The Future of UK Development Cooperation Phase 1: Development Finance

Written evidence submitted by the Department for International Development

INTRODUCTION

1. The Department knows from its recent horizon scanning and analysis – and analysis produced by others, including the IDC – that the development landscape has changed rapidly, and will continue to change rapidly, affecting the nature, context and geography of poverty and the future prospects of the poor. In recent years, many developing countries have experienced fast growth, and in most parts of the world, poverty has been decreasing, albeit at vastly different rates across countries and regions. DFID also knows that population trends, urbanisation, natural resource riches and technology will offer a unique opportunity to accelerate and lock in these gains. Despite this opportunity, the majority of the poor will live in transition countries (with average incomes of less than £1,000 per person per annum), with an ever increasing number concentrated in fragile states, and in countries affected by the impact of climate change and resource scarcity.

2. The analysis also highlights that the financing support to, and the needs of, developing countries is changing, due to economic growth and the rise of alternative funding sources, including capital markets and emerging powers. Private sector investors as well as large scale private philanthropy have become increasingly important; so too have remittances. The World Bank estimates remittance flows to developing countries rose by 6.5% in 2012 to total US$406 billion and are projected to grow to US$685 billion by 2015.

3. These changing financing flows and the changing prospects for poverty exit by the poor in some countries, determined by the extent and pattern of economic growth, challenge how development is supported. This is especially true in the poorest countries (low-income countries), the most fragile countries (where conflict and violence is the biggest barrier to reducing poverty) and those countries which are transitioning out of extreme poverty.

4. The combination of the changing context of poverty, alternative financing sources and the rising UK development budget have led the Secretary of State to initiate internal work on the kind of organisation DFID wants and needs to be to support the new post-MDG framework and tackle the development challenges in 2015 and beyond.

Question 1: Whether the 0.7% ODA target will be appropriate in the long term

5. The UN’s development financing target, which calls on economically advanced countries to allocate 0.7% of their GNI to Official Development Assistance (ODA), is both long-standing (having been first enshrined in a UN resolution in 1970) and widely recognised. In 2005, for example, EU Heads of States specifically committed to increase collective EU ODA to 0.7% of GNI by 2015. Since 2002, the combination of the Millennium Development Goals and the 0.7 target have resulted in renewed political support for official development finance and an unprecedented increase in global ODA levels. The 0.7 target also provides a firm benchmark against which to measure donor effort and encourage international burden sharing. The Government is therefore committed to spending 0.7% of GNI as ODA from 2013 onwards.

6. The Government believes that the 0.7% target will continue to have relevance in the longer term, both as an established benchmark for international burden sharing, and as a way of encouraging an on-going flow of ODA. With its tightly governed definition, concessional nature and focus on poverty reduction, ODA will continue to play a critical role in global development. It is important to complement this quantitative target with measures of quality and impact of development cooperation.

Question 2: Whether DFID has the right mix of financial instruments and whether it should introduce new ones, including concessional loans, t he balance between loans and traditional grant aid; and the role of the UK as a provider of climate finance.

Question 3: Specifically whether the UK should establish a new, independent development finance institution to offer concessional loans

7. As countries steadily transition and become emerging economies the Department’s increased emphasis on economic development means there are a number of possible new financial instruments which could be introduced alongside traditional grant financing and the operations of CDC. For example, lending to partner governments and enhancing private sector capital flows into developing countries.

8. 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.

9. The criteria being used to assess these options, including whether the UK should set up a separate legal entity for lending, are:

i) Development effectiveness: In terms of addressing barriers to poverty reduction and allowing a new partnership with these countries.

ii) Administrative requirements: The time needed to introduce an instrument, the skills required and cost of administration.

iii) Potential demand: This would need to be determined by a variety of factors including: if a country has a development financing gap, its debt levels as informed by the IMF’s Debt Sustainability Analysis, the nature of UK engagement, and if DFID has a comparative advantage.

iv) ODA and IDA frameworks: The UK’s development expenditure must adhere to the Official Development Assistance (ODA) guidelines and the UK’s International Development Act.

v) The implications for Government expenditure and borrowing: the extent to which an instrument might enable a higher level of ODA for a given level of government expenditure and the impact on the Government’s net public sector borrowing requirement.

