Chapter 5. Designing effective sector financing instruments and approaches

This chapter provides a cross-sector analysis of official development finance by the financial instruments, approaches and channels of implementation used by development partners. The first section focuses on the use of various instruments across sectors, outlining the main trends and patterns in the use of concessional and non-concessional resources. The second section explores funding patterns across the different financing approaches and implementation channels used in development co-operation across sectors.

    

Key messages

Key messages to providers of development co-operation emerging from this chapter include:

  • The interest and resources to promote commercial solutions that can close important financing gaps in infrastructure, climate change and social services are growing. For example, annual commitments from European Development Finance Institutions (EDFI) increased from USD 11 billion in 2005 to USD 36 billion in 2015, mainly driven by government replenishments and reinvested earnings. Recent political commitments to harness the potential of the private sector have been made in the Addis Ababa Action Agenda (AAAA), the Paris Agreement and intergovernmental processes by, for example, the Group of Twenty (G20) and the United Nations. This shows that political interest for this type of operations is growing.

  • The use of debt instruments to support the infrastructure and commercial sectors is growing, calling for increased attention to fiscal sustainability in countries most in need. While grants by development co-operation providers are increasing moderately at a compounded annual growth rate (CAGR) of 2%, loans are increasing at a CAGR of 7%, i.e. more than three times faster than grants. Debt vulnerability is becoming a concern in the most vulnerable economies, with the number of developing countries in debt distress or at high risk of debt distress doubling from 12 to 24 between 2013 and 2017.

  • Of sector-allocable official development finance (ODF), 8% is implemented using sector budget support and 4% is channelled using pooled funding. The Sustainable Development Goals (SDGs) call for increased policy coherence and more co-ordinated approaches. There is no definite answer to the question of how best to support sectors and cross-sectoral approaches using ODF, but pooled funding mechanisms and sector budget support can promote coherence and co-ordination across sectors and partners if well-funded and managed.

  • The untying agenda needs to be finished. Of the USD 69 billion of sector-allocable official development assistance (ODA) commitments formally tied by Development Assistance Committee (DAC) countries in 2012-16, 58% are in social sectors. Moreover, two-thirds of ODA procured by DAC countries in 2015-16 were awarded to companies from the donor country in competitive procurement.

  • While channels of delivery may vary, depending on sector priorities and strategies, development effectiveness and good donorship need to guide development partners’ efforts. For example, in the social and humanitarian sectors, bilateral providers need to implement good funding practices with civil society organisations and multilaterals implementing projects in the most challenging contexts. This is particularly true for those highly dependent on bilateral resources.

5.1. The sector allocation of official development finance instruments

This section discusses the major trends shaping the sector allocation of ODF instruments.1 It will first provide an overview of the different instruments used across sectors, including an overall thematic focus on instruments used in private sector operations. It will also present the main characteristics, challenges and opportunities arising from current trends related to specific instrument groups, i.e. grants, debt instruments, equity and investments.

5.1.1. A wide array of development finance instruments is used depending on the characteristics of each sector

ODF is provided through a wide variety of instruments

As indicated in Chapter 3, ODF consists of both concessional and non-concessional resources provided by bilateral and multilateral development partners. It can take the form of financial, technical or in-kind assistance (such as food aid and commodity). According to the OECD, ODF is provided using five main groups of instruments (see Figure 5.1):

  • Grants: transfers in cash and in kind, where no legal debt is incurred.

  • Debt instruments: transfers in cash and in kind where legal debts are incurred (e.g. loans, bonds and other securities) or could be incurred in certain events occur (e.g. reimbursable grants).

  • Equity: a share in the ownership of a company or a collective investment scheme.

  • Mezzanine finance: hybrid instruments, such as subordinated loans and preferred equity, that present risk profiles between senior loans and equity.

  • Guarantees/insurance: risk-sharing agreements under which the guarantor agrees to pay part or all of a loan, equity or other instrument to the lender/investor in the event of non-payment by the borrower, or loss of value in case of investment.

While grants, debt instruments, equity investment and mezzanine finance are funded positions (i.e. there is an upfront transfer of resources), guarantees and insurance are unfunded, which means that the transfer of resources occurs only in certain conditions, mainly if a default of payment or other financial loss occur.

Figure 5.1. Simplified taxonomy of official development finance instruments
picture

Source: Authors based on (OECD, 2018[1]), “Converged statistical reporting directives for the Creditor Reporting System (CRS) and the annual DAC questionnaire”, https://one.oecd.org/document/ DCD/DAC/STAT(2018)9/FINAL /en/pdf.

ODF instruments can have different levels of concessionality, which is a proxy for the level of subsidy or favourable treatment that development partners accord to public and private recipients. In this context, while grants are 100% concessional, the level of concessionality of the other instruments varies depending on their grant element, which is a proxy of concessionality compared to similar instruments available in the market. According to the new 2014 OECD DAC reform on loans, the concessionality of loans is calculated based on their interest rate, the grace period, the maturity and the discount rate (OECD, 2018[1]). The more these elements of loans are favourable for the recipients, the more the loan will be considered concessional.2

As shown in Chapter 4, the level of concessionality of ODF is generally higher for countries at a lower income level and with low fiscal and macroeconomic conditions. Favouring countries most in need is further encouraged in the new statistical framework agreed by the DAC in 2014.3 This new framework revised the treatment of loan concessionality in OECD DAC statistics, attributing higher levels of concessionality for loans to least developed countries (LDCs) and other low-income countries (LICs) compared to loans provided at the same conditions to middle-income countries (OECD, 2014[2]). This is in line with the AAAA, which states that concessional resources need to be prioritised to countries with the greatest needs and the least ability to mobilise other resources, such as LDCs (United Nations, 2015[3]).

Overall, grants are mainly used in social sectors, whereas loans, equity and guarantees are mostly provided for the infrastructure and commercial sectors

Grant funding is the main source of ODF in social sectors whereas debt, equity and guarantees are mainly concentrated in infrastructure, business and banking and production sectors (see Figure 5.2). Grants are traditionally used in social sectors, which generate low or no returns to be financed through revenue-making instruments (e.g. loans). Grants are particularly important for the most vulnerable countries and population groups, where social needs are generally high and capacity to mobilise other types of resources is low. Conversely, the infrastructure, banking and business, and production sectors mainly rely on loans. This is for two reasons: the first is that costs in these areas are too high for scarce grant finance; the second is that investments can be recovered from public and private borrowers by increases in tax revenues from higher economic growth and future cash flows from users and consumers (e.g. fees and tolls). Similarly, equity investment and guarantees, which are instruments used to support private investment, are mainly in commercial sectors because they can generate revenue, such as in energy and banking and business.

Figure 5.2. Grants support social sectors whereas loans and equity support economic sectors
ODF by instrument and sector, average 2012-16, 2016 constant prices, USD billion commitments
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Source: (OECD, 2018[4]), “International development statistics (database)”, http://www.oecd.org/dac/financing-sustainable-development/development-finance-data/idsonline.htm.

 StatLink https://doi.org/10.1787/888933856036

Development partners’ interest in instruments supporting the private sector is growing, particularly in areas where commercial opportunities exist

Development partners are engaging the private sector in a significant way, with an estimated annual amount that reached about USD 48 billion in 2016. This amount includes direct grants, interest subsidies, standard and syndicated loans, credit lines, direct investment in companies and participation in investment funds. However, it does not include the USD issuance value of credit enhancement and risk-mitigation instruments, such as guarantees and political risk insurance, as they are not financial flows. About two-thirds (60%) of these resources are loans, a fifth are grants and a fifth equity. Multilateral development banks (MDBs), particularly the International Finance Corporation (IFC) and the European Bank for Reconstruction and Development (EBRD) provided most of this financing (see Figure 5.3). Bilateral development finance institutions (DFIs) and aid agencies provided the remainder, with Nederlandse Financierings-Maatschappij voor Ontwikkelingslanden N.V. (FMO) being the largest DFI and the U.S. Agency for International Development (USAID) the largest aid agency.

