The Complementary Role of Official Development …...Article: “The complementary role of Official Development Finance: some observations and recommendations” Sustainable Finance

Article:“ThecomplementaryroleofOfficialDevelopmentFinance:someobservationsandrecommendations”SustainableFinance&Insurance,October2017

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The complementary role of official development finance: someobservationsandrecommendations.ByPaulH.J.MuddeConsultantofSustainableFinance&Insurance.I. Introduction.InvariousstudiesoftheWorldBankandotherdevelopmentfinanceinstitutions(DFIs1.)it is highlighted that the financing needs of developing countries to meet the UNSustainable Development goals (UN SDGs) are enormous. These SDGs cover a broadrange of development topics among which infrastructure, climate change, povertyreduction, education and health. UNCTAD estimates that the UN SDGs require anadditionalinvestmentof$2.5trillionayearoverthenext15years.Estimatedannualinvestmentneeds&UNSDGFinancingGapinU$trillion.

The international aid community broadly recognizes there is a huge financing gap between the UN SDG financing needs and the financing that is available from developing countries’ own resources and funds from bilateral aid donors and DFIs. This implies that mobilization of non-developmental sources of capital – both public and private – is of utmost importance. Intheirjointreport“frombillionstotrillions”,publishedinApril2015,leadingDFIsamongwhich theWorldBankGroup, ADB, EIB, EBRD, IaDB, AfDB and the IMF state that “tomeettheinvestmentneedsoftheSDGs,theglobalcommunityneedstomovethediscussionfrom“Billions”inODAto“Trillions”ininvestmentsofallkinds:publicandprivate,nationalandglobal,inbothcapitalandcapacity”.It isalsorecognizedby leadingDFIsthattheSDGagendaandtheireffortstomobilizenon-developmental sources of capital require “not only just more money”, but also “aglobal change of mindsets, approaches and accountabilities”. In other words afundamentalredesignoftheaidarchitectureisneeded.AsubstantialpartoftheUNSDGfinancinggapiscausedbythelackofbankableprojects.Thismeans thatmoreeffortshave tobeput intoprojectdevelopment. An interestinginitiativeof theDFIcommunity isSOURCE,which isapublicprojectmanagement tool1TherearemultilateralandbilateralDFIs.ThemostwellknownmultilateralDFIsareIBRD/IDA,IFCMIGA,ADB,IaDB,AfDB,EBRD,IDBandEIB.RecentlytwonewmultilateralDFIswereestablished,namelytheAIIBandNDB.ExamplesofbilateralDFIsarepublicsectordevelopmentbanks/agenciessuchasKfW(Germany)andAfD(France)andprivatesectordevelopmentbankssuchasOPIC(USA),DEG(Germany),Proparco(France)andFMO(TheNetherlands).


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enabling government and public sector agencies to improve their project preparationactivities.2II. TheroleoftheOECDDAC.In light of these developments the OECD Development Assistance Committee (DAC),which is the most important international forum dealing with the international aidarchitecture, has made some important changes that have an impact on thedevelopment finance community and other providers of finance for developingcountries. Themain topic in theOECDDAC concernsOfficial Development Assistance(ODA), which is basically a soft or concessional form of development finance. Theinternationaldonorcommunityhascommittedtoallocate0.7%oftheirGrossNationalIncome(GNI)toODAfordevelopingcountries,whichexplainsthe importanceofODA.ODA consists of bilateral ODA from donor countries to aid recipient countries andcontributions from ODA donor countries to multilateral development financeinstitutions. A grant to for example IDA is recognised as ODA. Disbursements underbilateral aid loanswith aminimum concessionality or grant level of 25% can also bereportedasODA.RepaymentsoftheseloansaretreatedasnegativeODA. This iswhythecurrentODAframeworkrecognisesgrossandnetODA.According to preliminary OECD DAC statistics the net ODA disbursements of all DACmembers were in 2016 approximately U$ 170 billion, of which U$ 128.6 billionconcerned bilateral ODA and U$ 41.6 billion financial contributions to multilateralinstitutions.CurrentODAdefinition.The DAC defines ODA as “those flows to (1) countries and territories on theDAC List of ODARecipientsandto(2)multilateralinstitutionswhichare:i.provided by official agencies, including state and local governments, or by their executiveagencies;andii.eachtransactionofwhich:a) is administered with the promotion of theeconomic development and welfare ofdeveloping countriesas its main objective; andb)isconcessionalincharacterandconveysagrantelementofatleast25percent(calculatedatarateofdiscountof10percent).” Source:OECDDAC.In 2014 the OECD DAC agreed to implement a new methodology to measure theminimum concessionality level for Official Development Assistance (ODA). Withconcessionality calculations the OECD DAC donor countries measure in essence theamountofsubsidyprovidedbyadonortodistinguishODAfromotherformsof(official)financing.

