3 Scaling Up Aid: Opportunities and Challenges in a Changing Aid Architecture
- International Monetary Fund
- Published Date:
- April 2008
The global aid landscape is undergoing profound changes in the way aid is financed and delivered. The new aid architecture is marked by the emergence of global funds and nontraditional bilateral donors; a growing role in aid of private foundations, nongovernmental organizations (NGOs), and corporations; and more public-private partnerships. Changes to the aid architecture are expanding the availability of resources for poor countries and spurring new and innovative ways of addressing pressing development needs. But they also pose new challenges for aid effectiveness.
The latest aid numbers point to mixed progress on aid volumes from traditional Development Assistance Committee (DAC) donors. Aid declined in 2006 and 2007 as major debt relief operations tapered off. To meet the commitment of the Group of Eight and other donors to increase aid by $50 billion (from 2004 levels) by 2010, donors will need to sharply accelerate the expansion of core development aid to an estimated 12 percent annual growth rate. However, preliminary evidence from the forward survey of donors’ aid allocations suggests that these rates are not yet sufficiently ambitious to meet the targets set for 2010. Yet, a substantial number of African countries and fragile states remain dependent on external assistance. Scaling up of aid is a priority if these countries are to attain the Millennium Development Goals (MDGs).
Assistance from non-DAC donors, both official and private, has grown in size and importance. The most dynamic parts of the aid system are the new players who are bringing fresh funding, enthusiasm, and business models into the system. Although traditional official donors remain major players in the development business, new public and private actors are committing growing volumes of financial assistance to the developing world.
The increasing complexity of the aid architecture also presents challenges. In particular, a proliferation of aid channels, fragmentation of aid, and a trend toward vertical programs and earmarking of funds pose new challenges for coherence and predictability in the delivery of aid. These developments call for better donor coordination, division of labor, harmonization of the new sources of aid with the principles of the Paris Declaration, and alignment of global public needs with national development interests. The upcoming Accra High Level Forum provides a timely opportunity to address these new, dynamic dimensions of the aid agenda.
The health sector epitomizes many of the challenges to aid effectiveness in the new aid architecture. A wide range of new donors and aid channels has contributed to a sharp increase in aid to health. At the same time, the multiplicity of donors and channels and a vertical focus on specific communicable diseases have made aid effectiveness and coherence more challenging. The need to address these issues is recognized by initiatives such as the International Health Partnership launched in September 2007. Health has been selected as a special focus sector in deepening and widening the Paris principles and monitoring their application.
Climate change is becoming an urgent concern, and addressing climate change activities in mitigation and adaptation will require significant increases in development finance. It is important that support to developing countries for mitigation and adaptation be additional and not divert resources from other development programs. New and innovative sources of funding will be required to support climate change activities.
The Heavily Indebted Poor Countries (HIPC) Initiative and Multilateral Debt Relief Initiative (MDRI) have substantially lowered debt burdens. Yet, vulnerability of economic activity to terms-of-trade and climate-related shocks presents a challenge to long-term debt sustainability of several post-completion-point HIPCs. Strong debt management as part of a sound macro framework and reforms to build resilience to exogenous shocks will help prevent debt burdens from becoming unsustainable again. On their part, creditors need to take debt sustainability considerations into account in their lending decisions.
Aid Trends and Prospects
Mixed Progress on Aid Volumes
A growing number of public and private actors are boosting global aid volumes. But the overall picture is mixed. Aggregate trends in volumes mask important differences across donor groups.
Stalling aid volumes.
The commitment of the Group of Eight and other donors to increase aid by $50 billion (from 2004 levels) by 2010, with half of the increase going to Africa, is becoming harder to achieve. Between 2002 and 2005, DAC donors managed a creditable increase in aid by relying on major debt relief operations, which have been instrumental in significantly reducing poor countries’ debt burdens and increasing fiscal space for priority spending. The latest DAC numbers show that the upward trend in official development assistance (ODA) stalled in 2006–07; after contracting by 4.5 percent in real terms in 2006, net ODA fell an additional 8.4 percent in real terms to $103.7 billion in 2007 (figure 3.1).1 Aid levels were pulled down as the exceptionally large debt-relief operations for Iraq and Nigeria tapered off.2 Most eligible countries will already have had their debts written off by 2010, so to meet the 2005 Gleneagles commitments, which were reaffirmed at Heiligendamm in 2007, donors need to find other channels through which incremental aid can flow.
figure 3.1DAC members’ net ODA flows and 2010 target
Of the $104.4 billion aid envelope from DAC in 2006, $73 billion was for core development assistance, which excludes bilateral debt relief, bilateral emergency assistance, and administration costs.3 The growth of this component of aid slowed to about 4 percent in real terms in 2006, below the 10.3 percent expansion reached in 2005 and also below the average annual growth of 5 percent during 2002–06. Prospects for meeting 2010 targets will depend on accelerating the growth of core development aid. To put this in perspective, assuming that debt relief falls back to levels of the early 2000s and the share of humanitarian assistance continues at current levels, core development aid would need to grow by about $40 billion or at an average annual growth rate of around 12 percent.4 Without such expansion, 2010 targets will not be met.
The decline in aid volumes pulled down the size of donors’ net ODA relative to gross national income (GNI). At 0.31 percent, combined net ODA/GNI in 2006 was below the level of the early 1990s and also below the 2010 projected target of 0.35 percent (based on announced commitments). The ODA/GNI ratio for DAC members of the European Union (EU) was 0.43 percent. There is considerable variation across donors, with five donors reaching or exceeding the United Nations ODA target of 0.7 percent of GNI, and two donors with net ODA less than 0.2 percent of GNI (figure 3.2).
figure 3.2DAC members’ ODA
Source: OECD 2008a.
Note: 2010 ODA/GNI are based on announced commitments and are not forecasts. Not all donors have announced forward commitments.
DAC members’ ODA shows a substantial shift in composition during 2004–06 (figure 3.3). The share of debt relief doubled, to almost one-fifth of the total. DAC donors’ contributions to multilateral institutions fell from nearly a third to a quarter, as a larger share of aid was provided bilaterally through exceptional debt relief. The share of technical cooperation also trended down—from 24 percent in 2004 to 21 percent in 2006.
figure 3.3Distribution of DAC members’ ODA by type
Source: DAC database and staff estimates.
Note: Administrative costs include in-donor country refugee costs.
Mixed response to scale-up opportunities.