10. For an independent development finance institution the administrative requirements and the implications for government expenditure and borrowing are particularly relevant. Officials are currently exploring the administrative costs of similar institutions as well as discussing with HM Treasury the impact on the PSBR.

11. For climate change related finance, DFID is increasingly financing intermediaries to provide loans, guarantees (an example being the Asia Solar Loan guarantee) and equity (e.g. CP3 Climate £110 million equity project) alongside grants and reimbursable grants (challenge funds). It has also invested in micro-insurance schemes e.g. for smallholder farmers and is looking at wider insurance schemes e.g. Africa Risk Capacity. These instruments give us more flexibility to address specific market failures e.g. equity is particularly useful for high risk businesses such as early stage ones. The Green Africa Power project uses debt with equity features to address the absence of long-term patient capital for power plant projects in Africa and a contingent credit feature to tackle power plant construction risk concerns. Along with bidding mechanisms such as advance market commitments or reverse auctions these instruments can reduce the risk of over-subsidy, which is important not just for taxpayer value for money but also to avoid distorting the market and crowding out competition or local finance players. Guarantees can address investors’ concerns around policy risk or perceived risks effectively or underwrite for example carbon market type instruments.

12. The OECD DAC definitions and rules set some constraints on the use of loans, equity and guarantees in a bilateral project. This is something a number of countries, including the UK, are raising in ODA reform discussions at the Development Assistance Committee and in the EU.

Question 4: Whether DFID has the right balance between bilateral and multilateral aid

13. Decisions on bilateral funding were based on the Bilateral Aid Review (BAR), which identified good value for money results offers from DFID country offices, (building bilateral allocations from the bottom up). Similarly, the decisions on core multilateral aid from 2011 up until now were based on the Multilateral Aid Review 2011 (MAR), which assessed value for money for UK aid across the multilateral organisations. Based on these assessments, Ministers increased funding to the best organisations, and stopped funding to the worst - except where wider UK interests or critical development roles implied a need for continuing UK engagement to urge reform. The MAR was commended by the NAO in its recent review, noting that "The Department’s multilateral aid review provided a much improved basis for deciding how to allocate funding and for promoting multilateral effectiveness."

14. In making decisions about our multilateral funding, wherever multilateral organisations are delivering outputs that could be delivered through DFID’s own bilateral programme we want to consider which channel would deliver the best value for money. It is important to note that there is not often direct competition between multilateral organisations and the DFID bilateral programme.  Instead, multilateral organisations often perform roles which complement those of bilateral programmes – delivering public goods such as international agreements, reaching the poorest in conflict zones where bilateral donors are not welcome, shaping markets to reduce the cost of vaccines for poor countries, managing large, complex regional infrastructure projects, for example – and this makes it difficult to make direct comparisons of value for money across the two channels.

15. Comparing DFID with other bilateral donors, the data suggests that DFID gives a slightly higher share of non-EU aid through core multilateral funding than most donors, but that it is well within the normal range of 20% to 30%. .

Table 1. Multilateral funding as a share of all aid for DAC donors 2011

Source: 2012 DAC Report on Multilateral Aid, OECD 2013

Question 5: What lessons can be learnt from other national donors

16. Some donors use their bilateral development agencies to directly provide a greater range of development finance instruments, from grants in low income countries, to loans at close to market rates in middle income countries. Loans to middle income countries often combine public budget funds with funds raised at capital markets. This allows those donors to provide financing that is specifically targeted to the country situation and the sector. Other bilateral agencies also use innovative ways of leveraging private sector resources. Germany, for example, uses their development bank, KFW, for loans, including structured models with first loss schemes.

17. In the US, USAID does not carry out sovereign lending but works directly in development finance through the Development Credit Authority (DCA). Guarantees do not score as ODA but they facilitate financial flows to developing countries. Since its establishment in 1999, DCA has facilitated $2bn of credit for 100,000 borrowers in 67 countries.