2SOURCEhasbeendevelopedbytheSustainableInfrastructureFoundation(SIF),whichactsasexecutingagencyforallparticipatingdevelopmentbanksamongwhichADB,AfDB,BNDES,DBSA,EBRD,IaDBandtheWorldBankgroup.


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NetODAdisbursementsinmillionU$(atcurrentprices).

Source:OECDDAC.III.DevelopmentofanewODAframework.In the current OECD DAC system to measure concessionality a grant leads to aconcessionality level of 100%, whereas a commercial bank loan (without any officialsubsidies) leads to a concessionality level of 0%. According to the current ODAdefinitiontheminimumconcessionalitylevelforaloantoqualifyasODAis25%,butformanyyearsafixed–highlydoubtful–discountrateof10%hasbeenused,irrespectivethe tenorof the loan, therelevantcurrencyandmarket interestratesof the financing.Todaymarket discount rates are substantially lower than the fixed 10%of theOECDDAC.InthecontextofOECDtiedaidregulationsintheOECDArrangementforofficiallysupportedexportcredits(whichisgovernedbyadifferentOECDforumthantheDAC)more realistic discount rates are used. They are currency specific; take into accountmarket interest rates for sovereign borrowers and the tenor of the loan. Today’sdiscountratesfortiedaidcreditswithatenorbetween15and20yearsarefortheEuro1.7% and for the U$ 3.7%3. They are therefore substantially lower than the 10%discountrateforODA.Formanyyearsithasbeenquiteeasyformanydonorstolendatorslightlyabovetheirownlong-termsovereignbondrates,whilestillmeetingthe25%ODAconcessionality threshold.TheartificialhighODAdiscountrate ledthereforetoahighlyinflatedODAperformanceofdonorcountriesduringthepastdecade.ThiswasanimportantmotivefortheDACtoredefineODA.At the end of December 2014 OECD DAC members agreed to count only as ODAdevelopmentgrantsandfordevelopmentloansonlythe“grantportion”oftheloan.This“grantportion” is inessence theaidsubsidy involvedand iscalculatedon thebasisofnew specific ODA discount rates. These new discount rates are now differentiated inthree country categories, namely 9% for Least Developed Countries (LDCs) and LowIncomeCountries (LICs), 7% for LowerMiddle IncomeCountries (LMICs) and6% forUpperMiddleIncomeCountries(UMICs).UnfortunatelythenewODAdiscountratesareagainnotanaccuratereflectionofmarketinterestratesandstillmuchhigherthanthe3Thesearetheso-calledDifferentiatedDiscountRates(DDRs)thatarepublishedbytheOECDExportcreditsecretariat.TheDDRsvarybycurrencyandtenorofthefinancing.

122,168

144,422140,152

147,644 161,248 150,614167,062 178,595

162,739170,315

020,00040,00060,00080,000100,000120,000140,000160,000180,000200,000

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016(P)

BilateralODA ContributionstoMultilaterals TotalODA


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morerealisticdiscountratesfortiedaidcredits.ItimpliesthatODAwillremainhighlyinflatedinthefuture.InterestingisthattheIMFandWorldBankapplyafixed5%4discountratetomeasureminimumconcessionality levels for loans tocountries that fallunder the IMF/WorldBankDebtSustainabilityFramework (IMF/WBDSF).TheDSFwasdeveloped toavoidunsustainable borrowing by developing countries. It applies to all Low IncomeCountries(LICs)ofwhichmanyinthepasttwodecadesbenefittedfromdebtrelief.As a consequence of these recent changes there are currently three differentmethodologiesforconcessionalitycalculationsforaidloansofwhichtheoneforODAisthe least realistic. This is likely influenced by the desire of DACmember countries tomeetthe0.7%ODA/GNIcommitment.InadditiontheOECDDACagreedin2014tonewminimumconcessionalitylevels,whichfurthercomplicatetheODAframework.ForLowerMiddleIncomeCountries(LMIC)theminimum concessionality level is set at 15% and for UpperMiddle Income Countries(UMIC)itis10%.ThisimpliesthatforaidloanstothesecountrieslessaidsubsidiesarerequiredthanundertheoldODAframework.FurthermoretheconcessionalitylevelfortheLeastDevelopedCountries(LDC)andotherLowIncomeCountries(LIC)havebeenincreasedfrom25%to45%,whichimpliesthatforthesecountriesaidloansrequireahigheramountofsubsidytoqualifyasODA.ImportantisthatthesenewODArulesarenotonlyrelevantforbilateralODAloans,butalsofortheconcessionallendingactivitiesof multilateral donors such as IDA and the regional development banks. Forconcessional loans of Multilateral Development Banks (MDBs) have to meet theapplicableODAminimumconcessionalitylevels.The rationale of the ODA changes of minimum concessionality levels is to encouragedonorstoprovidemoreODAtocountriesthatarehighlydependentonaidandlessODAto countries that have reasonable access to alternative sources of finance. But theunintended side effect could very well be that ODA loans to LMICs and UMICs willincrease, because donors require substantial less aid subsidies for aid loans to thesecountries. The new concessionality rules could therefore be completelycounterproductive.AdditionalmeasuresareneededtoavoidamisallocationofODA.Table1:Aidarchitectureandconcessionalitycalculations OldODA NewODA IMF /WB