Thanks to the progress countries are making in strengthening their development strategies and institutional frameworks for implementation, a broad range of countries can productively absorb increased aid flows. A recent World Bank report found that there are several strong performers, typically second-generation poverty reduction strategy (PRS-II) countries, where the strengthening of the strategic and institutional framework is sufficiently advanced to merit early delivery on the Gleneagles commitments.5 Also, a larger proportion of aid can be provided to these countries in the form of budget support. Some examples include Burkina Faso, Ghana, Madagascar, Mozambique, Rwanda, Tanzania, and Vietnam. There is scope as well for scaling up of aid in many first-generation PRS countries, starting with moderate increases but building to larger amounts as absorptive capacities expand. In these countries aid programs could comprise a mix of modalities such as budget support, investment projects, including sectorwide approaches, and technical assistance, depending on specific country circumstances. Examples include Armenia, Bangladesh, Honduras, the Kyrgyz Republic, and Mali. Fragile states, particularly postconflict and reengagement countries, also present opportunities for selective, focused, and carefully sequenced increases in aid for projects and programs tailored to their weaker governance contexts.
Despite the opportunities for scaling up, much of the expansion in ODA over 2002–06 has been concentrated in a few countries (figure 3.4). The pattern of concentration reflects, in part, global and security concerns—for example, Afghanistan and Iraq account for nearly half of the increase in ODA.6 Additional aid in the case of Nigeria and the Democratic Republic of Congo mostly reflects debt relief. Scaling up of donor support to countries that are well positioned to absorb more aid has been relatively limited, and there is also wide variation across countries. For example, the expansion in aid flows to PRS-II countries such as Burkina Faso, Ghana, Madagascar, Mozambique, Rwanda, and Tanzania, which had initially been singled out for scale-up efforts by the Organisation for Economic Co-operation and Development (OECD) DAC and the World Bank, is mixed: during 2002–06 aid flows expanded by around 50 percent to Burkina Faso and Madagascar and by about 40 percent to Ghana, while other countries saw modest increases or even a decline.
figure 3.4Top 10 recipients of the increase in net ODA, 2002–06
Source: DAC database and staff estimates.
The challenge of meeting targets.
It is not easy to set up new channels to disburse aid effectively. One of the fastest-growing programs, the Global Fund to Fight AIDS, Tuberculosis and Malaria (GFATM), was able to reach $1 billion in disbursements in its fourth year of operation. Another new agency, the United States’ Millennium Challenge Corporation, had committed $5.5 billion in multiyear aid compacts to 16 countries as of February 2008 but had disbursed only about $180 million.7 Though the new channels are making a contribution, the bulk of the increase in aid flows in the short to medium term will have to pass through traditional channels. However, the planning in most agencies to scale up to the required degree is not yet under way.
Preliminary evidence from the forward survey of donors’ aid allocations suggests that these are not yet sufficiently ambitious to meet the targets set for 2010. The 2007 survey adopted a new methodology—one where information on forward spending plans was collected for a subset of total ODA, defined as country programmable aid. The idea was to measure aid that is planned at the country level and for which forward spending plans are more likely to be available.8 Compared with the 2006 survey, donor response to the 2007 survey was higher, at 47 percent of coverage of estimated total country programmable aid for DAC members and 69 percent for multilateral donors.9 Nevertheless, signs of scaling up in donors’ plans are modest. And though Sub-Saharan Africa receives the largest increase, the survey indicates a planned increase in volume of country programmable aid of $100 million or more between 2005 and 2010 for only a handful of poor countries (IDA-eligible). The results also indicate that several fragile states are among those seeing increases in planned country programmable aid.
More encouraging are donors’ funding commitments to the replenishment cycles of the International Development Association (IDA) and the concessional windows of other regional development banks and GFATM. New donor pledges for IDA15 (covering the period mid-2008 to mid-2011) amount to $25.1 billion, representing the largest expansion in donor funding in IDA’s history and indicating strong support for IDA (see chapter 5 for details). The latest replenishment of GFATM also points to larger contributions by donors.10
Innovative financing approaches can help raise funds for short-term needs or provide long-term, sustainable funding for development. The solidarity tax on airline tickets was introduced in France in mid-2006, and has been implemented since then in Chile, Côte d’Ivoire, the Democratic Republic of Congo, the Republic of Korea, Madagascar, Mauritius, Niger, and Norway. Another 15 countries are in the process of implementing the tax. The funds are used to finance UNITAID, an international purchase facility for drugs and treatments for HIV/AIDS, malaria, and tuberculosis. The contributions to UNITAID’s budget for 2008, financed primarily through air ticket taxes, are expected to be $364 million. The International Finance Facility for Immunisation (IFFIm) provides frontloading to support development investments that are needed in the short term, even though donor funding is available only over the long term. IFFIm was established as a new supranational in 2006, with some $4 billion in assets in the form of irrevocable donor grants paid over 20 years. IFFIm’s first triple-A rated $1 billion bond issuance funded immunization programs of the Global Alliance for Vaccines and Immunizations (GAVI).
Overall, however, DAC donor intentions of scaling up assistance are falling short of promised increases. A stronger and more expeditious donor response is needed to support opportunities that exist in a number of countries for scaling up development results and accelerating progress toward the MDGs.
Expanding Role of Non-DAC Donors
New players such as non-DAC bilaterals, private entities, and vertical funds are the fastest-growing sources of funds. Their increasing role is changing the aid landscape. New donors and modalities promise more resources and innovation for development.
Non-DAC bilateral donors.
The number of non-DAC countries that now provide aid has risen steeply to nearly 30. That number includes emerging market countries such as Brazil, China, India, Malaysia, the Russian Federation, Thailand, República Bolivariana de Venezuela, and a number of oil-rich countries. These donors now provide significant resources, totaling perhaps $8 billion annually (figure 3.5a). Non-DAC OECD countries are providing sizable amounts of aid and have plans to substantially scale up flows; for example, Korea, which provided $455 million in 2006, has plans to provide $1 billion of ODA by 2010.11 Non-DAC OECD countries are expected to double ODA by 2015. New EU member countries (not members of the OECD) could well reach ODA effort of 0.17 percent of GNI by 2010 and 0.33 percent by 2015. Middle Eastern countries provided $2.5 billion in assistance in 2006, with Saudi Arabia contributing $2.1 billion (as reported to the DAC). Firm data on assistance from other bilaterals are not available. Estimates place aid from China and India at about $3 billion annually, and both countries are developing larger aid programs.12
figure 3.5Rising trend in aid from non-DAC bilaterals and NGOs
Source: DAC database; Kharas 2007a.
Note: Data for non-DAC bilaterals are for countries that report to the DAC; OECD non-DAC countries include the Czech Republic, Hungary, Iceland, Korea (Rep. of), Poland, the Slovak Republic, and Turkey; Arab countries are Kuwait, Saudi Arabia, and the United Arab Emirates; and other bilateral donors are Israel, Taiwan (China), and Thailand. Data for China and India are estimates.