Development partners channel resources to companies and financial institutions in areas with established commercial opportunities. These include banking and business, infrastructure and industry, which collectively receive more than two-thirds of total direct support for private-sector projects. Conversely, social sectors receive a tenth of the total, mainly from aid agencies, such as USAID and the United Kingdom government’s Department for International Development (DFID). This shows that the vast majority of financing support for the private sector is used to mobilise commercial investment in sectors where the private sector is active. It is also worth noting that support for banking and business is provided for projects in infrastructure, manufacturing and agriculture via investment funds or banks that on-lend to private companies, especially small and medium-sized enterprises (SMEs). Therefore, the banking and business sector should also be seen as a channel for investment in infrastructure and various industries, in addition to being a sector on its own.

Figure 5.3. Development partners support the private sector in areas with established commercial opportunities
ODF in support of private sector operations, 2016, USD billion commitments
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Note: some data include estimates from the author. See the Annex at the end of this report.

Source: (OECD, 2018[4]), “International development statistics (database)”, http://www.oecd.org/dac/financing-sustainable-development/development-finance-data/idsonline.htm and annual reports.

 StatLink https://doi.org/10.1787/888933856055

The increasing focus on private sector development is creating opportunities to mobilise additional finance for development

Mobilising additional private finance for development is one of the objectives of bilateral and multilateral development partners in their private sector development operations. However, amounts mobilised from the private sector through ODF instruments are still small when compared to the USD trillions that are needed to close the financing gaps to achieve the SDGs. In fact, according to a survey conducted by the OECD, amounts mobilised from the private sector accounted for an annual average of USD 20.3 billion between 2013 and 2015 (OECD, 2016[5]). Most of this financing was mobilised through guarantees and debt instruments, such as syndicated loans and credit lines, in areas with clear commercial opportunities, such as energy, banking and business, industry and mining and construction (see Figure 5.4). Conversely, equity instruments, such as direct investment in companies and shares in collective investment vehicles, mobilised less financing from the private sector compared to the other instruments, although they were used by a higher number of institutions.

The higher amounts mobilised through debt instruments and guarantees and lower levels from equity instruments can be explained by the fact that the magnitude of volumes and operations for loans and guarantees is much larger than for equity. In fact, as shown earlier in Figure 5.2, equity is only a small share of ODF from bilateral and multilateral development partners, whereas loans are the largest. For guarantees, it is more difficult to assess the potential of this instrument to mobilise resources as they are not financial flows, even though they do represent a risk for the provider. However, if one looks at the issuance value of the underlying instruments covered by guarantees, the magnitude of the operations would be much bigger than equity.

Figure 5.4. Amounts mobilised from the private sector by official development finance interventions are still small and concentrated in a few sectors
Amounts mobilised from the private sector by selected ODF interventions by sector, average 2012-15, current prices, USD billion commitments
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Source: (OECD, 2016[5]) “OECD DAC survey on amounts mobilised from the private sector by official development finance interventions 2012-2015”, http://www.oecd.org/dac/financing-sustainable-development/development-finance-standards/mobilisation.htm.

 StatLink https://doi.org/10.1787/888933856074

Albeit still relatively small, private amounts mobilised by ODF are set to grow considerably in the coming years. This is due to the increasing lending capacity of DFIs and MDBs as well as the increasing interest in commercial solutions for development. The AAAA, the Paris Agreement and intergovernmental processes at the DAC, the G20 and the United Nations clearly show a widespread political commitment to promoting commercial solutions for closing important financing gaps in infrastructure, climate change and social services [ (United Nations, 2015[3]); (G20, 2017[6]); (OECD, 2017[7])]. Political commitment to increasing private finance is reflected in unprecedented capital reforms by MDBs to increase lending capacity, including joint targets at the G20 level (AIIB et al., 2017[8]). In the same vein, the financial capacity of bilateral DFIs is expanding considerably. For example, EDFI’s annual commitments increased from USD 11 billion in 2005 to USD 36 billion in 2015 (EDFI, 2016[9]). This increase was mainly driven by government replenishments and reinvested earnings, and suggests a continued upward trend in the short to medium term. This trend is compounded by widespread interest of bilateral donors in providing commercial solutions for development, including through blended finance funds and facilities.

The growing interest in mobilising volumes of financing from the private sector points to the need for development partners to establish long-term strategies for addressing the needs of the private sector, including clear exit strategies and minimal use of concessionality. ODF can be strategically used to help private investment in development-related areas reach an appropriate scale. However, mobilisation strategies need to minimise the use of scarce concessional resources and envisage an exit strategy, so that private market financing can eventually self-sustain. This is in line with the recently agreed OECD blended finance principles, which state that blended finance operations should focus on commercial sustainability, minimise the use of concessional resources and have a clear strategy for the duration and exit of concessional finance [see Principle 2.c and 2.d in (OECD, 2018[4])].

5.1.2. Grants are mostly used for social sectors and agriculture in volumes that are stagnating

Development partners use grants for downstream projects mainly in social sectors and agriculture, in amounts that are stagnating

Grant funding is mainly concentrated in social sectors (including government and civil society), agriculture and multisector projects (including environment). The largest sectors are health and government and civil society. Beyond health4 and multisector programmes, grants to other sectors are stagnating (see Figure 5.5).

Figure 5.5. Grants for sectoral programmes are stagnating
Share of grants over other instruments by official development partners (left hand chart) and volumes of grants by official development partners by groups of sectors (right hand chart), 2012-16, 2016 constant prices, USD billion commitments
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Source: (OECD, 2018[4]), “International development statistics (database)”, http://www.oecd.org/dac/financing-sustainable-development/development-finance-data/idsonline.htm.

 StatLink https://doi.org/10.1787/888933856093

In addition to the budget constraints faced by bilateral providers, the stagnation of grants to other sectors reflects an increased use of these resources for non-sector-allocable operations, in other words, contributions that are not allocated to specific development programme areas – examples include general budget support, debt relief, humanitarian assistance and in-donor refugee costs (see also Box 2.3 in Chapter 2). In fact, grants for non-sector-allocable operations increased from USD 28 billion in 2012 to USD 57 billion in 2016, and a large part of this financing was spent on addressing humanitarian crises. In particular, the share of grant support for humanitarian assistance and in-donor refugee costs, which are non-sector-allocable operations, more than doubled within total grant volumes from 14% in 2012 to 30% in 2016. This shows that an increasingly large proportion of grants is provided for short-term humanitarian response rather than long-term development, such as for sector programmes.

DAC members account for the vast majority (82%) of sector grant funding committed every year by all bilateral and multilateral development partners reporting to the DAC (Figure 5.6). Multilateral agencies and funds, such as the Global Fund, Gavi, the African Development Bank (AfDB) and the Global Environment Facility (GEF) provide most of the remaining portion. The largest providers of grants among all donors are by far the United States and European Union institutions. They allocate on average USD 20 billion and USD 11 billion of sector grant funding per year, respectively.

Figure 5.6. Bilateral donors and vertical funds provide the bulk of grant funding for sectoral operations
Grants from development partners by provider and sector groupings, average 2012-16, 2016 constant prices, USD billion commitments
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Source: (OECD, 2018[4]), “International development statistics (database)”, http://www.oecd.org/dac/financing-sustainable-development/development-finance-data/idsonline.htm.

 StatLink https://doi.org/10.1787/888933856112

Sector grant finance is mostly used to fund easily identifiable outputs and advisory services for policy and institutional development

Development partners provide large amounts of grant resources to cover physical inputs and services procured in projects. For instance, between half and two-thirds of the 2016 USD 20 billion of grant finance for health, which is the largest grant-funded sector, is for purchasing medical goods and services to prevent and control infectious diseases, such as HIV, polio, Ebola, Zika, malaria and tuberculosis. Notable examples include multibillion programmes that provide anti-retroviral drugs, anti-tuberculosis medicines and other medical commodities, such as the United States’ President’s Emergency Plan for AIDS Relief (PEPFAR) and Global Health Supply Chain programmes. Other examples include programmes supported by the Global Fund to fight AIDS, tuberculosis and malaria (see Box 5.1).