DSFTiedAid

GrantElementThresholds

25% • 45%forLDCsandotherLICs• 15%forLMICs• 10%forUMICs

35% • 50%forLDCs• 35%forallothercountries

DiscountRates

10%

• 9%forLDCsandotherLICs• 7%forLMICs• 6%forUMICs

5% • Euro:1.7%(1)• U$:3.7%(1)

(1) These interest rates are according to the OECD arrangement on officially supported export credits theapplicablediscountratesfortiedaidcreditswithatenorbetween15and20yearsinMarch2017.

IntheIMF/WBDSF,whichappliestoLICs,theminimumconcessionalitylevel is35%,whilefortiedaidcreditstheminimumconcessionalitylevelsare50%forLDCsand35%for all other countries. It is unclear why the DAC has opted for its own minimumconcessionaltyrequirements.FactisthatthenewODAminimumconcessionalitylevelsanddiscountrateshavecomplicatedtheinternationalaidarchitecture.4TheIMF/WBadopteda5%discountrateforsimplicityreasons.


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CurrentlytheOECDDACisdiscussinghowODAcanbeusedtoencouragemobilizationof private sector sources of capital. This concerns a discussion on Private SectorInstruments(PSI),whichincludes loans,guaranteesandequity investments.Thefocusofthecurrentdiscussionistodeterminetheso-calledODAcomponent(i.e.aidsubsidy)of these PSI-instruments. Very arbitrary calculation methodologies are suggested todistract the ODA subsidy from these financial instruments. This ODA component canthenbereportedasODA,whichwilllikelyimplyanincreaseoftheODAperformanceofdonors.TheintentionoftheOECDDACistoseekfirstanagreementontheseODAaidsubsidy calculations and at a latter stage a discussion will take place on thecomplementaryroleofODA.Oneoftheproblemsisthatagainunrealisticdiscountratesare used to calculate the ODA component of the PSI–instruments, which has also animpactonothersformsofofficialfinance.AchallengeinalltheseOECDDACdiscussionsisthattheentirenewODAframeworkisdiscussed in complete isolationwithout properly taking into accountmarket realitiesandthepotentialnegativeimpactofnewregulationsonalternative(non-ODA)sourcesof capital that are available to developing countries. Instead of crowding in non-developmentalsourcesofcapitalODAmaycrowdoutthesealternativesources.Clarityabout the complementary role of not only ODA, but also other forms of officiallysupporteddevelopmentfinancing,isthereforeofutmostimportance.Itisintheinterestof the donor community and the SDG agenda at large to use scarce subsidized aidfinancing only for projects in countries that do not have adequate access to financingthatrequiresnoorlessofficialsupport.Thehighertheaidsubsidiesinvolvedthemoreprudencyisneededtoavoidcrowdingout.In other words a clear understanding on the complementary role of developmentfinance is critical and urgently needed to enhance aid efficiency and aid effectivenessandachievetheUNSDGs.IV. ODAandothersourcesoffinanceavailablefordevelopingcountries.Countriesmakeuseofvarioussourcesof finance.Thesesources includemarketbaseddebt finance from domestic and international bank and capitalmarkets (without anyform of official support), ODA and Other Official Flows (OOF). OOF, which is alsoreportedtotheOECD,concernsofficial (governmentsupported) financing,whichdoesnotmeettheODAconditions,eitherbecauseitisnotprimarilyaimedatdevelopmentofdeveloping countries or because it has a concessionality level of less than 25%. OOFincludesofficiallysupportedexportcreditsofofficialExportCreditAgencies(ECAs)andloans from bilateral DFIs that provide financing on non-concessional terms, either atpreferential interest rates (but toohigh toqualify asODA)oronmarketbased terms.OtherexamplesofOOFareofficialinvestmentloans5ofEXIMbanksandECAsthatareinparticularusedinprojectfinance,privatesectormarketbasedlendingofbilateralDFIs(e.g. loans from FMO, DEG, Proparco) and so-called bilateral “promotional loans6” tosovereignborrowers,wherebythebilateralDFIpassesonthebenefitsofitslowfundingcoststotheloantothesovereign.TheGermandevelopmentbankKfWisquiteactiveinthisareaofpromotionalsovereignloans.5InvestmentloansorinvestmentguaranteesfromEXIMbanksandECA-insurersareformallynottiedtoexportsfromtheECAcountry,buttiedtothenationalityoftheinvestor.6ItisunknownwhetherthesebilateralpromotionalloanswillqualifyasODAorOOFunderthenewODAregime.Italldependsonthelevelofconcessionalityofthesepromotionalloans.