Private donors now contribute substantial amounts of aid. Net grants from NGOs in DAC countries are estimated by the OECD at $14.6 billion in nominal terms in 2006. Although these grants leveled off in 2006 in real terms, they have grown by nearly 40 percent during 2004–06 (figure 3.5b). Other estimates suggest that the total amount of private international giving, from NGOs as well as other entities such as corporations, educational institutions, and religious organizations, may be substantially larger. One estimate places private international giving from all sources in the United States alone at $33.5 billion.13 A survey estimates that a little over a third of this amount is related to emergency assistance.14
Globally, there are thousands of international NGOs, foundations, and corporations now engaged in transnational development activities.15 There are also tens of thousands of developing-country NGOs that are increasingly active in raising local funds for development, and possibly millions of community-based organizations that implement development projects. Private players are changing the aid landscape in two ways. They are providing significant sums of money to complement official aid, and prospects for continued strong expansion are good—for example, the Gates Foundation alone disbursed over $1 billion in 2006, and the outlook is for a ramping up of disbursements to about $3 billion annually in a few years.16 And they operate largely outside official structures, dealing directly with local beneficiaries.
Innovative approaches to financing development have also spurred increased voluntary contributions from individuals. Individuals holding “affinity” credit cards, for example, agree to make small contributions proportionate to their purchases. Investment funds can also generate contributions; IDA receives a part of the manager fee income of the World Bank Bond Fund established by Japanese financial institutions. (PRODUCT) RED, launched in 2006, raises funds for GFATM HIV/AIDS programs in Africa, as partner corporations design and sell (RED) products and make corresponding contributions. By the end of 2007, contributions of the corporate partners totaled more than $50 million.
Vertical funds—or funds that are focused on specific objectives, such as fighting particular communicable diseases, for example, GFATM and GAVI—are one of the most rapidly increasing sources of official aid and have also become platforms where the private and official sectors can cooperate with funding and expertise. New vertical funds have disbursed about $7 billion over the last five years.
Aid to Sub-Saharan Africa Growing, at a Modest Pace
Financial globalization is contributing to a widening range of financing options for developing countries. Yet, for a substantial number of poor countries in Sub-Saharan Africa and for fragile and conflict-affected states, official development assistance remains important. Scaling up of aid is a priority if these countries are to attain the MDGs. For low-income countries in the region, ODA accounts for almost two-thirds of all external financing on average.
Although aid to Africa has risen, new aid has been largely debt relief. DAC donors are providing larger amounts of bilateral aid to the region and are allocating a larger share of ODA to Sub-Saharan Africa—over a third in 2006 compared to about a quarter in 2000. Overall, aid flows from DAC and multilateral donors to the region climbed to $40 billion in 2006, representing an increase of $6.9 billion in real terms over 2005 levels and $12.4 billion over 2004 amounts. The expansion in net ODA, excluding debt relief and humanitarian assistance, has been limited, however, accounting for less than a third of the expansion in ODA to the region in 2006 and a fifth of the increase in aid during 2004–06 (figure 3.6). Debt relief has benefited recipient countries through reduced debt burdens and expanded fiscal space for development spending. As debt relief operations taper off, other types of aid to the region will need to rise sharply if the Gleneagles commitment to increase ODA to Sub-Saharan Africa to $50 billion (a doubling from the 2004 level) is to be achieved.
figure 3.6Net ODA to Sub-Saharan Africa
Source: DAC database and staff estimates.
Note: Net ODA received from DAC donors and multilateral donors.
Assistance to Fragile States: Issues of Timing and Duration
Fragile states face the toughest challenges in achieving progress toward the MDGs.17 More than four-fifths of fragile IDA countries have been subject to conflict. Conflict is one of the main reasons why countries slide into fragility. While the number of conflicts in low-income countries has been declining, the risk of reversal in postconflict countries is high: around 40 percent of countries relapse into conflict in the first decade of postconflict recovery.18 Recent research suggests that conflict risk is particularly high in the first four years of a peacekeeping operation, decreasing thereafter but still remaining significantly above the level of risk in other (non-postconflict) low-income countries. It also appears to be correlated with the timing of elections, with the risk of relapse increasing in the year following an election.19
Size and pattern of assistance.
Development assistance to fragile states rose from $9.7 billion to $26.2 billion between 2002-06, a doubling in real terms.20 Bilateral donors, the source of about 90 percent of ODA flows to fragile states, accounted for most of this increase, much of it associated with debt relief. Support to individual countries varied widely; countries affected by conflict and post-conflict countries typically received much more aid than other fragile states.21 For example, between 60–70 percent of the aid to fragile states in 2005 and 2006 was concentrated in four countries—Afghanistan, Democratic Republic of Congo, Nigeria, and Sudan.
One perspective on the effectiveness of assistance in fragile situations is to evaluate the timing and duration of assistance—namely, whether it was provided during periods of highest conflict risk.22Figure 3.7 shows that in a sample of 54 cases both peacekeeping expenditures and development aid dropped sharply in the fourth year following the deployment of a new peacekeeping operation.23 This drop coincides with the period directly following the first post-crisis elections and may reflect certain donor considerations: commitments to deploy peacekeepers up to the elections and then draw them down immediately following the election itself, or donor concern over the potential to manipulate aid for political advantage. Evidence on the high risks accompanying post-election periods suggests the need to maintain both peacekeeping and development aid at a consistent level until the risk of conflict relapse has diminished. The data also show that aid tends to taper off mid-decade, even though conflict risks remain significant and just when countries have rebuilt or strengthened capacity to better absorb aid. This pattern of assistance to post-crisis countries may be driven by popular media coverage of crises, or the so-called CNN effect—large-scale commitments are provided when crises are visible in the mass media, but this support drops off as media coverage declines.24 But a sharp decline in aid mid-decade may well miss an opportunity to consolidate the early gains of peace.
figure 3.7Conflict risk, aid, and peacekeeping
Pattern of peacekeeping and aid expenditures against conflict risk in the years following the deployment of a new peacekeeping operation
Source: Cliffe and Milante 2008.
Note: The first year of peacekeeping is denoted as zero.
Strengthening coordination in fragile situations.
The international community is taking steps to strengthen coordination of activities across as well as within peacekeeping, humanitarian, and development areas—examples are the OECD’s formulation of Principles of Good International Engagement in Fragile States and the establishment of the UN Peace-Building Commission. Recently, the multilateral development banks (MDBs) have agreed to a common goal for MDB engagement in fragile states, a set of guiding principles for MDB engagement, and a set of operational and implementation arrangements that will contribute to improved coordination among the MDBs. 25 As part of this, the MDBs also agreed on a shared approach to identifying fragility and on the need to continue to have regular consultations on priority country situations. OECD DAC is developing practical guidance on state-building in fragile situations. It is also evaluating development effectiveness in situations of fragility and conflict and the applicability of the Paris Declaration in these situations.