Box 5.1. United States’ President’s Emergency Plan for AIDS Relief

The United States’ President’s Emergency Plan for AIDS Relief (PEPFAR) is a multibillion global health programme started in 2003 by President George W. Bush. In the period 2004-17 PEPFAR provided about USD 70 billion of grants for HIV/AIDS and malaria programmes. This was done either bilaterally through United States agencies or via core and earmarked contributions to multilateral organisations, particularly the Global Fund. In 2017, grant funding from the United States under the PEPFAR programme amounted to USD 7 billion.

Slightly more than half (55%) of PEPFAR support is earmarked for health treatment, 15% for palliative care, 20% for prevention programmes and 10% for projects targeting orphans and vulnerable children, including babies. PEPFAR-funded activities mainly cover the provision of anti-retroviral treatment health care services and health care services to prevent and respond to HIV/AIDS.

PEPFAR is led and managed by the U.S. Department of State’s Office of the United States’ Global AIDS Coordinator and Health Diplomacy. Beyond the United States’ Department of State, PEPFAR is implemented by seven US government departments and agencies, including: USAID, the U.S. Department of Health & Human Services; the U.S. Department of Defense; the Peace Corps; the U.S. Department of Commerce; the U.S. Department of Labor; and the U.S. Department of the Treasury.

Source: Authors based on [ (Kaiser Family Foundation, 2017[10]) and (PEPFAR, 2016[11])].

Large portions of grant finance are also used to support advisory services as well as technical assistance for governance and democratic participation implemented by various public and private agencies. These include central governments, non-governmental organisations, multilateral agencies and private firms. In these situations, while projects are reported as supporting local governments, they may be implemented by large consulting firms providing technical expertise. Two-thirds of support for governance, which is the second-largest grant-funded sector, is for advisory services and technical assistance for:

  • reforms on legal and judicial development and other public reforms (e.g. decentralisation, public financial management, modernisation of procurement)

  • civilian peacebuilding, conflict resolution and stabilisation programmes

  • human rights and democratic participation initiatives through core and non-core support to local non-governmental organisations.

Grant finance for policy and institutional development only accounts for a small portion of total grant resources to sectors, and is decreasing (see Figure 5.7). This includes technical assistance for policy reforms and institutional capacity building in areas such as public governance, environment policy, infrastructure policy and social sector policy. This could be explained by costs that are lower for technical assistance and other capacity-building activities than for physical inputs (e.g. medical drugs, machinery and social buildings). There is also an increased preference for donor support for specific projects with short-term and measurable impacts rather long-term, sector-wide approaches. However, more research is needed to better understand the reasons.

Figure 5.7. Sector grant finance for policy and institutional development is decreasing
Grant finance for policy and institutional development by sector (left hand chart) and by type of purpose (right hand chart), 2012-16, 2016 constant prices, USD billion commitments
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Source: (OECD, 2018[4]), “International development statistics (database)”, http://www.oecd.org/dac/financing-sustainable-development/development-finance-data/idsonline.htm. See Annex for a list of purpose codes selected.

 StatLink https://doi.org/10.1787/888933856131

Development partners are increasingly using grants for private-sector projects across sectors

Overall, development partners provided about USD 8 billion of grants directly to the private sector in 2016, most of which was from USAID, DFID and the European Union. Donors provide grant finance in their engagements with the private sector particularly to:

  • mobilise additional private finance (i.e. blended finance)

  • foster social and environmental impact (e.g. support innovative business models)

  • promote job creation and entrepreneurship, including for micro and small enterprises (see Section 5.2 below).

One example of support for these three objectives is DFID’s contribution to the Global Innovation Fund, the main goal of which is to promote social innovation. Another example is the European Union’s grants to microenterprises, which mainly aim to increase the competitiveness of companies to support job creation. In blended finance projects, DAC members use grants to bring projects to commercial viability. They do this by subsidising loans and equity, providing partial protection against investment risks, and funding technical assistance and feasibility studies for project preparation (OECD, 2018[12]). While these objectives are not mutually exclusive, development partner grants may emphasise one objective over another.

Overall, the interest of development partners is mainly growing for the support of blended finance to increase the volumes of financing in specific areas, particularly renewable energy and SME finance, which are especially underfunded. Grant finance is increasingly provided for blended finance operations, both upstream through replenishments of DFIs and downstream via blended finance funds and facilities, generally managed by DFIs and MDBs. Between 2000 and 2016, a total of 167 blended finance funds and facilities were launched, with a combined size of approximately USD 31 billion, mainly financed by DAC members (OECD, 2018[12]).

In light of this trend – and as grants for sector programmes are stagnating (Figure 5.5) – it is vital to ensure that these scarce concessional resources are prioritised to support initiatives with the highest potential for the most vulnerable people across sectors. As mentioned above, this is in line with the AAAA, which states that the most concessional resources need to be prioritised for countries with the greatest needs and the least ability to mobilise other resources, such as LDCs (United Nations, 2015[3]). It is also true for those sectors, such as the social sectors, that are experiencing major financing challenges and have less capacity to mobilise resources from the private sector (see Chapter 3).

Prioritising the concessional resources for the sectors and projects that need it most includes:

  • supporting business models and technology with more evident pro-poor impact (e.g. health technology, safe lighting, nutritious food and clean water)

  • promoting entrepreneurship among the poorest, who normally lack the skills and the resources to start and run sustainable businesses.

For example, the United States’ Helping Babies Breathe project mobilised private expertise to develop and implement evidence-based health-care practices to decrease neonatal mortality in 77 low-resourced countries. Early infant mortality was reduced by 47% and stillbirth by 24% in two years. Similarly, as mentioned in Chapter 3, mobile technologies promote financial inclusion by offering poor people previously inaccessible financial services. This has been shown by the development of mobile money transfer systems that are helping many poor people, including women, escape poverty and graduate from subsistence agriculture to small businesses (Suri and Jack, 2016[13]). In this context, M-Pesa is one of the most successful mobile money transfer systems. It increased financial access for millions of poor people in Kenya, and was kick-started with a GBP 1 billion grant from DFID (Martinez and McKay, 2011[14]).

5.1.3. The use of debt instruments to support the infrastructure and commercial sectors requires attention to fiscal sustainability in countries most in need

Multilateral development banks and a few large DAC members provide the majority of loans

Multilateral Development Banks (MDBs) and a few large DAC members provide the vast majority of concessional and non-concessional loans for development, mainly for the infrastructure and commercial sectors (see Figure 5.8). Among them, MDBs and Korea provided more non-concessional loans, whereas most DAC members, including the European Union, provide more concessional loans. In volume terms, loan amounts from the World Bank Group dwarf those of any other debt provider. They represent one-third of all concessional and non-concessional loans from bilateral and multilateral development partners reporting to the DAC. Moreover, while the concessionality of debt varies across sectors, the largest recipients are usually large middle-income countries, even when only concessional debt is taken into account. In fact, only a third of concessional debt was provided to LDCs and other LICs between 2012 and 2016. This can be explained by the fact that the volumes of financing needs are more important in countries with large and more advanced economies, because the volume of needs is higher and they have more capacity to absorb financing (see Chapter 3).

Figure 5.8. Multilateral development banks and a few DAC members provide the bulk of loans for development across sectors
Largest ODF providers of concessional and non-concessional debt by sector grouping (left hand chart) and sectoral distribution of ODF concessional and non-concessional loans (right hand chart), 2012-16 annual average, USD billion commitments
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Source: (OECD, 2018[4]), “International development statistics (database)”, http://www.oecd.org/dac/financing-sustainable-development/development-finance-data/idsonline.htm.