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TheroleofofficialExportCreditAgencies(ECAs).ECAsexist inmanyOECDandnon-OECDcountries.Theirmainobjective istosupportexportsandforeigninvestmentsfromtheirhomecountry.LeadingECAsarememberoftheso-calledBerneUnion,whichisaglobalassociationofcreditandpoliticalriskinsurers.BerneUnionmemberssupportedin201611.1%ofglobalexports.Attheendof2016thetotalMLTexposureofBerneUnionmembersinbothexportcreditsandinvestmentswasapprox.U$961billion.Thisamountis more than 200% of the outstanding exposure of leading DFIs on developing countries, which in 2016 stood atapproximatelyU$419billion.OutstandingexposureofleadingMDBsin2016(inmillionU$)

Loans Equity Guarantees Total

IBRD/IDA 167.643 0 5.198 172.841

IFC 23.910 10.793 3.478 38.181

ADB 67.599 1.187 2.105 70.891

IaDB 81.952 0 230 82.182

AfDB 21.641 104 565 22.310

EBRD 26.213 5.949 638 32.800

Total 388.958 18.033 12.214 419.205ObviouslythemandatesofECAsandDFI’sdiffer.DFI’shaveadevelopmentalmandate,whereasECAshaveprimarilyanexportpromotionmandate.Itis,however,afactthatbothDFIsandECAshaveanimportantdevelopmentalimpact,fortheyarebothkeyinfinancingtheimportandinvestmentneedsofdevelopingcountries.

Source:BerneUnionandMDBannualreports2016.Developing countriesborrowalso substantial amounts fromMultilateralDevelopmentBanks(MDBs).SuchfinancingprovidedbyentitiesliketheIBRD/IDAisreportedtotheOECDunder“multilateralconcessionallending”(whichistheODAequivalentforMDBs)or“multilateralnon-concessionallending”(whichistheOOFequivalentforMDBs).MultilateralgrossdisbursementinbillionU$.

Source:OECDDACNon-concessional loans of MDBs include market-based loans to private sectorborrowers.Examplesareprivatesector loansprovidedby IFCand theprivate lendingdepartmentsofADB,EBRD,IaDBandAfDBandsovereign loanstothepublicsectoratpreferential subsidized interest rates. The latter concerns loans whereby the MDBpasses on the benefits of its low funding costs (based upon its AAA credit rating andpreferred creditor status) to the loans for their sovereignborrowers.These sovereign

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27

48 50 52 53 51

26 24

44 4549

4449

-

10

20

30

40

50

60

1999-2000average

2004-2005average

2011 2012 2013 2014 2015

Concessional Non-Concessional


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preferentialloansareunderthecurrentODAregimenotconcessional7,butbenefitfroma substantial subsidy. The interest rates are not market based. Although each MDBapplies its own pricing system and pricing differs amongMDBs, the interest rates ofindividualMDBsareforalltheirsovereignborrowersthesame,irrespectivetheircreditstanding.An IBRD loantoacountry likeChina,Mexico,Brazil,Turkeyor Indiahas forexamplethesameinterestrateasanIBRDloantoahighriskcountryinAfrica.Indicativenon-concessionalU$lendinginterestratesofMDBsforsovereignloanswithanaveragematurityof15years(Sept2017). IBRD ADB IaDB AfDBFloating BaseRateforU$

6monthLibor 6monthLibor 3monthLibor 6monthLibor

Baserate 50Bps 50Bps 85Bps 80BpsMaturitypremium

30Bps 20Bps NotApplicable 10Bps

Fundingrebate/costs

-5Bps -5Bps +10Bps -2Bps

Total spreadoverLIBOR

75Bps 55Bps 95Bps 88Bps

Sources:IBRD,ADB,IaDB,AfDB.In theOECDDACdiscussionson theODAcomponentofPSI instruments theDAC is infactlookingatthe“ODAaidsubsidy”inOOFfinancingstatistics.WoulditnotbeeasierfordonorstopartiallyreallocateODAfundstoOOFfinancinginstruments?MostOECDDAC donors are apparently not in favor of that because this would likely negativelyaffecttheirinternationalcommitmenttospend0.7%ofGNIonODA.Main sourcesofofficial finance fordeveloping countriesand the levelofofficialsupport involved.

Source:SustainableFinance&InsurancePCF:PrivatecapitalflowsOOF:OtherofficialflowsMOOF:MultilateralOOF=multilateralnon-concessionallendingODA:OfficialDevelopmentfinanceMODA:MultilateralODA=multilateralconcessionallending.

7ItisunknownwhetherthesepreferentialMDBsovereignloanswillbereportedasconcessionalornon-concessionalloansunderthenewODAframework.ItwilldependontheconcessionalityleveloftheMDBloans.