Donor Response to Climate Change: Scale-Up of Resources Needed
Climate change has the potential to seriously undermine development progress. The impacts of climate change include, among others, increased frequency and severity of droughts, floods, and storms; decline in agricultural productivity and food security; further spread of water-related diseases (particularly in tropical areas); population displacement; and conflicts over scarce resources. With increasing climate variability and risks, the poorest countries and communities, particularly in Sub-Saharan Africa and Southeast Asia, are likely to suffer the earliest and most because of their geographical location, low incomes, and low institutional capacity, as well as their greater reliance on climate-sensitive sectors like agriculture. Addressing these challenges requires urgent action on several fronts: mitigation, adaptation, and the global humanitarian system. Chapters 6 and 7 address the challenge of combating climate change and promoting environmental sustainability. The focus here is on the donor community’s mobilization of resources to assist developing countries in meeting this challenge and dealing with its impacts.
The rising frequency and severity of natural disasters has focused increased attention on humanitarian aid. Humanitarian aid has risen, and new donors and new ways of delivering humanitarian assistance are changing the response to disasters. There is a wider application of good humanitarian donorship principles that call for more adequate and equitable assistance, provided in a timely manner, and with a larger share being channeled through consolidated appeals processes.26 Despite the global concern with humanitarian issues, there is still a gap between needs and funds: 72 percent of estimated funding requirements were met in 2006 compared with 59 percent in 2000.27 High-profile disasters receive more resources and attention than less visible ones: a drought in Niger might see $20 per capita in assistance, while a visible crisis such as the South Asia earthquake might receive $300 per capita.28
The total size of global humanitarian assistance is not readily available. The Global Humanitarian Assistance Report 2006 estimates the amount to be $18 billion in 2005, compared with $10 billion in 2001.29 Humanitarian assistance from DAC donors shows an upward trend—the size of bilateral emergency and disaster relief was $7.1 billion in 2005 (boosted by the Indian Ocean tsunami and the South Asia earthquake) and $6.6 billion in 2006 (figure 3.8). DAC bilateral humanitarian assistance is highly concentrated, with the top five recipients receiving nearly 50 percent of the resources. The Financial Tracking Service (FTS) of the Global Humanitarian Aid Database shows that private sources of funding rose sharply in 2005 to nearly $4.5 billion, but have since fallen back to much lower pre-2005 levels.
figure 3.8Humanitarian aid, 1970–2006
Source: DAC database, FTS, WFP, and Lee 2008.
The European Union collectively is the leading provider of humanitarian assistance, providing $3.7 billion of humanitarian aid in 2006. The EU has adopted a common vision, policy objectives, and shared principles to enhance the coherence and effectiveness of EU humanitarian aid.30 These principles emphasize adequacy and equity in provision of humanitarian aid, partnership, effectiveness and accountability, and capacity to respond rapidly.
Along with seeking to provide more timely and adequate aid, new approaches to humanitarian assistance emphasize prevention and longer-term risk reduction. Poor countries need to develop the capacity to monitor and respond to risks if they are to reduce their vulnerability. An essential component of the EU’s approach is promotion of disaster risk reduction strategies and preparedness activities. The World Bank’s Global Facility for Disaster Reduction and Recovery (established in 2006) helps developing countries fund projects and programs that enhance local capacities for disaster prevention and emergency preparedness. New approaches to humanitarian response also recognize that a smooth transition from relief to rehabilitation and recovery is critical to aid effectiveness. This calls for strengthened cooperation between humanitarian and development agencies and other actors.
Funding mitigation and adaptation.
Addressing climate change in developing countries requires financial flows and technological support much beyond current public funding levels. The UN Framework Convention on Climate Change (UNFCCC) estimates that by 2030 financial flows to developing countries should be on the order of $100 billion annually to finance mitigation and somewhere between $28 billion and $67 billion for adaptation. Focusing on adaptation only, the Human Development Report concludes that the additional cost will be $86 billion a year by 2015—$44 billion for climate-proofing development investments, $40 billion for adapting poverty reduction programs to climate change, and $2 billion for strengthening the disaster response system.31
The UNFCCC process has created a number of avenues for increasing financing for mitigation (essentially through the creation of a carbon market, under the Kyoto Protocol) and adaptation (with the Global Environment Facility, or GEF, a key instrument to develop a knowledge base for adaptation). To comply with their obligations under the Kyoto Protocol, industrial countries can, above and beyond domestic emissions reductions, trade emission permits or purchase emission reduction credits from projects in developing countries using the Clean Development Mechanism (CDM), or in economies in transition using Joint Implementation. This has led to a vibrant global carbon market reaching an estimated $30 billion in value in 2006, three times greater than in 2005. According to preliminary estimates, this growth continued in 2007 (roughly doubling over 2006). The CDM unambiguously dominates the project-based market, with more than 1 billion Certified Emissions Reductions (CERs) transacted (from 2002 onward), for a cumulative value exceeding $17 billion. By some estimates, the CDM—in 2006 alone—leveraged approximately $9.2 billion in clean technology investments in developing countries, about 48 percent of their total investments in clean technologies. Finally, the carbon market provides additional resources for adaptation, through a 2 percent share of proceeds on CERs issued for a CDM project activity, collected in the Adaptation Fund (together with other sources of funding). The size of the Adaptation Fund could reach $100 million per year, or more, depending on the activity of the carbon market.
In contrast to the rise of carbon finance, resource mobilization under the GEF has been modest. But the GEF has been a key instrument for addressing climate change (particularly adaptation), through its significant leverage power: during 1991–2007, the GEF allocated $2.3 billion for climate change projects.32 The GEF continues to rely principally on voluntary contributions—an arrangement that reduces the predictability of finance.
Clearly, new and innovative sources of funding will be required to support climate change activities as highlighted in the Bali Action Plan. The action plan embraces mitigation of climate change (including, for the first time, consideration of reducing emissions from deforestation and land degradation), adaptation, technology development and transfer, and provision of financial resources in support of developing countries’ actions. The latter include, in particular, better access to predictable, adequate, and sustainable financial support and provision of additional resources; mobilization of public and private sector funding and investment, including facilitation of climate-friendly choices; and positive incentives for developing countries to enhance mitigation and adaptation actions. There are some encouraging developments in this direction, including joint efforts by the World Bank and other MDBs with interested parties to establish a portfolio of strategic climate investment funds to facilitate early transformational climate actions.33
The Challenge of Aid Effectiveness
New donors and modalities promise more resources and innovation, but the increased complexity of the aid architecture adds to the challenge of ensuring effectiveness and coherence of aid. As aid increases and involves more players, three challenges present themselves: how to integrate the new players harmoniously into the overall aid framework; how to develop modalities that would permit new aid commitments to be met in an effective way; and how to improve the efficiency and effectiveness of aid through better aid delivery.