 StatLink https://doi.org/10.1787/888933856150

Between a fourth and a fifth of debt instruments is provided by development finance providers to private companies and financial institutions in banking and business, infrastructure and production. Debt instruments make up the largest portion of ODF for private-sector projects, particularly from MDBs. Private-sector loans and other debt instruments account for about USD 31 billion in 2016 when estimates from development finance providers not reporting to the DAC are included. A third of the total is from the IFC and EBRD. Debt instruments from DFIs and MDBs to the private sector cover:

  • large syndicated loans for infrastructure, including through public-private partnerships

  • senior and subordinated loans to both SMEs and large companies in manufacturing, agriculture, and mining and construction

  • credit lines to financial institutions that on-lend to SMEs in various industries

  • project bonds from infrastructure companies and funds.

Debt instruments are the main financing mechanisms for MDBs and a few bilateral DFIs, such as the Overseas Private Investment Corporation (OPIC) or the Oesterreichische Entwicklungsbank AG (OeEB), and for aid agencies, such as the Agence Française de Développement (French Development Agency). For MDBs, loans are mostly non-concessional but they are usually provided at better terms and conditions than alternative options available to developing countries.

The use of loans is increasing in most sectors and income groups, particularly in the infrastructure and production sectors

While grants are increasing moderately, at a CAGR of 2%, loans are increasing at a CAGR of 7%, i.e. more than three times faster than grants (see Figure 5.9). In volume terms, the trend reflects a widespread boost of non-concessional loans by MDBs and a global upsurge of infrastructure finance by both bilateral and multilateral providers, including in LDCs and other LICs. This is reshaping the ODF architecture across income groups and sectors. While in 2012 two-thirds of sector-allocable ODF to LDCs and other LICs were in the form of grants, these instruments only accounted for slightly more than half in 2016. This trend was driven by minor increases of grants in most sectors and a significant rise in concessional and non-concessional loans for the infrastructure and social sectors. In middle-income countries, there is a significant upward trend in non-concessional debt, which boosts resources for the infrastructure and production sectors in lower middle-income countries (LMICs) and financing for every allocable sector, including social sectors, in upper middle-income countries (UMICs).

Figure 5.9. Loans are playing a bigger role in most sectors in the development finance architecture, particularly in infrastructure
Shares of concessional and non-concessional loans in total ODF from bilateral and multilateral development partners (left hand chart) and total of concessional and non-concessional loans by sector groupings (right hand chart), 2012-16, USD billion commitment
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Source: (OECD, 2018[4]), “International development statistics (database)”, http://www.oecd.org/dac/financing-sustainable-development/development-finance-data/idsonline.htm.

 StatLink https://doi.org/10.1787/888933856169

Rising loans in the infrastructure and production sectors point to the need for increased attention to fiscal sustainability in countries most in need

Overall, the debt situation of developing countries is positive. External debt to gross domestic product (GDP) ratios declined significantly in the 2000s, thanks to high GDP growth, debt relief and countercyclical policies (Julks and Kawamura, 2017[15]). However, debt vulnerability is becoming a concern in the most vulnerable economies. The number of developing countries in debt distress or at high risk of debt distress doubled from 12 to 24 between 2013 and 2017 (IMF, 2018[16]). This can be explained by unproductive debt accumulation; the occurrence of shock, crises and disasters; and the hardening of loan terms and conditions for the poorest countries. The latter also borrow from the bond market and on semi-concessional terms from bilateral loan agencies, notably The Export-Import Bank of China and the Chinese Development Bank. This new debt composition in developing countries poses challenges both in preventing and resolving debt crises.

In this context, development partners need to continue to ensure the financial sustainability of their lending operations and provide technical assistance, including debt-management services and capacity building. Upstream policies,5 sovereign risk frameworks6 and other debt-assessment tools are used to evaluate countries’ ability to take on debt. However, these assessments can be optimistic due to overly ambitious growth forecasts and unpredictable shocks, such as commodity price changes, conflicts, epidemics and fraud (IMF, 2018[16]); (Mooney and de Soyres, 2017[17]). Particular attention is required in countries most in need, e.g. small island developing states (SIDS) and conflict-affected countries, due to fragile fiscal and macroeconomic situations and vulnerability to shocks and disasters. In these countries, the AAAA encourages using debt relief or other risk-reducing instruments, including exchanges of public debt obligations for social or environmental expenditure. Examples include debt-for-health and debt-for-nature swaps, GDP-linked securities, or catastrophe and pandemic bonds (United Nations, 2015[3]).

5.1.4. Equity investments are used to boost innovative private solutions

Equity investments can have a significant development impact by supporting business innovation for development and paving the way for the growth of high-potential companies. First, the equity participation of a development partner in a company can boost the confidence of private investors, in turn attracting commercial investors and reducing the cost of capital. This was the case, for instance, in the European Commission’s concessional equity investment in the Kenyan Lake Turkana Wind Power project via the Africa Infrastructure Trust Fund (OECD, 2018[12]). Second, investing in private equity funds that in turn support companies in developing countries can promote market-based solutions for development. This is especially the case when the fund targets areas with high positive social and environmental impact (e.g. seed funding or growth capital for SMEs, and funds investing in sustainable infrastructure).

Development partners provide equity instruments in private-sector projects with a much lower, but increasing, level of support compared to debt instruments (see Figure 5.10). OECD DAC data show that equity from bilateral and multilateral development partners increased from USD 4 billion in 2012 to USD 6 billion in 2016. If amounts from bilateral and multilateral development partners that do not report to the DAC are included, 16% of official support to the private sector is through equity instruments, particularly for funds investing in SMEs and infrastructure. The largest providers of equity are IFC, EBRD, CDC Group plc (CDC United Kingdom) and FMO (Netherlands).

Equity investments can support companies directly, particularly in manufacturing, and mining and construction. They can also support companies indirectly via collective investment schemes (such as investment funds providing seed funding or venture and growth capital for SMEs) or funds supporting energy and other infrastructure projects. The choice between direct investment in companies and investment in equity funds depends on a variety of factors, including:

  • the degree of control and engagement

  • risk-and-return profiles

  • expertise with the required corporate governance skills

  • country knowledge

  • industry experience (IADB, 2017[18]).

Figure 5.10. Equity investments are small but growing
Equity investments of sector-allocable ODF by sector groupings (left hand chart) and by type of partner (right hand chart), annual average 2012-16, 2016 prices, USD billion commitments
picture

Note: amounts from DFIs and other development partners not reporting to the DAC are not included.

Source: (OECD, 2018[4]), “International development statistics (database)”, http://www.oecd.org/dac/financing-sustainable-development/development-finance-data/idsonline.htm.

 StatLink https://doi.org/10.1787/888933856188

While most MDBs provide low shares of equity compared to loans, the picture within most bilateral DFIs is more nuanced. For instance, the CDC (United Kingdom), Norfund (Norway), the Swiss Investment Fund for Emerging Markets (SIFEM) and the Investment Fund for Developing Countries (IFU; Denmark) invest more through equity than debt instruments. The FMO (Netherlands), the German Investment and Development Company (DEG), the Compañía Española de Financiación del Desarrollo (COFIDES; Spain), the Società Italiana per le Imprese all’Estero (SIMEST Spa; Italy), the Belgian Investment Company for Developing Countries (BIO) and the Société Belge d’Investissement International (BMI-SBI ; Belgium) provide an even mixture of debt and equity (EDFI, 2016[9]). Examples of innovative equity investments include the Global Energy Efficiency and Renewable Energy Fund (GEEREF), which is advised by the European Investment Bank (EIB). GEEREF is a fund-of-funds that supports private equity funds investing in renewable energy and energy efficiency in developing countries. Another example of innovative equity investment by multilateral agencies is the EBRD Equity Participation Fund. It mobilises funds from global institutional investors to participate in 20%-30% of EBRD’s new direct equity investments above EUR 10 million.

5.1.5. Guarantees can boost private finance mobilisation in infrastructure and production sectors, but lack the appropriate incentive structure to be promoted

Guarantees and other risk-mitigation instruments are used by development partners to cover defaults of payments or other financial losses incurred by a lender or other investor. Risk-mitigation instruments include political risk insurance, foreign exchange risk mitigation or partial credit guarantees. The latter also serve to reduce default exposure and spread on project bonds in infrastructure funds and companies.

