4 Lending to the public sector
Potential role for UK bilateral
40. In this Chapter we consider the
potential advantages and drawbacks of DFID providing concessional
loans to partner governments. The International Development Act
2002 gives DFID the power to provide loansa power which
the UK Government used before the 1980s debt crisisbut
the vast majority of UK bilateral ODA is currently provided in
grant form. According
to a recent analysis by Development Initiatives, only a small
number of donors disburse significant amounts of bilateral ODA
loans, with 90% of these in 2011 coming from Japan, France and
Germany, and Japan's loans being more concessional on average
than those of France or Germany.
OECD DAC regulations stipulate that "to qualify as ODA, a
loan must include a 25% "grant element", in comparison
with a loan of similar nominal amount and duration carrying a
10% interest rate". The term 'concessional loan' is often
used more broadly to refer to loans which have preferential terms
such as a lower interest rate and/or, a longer or more flexible
repayment term, and to loans for projects with higher risks which
would not attract market rate loans.
POTENTIAL ADVANTAGES OF CONCESSIONAL
41. Several witnesses said that loans
had potential advantages, provided that they were carefully and
There are many large public sector projects, particularly infrastructure
projects in Africa, which require long-term financing, potentially
in politically unstable countries, which is often not available,
or affordable, through the market.
A key benefit of concessional loans is the ability to mobilise
large levels of upfront financial resources, with affordable terms
and conditions, for these projects.
Matthew Martin told us that many recipient countries were already
using concessional loans and were also being pushed to fund infrastructure
on much more expensive loans, such as borrowing on bond markets
and doing off-budget PFI deals in an extremely high cost way.
He added that the alternative of having lower cost concessional
loans would probably be very welcome to them, and suggested that
loans should be focussed on high-return projects, public-sector
projects which had a high impact on growth and development, and
where there was currently a real funding gap.
42. Other arguments offered in favour
of loans are that they can help recipient countries improve their
debt management capabilities; they can strengthen partnership
and cooperation; they offer flexibility to meet specific project
needs; and they can provide a way of offering a larger volume
of funding and over longer term periods.
POTENTIAL DRAWBACKS OF CONCESSIONAL
43. A key drawback of loans is the risk
that they can lead to an accumulation of debt which, if not managed
well, can threaten the future stability of vulnerable economies.
Concessional loans can however help countries reduce their exposure
to indebtedness by providing an alternative to riskier and more
expensive loans. The TUC pointed out that an accumulation of debt
could threaten the stability of vulnerable economies, but said
that it had no objections to the setting up of a separate financial
institution for concessional development finance if the new institution
were to provide additional finance for development. However it
also argued that concessional finance could be provided more effectively
by other existing financial institutions.
Peter Chowla, Coordinator, Bretton Woods Project, said that public-sector
concessional loans "need to be carefully and strategically
used for different kinds of things because of the debt-creating
nature of them, the governance arrangements over how they are
controlled, and potentially the purposes and strings that might
be tied to them".
Richard Manning was of a similar view, saying that "To me,
a critical issue is the proper use of these funds and whether
we have a good system internationally for encouraging debt-creating
flows to be used in a sustainable manner."
Investing in large public and private sector projects is not risk
free: there are, sadly, many examples of poor use of aid in past
years on private investments and large public sector infrastructure
projects which failed to deliver long-term development benefits
commensurate with their cost, but nevertheless left the countries
concerned with high levels of development debt, which in the case
of many least developed countries was eventually written off by
44. Several witnesses mentioned complications
with regard to the calculation of the ODA element of loans. Loan
repayments count as negative ODA and so DFID would need to forecast
these, as well as tracking new grants and loans, in order to monitor
its total annual ODA contribution. Some experts have questioned
whether the OECD DAC definition, requiring concessional loans
to include a grant element of at least 25%, is applied sufficiently
rigorously, and have suggested that this issue should be addressed
in the ODA definition review being undertaken by the DAC Expert
Reference Group on External Financing. Some question the current
rule where countries which borrow at market rates in developed
countries and on-lend to developing countries with a mark-up but
below ODA rates, can count that finance as ODA. The TUC stated
that "There is growing criticism of current methods of the
degree of concessionality - grant element - of loans taken out
by some developing countries from developed nations including
France and Japan. In fact, the methods used by DAC tend to inflate
the grant element significantly."
Richard Manning agreed, saying that "some countries are counting
flows that are not really concessional because of how the OECD
has chosen to [define ODA]".