The Paris Declaration addresses some of these issues. The Paris framework represents the international community’s consensus and resolve to improve the effectiveness of aid. Implementation of the Paris Declaration is spurring important reforms of the aid system. But many of the new donors bypass traditional channels and institutional arrangements. The Accra High Level Forum scheduled for September 2008 provides an opportunity to address the new, dynamic dimensions of aid harmonization. The forum will review progress on implementing the Paris Declaration, address new challenges, and help shape the evolution of the aid effectiveness agenda moving forward.
Integrating New Players into the Aid Architecture: Competitive Pluralism
The current aid system is organized around a dialogue between a recipient country government and its major aid donors. These country-level platforms coordinate development resources with country priorities and translate broad strategies into specific projects and programs. Donors are asked to be responsive to country development priorities; recipients are asked to be focused on implementation of projects and programs. The challenge of integrating new players into this framework arises on many fronts. The new players may not have the flexibility to respond fully to recipient priorities—they tend to be organized to deliver on a narrower set of areas. Vertical funds have specific mandates, the non-DAC bilaterals may have selected expertise to share, and private donors must specialize to attract funds. At the same time, the new players tend to have limited country presence and participation in the development dialogue. And the sheer number of players implies that the process of face-to-face dialogue between governments and donors is harder to manage.
Other challenges also present themselves. Some new players eschew government agencies for implementation of their projects, either choosing private nonprofits or else undertaking implementation themselves. That raises issues of whether local capacity and institutions are being strengthened or weakened.
The aid architecture must recognize the opportunities and challenges that come with the new players. It will be difficult to bring all sources of aid under the same umbrella of a country-level platform. The most urgent needs are for better information sharing, learning, and evaluation of innovations and scaling up. There is currently not enough information on the operations of the new players. When donors have different approaches to a problem, it is important to do comparative analysis to establish which ones are more cost-effective. A harmonized, coordinated system must be complemented by an openness toward alternative approaches and the innovation they may bring. Competitive pluralism needs to be built into the aid architecture.
Innovative Financing for Development
Recent innovative approaches include creating new competitive markets for undersupplied goods and services, shifting risk to resolve market failures, and using results-based financing. Expanded partnerships involving both donor and developing country governments, multilateral institutions, the private sector, and civil society are also exploring innovative approaches to development financing. The Bill and Melinda Gates Foundation, for instance, has been a substantial supporter of innovative initiatives, funding exploration and design work for many new initiatives, in particular in the health sector. In cooperation with the International Finance Corporation (IFC), it seeks to encourage the private sector to invest in health care in Africa. The IFC plans to set up a $300 million–$350 million equity fund to invest in health care businesses and a $400 million–$500 million debt vehicle to provide long-term finance to health care organizations.
Several initiatives link funding with performance or results-based outcomes. The U.S. Millennium Challenge Corporation provides assistance to countries showing good performance according to key indicators. Debt buy-downs link debt relief with successful project implementation. The $1.5 billion Advanced Market Commitment (AMC) pilot is results based, subsidizing vaccines against pneumococcal diseases, which kill 1.6 million people every year (including 1 million children), overwhelmingly in poor countries. Donors commit to fund an AMC of a specified market size and price for vaccines that meet set specifications to ensure public health impact in developing countries. AMCs encourage the development of target products, but only subsidize actual product sales to interested governments.
Other new mechanisms linked to results include output-based aid. This aid provides direct subsidies to service providers for the delivery of specified basic services or outputs.34 For example, a recent output-based scheme in Uganda aims to give a subsidy (of $2.5 million) for connecting poor households in slum and peri-urban areas of Kampala to water services.35 The output-based approach to aid delivery uses explicit performance-based subsidies to help the poor afford access to basic services.36 The subsidies target poorer consumers and are paid to the service provider only after the delivery or provision of the agreed-to service. This approach harnesses the private sector to deliver results.
Improving the Impact of Aid through Better Aid Delivery
DAC peer reviews of aid programs point to 12 lessons for effective aid management.37 Among these are the need for DAC donors to focus their assistance on fewer countries, fewer sectors, and fewer activities, and to develop a stronger culture for managing for results and aligning incentives accordingly, but in ways that strengthen local structures of accountability. These issues have been taken up through the Paris Declaration. Partner countries, donors, and the international financial institutions are taking substantial actions toward meeting the Paris commitments on aid alignment and harmonization.
Alignment and harmonization.
The findings of the 2006 Survey on Monitoring the Paris Declaration indicate mixed progress on alignment and harmonization. 38 For example, the survey results show that donors provide 43 percent of their aid to governments through program-based approaches such as budget support and sectorwide approaches, relative to the Paris target of 66 percent.39 In addition, the extent to which donors conduct joint missions is low—the survey found that 18 percent of missions were undertaken jointly, while 42 percent of country analytic work was prepared jointly with another donor, relative to the 2010 Paris targets of 40 percent joint missions and 66 percent joint analytical work. Greater donor efforts are going to be needed if the 2010 targets in these areas are to be met. The 2008 survey, which is under way and which will cover nearly twice as many countries as the 2006 survey, will provide stronger and more up-to-date information on the progress and prospects for reaching the 2010 Paris targets.
Aid fragmentation has emerged as a serious issue, with multiple aid agencies from each country joining the new players. Fragmentation refers to a large number of donors each with a small share of total aid. Projects have become smaller. Each agency makes requests for studies and for individual meetings with country officials;40 they often also establish separate project management units and procurement practices for their own projects. High fragmentation can have negative implications for aid quality. DAC data for 61 PRS countries and fragile states show that over 60 percent of countries had 20 or more donors and over 75 percent of countries had 10 or more donors together accounting for 10 percent or less of aid (figure 3.9).
figure 3.9Concentration of DAC donors and multilaterals in selected countries, measured by programmable aid
Source: OECD DCD 2007c.
Note: Data are for country progammable aid (gross).
Division of labor.
The EU has recently adopted a voluntary Code of Conduct on Complementarity and Division of Labor in Development Policy to facilitate division of labor as a way to improve aid effectiveness. Among the 10 operational principles of the code of conduct for donors’ actions are concentration in a limited number of sectors in a country based on a donor’s comparative advantage; enhancement of donor coordination by supporting a lead donor arrangement in each priority sector; assurance of adequate donor support in sectors that are relevant for poverty reduction; and establishment of priority countries for EU donor engagement.