The main sectors in which guarantees are used are infrastructure and production. The largest provider of guarantees and risk-mitigation instruments is by far the World Bank Group’s MIGA. It provides insurance against political risks such as expropriation or civil disturbance, or partial risk guarantees to cover government non-payments. While smaller in size, other MDBs [e.g. IFC, the Asian Development Bank (AsDB), the Inter-American Development Bank (IADB), the African Development Bank (AfDB), the Islamic Development Bank (IsDB)], DFIs [e.g. Overseas Private Investment Corporation (OPIC), CDC, FMO, OeEB, Proparco and Norfund] and aid agencies (e.g. USAID) provide guarantees and other credit-enhancement facilities. For instance, the AsDB provides partial credit guarantees in local currencies to reinsure financial institutions’ first loss default exposure to project bonds issued by infrastructure project companies. Another example is USAID’s Development Credit Authority, which uses partial credit guarantees to cover loans for entrepreneurs who align with USAID’s priorities in agriculture, education, energy, the environment, health, infrastructure, SMEs, trade and water (OECD, 2016[19]).

There is certainly an interest from the development community in ensuring an appropriate level of guarantees for development. Nevertheless, achieving this objective has been hampered by lack of understanding and incentives for providing these instruments. Understanding and measuring the impact of guarantees has been notoriously challenging given that, unlike grants, loans and equity, guarantees are unfunded positions. In fact, unless guarantees are activated, there is no financial flow. At the same time, guarantees entail a cost for the providers that use these instruments, such as DFIs and MDBs among others, since they represent a financial exposure that limits space for new investment in the same way as loans would do. Since guarantees appear to be particularly complex instruments, development partners prefer providing loans as they are better known, more standardised and easier to manage. Therefore promoting the use of guarantees to mobilise finance in the highly underfunded infrastructure and production sectors will require a change in the incentive structure for guarantee providers. This could include:

  • using set-aside equity capital funds

  • providing incentives to staff to encourage the use of guarantees

  • reducing the equity capital allocation required for certain classes of guarantee (particularly partial/political risk guarantees)

  • unilaterally reducing pricing for guarantees (Humphrey and Prizzon, 2014[20]).

5.2. Improving financing approaches and channels within and across sectors

5.2.1. An integrated development agenda requires financing approaches that are coherent within and across sectors

The integrated nature of the SDGs reinforces the need to adopt coherent approaches based on country needs. For this reason, this subsection will highlight the challenges and opportunities arising from a growing development finance architecture, such as more financial resources for development and the emergence of competing and particularistic interests. Some topical areas will be discussed in more detail, such as the importance of sector budget support, pooled funding mechanisms and the untying agenda as ways to promote coherence within and across sectors and actors.

While a growing number of development partners increases sector financing for development, it also makes coherent and co-ordinated approaches more difficult

The development finance architecture is becoming increasingly complex as the number of development finance providers and intermediaries is growing (see Figure 5.11). Resources from taxpayers and private endowments are used to support country governments directly or are channelled in multiple ways through intermediaries such as CSOs and multilateral organisations or through private channels (such as companies and financial institutions). A growing galaxy of intermediaries is expanding resources for development operations as these institutions can pool financing upstream from a variety of public and private sources or by reinvesting earnings from revenue-making operations, such as loans. For instance, since the inception of their operations, the World Bank Group’s International Bank for Reconstruction and Development (IBRD) and IFC unlocked USD 900 billion of financing (mostly loans) with only USD 19 billion of paid-in capital (World Bank, 2018[21]). Capital was built through internal income, such as through capital markets and loan repayments.

Figure 5.11. The increasing complexity of development finance architecture
picture

Source: Author’s own stylised representation

Note: the representation above aims to show the potential complexity of the involvement of a galaxy of providers and intermediaries in the delivery of development finance, rather than being a comprehensive description of the entire development finance architecture. TA stands for technical assistance.

At the same time, a proliferation of actors and sources of finance brings new ways of working and potentially diverging interests into the development landscape. This might challenge co-ordinated approaches for development across sectors. For example, preliminary findings from an upcoming OECD report on multilateral development finance show that private sources and philanthropies are increasing resources for multilateral organisations in some sectors, particularly for health. However, the financing is piecemeal and often provided for areas that follow their own priorities rather than the strategic priorities of multilateral organisations (OECD, Forthcoming[22]). Similarly, an increased reliance on companies and financial institutions can leverage significant amounts of private financing in areas with established commercial opportunities. But this requires attention in balancing the commercial motives of private projects and the development objectives of official support provided for these initiatives [ (OECD, 2018[4]); (OECD, 2018[12])].

The 2030 Agenda requires increasing support through approaches that enhance policy coherence, such as sector-wide financing and joint funding mechanisms

Development partners allocate most of their sector financing for specific projects. The interest of development partners in supporting specific projects could be explained by the need to control resources and the preference for delivering outputs that are quantitatively measurable. This development finance paradigm is exemplified in results-based aid modalities, in which tranches of financing are disbursed when measurable outcomes are achieved. By contrast, development partners provide low shares of their resources as sector budget support and through pooled funding mechanisms (see Figure 5.12). However, sector budget support and pooled funding could increase policy coherence and better serve the achievement of an integrated development agenda if well designed and implemented.

Figure 5.12. Project-type interventions are prevalent in most sectors
ODF volumes for sectoral programmes by type of intervention (left hand chart) and shares of ODF for sectoral programmes by type of intervention and sector grouping (right hand chart), annual average 2012-2016, 2016 prices, USD billion commitment
picture

Source: (OECD, 2018[4]), “International development statistics (database)”, http://www.oecd.org/dac/financing-sustainable-development/development-finance-data/idsonline.htm.

 StatLink https://doi.org/10.1787/888933856207

Sector budget support can foster sector coherence, but policy conditionality needs to be aligned with country priorities

Only 8% of sector-allocable ODF is implemented through sector budget support, which is about loans, grants and technical assistance provided for the implementation of national sector strategies of recipient governments (e.g. energy, health and education). Resources are generally provided through the recipient government’s system, usually the ministry of finance. They are then channelled to the sector ministry or public agency responsible for budget execution (Williamson and Dom, 2010[23]). While policy conditionality is set at a broad thematic level, there is no earmarking on specific projects. In sector budget support (as well as in general budget support) donors and recipient governments negotiate overarching principles of reform and performance assessment frameworks to provide indicators for monitoring the implementation of reforms.

Sector budget support is mostly provided by multilateral organisations, particularly MDBs and the European Union (see Figure 5.13). MDBs mainly provide concessional and non-concessional loans for sector budget support, in amounts that are increasing. For instance, the World Bank provides development policy loans to support policy reforms in infrastructure, financial policy and public governance (e.g. public financial management, decentralisation and investment laws). Grant finance for sector budget support is less than loans and mainly provided by the European Union. Examples of grant-funded sector budget support includes the USD 1 billion committed by the European Development Fund in 2016 to support broad-based agricultural policy reforms to promote food security and agricultural development in Burkina Faso, Mali, Niger and Rwanda.

Figure 5.13. Sector budget support is mostly provided by multilateral development banks and EU institutions
ODF volumes for sector budget support by provider and sector (left hand chart) and shares of ODF for sector budget support by sector grouping (left hand chart), annual average 2012-16, 2016 prices, USD billion commitment
picture

Source: (OECD, 2018[4]), “International development statistics (database)”, http://www.oecd.org/dac/financing-sustainable-development/development-finance-data/idsonline.htm.

 StatLink https://doi.org/10.1787/888933856226

Proponents of sector (and general) budget support point out that this type of financing increases national ownership, aligns with domestic sector strategies, and allows for harmonisation among donors. However, detractors emphasise that it can lead to corruption and misappropriation of funds in contexts with high political and fiduciary risks. Nevertheless, a comprehensive review of general and sector budget support evaluations of donors suggests that evidence is needed to confirm the assumed risks of corruption of budget support (Orth et al., 2017[24]). However, evidence shows that this type of support improves public financial management and the provision of public goods and services when there is the institutional capacity and political will for reform of the recipient government (Orth et al., 2017[24]).