Another issue raised by witnesses was the difficulty of tracking
the development outcomes of loans. For example, the UK Aid Network
and Bond maintain that any increase in the use of loans must be
assessed against the risks which include "lack of transparency,
lack of evidence of impact or very long evidence chains".
45. Diana Noble, Chief Executive Officer,
CDC, cautioned against any rapid change of focus for DFID, saying
that "It really takes time to scale up teams and strategies.
The history of CDC shows that the biggest disasters happened when
CDC rushed into a market too quickly, without really understanding
what worked at small scale and before accelerating investment
over time. One of the big challenges will be to resist the temptation
to give a new team a big pot of money and incentivise them to
spend it quickly."
Owen Barder argued against any major change of approach for DFID,
saying that it should continue to focus on providing grants to
the very poorest:
We have learned lessons about how
to deliver aid effectively over the last 50 years. That means
we should continue to do that, and not follow the new donors into
less effective ways of giving aid. The fact that there are more
people giving hard and concessional loans should focus us on the
areas where aid can make most difference in grant form. I think
we should resist the tendency to be pulled into doing more of
what everybody else is doing, because if aid does not focus on
the very poorest, most marginalised people, who will?
46. The Secretary of State agreed that
there was a need for greater clarity of the OECD DAC definition
of concessional loans, and also for the accounting of other instruments
such as guarantees.
However, she expressed reservations about the option of UK bilateral
loans in the immediate future saying that:
We do not have any plans to do any
concessional loans directly to governments bilaterally. Our sense
is that a more sensible route is to work with multilateral agencies,
which often have the scale and reach, and can pull in not only
other donor investment ... but also the private sector.
The Secretary of State suggested that
a multilateral approach was particularly appropriate for many
of the infrastructure projects in Africa because "these are
very big projects that no donor country could finance on its own
or would want to finance on its own".
However, she indicated that DFID might consider providing bilateral
loans on a case-by-case basis, and said that "there is a
range of different mechanisms we can use in order to carry out
investment. It is about finding the right one for the project".
47. There are many large public sector
projects in the developing world which require finance. Concessional
loans are one way of supporting such projects which have potential
economic benefits for developing countries. They can offer benefits
to donors in terms of recycling finance and leveraging additional
finance; and to recipients in terms of offering a less expensive
option to market loans. For concessional loans to be effective,
donors need to have the appropriate skills and expertise to ensure
that loan finance works properly and is used appropriately, so
that projects are fully implemented and achieve the desired development
impact; that the debt sustainability of the recipient country
is not threatened; and that the loan is repaid.
48. The Secretary of State told us
that DFID would continue to provide concessional loans where necessary
through multilaterals, but that it had no immediate plans to start
offering bilateral concessional loans. She also said that DFID
might consider providing bilateral loans on a case by case basis.
This ambiguity could be confusing.
49. We believe that there is a strong
case for providing concessional loans, especially to lower Middle
Income Countries. For example, DFID is working with the Indian
Government on a programme to support the transition from a grant
aid based relationship to one of mutual cooperation on trade and
economic development. We believe that DFID should consider
the scope for providing loans to regional governments within India
as part of this transition programme, in order to support public
sector projects in those regions which continue to have high levels
of extreme poverty. This could provide a model for the transition
arrangements for other middle income countries.
50. We recommend that DFID sets
out criteria which it can use to judge whether it still has the
most appropriate multilateral and bilateral instruments. Given
the rapidly changing context, it should actively consider introducing
new finance instruments, or it will risk reducing its effectiveness.
We recommend that DFID includes an assessment of the following
issues in its finance strategy:
· Is there a demand for
bilateral concessional loans for public sector projects, and if
so, from which countries and sectors?
· What additional skills
and expertise would DFID need to provide and manage bilateral
loans? What additional processes would it need to introduce?
· What are the relative
merits of providing loans through multilaterals, and bilaterally?
In what circumstances and for what projects would DFID consider
providing bilateral loans?
87 Ev 88 Back
Ev w48 Back
Eg Ev 92, Ev w10, Ev w5 Back
Ev w 48 Back
Ev 114 and Q29 Back
Q 30 Back
Note on development banks, Dirk Willem te Velde, Annex 2 Back
Ev w1 Back
Q 28 Back
Q 2 Back
Ev w1 Back
Q 20 Back
Ev w10 Back
Q 177 Back
Q 42 Back
Q 231 Back
Q 235 Back
Q 236 Back
Q 246 Back