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

Conclusions and recommendations

1.  We were surprised to see a huge fall in the percentage of UK bilateral ODA spending on Low Income Countries. We note DFID's explanation that the main reason is the graduation of countries to middle income status. Nevertheless, we recommend that DFID maintain spending on Low Income Countries as its priority. We further recommend that DFID review its programmes in all MICs to examine the scope for reallocating bilateral aid from MICs to LICs and to set a timetable for doing so. (Paragraph 7)

2.  There has been huge progress in developing countries. The number of people living in extreme poverty since 1990 has halved, and the prospect of ending extreme poverty by 2030 is within reach. Aid is still of critical importance, especially for reaching the very poorest people in Low Income Countries and we believe that they should remain the priority for UK aid. Aid programmes can help to build mutually beneficial trade and economic cooperation relationships with emerging economies and we believe that a stronger emphasis on economic development can be fully consistent with poverty reduction. As a first step, we recommend that DFID work with the OECD DAC to review, update and clarify the ODA definitions. (Paragraph 18)

3.  Members of the Committee, during visits to developing countries, have observed repeatedly the enormous inequalities in income, health, education and life prospects for the people in developing countries compared to those in richer countries like the UK and, frequently also, the gross inequality between richer and poorer people within developing countries. The High Level Panel drew attention to the continuing challenge of addressing inequality and rightly emphasises the maxim "Leave No One Behind". We recommend that DFID should set out in its response to this report what steps it intends to take to assist in the reduction of inequality globally and within the developing countries in which it has bilateral programmes. (Paragraph 19)

4.  We recommend that, in general, Middle Income Countries should graduate from aid, but in a controlled manner which takes account of needs and resources. During the transition period, we recommend that aid programmes make more use of technical assistance, support to NGOs, and loans, as discussed later in this Report. Meeting the needs of the poorest in Low Income Countries should remain our priority, but supporting transition in Middle Income Countries, and financing global public goods all make the case for significant development finance. We plan to hold a separate inquiry in the future into climate finance. We fully support the international commitment to the 0.7% aid target and believe that it should be maintained. (Paragraph 20)

5.  In this connection, we welcome the Secretary of State's initiative of conducting a review into how DFID should respond to the changes in the development landscape. We recommend that this should include the publication of a development finance strategy for the coming decade, setting out DFID's analysis of the issues to which it must respond, the pros and cons of different options, its preferred approach and the reasons for those choices. It should include an assessment of the following issues: (Paragraph 21)

·  The function of aid, should it remain focused on poverty reduction and economic growth, but in the longer term should it also include international cooperation on global public goods if so, what are the implications of this for both future funding requirements and cooperation with other Government Departments?

·  Climate finance, which requires much more serious analysis, including the extent to which aid is used to fund climate related projects and which countries should be eligible for aid to fund such projects.

·  The OECD definition of ODA; how DFID will work with the OECD review to ensure that the focus remains on addressing poverty? We believe that DFID should make a statement about its proposals for change in the definition before the Summer Recess 2014 to give Parliament and civil society the opportunity to comment on the Government's objectives before the OECD finalises any changes at the meeting of OECD Ministers in December.

·  Whom is aid for: just for low income countries, or for people in poverty wherever they live? Whether the existing definitions of low, middle and high income countries are still useful or whether there are better ways of defining priority countries and identifying financing gaps? Should aid be targeted at extreme poverty, or at other levels of poverty as well, or at countries with large financing gaps and weak prospects for economic growth? How can aid help to reduce inequality when average incomes are rising but poverty levels are not reducing?

·  The thresholds for defining Middle Income Countries needs to be reviewed and updated. We urge DFID to encourage the World Bank to examine them.

·  DFID's strategy for aid to middle income countries: how will DFID identify and respond to the continuing development needs of these countries? What criteria will it use to withdraw aid from countries as they transition, and how will it decide to start different types of relationships based on different instruments?

·  The contribution of DFID and its financial mechanisms towards addressing inequality, equalising opportunities and ensuring that no one is left behind.