Pooled funding mechanisms can promote cross-sector approaches if well-funded and managed

Pooled funding mechanisms are financing vehicles that earmark or blend resources to support sector, integrated or system-wide programming and implementation. Providers contribute resources to an autonomous account, managed jointly with other providers and/or the recipient, or through more complex fund structures similar to multilateral institutions. The account or other fund has specific purposes, modes of disbursement and accountability mechanisms. Pooled funding mechanisms are generally administered by a multilateral agency or by a sector ministry in developing countries through basket funds. Their configurations can be quite diverse in terms of sector scope, geographic eligibility, financing model, funding governance, administration and implementation channels.

While far from being a panacea, pooled funding mechanisms can support a cross cutting and integrated development agenda, but need good governance and financing structures to succeed. These mechanisms offer the opportunity to increase the quantity and the quality of financing by:

  • consolidating scattered earmarked funding

  • promoting innovation

  • fostering policy coherence and co-ordination

  • increasing financial mobilisation (OECD, 2015[25]).

However, they can:

  • increase transaction costs and fragmentation

  • need governance mechanisms that ensure country ownership and co-ordination

  • require donor financing streams that are predictable and flexible.

In a similar way to sector budget support, resources channelled as pooled funding are small (4% of total ODF to sectors) and concentrated among a few donors, mainly bilateral providers and the European Union institutions, in governance and other social sectors (Figure 5.14). These amounts do not include support provided as core finance from bilateral donors to large multilateral pooled funds, such as Gavi or the Global Fund, as the large size and institutional complexity of these mechanisms make them more like multilateral organisations than pooled funds.

Amounts of pooled funding increased significantly in 2015 and 2016 thanks to increased support from the European Union through multisector trust funds in Africa. Multilateral pooled funding is much larger than support through basket funds, accounting for 81% of all resources channelled through pooled funding. Multilateral pooled funding mechanisms support a large set of activities across development, humanitarian and peacebuilding programmes, mainly created and managed by the United Nations and the World Bank. While United Nations pooled funds are mainly used for humanitarian and peacebuilding work, the World Bank’s managed or administered trust funds7 focus on health, environment, infrastructure, agriculture and SME finance.

Figure 5.14. A few DAC members provided most of pooled funding, mainly for governance, other social sectors and multisector projects
ODF for sector programmes channelled through pooled funding mechanisms by sector groupings (left hand chart) and by provider (right hand chart), annual average 2012-2016, 2016 prices, USD billion commitments
picture

Source: (OECD, 2018[4]), “International development statistics (database)”, http://www.oecd.org/dac/financing-sustainable-development/development-finance-data/idsonline.htm.

 StatLink https://doi.org/10.1787/888933856245

Interest in the use of multilateral pooled funds is growing, especially in the United Nations. In fact, the upcoming United Nations reform aims to double the share of financing received from donor through multi-donor trust funds in various sectors and themes in order to reduce the very high level of funding earmarked by donors at the project level. One of the initiatives for achieving this objective is to boost the SDG Fund. This international multi-donor and multi-agency development mechanism (created in 2014) pools resources from various donors in order to support multi-sector programmes and partnerships in various SDG-relevant themes.

Bilateral donor support for their national companies can stifle appropriate sector allocations if they prevail over assessments of local needs

The success of the 2030 Agenda will require supporting appropriate sector allocations based on country needs. In contrast to this, tied aid, which is ODA that can only be used to buy goods and services from the provider country, can stifle appropriate sector allocations of resources if motivated by the national interest of the provider rather than the local needs of developing countries. In fact, while case-by-case analysis is needed to evaluate the development impact of tied ODA, the risks are:

  • bias towards sectors of interest for donor companies rather than priority sectors of developing countries

  • reduced ownership of national development policy by the recipient countries

  • higher project costs due to uncompetitive procurement (Miyamoto and Chiofalo, 2017[26]).

DAC countries have significantly reduced formal restrictions in their procurement processes in the last decade. DAC members have committed to untie bilateral ODA to the greatest extent as suggested by:

  • a 2001 DAC recommendation on untying aid to LDCs, which was extended to non-LDC heavily indebted poor countries (HIPCs) in 2008

  • the aid effectiveness principles agreed in Paris and reiterated in Busan and Nairobi

  • the indicators used in DAC peer reviews and Global Partnership for Effective Development Co-operation (GPEDC) monitoring exercises.

OECD data shows that the share of tied ODA to LDCs and non-LDC HIPCs decreased significantly in 2005-15 – from 30% to 12% of bilateral ODA (which includes both sector-allocable and non-sector-allocable ODA) (OECD, 2018[27]).

However, the untying agenda seems to have slowed in recent years. The share of tied ODA commitments for allocable sectors to all ODA-eligible countries remained at an average of 18% of their total sector-allocable bilateral ODA8 between 2012 and 2016. Most (58%) of the USD 69 billion of ODA commitments formally tied by DAC countries in 2012-16 are for social sectors. Slightly less than half is for government and civil society, with the rest being equally split between health and education. Beyond social sectors, a fifth of sector-allocable tied ODA is for infrastructure (mainly transport), a tenth is for multisector projects and 5% is for agriculture. In terms of providers, about half (53%) of sector-allocable tied ODA from DAC countries is from the United States, and about a third (29%) is provided by Germany (16%), Japan (13%) and Korea (7%). Sector-allocable tied ODA from the United States is mainly spent on legal and judicial development and various disease-control interventions. From Germany it is spent on education, and from Japan and Korea on transport and other infrastructure.

Moreover, by looking beyond formal tying, OECD data show that a very high share of ODA is still awarded to companies from the donor country in competitive procurement. Tying generally refers to a legal/formal restriction for companies to participate in ODA-funded procurement based on nationality (de jure tying). But it can in fact also take place through various informal restrictions that favour companies from provider countries (de facto tying which is tying by default). Examples include advertising the tender in the donor country’s language or setting criteria that only certain firms can meet (Meeks, 2017[28]). In particular, about two-thirds of ODA procured by DAC countries in 2015-16 were awarded to companies from the donor country in competitive processes (OECD, 2018[27]). Case-by-case analysis is needed to demonstrate de facto tying practices. Meanwhile, the very high share of ODA procured to donor country companies raises some issues about financing awards in open procurement processes and points to the need for further analysis in this area.

5.2.2. Development effectiveness and good donorship need to guide development partners’ efforts, even if channels of delivery vary, depending on sectoral priorities and strategies

Development partners use different channels depending on their priorities, knowledge and country needs. This subsection will highlight the salient characteristics and issues of the sector financing channels, including by comparing bilateral and multilateral development partners. While the use of different channels is justified by the sector specialisation of development partners, this subsection argues that development effectiveness principles always need to guide development partners’ efforts.

Operations with country governments are mainly financed and implemented by multilateral (rather than bilateral) development partners in both the economic and social sectors

Bilateral development partners implement most of their ODF using channels other than governments, particularly in social sectors. By contrast, multilateral development partners channel most of their financing to governments. In fact, only a third of concessional and non-concessional finance from bilateral development partners reporting to the DAC was channelled to country governments between 2012 and 2016. This was mainly in infrastructure and to LMICs and UMICs rather than to LDCs and other LICs (see Figure 5.15). The remaining two-thirds of bilateral development finance beyond country governments is almost equally split between (i) donor agencies; (ii) external intermediaries, such as CSOs and multilateral organisations; and (iii) the private sector. Low levels of support through country governments beyond infrastructure may be explained by sector specialisations of implementing channels in certain sectors (e.g. companies in the production sectors). They may also be explained by mixed results in the public financial management agenda in some developing countries.

Figure 5.15. Large portions of bilateral development finance are provided beyond national governments, particularly in social sectors
ODF from bilateral development partners by channels (left hand chart) and sector groupings (right hand chart), annual average 2012-16, 2016 prices, USD billion commitments
picture

Source: (OECD, 2018[4]), “International development statistics (database)”, http://www.oecd.org/dac/financing-sustainable-development/development-finance-data/idsonline.htm.