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Thetableabovesummarizesallmainformsofofficialfinancingavailabletodevelopingcountries.Itprovidesalsoindicationsofthe‘”levelofofficialsupport”foreachfinancingmodality.Obviouslyan“ODAgrant”constitutesthehighestformofofficialsupportand“market based finance”, such as a commercial bank loan, involves no official support.Between “market based finance” and “ODA grants” there are various forms of officialfinance, with different levels of official support. Official non-development financeconcerns(1)OECDECAexportsand(2)OECDECAinvestmentloans.TheotherformsofofficialfinanceconcernsOfficialDevelopmentFinance(ODF),whichisthesumofODA+OOFprovidedbyDFIs.IV. How to avoid crowding out ofmarket based finance or other sources of officialfinance.Given the enormous financing needs of developing countries mobilization of privatecapitalishighontheagendaoftheinternationalaidcommunity. ThisimpliesthattheDFIs and their guardian authorities need to be fully aware ofwhich other sources offinanceare(potentially)availabletodevelopingcountriesandhowtheseothersourcescanbetapped.There is tendency within the aid community to narrow the discussions on themobilizationofprivatecapitaltothedevelopmentofpublicprivatepartnerships(PPPs),in particular through project finance. The latter concerns projects that have thepotential to generate sufficient income to repay commercial debt financing and paydividend to equity investors. The too narrow approach ignores amongst others thatprivatecapitalcannotonlybemobilizedforprivatesectorsponsoredPPPprojects,butalso for typical public sector projects, whereby the government (sovereign) or a subsovereignentity(e.g.municipality)orstateownedenterprise(SOE)actsasborrowerorguarantor. This is for example relevant for most transport, electricity distribution,climateadaptationandwaterprojects.Mostroads,railways,regionalairports,harbours,drinking water & sanitation projects are and will likely remain typical public sectorprojectsinmanydevelopingcountries8.In India,which is themost advanced in private sector participation in infrastructure,64%ofthecountry’sinfrastructureisstillfinancedandmanagedbythepublicsector.Inmost other developing countries the share of public sector infrastructure is likelysubstantiallyhigher.PPPcancontributetobridgingtheinfrastructurefinancinggap,butis clearlynot thepanacea.DFIs’mobilizationstrategiesshould thereforealso focusonmobilizingcapitalforpublicsectorprojects.ThisiscurrentlyhardlydiscussedintheDFIcommunity,whereas theopportunities for themobilizationofcapital forpublicsectorprojects are substantial. Many governments in developing countries –in particularmiddle-income countries –have good or reasonable access to the privatemarket andcan obtain financing (support) from for example official Export Credit Agencies,commercial banks andprivate insurers. This concerns inparticular countries that areratedinOECDECAriskcategories2–4,butopportunitiesalsoexistincountrieswithahigherriskprofile9.TheimpressiveoverlapofexposuresofforexampleIBRD/IDAandBerne Union members on many countries show there are huge opportunities forcooperation and alignment of operations.More or less similar overlaps existwith theportfoliosof otherMultilateralDevelopmentBanks (e.g.ADB, IaDB,EBRD,EIB,AfDB).8ItisnoteworthythatmostPPPprojectsindevelopingcountriesconcernelectricitygeneration/energyandtelecomprojects.SeethePPIdatabaseoftheWorldBank.9MoreinformationabouttheOECDcountryriskclassificationcanbefoundviathefollowinglink:http://www.oecd.org/trade/xcred/crc.htm


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Enhanced cooperation through among others guarantee and risk transfer operationsshould be explored and utilized to mobilize more financing for development and toimproveaidefficiencyandaideffectiveness. Top 10 MLT export credit exposure countries Berne Union members 2016. Between brackets the OECD ECA country risk rating of Oct. 2017.

Source:BerneUnion. IBRD top 10 exposure countries in % of total exposure in 2016 Between brackets the OECD ECA country risk rating of Oct. 2017.

Source:IBRDAnnualreport2016.Theaidcommunityfocusesonmobilizingprivatecapital,butthisignoresthatimportantpublic –non-developmental –sources of capital can be catalyzed for developingcountries, This concerns among others insurance capacity of official export creditagencies and lending capacity of EXIM banks and investment capital from sovereignwealth funds.These threepublic sourceshave substantial capital available to supportSDG projects in developing countries. That’s why (governments through their)multilateral and bilateral DFIs should include these potential sources in theirmobilizationstrategies.DFImobilizationstrategiesrequirenotonlyclarityonwhichpublicorprivatefundscanbecrowdedin,butalsoaclearviewonhowpotential“crowdingout”ofotherformsoffinancewithoutorwithsubstantiallessofficialsupport,canbeavoided.Inotherwords:

7%5%

4%3%3%3%3%3%3%3%

64%

UnitedStates(0)