6.  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. (Paragraph 35)

7.  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. (Paragraph 38)

8.  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 is 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. (Paragraph 39)

9.  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. (Paragraph 47)

10.  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. (Paragraph 48)

11.  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. (Paragraph 49)

12.  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: (Paragraph 50)

·  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?

13.  It is important to be clear where public money (ODA) is likely to strengthen the private sector and where it risks compromising the useful free play of market forces. DFID has provided effective support for the private sector (establishing land registries, strengthening support for SMEs, capital markets, trade facilitation etc). However, there are potential dangers, notably in creating non-competitive businesses through public funding. (Paragraph 60)

14.  Supporting the private sector can have significant benefits in terms of boosting economic growth, creating jobs and raising incomes in developing countries and helping to deliver projects with other social benefits. Finance provided as returnable capital could potentially play a greater future role, and enable the finance which has helped businesses to become sustainable and profitable, to be reinvested in other projects. We think that there is significant scope for support to the private sector, but as such projects are expected to make a return, we recommend that when DFID is dealing with the private sector, the presumption should be that finance will be provided as returnable capital. (Paragraph 67)

15.  We welcome the launch of the Impact Investment Fund and ask DFID to supply further details of the role and operation of this fund, including details of whether finance will be provided as grants or loans or other instruments. (Paragraph 68)

16.  We recommend that private sector support should be an integral part of DFID's finance strategy, and that support for the private sector could be scaled up. We recognise that this will require new skills. We recommend that DFID's finance strategy includes an assessment of the following factors: (Paragraph 69)

·  How can DFID target its private sector support such that it supports inclusive growth?

·  How can DFID assess and measure the development impact of its private sector support so as to take account of broader outcomes such as improved livelihoods, income growth and leverage, as well as jobs created?

·  Should the remit of CDC be extended? Have the recent CDC organisational changes increased its development impact? Would bringing CDC under more direct DFID control improve DFID's development impact?

·  Can the success of PIDG be further extended or replicated for other countries and sectors?

We propose in a future inquiry to look at DFID's private sector work.

17.  In addition, the creation of a new UK institution with the capacity to provide a range of bilateral finance instruments and technical assistance and the ability to work in partnership with other development banks and multilaterals could enable it to deliver a range of longer term support to build on its humanitarian and rapid response to emergencies, such as that to Typhoon Haiyan in the Philippines. The Philippines is a lower middle income country with which the UK has no bilateral aid programme. It will need substantial investment to enable it to rebuild essential infrastructure and services. DFID has promised to assist in the reconstruction of the Philippines; the technical assistance, guarantees and loan finance which will be needed might best be delivered through a development bank. (Paragraph 74)

18.  The UK is unusual in the G20 in not having its own development bank. Establishing a UK development bank could give the DFID bilateral programme a way of providing a wider range of finance instruments, to complement its grant aided programmes which we would expect to continue for the poorest countries. A UK development bank could offer a range of new instruments, including concessional loans, together with technical expertise which is often valued as much as finance. However, there is a real danger that establishing a new UK development agency outside DFID would fragment UK development policy. Great care would need to be taken to avoid this danger and to ensure that a new development bank would work closely with existing institutions. (Paragraph 81)

19.  We recognise that establishing a new UK development bank would be a major undertaking, which would need careful planning and a measured implementation, but believe that DFID should plan for the long term. Creating new institutions is challenging but not impossible; for example the Government has created the Green Investment Bank in less than three years. The 'do nothing now' option carries the risk that DFID's bilateral approach becomes less effective over time and that it is unable to play a key role in the future. (Paragraph 82)

20.  We recommend that DFID establish a financial instrument team that can prepare a development finance strategy; coordinate the various finance initiatives that are currently being piloted by DFID; draw together the different bilateral and multilateral approaches; design new instruments and build up the necessary skills for future innovation and development. Without this effort, DFID may not be in a position to establish a development bank if and when it were deemed advantageous to do so. (Paragraph 83)

21.  We recommend that DFID considers the following questions in its finance strategy: (Paragraph 84)

·  What are the development financing gaps in terms of instruments, sectors and countries? What niche could a new UK development bank fill? Would the new instruments be more effective in terms of fostering growth, reducing poverty and addressing global public goods?