Aid predictability is an important dimension of aid quality. In aid-dependent countries, the variability and unpredictability of donor funding undermine aid effectiveness by affecting short- and medium-term budget planning and programming, disrupting implementation of expenditure allocations, complicating macroeconomic management, and deepening the challenge of building absorptive capacity. Donors and recipients have focused on both short- and medium-term predictability. While short-term aid predictability is improving, less progress has been made in improving medium-term predictability. The 2007 budget support survey by the Strategic Partnership with Africa finds that of the $2.7 billion in general budget support committed by donors for 2006, 92 percent was disbursed within the year, compared with 85 percent in the 2006 survey and below 70 percent in the 2003 survey (figure 3.10). Within-year delays are less pronounced as well. The pattern of shortfall in disbursements in the first quarter and a surge in funds in the fourth quarter is less evident.
figure 3.10In-year predictability is improving
In contrast, with respect to medium-term predictability, the Strategic Partnership with Africa survey finds that the proportion of current (2006) donor programs committing general budget support for future years falls off dramatically in outer years, to 69 percent for 2008 and 35 percent for 2009. Medium-term predictability has remained relatively low in most cases, despite mechanisms such as multidonor budget support, joint country assistance strategies, and pooled financing through sectorwide approaches, and despite recipient countries taking steps to strengthen public financial management (box 3.1).41
box 3.1Improving the predictability of aid: Ghana and Tanzania
The experience of Ghana and Tanzania provides evidence of both continuing challenges and some progress in improving multiyear aid predictability.
Ghana. Ghana has had some success in improving aid predictability, thanks to improved coordination through a multidonor budget support framework. Multidonor budget support (MDBS) partners disburse their budget support based on triggers defined two years in advance and assessed in the year prior to disbursement. This new schedule allows the MDBS partners to inform the government about their budget support before the government’s budget proposal is submitted to Parliament. Better predictability was achieved even as donors were scaling up: MDBS disbursements rose throughout 2003–07.a The Ghana experience suggests that increasing predictability requires progress across three fronts: mechanisms to improve coordination, ownership within government and among development agencies, and clearly defined measurement yardsticks. In an effort to enhance predictability, the government has involved all active budget support donors in the Ghana Joint Assistance Strategy process.b
Tanzania. Total aid to Tanzania climbed from 6 percent of GDP in 2000 to over 12 percent in 2005/06, and accounts for 40 percent of public expenditure. Aid projections have been embedded in the annual budget process in recent years—the authorities ask each donor to provide three-year projections of disbursements as input to the annual budget guidelines and Medium-Term Expenditure Framework (MTEF) preparation. A review of these projections shows a sharp divergence between actual financing and projections; indeed, projections systematically under-predict actual flows (figure and table). The forecasting error is large as a percentage of GDP and larger than that of other components of revenue. In every year donors collectively increased total external financing but forecast significant reductions over the following three years. The substantial size of external financing means that the predictability of medium-term external financing is particularly important to strengthening the country’s MTEF.
Tanzania: Aid is not very predictable in the medium term
Source: Government of Tanzania et al. 2007.
Note: MTEF stands for Medium-Term Expenditure Framework.
|Average forecast error in % (2003/04–2005/06)||Average forecast error in % of GDP (2003/04–2005/06)|
|Budget support (+ HIPC)||28.5||54.0||51.0||1.2||2.6||2.2|
|Project + basket support||-4.8||35.7||61.3||-0.3||0.9||2.5|
|Total external support||10.0||43.2||61.9||0.9||3.6||4.6|
The potential costs of variability of aid can be large. One study finds that unforeseen variations in aid primarily impact domestic investment expenditure.42 It also finds that periods of excess aid are seldom used to accelerate spending on this category so as to catch up with previous shortfalls. Thus, aid volatility may have permanent costs in terms of reduced investment and growth. A recent study attempts to measure the cost of volatile flows by applying the concept of “certainty equivalence” to the flows received by recipient countries.43 On this basis, the study estimates the cost of volatility to be quite large at 22 percent—that is, the value of aid flows may be discounted by as much as 22 percent on average to take into account the effect of volatility. The cost varies considerably across countries; it is particularly large for countries such as Cambodia, the Democratic Republic of Congo, and Nigeria, which have seen extreme movements in their aid flows.
An encouraging development is the European Commission’s MDG contract, which provides a more predictable way of delivering aid.44 It is not a new EC financial mechanism, but rather an enhanced form of budget support for implementation under the 10th European Development Fund (EDF 10), which will provide €22.7 billion over the period 2008–13. More than half of all EDF general budget support commitments would be disbursed through MDG contracts. About half of the African countries that are to receive general budget support would receive it in the form of MDG contracts. The funds would be committed for the six years of EDF 10. A proportion of funds committed to a country—80 percent—would be virtually guaranteed except when there is a clear failure to meet key criteria. Under the MDG contract, monitoring will be on an annual basis with a focus on results, especially in health and education, and performance assessment will be within a medium-term framework so as to foster more comprehensive analysis and dialogue. The initial focus will be on countries with a strong performance track record and multiyear monitoring framework. Among other mechanisms that have the potential to enhance predictability of aid are the U.S. Millennium Challenge Account and the International Health Partnership.
On their part, aid recipients can take measures to mitigate the adverse effects of aid variability.45 They can build up reserve buffers that can be drawn down in the event of temporary aid shortfalls. Countries can identify priority spending programs and safeguard these from unexpected cuts in aid. They can also build flexibility into spending programs by designing programs that can respond quickly to aid volatility. By regular stress testing of baseline projections, countries can assess the short-term financing risks to the budget.
Donors’ aid allocations indicate that aid is becoming more selective. Empirical estimates of the responsiveness of aid to policy performance and the quality of institutions (as measured by the World Bank’s CPIA ratings) show an improving trend. Overall, bilateral donors are found to be less selective than multilateral donors, a trend that has persisted. There is also considerable variation among donors, which suggests that several criteria influence the allocation of aid. A recent study assesses how changes in the international aid architecture have affected the allocation of bilateral aid over 1970–2004.46 The study finds an improving trend in donor selectivity, reinforcing the above results. Specifically, the study finds that countries that formulate poverty reduction strategies see higher amounts of aid and that debt reduction has reduced defensive lending by donors.
Aligning Global Funds with Country Programs
Global programs have become an important part of the aid landscape. A desire to address specific priorities—global challenges or development goals—and advantages of greater attributability provide strong incentives for the donor community to create new global programs and vertical funds and to earmark funds as part of their effort to scale up aid. Despite broad agreement on the importance of global programs, concerns abound on how to strengthen the broader development effectiveness of these programs and improve the sustainability of the desired outcomes. Global programs illustrate the challenges of applying the Paris principles. An important issue that arises is that of alignment of these programs with country strategies and complementarity with traditional, country-based aid.
Several recent discussions, supported by analysis of country experiences, have focused attention on improving the alignment of global programs at the country level. A workshop for developing coutry policy makers organized by the World Bank and the OECD DAC in Mauritius in June 2007 highlighted several challenges on this front. For example, in cases of weak country capacity and leadership, country strategies and expenditure patterns can be highly influenced by external partners.47 Often there are differences in priorities of donors and development partners, and this can create imbalances and development gaps. There is also a tendency to neglect implications for accountability. The problem can be especially acute when global programs are the main contributors to a sector and particularly when earmarking is at the level of a subsector (such as HIV/AIDS). Country experiences—as in Benin, Madagascar, Malawi, and Sierra Leone—indicate that global program support was often not integrated into the national development or sector strategies. For example, the President’s Emergency Plan for AIDS Relief (PEPFAR) and GFATM support operated in parallel to government health sector policies and systems in Malawi and Benin.
