Lots of extra aid money is needed to meet the UN's new sustainability goals. To get there, we must have a more generous definition of aid. We need assistance that stimulates innovation and private capital, writes Annie Sturesson, senior economist at the Ministry of Finance in Uganda.
"Making billions into trillions" was the mantra at the development finance conference in Addis Ababa in July this year. At the global level, development assistance in 2014 amounted to $ 135 billion. But to meet the new sustainable development goals, around 5-7 trillion dollars are needed annually. The solution is considered to be a more innovative and catalytic assistance that stimulates private capital.
More money sounds good. But do the quantity and quality of aid go together? Is more innovative aid compatible with strict principles on aid effectiveness and prevailing aid definitions?
At a side event at the Addi Conference on Development Aid, I took the opportunity to ask this very question to Minister for Development Aid Isabella Lövin. Unfortunately, I did not get a clear answer. My answer to the question is no. It is not possible to maintain strict principles for the calculation of aid and at the same time advocate more innovative aid. To bring the equation together, the definition of development assistance needs to be reviewed and better in line with the new economic and political reality in which development assistance operates.
From my experience at the Ministry of Finance in Uganda, I have two examples of how a relaxed definition of official aid would promote more innovation among donors, and more importantly benefit partner countries. Namely guarantees and fixed loans.
Narrow definition of aid
In order for donors to dare to be more innovative, incentives are needed to test new financing mechanisms. An important one is how aid is classified. How official State Development Assistance (ODA) should be defined and reported is determined by the OECD's Assistance Committee DAC. A couple of years ago, there was a debate about DAC's regulations. In December last year, the rules for how loans may be reported as development assistance were changed. One area where an agreement on new writings has not yet been reached is guarantee instruments.
In many growing economies, access to loans with reasonable interest rates is a major problem. The purpose of guarantees is to make loans more advantageous by reducing the risks of loan transactions. By pledging a guarantee, a donor guarantees a state or private borrower. If he fails to repay the loan, the guarantee falls and the donor replaces the lender. The guarantee thus reduces banks' risks, which means that they can offer loans at a lower cost. When Sida pledges such a guarantee, the authority asks for a guarantee premium, often at a heavily subsidized cost.
Despite the great potential and popularity of guarantees in partner countries, the use of guarantees has been limited. Sida and American USAID are two exceptions and pioneers in the field. Sida's first guarantee was pledged in 1999 in Uganda to the mobile network provider MTN. Thanks to the guarantee, MTN gained access to more advantageous loans and the opportunity to expand its network in rural areas. The instrument was so successful that MTN even repaid the second loan in advance. An exemplary aid can be believed. But there is a catch. It does not count as assistance.
Only paid guarantees are counted as assistance
According to DAC's regulations, only guarantees paid out as ODA are counted. The funds that Sida needs to reserve in case a guarantee would need to be paid out, and which thus cannot be used for other projects, are not counted as assistance. For donors concerned with achieving their development assistance goals, guarantees are therefore a blunt instrument. ”We can not afford to sit and hold money for guarantees that in the end may not be counted as ODA ", explains an employee at British Dfid in Kampala.
The fact that only "failed" guarantees are counted as ODA also risks leading to distorting incentives for the donor. "According to the prevailing logic, we should take great risks and take out bad guarantees in order for our work with guarantees to be counted as assistance.", points out the Dfid colleague.
International commitments for development assistance goals not only put pressure on donors to mobilize larger development aid budgets, but also affect the use of these resources. Few countries, like Sweden, can "afford" to spend resources and time on instruments that do not count as development assistance.
In July this year, all EU member states undertook to achieve the aid target of 2030% of estimated gross national income (GNI) by 0,7. To achieve this, several EU countries must multiply their aid budgets. The focus for these donors will most likely be on spending money quickly and easily in line with prevailing aid definitions. A more inventive use of aid resources requires a definition of aid that rewards innovation.
Different rules regarding tied aid create uneven playing field
Another innovative financing instrument being tested in Uganda is so-called Contracter Facilitated Financing (CFF). In a CFF procurement, for example for a road construction, interested companies present both a technical and financial proposal. It is up to the company to secure financing. In this way, the Ugandan state does not have to spend time mobilizing loans and the project can hopefully get started sooner.
A prerequisite for companies to be able to offer competitive loans is that they receive subsidized government loans. Countries such as China, India and Turkey offer generous loans to their companies to help them enter new markets. For OECD countries, fixed-term loans are not an option. In 2001, the DAC adopted recommendations to stop using tied aid, which includes tied loans to low-income countries.
This means that it is difficult for European, North American and Japanese companies to compete with Chinese companies, which in turn risks having consequences in terms of the quality of the investment projects. Uneven competition is also affecting Uganda. In CFF procurements, the range of interested companies is limited and for more complicated road constructions, the Ugandan Road Administration has unfortunately had mixed experiences of Chinese companies' expertise and the quality of their machines. Another risk with CFF is that the state's bargaining power is limited by the technical and financial tenders of a project being discussed jointly.
Financing tied to companies is problematic. Despite the ambition to mobilize more private investment, fixed-term loans to developing countries are probably not the best model for donors to follow. At the same time, CFF points out how strict, albeit well-meaning, aid definitions risk leading to distorted competition in a context with new donors that are subject to other rules.
Innovation requires more pragmatism
The answer I had hoped to get from the Minister for Development Aid is that the goal of going from billions to trillions requires a large dose of innovation and increased pragmatism for the definition of development assistance. Arguing for tied aid to the world's poorest countries would go too far. However, the DAC's regulatory framework for innovative instruments as guarantees should be more flexible and generous. The purpose of this is not to make it easier for donors to achieve development assistance goals, but to encourage funding mechanisms that achieve more impact and results for partner countries.