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).
JAPAN
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]
GERMANY31.
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]
FRANCE
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, http://www.jica.go.jp/english/ir/financial/pdf/articles_120405.pdf
Back
73
DFID Statistics 2013, p72 Back
74
www.oecd.org/dac Back
75
Q 111 Back
76
Q 108 Back
77
Q 94 Back
78
Q 94 Back
79
DFID Statistics 2013, p72 Back
80
www.oecd.org/dac/france.htm Back
81
http://www.afd.fr/webdav/site/afd/shared/L_AFD/L_AFD_s_engage/documents/rapport_public_politique_francaise_aide_publique_au_developpement.pdf Back
82
http://www.coordinationsud.org/wp-content/uploads/SUDLOI_2013_WEB2.pdf
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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