Russia(4)

Turkey(4)

Brazil(5)

SaudiArabia(2)

UnitedKingdom(0)

Angola(6)

India(3)

VietNam(5)

Argentina(6)

Other

TotalExposureU$691.8billion

9%

9%

8%

8%

7%6%6%5%

3%3%

36%

Brazil(5)

Mexico(3)

Indonesia(3)

China(2)

India(3)

Turkey(4)

Colombia(4)

Poland(0)

Argentina(6)

Peru(3)

other

TotalExposureU$172.8billion


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clarityaboutthecomplementaryroleofofficialfinance.InthisareatheOECDDAChasthusfarmadelittleprogress.Thereistheintentiontodiscuss“additionality”inthenearfuture,butthisislimitedtoODAPSI-instruments.TheupcomingDACdiscussionshouldalso include additionality of non-ODA forms of official development finance anddevelopmentfinanceforpublicsectorborrowers.ParticipantstotheOECDArrangementonofficiallysupportedexportcreditshavemadesomeimportantregulationsonthistopic.TheyhaveamongstothersdefinedminimumpremiumstoavoiddistortionofcompetitionbetweenvariousECAsthatarecausedbypricingdifferences.Furthermoretheruleshavebeensettoavoidacreditsubsidyracebetween OECD governments, because ultimately the ECA export promotion schemesinvolve scarce governments budgets and tax payers’money. These considerations areobviously also relevant for other forms of official finance, including developmentfinance.TheminimumOECDECAriskpremiumsarebasedupona jointriskassessmentbyallOECDECAsofthefinancial,economicandpoliticalsituationofcountries.Inthedesignofthe minimum premiums market based pricing benchmarks were also taken intoaccount.ThesystemisfurthermorefedbythejointpaymentexperiencesofOECDECAswithdevelopingcountries.Theseminimumpremiumruleshavebeenhighlyeffectivetoavoid pricing distortion of competition in the export finance business between OECDECAs.10TheminimumOECDpremiumrulesdonotapplytobilateralinvestmentloansprovidedby EXIM banks or supported by investment guarantees from ECA-insurers, becausethese loans or guarantees are not tied to exports but tied to the nationality of the(equity) investor.ReliabledataonECApricingpractices for these investment loansorinvestmentguaranteesareunfortunatelynotavailable.Thereare,however,indicationsthat theseuntied investment loansarecrowdingoutofficialexportcredits.During thepast6-8yearsthevolumeofuntiedinvestmentloansandguaranteeshavesubstantiallyincreased11. They are mainly used for debt financing of greenfield project financetransactions inwhich foreign equity investors are involved. This concerns the largestshareofPublicPrivatePartnershipprojects.Theproblemofcrowdingoutofofficialexportcreditsbytheseofficialinvestmentloans/ guarantees could be avoided if for these EXIM / ECA investment loans the OECDminimumpremiumswouldapply.FortheECAsinvolvedthisshouldtechnicallynotbeaproblem,becausetheyarealreadyfamiliarwiththeOECDpricingsystemandtheriskstowhichtheyareexposedundertheirinvestmentprogramsareverysimilartotherisksundertheirexportcreditprograms.

10MoreinformationabouttheOECDminimumpremiumforofficiallysupportedexportcreditscanbefoundonthefollowingwebsiteoftheOECD:http://www.oecd.org/tad/xcred/11ImportantprovidersofuntiedinvestmentloansareamongstothersJBIC(Japan),KEXIM(SouthKorea)andOPIC(TheUnitedStates).


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ThecomplementaryroleofdifferentformsofofficialfinanceNo. Typeoffinancing OECD

StatisticsreportingLevel of official subsidyinvolved(Scoring0–5ofwhich0 means no subsidy involvedand 5 concerns the highestsubsidylevel)

Regulationstoavoid“crowdingout” (e.g. minimum pricing toavoid distortion ofcompetition?)

1 Market based financingfrom domestic orinternationalbank/capitalmarkets

Domestic: NotavailableInternational:Privatecapitalflows(1)

Subsidylevel:0The market provides financing;there is no official supportinvolved.

Notapplicable

2 Officiallysupportedfinancing2A Officially supported Export

Credits supported /provided by official ECAs/EXIMbanks

OOF Subsidylevel:1Official support is provided, butthere are no aid subsidiesinvolved.

Yes, for officially supportedexport credits the OECD ECAminimumpremiumsapply,whichareriskbased.