 StatLink https://doi.org/10.1787/888933856264

Conversely, multilateral organisations provide higher shares of their sector-allocable ODF to developing country governments than bilateral providers (see Figure 5.16). This could be explained by the specialised knowledge of multilateral organisations in certain sectors (e.g. infrastructure), in policy and institutional reforms, as well as their extensive country presence. Multilateral organisations, particularly MDBs, are the largest providers of public sector loans for infrastructure. They are also the biggest providers of project loans and of sector budget support in social sectors.9 Moreover, the European Union provides large amounts of grants to governments for policy and institutional development in infrastructure sectors, the financial sector and for agriculture. In particular, the European Union is the largest provider of grant finance for policy and institutional development among all bilateral and multilateral development partners.

Figure 5.16. Multilateral organisations channel most of their financing to country governments, mainly in the infrastructure and social sectors
Shares of ODF for sectoral programmes from multilateral development partners by channel (left hand chart) and ODF volume for sectoral programmes by channel and sector groupings, annual average 2012-16, 2016 prices, USD billion commitments
picture

Note: Amounts behind bar charts are annual averages. Amount from EU institutions through EIB were moved from multilateral to provider agency. “Other or unspecified” might also include the private sector.

Source: (OECD, 2018[4]), “International development statistics (database)”, http://www.oecd.org/dac/financing-sustainable-development/development-finance-data/idsonline.htm.

 StatLink https://doi.org/10.1787/888933856283

A large use of CSOs and multilateral institutions in the most challenging contexts by bilateral development partners point to the need for strong policy dialogue and good funding practices, particularly with institutions highly dependent on their resources

As shown above, large portions of ODF from bilateral development partners are channelled beyond national governments. About half of bilateral development finance within sectors is implemented by donor agencies (17%), CSOs (14%), multilateral organisations (10%) and research institutions (4%). In the most challenging contexts, bilateral development partners prioritise implementation through external agencies, such as CSOs and multilateral agencies, rather than their own agencies. In fact, the share of financing channelled through CSOs and multilateral agencies in LDCs and other LICs is much higher than through donor agencies (see Figure 5.17).

Figure 5.17. Bilateral development partners use multilateral and CSOs in their priority sectors and in LDCs and Other LICs
Shares of ODF for sectoral programmes channelled by bilateral development partners through donor agencies by sector group and income group (top chart), multilateral organisations (middle chart) and CSOs (lowest chart), 2012-16 annual average, 2016 prices, USD billion.
picture

Note: shares by income group only include amounts allocated to specified income groups.

Source: (OECD, 2018[4]), “International development statistics (database)”, http://www.oecd.org/dac/financing-sustainable-development/development-finance-data/idsonline.htm.

 StatLink https://doi.org/10.1787/888933856302

A greater use of external implementing agencies in the most challenging contexts could be seen as a risk-management approach. This allows donors to transfer part of the programmatic and fiduciary risk to the implementing agencies (with their greater thematic and country knowledge) while retaining some degree of control (OECD, 2012[29]). Previous OECD research shows that DAC members value CSOs as partners when they have grass-roots knowledge of needs in developing countries and expertise in specific sectors and themes (e.g. poverty, environment, governance and human rights) (OECD, 2012[29]). Similarly, the 2018 OECD Survey on Multilateral Aid Policies and Allocations (OECD, Forthcoming[22]) shows that DAC countries partner with multilateral organisation that share national priorities and have a perceived comparative advantage in terms of expertise and specialisation, including in risky environments and LDCs (OECD, Forthcoming[22]).

The delegation of operations by bilateral development partners to CSOs and multilaterals in the most challenging contexts is particularly visible when humanitarian aid is taken into account. Figure 5.17 above does not capture this, as humanitarian aid is not considered an allocable sector in the DAC reporting system. As shown in Figure 5.18, DAC countries channelled significantly higher amounts to humanitarian assistance through CSOs and multilateral organisations than through their donor agencies and other channels. Amounts channelled by DAC countries through multilateral agencies and CSO for humanitarian assistance increased significantly from 2012 to 2016. The largest increases in funding were through multilateral channels, doubling from USD 5 billion in 2012 to USD 10 billion in 2016.

Figure 5.18. DAC countries channel most of their ODA for humanitarian programmes through multilateral organisations and CSOs
DAC countries’ ODA for humanitarian programmes by channel, 2012-16 annual average, 2016 prices, USD billion commitment
picture

Source: (OECD, 2018[4]), “International development statistics (database)”, http://www.oecd.org/dac/financing-sustainable-development/development-finance-data/idsonline.htm.

 StatLink https://doi.org/10.1787/888933856321

Increasing the delegation of bilateral development partners to multilateral organisations and CSOs in priority sectors and challenging contexts raises the question of establishing effective funding polices and partnerships among donors and intermediaries. This is particularly evident for CSOs and multilaterals that rely heavily on bilateral donor assistance to fund their budgets, because they may feel constrained to accept resources for operations that are not entirely aligned with their mandate and strategy. This challenge is particularly prominent in the United Nations development system – 80% of the revenue of its agencies and institutions is in the form of piecemeal earmarked contributions (United Nations, 2017[30]).

Multilateral organisations and funds can act as donors in their own right and use other multilateral organisations as intermediaries for project implementation

Multilateral development partners also use the multilateral system for project implementation, even if they do so to a lesser extent than bilateral donors. On average, 12% of concessional ODF from multilateral development partners is channelled through other multilateral organisations and 0.2% for non-concessional operations in 2012-16. However, sector-specific or thematic vertical funds and a few United Nations agencies allocate very high shares of their sector resources through the multilateral channel (Figure 5.19). By only taking into account concessional ODF, Gavi, GEF, the Climate Investment Funds, the International Labour Organization, the Nordic Development Fund and the Green Climate Fund (GCF) channel most of their financing through other multilateral organisations.

Figure 5.19. Vertical funds and a few United Nations agencies allocate very high shares of their sector resources through the multilateral channel
Sector-allocable ODA volumes from multilateral agencies through other multilateral agencies by sector grouping (left hand chart) and shares of sector-allocable ODF from multilateral agencies through other multilateral agencies by sector grouping (right hand chart), average 2012-16, 2016 prices, USD billion commitment
picture

Note: concessional finance channelled by the EU inst. through EIB is not included.

Source: (OECD, 2018[4]), “International development statistics (database)”, http://www.oecd.org/dac/financing-sustainable-development/development-finance-data/idsonline.htm.

 StatLink https://doi.org/10.1787/888933856340

The main implementing agency for the European Union is United Nations Development Programme (UNDP; 10% of total outflows through the multilateral channel), for Gavi it is the United Nations Children’s Fund (UNICEF; 84%), for the GEF is UNDP (41%), for the Climate Investment Funds it is IBRD (33%) and AsDB (30%), and for the Green Climate Fund it is EBRD (34%).

Contributions from multilateral organisations are increasingly significant as a source of revenue for other multilateral organisations, particularly for those working on social sectors that rely on grants, such as United Nations entities. The upcoming OECD Multilateral Development Finance Report shows that multilateral organisations account for a fifth of resources to the United Nations development system (OECD, Forthcoming[22]). For example, the European Union provided 10% of all funding to the UNDP and 5% to the Global Fund in 2016 (OECD, Forthcoming[22]). Therefore multilateral organisations, like their bilateral donors, need to provide resources that are adequate, predictable, flexible and aligned with the mandate of the recipient multilateral institution.

Development partners also use private channels for their development co-operation across sectors

Development partners use the private sector to increase the quantity and development impact of their resources. These operations can be quite diverse, reflecting a wide variety of partnerships with micro firms, SMEs, large industrial companies, multinational groups, banks and financial institutions of various sizes. Overall, the reasons why development partners engage with the private sector include:

  • Mobilising private finance: mobilisation is mainly carried out by DFIs and MDBs through blended finance approaches that attract private investment in sectors with clear commercial opportunities – such as energy, manufacturing and SME finance. Operations in social sectors also exist but are less prominent due to limited commercial opportunities. Examples include DFI and MDB lending and derisking operations, coinvestment platforms and blended finance funds and facilities. While in these operations debt, equity and guarantees are sourced from capital markets and reinvested earnings of commercial operations, significant amounts of grants are provided by DAC members through DFI replenishments, blended finance funds and facilities, and direct credit enhancement.