There are signs of progress, however, as several countries have begun to better integrate global programs along with other donor support into sectorwide approaches (SWAps), as is now occuring in the health sector in Malawi. In the case of Mozambique, GFATM support was integrated into a SWAp and in 2006 into a common fund for health (Presaude). This approach allowed “virtual earmarking” of GFATM resources and the use of national systems rather than separate financial management and audit. It also reduced the proportion of aid funds that are off budget.48 The key lesson that emerges is that global programs should be integrated and mainstreamed into national development strategies and programs and linked to related sector priorities and systems. They should also be brought on budget, to reduce transaction costs and fragmentation of development approaches and to enhance transparency and accountability. Country experiences also suggest the importance of a strong monitoring and evaluation framework. The framework should be focused on results-based indicators relevant to the national development plan, and not simply on global program indicators. There is also a need to adapt donor procedures to local systems and place less reliance on setting up parallel systems, which should help strengthen country processes.
Addressing the Challenge of Aid Effectiveness in Health
Aid for health is changing rapidly. New actors such as private philanthropies have rapidly expanded the funds available for investment in global health. In tandem with rising private philanthropy, the channels through which bilateral, multilateral, and other donors are providing resources for health have grown. The current health aid system encourages innovation, flexibility, and speed.49 Yet, as indicated in the preceding section, its complexity poses the challenge of ensuring coherence and coordination and aligning global programs with national priorities.
Scaling up of resources.
The health sector has seen a rapid scaling up of both traditional and innovative aid flows. There are well over 100 international entities involved in supporting health. Concessional financing for health more than doubled, from $6.8 billion in 2000 to nearly $17 billion in 2006 (figure 3.11). The spurt in funding is the result of new (bilateral) programs such as the U.S. PEPFAR and increases in funding for health by bilateral donors, private foundations such as the Gates Foundation, and global health funds such as GFATM and GAVI.50
figure 3.11Strong growth in assistance for health, 2000 and 2006
Source: Michaud 2008.
Note: Concessional financing only. Other multilaterals include the European Commission, GAVI, and GFATM. Data for 2006 are provisional.
External assistance from both traditional and new sources accounts for 7 percent of health sector spending in developing countries. This figure masks large differences across countries and regions: In Africa this share is much larger at 15 percent. Fifteen of the 23 countries where external assistance supports over 20 percent of all health spending are in Africa.51 Seven African countries receive HIV/AIDS funding that is larger than 30 percent of their total public health budget; in some countries this funding exceeds other public sector health spending.52
While the focus on health is bringing much-needed financing to this sector, the narrow focus on a single issue or subsector can have unintended effects, particularly in the short run. For one thing, the pattern of external funding can create imbalances in the health sector and undermine attention to other local health priorities. For example, in Rwanda donor funding in health was unevenly allocated, with $47 million for HIV/AIDS, $18 million for malaria (which is the leading cause of morbidity and mortality in the country), and only $1 million for management of childhood diseases.53 Likewise, in Ghana malaria is the main cause of sickness and mortality, but donor funding to fight malaria has recently been 60 percent of the amount allocated for HIV/AIDS.
Sharp increases in vertical funds can also strain absorptive capacity. Since earmarked funds typically pay less attention to investment in health service delivery systems, inadequate capacity can translate into low efficiency and effectiveness of spending. An example of absorptive capacity constraints at the sector level is in Ethiopia, where the capital budget execution rate for external assistance has been found to be low at between 15 and 20 percent, compared with 80 percent for domestic resources.54 But strengthening the absorptive capacity of the health systems usually receives less attention than direct funding for HIV/AIDS in donor commitments (figure 3.12).
figure 3.12Ethiopia: Distribution of aid within the health sector
Source: Government of Ethiopia, et al. 2007.
A heavy reliance on aid to finance public expenditures, especially in health with a high proportion of recurrent costs, raises issues of sustainability of financing, and in turn of service delivery gains, and has implications for the ability of countries to budget and plan for the medium and long term. Most funding is short term—for example, in Ethiopia and Rwanda 55 percent of foreign-financed projects are negotiated on an annual basis. This short-term pattern of financing introduces uncertainty about aid amounts. Large year-to-year variations in aid levels constrain long-term plans of building capacity in the health sector—that is, hiring nurses and doctors and scaling up health services—especially in the poorest and most aid-dependent countries. The challenges are even more acute in fragile and conflict-affected situations, where aid is even more variable and is usually channeled through parallel systems because of weak public financial systems.
Amid the changing aid architecture and scaling up of financing for health, there is much scope to improve the efficiency and effectiveness of aid delivery and utilization in the sector. Health has been selected as a special focus sector (tracer sector) in applying the Paris principles at the sectoral level.55 There is growing awareness that health targets cannot be efficiently attained and sustained without appropriate health delivery systems. Adequate investment in health systems is therefore needed. To support effective scale-up of service delivery, donors will need to strengthen coordination and harmonization of aid, increase flexibility in funding, provide more predictable and sustainable assistance, and enhance alignment with country-owned and country-led health plans.
The need for more coherence in aid for health is recognized by several new initiatives. Among these are the creation of the group of eight heads of health agencies and the International Health Partnership. The group of eight heads of health agencies—World Bank, World Health Organization, Joint United Nations Programme on HIV/AIDS, United Nations Children’s Fund, United Nations Population Fund, GFATM, GAVI Alliance, and Gates Foundation—was formed by leaders of these institutions to strengthen collaboration to achieve better health outcomes. The International Health Partnership includes a number of bilateral donors, the group of eight agencies, as well as several partner countries. The main goals of the partnership are to improve health systems, provide better coordination among donors, and support countries in developing their own health plans.56
Implementation of the HIPC Initiative and the MDRI
International debt relief efforts have continued within the framework of the HIPC Initiative and the MDRI. The HIPC Initiative has remained the main framework for international coordination of debt relief to the poorest countries since its launch in 1996 by the International Monetary Fund (IMF) and the World Bank. Its primary goals are twofold: to bring the debt of the poorest countries to levels deemed sustainable so that these countries can pursue their developmental and poverty-reducing objectives; and to help HIPCs implement a set of institutional and policy reforms designed to prevent the reemergence of debt problems in the future. In 2005, the HIPC Initiative was supplemented with the MDRI, whereby IDA, the IMF, and the African Development Bank (AfDB) provide additional debt relief with the view to further freeing resources for poverty reduction and achievement of the MDGs. In 2007 the Inter-American Development Bank also decided to provide debt relief to the five HIPCs in the Latin America and the Caribbean region.