2B Officially supportedInvestment loans (not tiedto exports, but tied to thenationality of investor)supported / provided byofficialECAs/EXIMbanks

OOF Subsidylevel:2-3Official support is provided, butthe level of official support isunknown, because there is notransparency on the pricing ofinvestmentloans

No, OECD ECA minimumpremiumsforofficiallysupportedexport credits do formally notapply,

3 OfficialDevelopmentFinanceprovidedbybilateralandmultilateralDFIs3A DFI market based

investment loans forprivatesectorborrowers

BilateralDFIs:OOFMultilateral DFIs:non-concessionalloans

Subsidylevel:2-3Official support is provided, butthelevelofsubsidiesisunknown,because there is a lack oftransparency on the pricing ofDFI loans. DFIs price theirprivate sector loans marketbased, but there is a lack oftransparency on the pricingpractices.

No

3B DFI “promotional loans”(non-concessional)

Bilateral DFIs: ODAor OOF depends onconcessionality leveloftheloanMultilateral DFIs:Concessionalloansornon-concessionalloans depends onconcessionality leveloftheloan

Subsidylevel:4Official support is provided. DFIspass on their funding benefits tosovereignborrowers.Pricing is not risk based butsubsidized and pricing practicesdiffer among bilateral andmultilateralDFIsforeachDFIhasitsownpricingsystem.

No

3C DFIconcessionalloans BilateralDFIs:ODAMultilateral DFIs:concessionalloans

Subsidylevel:5Official support is provided.Loans are not risk based, butconcessional and benefit fromsubstantialaidsubsidies

No

4 OECDtiedaidcredits BilateralDFIs:ODA

Subsidylevel:5Official support is provided. Minconcessionality of 35% or 50%and DDRs for concessionalitycalculations

OECD tied aid rules in OECD“Arrangement on OfficiallySupported Export Credits apply,including a “commercial viabilitytest”

5 ODAgrants BilateralDFIs:ODAMultilateral DFIs:concessional

Subsidylevel:5The highest level of officialsupportisprovided.

No

Source:SustainableFinance&Insurance(1) Ithas tobementioned thatbank loansandother formsofdebt financing (e.g.bonds) thatbenefit fromguaranteesupport of ECAs, DFIs and specialisedmultilateral insurers are in current OECD statistics included in “private capitalflows”.Thismeansthatasubstantialpartoftheseflowsisofficiallysupported.Thisconcernsinparticularmediumandlongtermcommercialbankfinancing.MultilateralorbilateralDFI investment loans forprivate sectorborrowersareusuallyprovided onmarket based terms, but unlike the ECAs, DFIs do not have a system ofminimum risk based premiums. In this area DFIs compete with market financiers(withoutofficialsupport)andECAsupportedloansandevenamongeachother.“Unfaircompetition” causedbydifferent pricing practices could be avoided if theDFIswould


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implement the OECD minimum premiums for trade related foreign currencydenominatedexportor import financing12. ItwouldthereforenotapplytogeneralDFIcreditlinestolocalbankstoencouragethemtolendtocertainpartsoftheeconomyindevelopingcountries.(e.g.climatefriendlyinvestments,SMEsector,microfinance).FormanyprivatesectororientedDFIsthiscreditlinebusinessconcernsapproximately25%of their total lending to the private sector. Minimum premiums for trade relatedbusinesswouldreducetheriskofprivatesectorDFIloanscrowdingoutothersourcesoffinance that require no or less official support. For private sector oriented DFIsimplementation of the OECD minimum premiums should also technically not be aproblem, because they currently apply market-based rates. If needed, they can, likeECAsandEXIMbanks, chargehigher rates.Theadvantageof theOECDECAminimumpremiums isalsothat itwillreducepricingcompetitionamongDFIs.An issue is likelythatmostDFIsarenotfamiliarwittheOECDminimumpremiumratesanddonotliketobeboundby(new)rules.OntheotherhandtheOECDexportcreditrulesareformallyalreadyapplicabletobilateralDFIsifandwhentheysupportanexporttransactionfromtheir home country. It may be the case that bilateral DFIs are not fully aware of thepotentialrelevanceofexportcreditregulations.ItisthereforerecommendedthatECAsandDFIsworktogethertocomparetheirpricingpracticesandexperiences.PromotionalloansofbilateralDFIsandnon-concessionalpreferentialloansfromMDBs,which in general are only provided to sovereign borrowers, have a larger subsidycomponentthantheDFIprivatesectorloansorECAsupportedexportcredits.Theymaytherefore potentially not only crowd our market based financing, but also these twootherofficiallysupportedsourcesoffinance.ToavoidthisfromhappeningrelevantDFIsand MDBs should check whether their more favourable financing terms are indeedrequired.ItisalsointheinterestofbilateralDFIsandMDBstoharmonisetheirpricingpractices for these preferential / promotional loans, because today they differ quitesubstantially from one another, resulting in pricing competition among the variousprovidersof“promotional”developmentloans.BilateralODA loansandconcessionalMDB loanshaveevenagreater riskof crowdingoutotherformsoffinancefortheseloansinvolveasubstantialhigheraidsubsidy.Thesefunds should thereforeonlybeusedas “finance in last resort”,whenother sourcesoffinance are not (adequately) available. In thisway it can also be ensured thatODA ismainly provided to the least developed countries and low-income countries, whichcurrentlyfallundertheIMF/WBDSF.This complementarity ranking couldhelpofficial financiers, inparticularbilateral andmultilateraldevelopmentfinanciers,toallocatetheirsubsidizeddevelopmentfinancingonly for those (parts of) projects and countries that truly require subsidizeddevelopment financing. The suggested additionality check will contribute to aidefficiencyandaideffectivenessandachievementoftheUNSDGs.An interesting additional tool that can be introduced to check potential distortionbetween (highly) subsidized development finance and market based finance or ECAexport credits ormarket basedDFI loans could be the so-called “commercial viabilitytest” thathasbeendeveloped for tiedaid credits13.This test ensures thatnon-marketbased tied aid finance operates complementary to the market. A similar commercialviabilitytestcouldbeintroducedfornon-marketbaseduntieddevelopmentfinance.Inthis way it can be avoided that scarce non-market based funds are unintentionally