  • Fostering innovation for social and environmental impact: this objective is pursued to support business models with high social and environmental impact. Development partners can provide financial assistance (e.g. grant seed finance) or mentoring and technical assistance to companies with innovative business models and technologies. Examples include challenge funds, such as DFID’s Africa Enterprise Challenge Fund and the Swedish International Development Cooperation Agency’s Innovations Against Poverty Programme. These give grants to eligible companies to promote innovative business models in poverty reduction via competitive selection, particularly in agriculture and financial inclusion. Other examples include support from vertical funds (such as the GCF, the GEF, Gavi and the Global Fund) to companies with innovative business models and technology in the areas of environment and health.

  • Promoting entrepreneurship for job creation and poverty reduction: this objective aims to increase the productivity of local companies in order to promote local private-sector development and job creation (Miyamoto and Chiofalo, 2017[26]). Direct financial assistance and capacity building target companies, including small ones employing poor or disadvantaged people, e.g. in smallholder farming and informal manufacturing. For instance, Germany helps SMEs in developing countries through vocational training and by supporting business membership organisations, such as chambers of commerce and business associations, to foster investment and economic activity. Other donors channel resources to CSOs that work with small companies and farmers, such as the Netherlands and the United States supporting the Acumen Fund, which is a CSO supplying smallholder farmers in East Africa with asset-based financing and agricultural training services to reduce hunger and poverty.

As for any other channel of delivery, engaging with the private sector requires focusing on development results and supporting local priorities

Engaging with the private sector is needed to mobilise financial resources and expertise for development. At the same time, projects involving the private sector need to be inclusive and sustainable, and prevent social and environmental harm to local communities, just like any other development project. A priority in this regard is the implementation of environmental and social safeguards (ESS), which are policies, procedures and guidelines set by development partners to avoid, minimise or manage environmental and social risks in their operations. This is particularly true in large-scale infrastructure, which can have major impacts on local communities. While the need to comply with ESS is crucial for both public and private projects, it is increasingly recognised as a key element in the mobilisation of private finance. However, poor ESS monitoring and evaluation (M&E) by DFIs and MDBs means that they sometimes support private-sector projects that cause evident social and environmental damage for the local population [ (Roasa, 2017[31]); (Geary, 2015[32])]. This is all the more complex in engagements with financial intermediaries, as an extended chain of intermediation makes M&E more difficult [ (Geary, 2015[32]); (Roasa, 2017[31]); (CAO, 2017[33])].

Beyond ESS, private-sector engagements necessitate funding policies and practices responsive to local needs rather than the interest of donors and/or the private sector. This includes prioritising development over commercial objectives and investing in the local private sector rather than in donor country companies. DFI and MDB mandates may lack the explicit requirement of engaging with local governments and/or local stakeholders (e.g. local CSOs), threatening country ownership and alignment with local priorities (Pereira, 2016[34]). While alignment with local priorities is important in any sector, it is even more important in those with evident business opportunities where commercial motives could subdue development objectives. For instance, evidence from the mapping of private-sector partnerships in Uganda shows that the effectiveness of private partnerships decreases in sectors with stronger business opportunities – i.e. it is lower in financial services, medium in energy and higher in agriculture. This is due to low targeting of marginalised people, lack of systematic engagement with the government and poor M&E (see Box 5.2).

Moreover, the need to ensure the financial sustainability of DFIs and MDBs may push these entities to implement “bank-like” operations rather than development projects. This could explain why most of the operations of bilateral and multilateral DFIs are in UMICs and in sectors/projects with robust business cases, particularly in energy and financial services. In this regard, more effort is needed to support the riskiest projects, which include targeting the poorest countries and the poorest people. In blended finance, this will require a change of the incentive structure of DFIs and MDBs to prioritise the increase in development impact for the most vulnerable people over the increase in financial volumes from the private sector. This will also imply adapting skills sets and administrative processes to fragile contexts and addressing higher financial and programmatic risks for these projects.

Box 5.2. Developing the effectiveness of private-sector partnerships at sector level

The Global Partnership for Effective Development Co-operation (GPDEC) assesses the effectiveness of development co-operation projects and partnerships with the private sector. A mapping of 66 private-sector engagement (PSE) platforms at global, regional and sector levels found that sector approaches were more inclusive and country-owned, more likely to have an in-built monitoring and accountability function, and focused more on development results. Given that sector PSE platforms are often more focused and local in nature, these findings may not be surprising. Case studies subsequently conducted in Bangladesh, Egypt, El Salvador and Uganda echo the need for greater development effectiveness at the sector level as well. For example, a comprehensive review of 192 projects in Uganda in which the private sector has the implementation role finds that for agriculture, energy and financial services:

  • Only a limited number of the projects examined explicitly targeted the most marginalised people. This is the case for 44% of projects in agriculture, a critical sector for poverty eradication in Uganda. The figures are substantially lower for financial services (8.6%) and energy (2.3%). While other projects may still benefit those left behind, findings suggest that they do not focus enough on poverty impact and development additionality.

  • Most projects do not systematically involve the Government of Uganda or other local stakeholders as partners. This is the case in agriculture (40% involve local stakeholders, 11% the government), energy (16% engage local stakeholders, 12% the government) and financial services (1.7% involve both local stakeholders and the government).

  • There are significant information gaps in M&E. At best, 9% of projects in energy provide activity-level monitoring and 11% in agriculture are evaluated. The figures are even lower for the financial sector, suggesting considerable transparency gaps in PSE efforts in Uganda.

Sources: Authors based on (GPEDC, 2017[36]); (GPEDC, forthcoming[37]).

Finally, the impact and inclusiveness of private-sector engagements will require M&E systems that track and assess the link between private-sector engagements and the development results. However, the commercial nature of these engagements and the ensuing complexity and confidentiality of these operations make them difficult to monitor and assess. For example, many DFIs invest in funds located in offshore financial centres and tax heavens, which makes M&E even more challenging (Pereira, 2016[34]). In addition, further evidence is needed to prove the leveraging effect and in particular the development additionality of blending practices [  (OECD, 2018[12]); (Pereira, 2016[34]); (Oxfam, 2017[35])]. Development partners need to create systems that ensure financial allocations towards projects based on stronger evidence of financial mobilisation and development impact. These systems need to incorporate the effectiveness principles agreed in Paris and Busan, and more recently in the OECD blended finance principles (OECD, 2018[4]).

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Notes

← 1. The statistical data for Israel are supplied by and under the responsibility of the relevant Israeli authorities. The use of such data by the OECD is without prejudice to the status of the Golan Heights, East Jerusalem and Israeli settlements in the West Bank under the terms of international law.

← 2. While rules for calculating the concessionality of loans were well established in the 2014 reform, calculating the concessionality of other instruments (such as equity investments, mezzanine finance and guarantees) is still part of the ongoing process of modernisation of the DAC reporting system.

← 3. The statistical framework is currently in a test phase and will be applicable in 2019 on 2018 flows.

← 4. The increases of health financing in 2015-16 should be seen in the context of the Ebola crisis at the end of 2014, so the upward trend in this sector may not be structural, but rather related to the response by providers to this specific outbreak.

← 5. E.g. the International Monetary Fund (IMF) debt limits policy and the World Bank’s non-concessional borrowing policy.

← 6. E.g. the IMF-World Bank debt sustainability framework.

← 7. Such as financial intermediary funds, recipient-executed trust funds and World Bank-executed trust funds.

← 8. The share of sector-allocable tied ODA decreased slightly over the five years, from 19% of sector-allocable bilateral ODA from DAC countries in 2012 to 16% in 2016. While European Union institutions provide high amounts of tied ODA, which is procured to European Union member countries’ companies, it is not included in the calculation as it is a multilateral organisation.

← 9. Including governance.

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