To date, 41 countries have been identified as eligible for, or have already received, assistance under the HIPC Initiative. By the end of March 2008, 33 HIPCs had reached the HIPC Initiative decision point and were receiving debt relief; of these, 23 had also reached the completion point—when creditors provide the full amount of debt relief committed at the decision point. The 23 post-completion-point HIPCs have also benefited from debt relief under the MDRI.
The overall amount of debt relief to be delivered to the 33 post-decision-point HIPCs under the HIPC Initiative and MDRI is currently estimated at $72 billion in end-2006 net present value terms. As a result, the debt stock of the 33 post-decision-point HIPCs is projected to decline by nearly 90 percent in present value terms (figure 3.13).
figure 3.13Reduction of debt stock for the 33 post-decision-point HIPCs
Source: IMF–World Bank 2007; staff estimates.
Note: Based on decision-point debt stocks.
Debt relief under the HIPC Initiative and MDRI has helped to expand the fiscal space for the 33 post-decision-point HIPCs for their poverty-reducing and other development expenditures. The debt service paid by these countries has declined by about 2 percentage points of GDP between 1999 and 2006, while their poverty-reducing expenditures have increased by about the same magnitude. The HIPC Initiative and MDRI relief is expected to reduce the debt service payments of post-decision-point HIPCs by another 1 percentage point of GDP by 2009.
Despite the significant progress achieved to date in the implementation of the HIPC Initiative and MDRI, important challenges remain. Some eligible HIPCs face difficulties in qualifying for the HIPC Initiative debt relief. Before reaching the decision point, they must exhibit a solid macroeconomic policy track record under an IMF-supported program and develop a poverty reduction strategy. For the eight pre-decision-point HIPCs, progress in building a policy track record has often been hampered by internal conflicts, governance issues, substantial arrears to multilateral institutions (which preclude these countries from engaging in an IMF-supported program), and more generally, difficulties in formulating viable macroeconomic and poverty reduction programs. Several of the ten interim HIPCs also face similar challenges on their way to the completion point. These difficulties are reflected in the long interim periods (between decision point and completion point) experienced by a number of recent and prospective completion-point countries.
Additional donor resources are needed to cover the projected costs of debt relief to countries with protracted arrears to multilateral financial institutions. The IMF, in particular, will require substantial additional resources to provide debt relief to the remaining two protracted arrears cases (Somalia and Sudan). As of end-February 2008, the total arrears of these countries to the IMF amounted to SDR 1.3 billion. As the costs for providing debt relief to these countries were not included in the original financing framework of the HIPC Initiative and the MDRI, additional financing will need to be mobilized.
The participation of non–Paris Club official bilateral creditors and commercial creditors in the HIPC Initiative remains low. Non–Paris Club official bilateral creditors have on average delivered only about one-third of their expected share of debt relief to post-completion-point HIPCs.57 The participation of commercial creditors has been even lower, with a few exceptions. Moreover, some of these creditors have resorted to litigation against the HIPCs. The low participation of non–Paris Club and commercial creditors undermines the principle of “equal burden sharing” that is at the heart of the Initiative and presents a growing challenge in light of the higher share of these creditors in the debt of the pre-completion-point HIPCs.58
Concerted action by the international community is required to encourage fuller participation by all creditors and discourage aggressive litigation against the HIPCs. To that end, IMF and World Bank staffs have stepped up moral suasion, public dissemination of information on the HIPC Initiative, and provision of technical support. The World Bank’s Debt Reduction Facility for IDA-only countries can also help extinguish commercial debt of the HIPCs via debt buyback operations at a deep discount.59 Debt buybacks under two recent operations supported by the facility—for Mozambique and Nicaragua—extinguished nearly US$1.5 billion of commercial external debt on terms fully comparable with those provided by other creditors under the HIPC Initiative.
Maintaining Long-Term Debt Sustainability
Despite substantial debt relief, long-term sustainability remains a challenge for several post-completion-point HIPCs. For example, only nine of 23 post-completion-point HIPCs are now found at a low risk of debt distress, with the remainder being at either moderate or high risk according to their latest debt sustainability analyses (figure 3.14). The issue of sustainability often stems from underlying vulnerabilities in these countries: vulnerability to volatile terms-of-trade shocks and susceptibility to climate-related shocks. Sustainability will require reforms (strengthening of institutions and climate adaptation) to build resilience to exogenous shocks, a sound macro framework, and strong debt management. Thus, post-debt-relief HIPCs should continue to borrow prudently, in line with their debt repayment capacity. The IMF and World Bank are providing technical assistance to help HIPCs strengthen their debt management capacity and design sustainable financing strategies (box 3.2).
figure 3.14Risk of debt distress in post-completion-point HIPCs
Source: IMF–World Bank 2007; staff estimates.
Note: Debt distress classification of post-completion-point HIPCs refers to the assessment made under the latest available joint IMFWB debt sustainability analyses as of March 2008 and includes the effects of MDRI.
Other creditors are also encouraged to take debt sustainability considerations into account in their lending decisions to help HIPCs avoid reaccumulating unsustainable debt burdens. The joint Bank-Fund Debt Sustainability Framework (DSF) provides a potential coordination point for creditors. Debt sustainability analyses are, with the permission of governments, made public on Bank and Fund Web sites60 and Bank and Fund staff have conducted vigorous outreach efforts to all creditor classes. This has culminated in several agreements with creditors. Agreements have been signed with the main regional development banks, defining modalities for their staff to contribute to debt sustainability analyses; these institutions have in turn adopted similar financing approaches to that of IDA, adjusting their financial terms to mitigate debt distress risks. In addition, the export credit agencies of the OECD have adopted a set of sustainable lending principles that are harmonized with the Bank-Fund DSF. Activities with other creditor groups have raised awareness of debt sustainability issues and the approach followed by the World Bank and the IMF. Finally, the framework provides useful signals to the market, helping commercial creditors identify default risks and thus reducing the likelihood of another debt crisis.
box 3.2Debt Management Performance Assessment Tool
The World Bank, in collaboration with other stakeholders, has developed the government Debt Management Performance Assessment (DeMPA) Tool. Based on the public expenditure and financial accountability methodology for public financial management, and sound practices in government debt management, the DeMPA uses a set of 15 indicators that represent an internationally recognized and comprehensive methodology for assessing debt management performance. The DeMPA highlights strengths and weaknesses in government debt management practices in the respective country. The indicators are useful in guiding the design of reform programs, monitoring performance over time, and enhancing donor harmonization and capacity building.
The indicators have been field-tested in five low-income countries—Albania, The Gambia, Guyana, Malawi, and Nicaragua. The table summarizes the results of the five field-test assessments. The shaded areas represent indicators where the minimum requirement for effective operation of the debt management system was not met. This signals a priority area for reform. The comprehensiveness of the assessment allows important linkages between indicators to be emphasized. Recently, this assessment framework has been used to guide the design of debt management reforms in Albania and Bangladesh.
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