·  What would be the potential advantages and disadvantages of establishing a UK development bank? What could be achieved, or achieved better, through a new UK development bank compared to existing institutions? What comparative advantages would a UK development bank have over existing institutions?

·  What are the pros and cons of other alternatives, including no change; developing closer working arrangements with multilaterals; providing concessional loans through the existing DFID structure; and expanding the scope of CDC?

·  How would a UK development bank cooperate with other UK finance institutions and other development finance institutions?

·  What are the institutional and legal issues which would need to be addressed?

·  What would be the costs and possible timetable for establishing a UK development bank?

·  What new skills would DFID need to acquire and how would it do so?

·  What is the potential role of new finance instruments, such as Development Impact Bonds and Diaspora Bonds?

22.  One option open to DFID would be to channel more of its finance through multilaterals, and to make use of their wide range of specialist skills and expertise, rather than attempt to replicate all of these in its bilateral programmes. In order to determine the appropriate balance of bilateral and multilateral spending, DFID must be able to compare the relative outcomes and value for money of these different channels, both in countries where it has a bilateral presence and those where it does not. We reiterate the recommendation that we made in our recent report on the Multilateral Aid Review, that DFID develop mechanisms for comparing the relative effectiveness of bilateral and multilateral aid. (Paragraph 88)

23.  Whilst we recognize the strengths of multilaterals in some areas, we firmly believe that DFID must continue to maintain a strong bilateral presence in order to maintain the UK's influence in individual countries, and to monitor the performance of multilaterals which the UK finances. DFID must also maintain sufficient influence within multilaterals in order to monitor and influence their spending priorities. We recommend that DFID explore the potential for embedding more DFID staff within key multilaterals, and for increasing the opportunities for sharing learning and experience with its partners. (Paragraph 89)

24.  We welcome DFID's work on promoting South-South cooperation, as a complement to development finance efforts. Emerging economies, such as Brazil, have much to contribute to developing countries. DFID has only a limited presence in Latin America, and we recommend that it explores the potential for small DFID teams to work closely with multilaterals on specific projects, so as to benefit from their specialist knowledge and to contribute to its learning from emerging economies. We recommend that DFID establish an innovation and knowledge transfer unit which would be responsible for identifying good development practice and transferring relevant knowledge and experience to other projects and country programmes. We would expect the unit to be based in the UK, but to have sufficient capacity to deploy a few people to participate in and learn from country programmes, and to cooperate with the FCO where necessary. We also recommend that DFID explore ways of helping low income countries to share their knowledge and experience with each other. (Paragraph 93)

25.  An increasing number of people living in poverty are in Middle Income Countries, which should eventually graduate from traditional grant aid. Donors are likely to combine grant aid to the poorest countries with new forms of engagement in Middle Income Countries, including technical assistance, support to NGOs and loans. They will want to invest more in supporting South-South cooperation and they are also likely to spend more resources on global public goods. If DFID is to retain a leading role in this changing development world, and maintain its relevance, it will need to innovate in its use of development finance. DFID will need to think carefully about the balance between bilateral and multilateral aid, and about how to deploy new forms of finance. (Paragraph 94)

26.  DFID needs to have a more explicit overall strategy on what financial instruments to use when, how much in each case, to which countries, via which channels, under what circumstances, and what skills are required to use them effectively. It also needs to address how the UK can remain relevant for developing country needs, how it can remain an innovator in the provision of aid, what UK aid will look like over the coming decade, and its strategy for getting there. In particular, DFID will need to think carefully about whether and how to provide bilateral loans to developing countries. This will not be a process that can be done quickly, and will require a different set of skills. DFID will also need to consider the mechanisms which would be required for providing bilateral loans, including whether and under what conditions a development bank would be required. To do this effectively, we recommend that DFID develops a comprehensive statement and development finance strategy to define its future role and how it will be financed. This should take the form of a Development Finance White paper, to be published during 2014, which should, inter-alia, set out the contribution of DFID and its financial mechanisms can make towards addressing inequality, equalising opportunities so as to "Leave No One Behind", as advocated by the High Level Panel. (Paragraph 95)

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Prepared 13 February 2014