18. The Swedish Development Agency, SIDA, also has an innovative guarantee scheme for small and medium-sized enterprises, which underwrites working capital loans for trade. SIDA does this in addition to its ODA spending.    

19. Using bilateral agencies to directly provide a wider range of financing instruments can also have disadvantages, for example higher transaction costs for recipients of aid due the need for them to negotiate multiple agreements, deal with multiple donor missions and report in a variety of formats.

20. As part of its economic development focus, DFID is expanding its use of loans, guarantees, insurance schemes and equity alongside grants and reimbursable grants (challenge funds), we are working closely with other donors to learn from their experience.

Question 6: How DFID should monitor and influence expenditure by multilateral institutions, including in regions and countries where DFID does not have bilateral programmes

21. DFID gathers information on multilateral performance from a wide variety of sources, including: evaluations, assessments by the Multilateral Organisation Performance Assessment Network (MOPAN) and other bilateral donors, feedback from DFID country offices, feedback commissioned for the MAR from NGOs, visits to non-DFID-focus countries, and evidence from multilateral organisations themselves, either obtained through our membership of governing bodies, or specially requested.

22. The range and quality of these sources varies across the multilaterals. Full organisational evaluations based on country case studies tend to take place only every 3-5 years, if at all. MOPAN assessments, which usually gather evidence from 8-10 countries, are also on a 3-5 year cycle. Some organisations publish annual Development Effectiveness Reviews which synthesise information from across all of their operations, but many do not. DFID country office feedback, visits to non-DFID-focus countries, and feedback from NGOs are therefore important supplements to these other sources.

23. Core multilateral funding decisions are subject to the same programme management processes as other funding decisions in DFID. This includes annual assessments of progress against reform and results priorities, documented and published in Annual Reviews. Multilaterals are also being assessed this year through the MAR update process. This draws on information from all of the sources listed above, and compares and contrasts to draw out consistent messages. In some areas, the evidence base has been strong; in others, it has been weaker, and this will be set out clearly in the refreshed MAR assessments. DFID believes that the updates are a valuable assessment of the extent to which multilateral organisations have improved their performance since the MAR was carried out and published in 2011.

24. Individual bilateral projects and programmes delivered through multilateral agencies are also subjected to the same detailed scrutiny and the same business case process as all other bilateral aid. DFID spending departments are required to assess the strategic and tactical fit of the proposed programme, explore alternative options for delivering the same results, and analyse costs and benefits.

25. Gathering good quality evidence about in-country performance from across a wide range of countries remains challenging. DFID has focused on reforming MOPAN, so that it collects information on a wider range of organisations more frequently, and on accessing country office feedback from other bilateral donors with different country presence.

26. Influencing multilateral organisation performance takes place at different levels. The MAR has proved extremely successful as an influencing tool with MAR leadership. This impact has been amplified, as it has spurred others on to do similar exercises, often drawing on the UK’s MAR methodology (e.g. Australia, Canada) and/or data (e.g. Denmark). The multilaterals have been very constructively engaged with the MAR update – a clear indicator of how much it matters to them.

27. The UK is influential in the governing bodies of most multilateral organisations, partly because we are a relatively large funder and partly because our expertise in respected. However, the NAO noted in their report on DFID’s MAR published on 19 September 2012 that "they expected the Department to… tighten its approach to promoting and monitoring reform within individual agencies." Going forward, the Department plans to do more learning around influencing multilateral reform, drawing on best practice on evaluating influence.

28. At country level, DFID offices who are using multilaterals as delivery partners engage with them to improve their performance and feed information back to the centre as necessary. The relationship between the DFID UK office and country offices has been strengthened considerably over the last two years, with the recruitment of three country engagement managers. This is enabling DFID to take a much more consistent and consolidated approach to monitoring the value for money and effectiveness across the board from using multilaterals to deliver bilateral aid, and a much stronger and more systematic approach to promoting reform. 

June 2013

Prepared 21st June 2013