12DuetothelackofreliabledataontraderelatedDFIfinancingthevolumeofsuchDFIbusinessactivitiesisunknown.13SeetheOECDArrangementonofficiallysupportedexportcredits.


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crowding out private capital or public capital that involves less official support. TheOECDDACcouldbenefitfromtheextensive“bodyofexperience”ofOECDexportcreditParticipantswiththeirdiscussionsabouttiedaideligibility.A commercial viability test for non-market based untied aid will also contribute todefine more precisely the complementary role of non-market based DFI finance(including ODA) and enhance the developmental impact of DFI operations. This isobviouslyofgreatimportancetodevelopingcountriesandtheglobalSDGagenda.VI. ConclusionsEnormousamountsoffinancingareneededtoachievetheUNSDGS,whichimpliesthata strong alignment of development finance with other forms of finance is critical.Mobilization of non-developmental sources of capital is important to achieve the UNSDGS. The discussion should not be limited to mobilizing private capital. There areimportant non-developmental sources of public capital that can be catalyzed. Non-developmental sources of capital cannot only be catalyzed for private sector projects,but also for public sector projects. A focus on “crowding in” other sources of capitalrequires a different mindset, incentives and business approaches of DFIs. Of equalimportance is the question how “crowding out” of market based finance withoutsupportorofficialfinancewithsubstantiallessofficialsupportcanbeavoided.It isthereforeveryimportantthattheOECDDACstartswithafundamentaldiscussiononthecomplementaryroleofODAandotherformsofdevelopmentfinance,bothforthefinancingofpublicandprivatesectorprojects.ForthatpurposetheOECDDACshouldinvitenon-development financiers to the table. In thisway it canbeavoided thatnewODA regulations will be developed that negatively affect private or other official(financial) flows to developing countries. Clarity on the complementary role ofdevelopmentfinanceisalsocriticaltoimproveaidefficiencyandaideffectiveness.OECDmembers should thereforeseriously considerapplying theOECDECAminimumpremiumsto:

(1) untied investment loansofEXIMbanksand/oruntied investmentguaranteesfordebtfinancingofECAinsurers.

(2) Investment loans or guarantees for debt financing frombothmultilateral andbilateralDFIsforprivatesectorprojects.

Furthermore a commercial viability test could be introduced for non-market baseddevelopmentfinancewithrelativelyhighsubsidylevels.Thiscouldbeusedtoassesstheneed for sovereign “promotional loans” and concessional loans. Concessional loansshouldpreferablyonlybeprovidedtocountriesthathavenoorlimitedaccesstomarketbased finance or official finance that requires less official support. This includesamongstotherstheIMF/WBDSFcountries.These suggestions could assist OECDDACmembers andMDBs to enhance lending tothosecountriesthatreallyneedODAorotherformsofofficiallysupporteddevelopmentloans and improve the effectiveness and efficiency of their development financeactivities.ODAcanbeusedforprojectdevelopmenttoincreasethenumberofbankableprojects.InthiswayODAcancontributeveryeffectivelytotheachievementoftheUNSDGs.


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Last, but not least: the OECD export credit and DAC member countries and theinternationalDFIcommunityshouldreachanunderstandingwithnon-OECDcountriesonbothexportcreditanddevelopment finance(tiedanduntiedaid)topics. Forsomenon-OECD countries have become important official financiers of the SDG needs ofdeveloping countries. These non-OECD countries are currently not bound byinternationalexportcreditandaidregulations.BothOECDandnon-OECDprovidersofofficial finance should therefore work closely together on additionality of officialfinance.AglobalunderstandingonthecomplementaryroleofofficialfinanceiscriticalfortheachievementoftheUNSDGSs.October2017SustainableFinance&InsurancePaulMudde

Documents

The Complementary Role of Official Development …...Article: “The complementary role of Official Development Finance: some observations and recommendations” Sustainable Finance