, and a weak global recovery, the approach to financing development needs to evolve by bringing in more actors and instruments, while continuing to build on enhanced aid effectiveness.[84] DFID has indicated that it is considering a number of options for introducing new bilateral financial instruments, including lending to partner governments and enhancing private sector flows. In its written submission, it explained that:

    Lending could occur either on DFID's balance sheet or through a separate legal entity, which could be a small-sized entity or a larger independent development finance institution. All of these options could lend to multilaterals such as the World Bank who then on-lend or to countries either by co-financing multilateral loans or as stand-alone lending.[85]

DFID said that the criteria being used to assess these options were development effectiveness; administrative requirements; potential demand; ODA and IDA frameworks; and the implications for Government expenditure and borrowing.[86]

37. One of the options would be for the UK Government to establish a UK development bank (UKDB) which could provide loans and other instruments to the public sector or the private sector, or both. We consider this in more detail in the following Chapters, looking first at the needs of the public sector, then at ways of supporting the private sector, and finally at the potential for a UKDB to meet these public and private sector finance needs.

38. The growth in sources and types of development finance mean that developing countries now have more choice and can in some cases elect to opt for finance which is delivered more quickly and with less conditionality than traditional aid. However, aid is still of critical importance, especially for reaching the very poorest people, for leveraging in other resources and for helping growth in low income countries. For some other major national donors, such as Japan, Germany and France, concessional loans represent a significant part of their bilateral aid delivery. DFID must continue to evolve its strategy so that it continues to target its resources in the most effective way, including providing a combination of grant aid, loans and guarantees.

39. Development aid in the form of grants is very limited and precious and it is getting increasingly difficult to make the case for giving aid in the form of grants to MICs. We believe that DFID should also develop the capacity to distribute aid in the form of concessional and non-concessional loans either "in house" or by establishing a UK development bank. We recognise that it will take time to build the capacity to manage loan finance but the expectation, once the capacity has been established, should be that grants to MICs should only be used where no other form of finance is possible. There may also be circumstances where loan finance would be appropriate in low income countries, for example to finance infrastructure, such as power generation, which will generate a return on investment, but care should be taken not to re-burden least developed countries with unmanageable debt. We believe that grants should continue to be used for financing access to basic minimum needs in LICs like health, education, sanitation and water and where speed is of the essence, for example for emergency relief; for failed states and major conflict areas; and for global public goods which cannot be funded in other ways.

45   These include the 2nd UN Review Conference on Financing for Development expected in 2015 and the work on Financing the Rio+20 plans in June 2012 which will be taken forward by the Intergovernmental Committee of Experts on Sustainable Development Financing recently agreed by the UN General Assembly. The 2014 UN General Assembly will begin the process to bring together the discussions on post-2015 development goals and the ways to achieve these, including through financing. In addition, the Global Partnership for Effective Development Cooperation, which emerged from the 4th High Level Forum on aid effectiveness took place in Busan South Korea in 2011, will organise a high level ministerial conference in April 2014. Back

46   Towards a new generation of Aid for Trade, Dirk Willem to Velde, October 2013, International Trade Back

47   Financing for development post-2015, p ix Back

48   Social impact investments are financial investments made with the objective of generating a measurable social and environmental impact. Some may also generate a financial return. Back

49   ODI, The Age of Choice, Greenhill, Prizzon and Rogerson, March 2013 Back

50   Note on capital flows to developing countries, Dirk Willem te Velde, Annex 1 Back

51   Q 2. HIPC refers to the 39 Heavily Indebted Poor Countries which are eligible for special assistance from the International Monetary Fund and the World Bank Back

52   World Bank Financing for Development Post-2015, 2013 Back

53   Development Initiatives Investments to end poverty by 2030, 2013 Back

54   Accessed 17 December 2013, FDI = Foreign direct investment, net inflows (% of GDP), ODA = Net ODA received (% of GNI), Remittances = Personal remittances, received (% of GDP), Tax = Tax revenue (% of GDP) Back

55   Eg Development Initiatives, Investments to end poverty; ODI, Inclusive and sustainable development, September 2012; World Bank Group, Financing for Development post-2015 Back

56   ODI, The Age of Choice Back

57   On a purchasing power parity basis Back

58   Development Initiatives, Investments to End Poverty Back

59   World Bank Group, Financing for Development post-2015, p x Back

60   Development Initiatives, Investments to End Poverty, p64 Back

61   Q 27 Back

62   Q 15 Back

63   Q 27 Back

64   Accessed 17 December 2013, FDI = Foreign direct investment, net inflows (% of GDP), ODA = Net ODA received (% of GNI), Remittances = Personal remittances, received (% of GDP), Tax = Tax revenue (% of GDP), tax data for 2000 taken from 2002. Back

65   DIFD Statistics on International Development 2013, p23 Back

66   DFID Annual Report 2012-13, p112 Back

67   This was reduced from 43 countries, following the 2011 Bilateral Aid Review Back

68   DFID Global Partnerships Department, Operational Plan 2011-2015 Back

69   DIFD Statistics on International Development 2013, p27 Back

70   DFID Statistics 2013, p72 Back

71   JICA Annual Report 2012, p18 Back

72   JICA Sponsored Statement,  Back

73   DFID Statistics 2013, p72 Back

74  Back

75   Q 111 Back

76   Q 108 Back

77   Q 94 Back

78   Q 94 Back

79   DFID Statistics 2013, p72 Back

80  Back

81 Back



83   International Development Committee visit to Paris, informal meeting with CEO of AFD on 6 November 2012 Back

84   World Bank Group, Financing for development post-2105, p ix  Back

85   Ev 85 Back

86   Ibid Back

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Prepared 13 February 2014