Development Finance: More Bang for each ODA Buck

Posted on September 28, 2023September 28, 2023 by Marcus Fedder

The struggle to end poverty and fight climate change is leading to ever-growing demands for more development aid (ODA) in the form of capital replenishments of Multilateral Development Banks (MDBs) and other Development Finance Institutions (DFIs), especially towards funds dealing with development and climate issues.

The Summit for a New Global Financing Pact hosted by President Macron last June promised nothing less than a new era for development finance, one with a new financial system that will endeavor to make billions available in order to tackle the pressing climate challenges ahead.

Marcus Fedder is Vice Chair of TCX and was formerly Treasurer of the EBRD, Vice Chair of TD Securities and a Director of IFFIm. He also worked for the World Bank in the 1990s. He has acted as an advisor to IFAD in the past.

Alas, as stated in this column by Jayati Ghosh and co-authors, it has failed to meet its lofty goals so far. Mobilizing private capital is difficult and ODA is limited.

Even wealthy countries like Germany are cutting back on their development budgets. Ultimately, there is a growing realization that the billions, if not trillions, needed may not be coming fast enough. The subsequent logical question that has to be asked is whether or not more can be done with existing money within existing institutions. Are DFIs all operating at maximum efficiency?

A review of the lending capacities of MDBs was launched under the Italian G20 Presidency, leading to the publication of the Report of the Independent Review of MDB’s Capital Adequacy Frameworks: Boosting MDBs investing capacity in July 2022. The report sets out a package of recommendations which, taken together, were intended to help MDBs pursue increased development investment and impact as well as sound financial management. A key takeaway of the report was that MDBs should take more risks, which, in other terms, means lending more.

Unsurprisingly, the response from finance professionals at the World Bank was not particularly enthusiastic, fearing that an expansion of lending without a fresh capital injection could lead to a loss of its AAA rating.

This sacrosanct rating status guarantees capital market borrowings at the finest terms and hence lending at the lowest sustainable rates. Prodded by its main shareholder, the United States, the World Bank proposed to implement part of the panel’s recommendations, under what it called its “Evolution Roadmap”, which would add $50 billion to its balance sheet by 2030.

However, many deemed this proposal too timid. For instance, the UK based ODI promptly followed up, focusing inter-alia on the capital adequacy framework, stating that “the slight reduction in the equity-to-loans ratio, the elimination of the statutory lending limits and progress on hybrid capital instruments – as proposed in the draft Roadmap – are all positive steps and will generate an estimated $50 billion in lending space over the next 10 years.

Nonetheless, World Bank management has resisted grappling with the more fundamental aspects of the CAF (capital adequacy framework) reform proposals, particularly whether the Bank (as well as rating agencies) are overestimating financial risks to the detriment of lending capacity.” Under the Indian G20 Presidency, another taskforce produced the report “Strengthening MDBs: the Triple Agenda”, further elaborating on proposals of how to make MDBs more efficient. Whilst the focus on optimizing MDB balance sheets is important, one has to realize that according to Moody’s, the World Bank as of FY2021 already had a leverage ratio of 4.75, down from 5.19 in FY2020 and that the average leverage ratio of AAA MDBs stood at 2.8.

Yes, these ratios can be tweaked, but, as importantly, we should broaden the scope of institutions considered to include all DFIs, including bilateral funds, many of which have a leverage ratio of 0. If they were to add a 2.8 or 4.75 leverage ratio to increase business volumes and thus outreach, a lot more money would be available. The G-20 reports focused on MDBs alone as their first step, but next natural reform should address the inefficiencies of (a) funds that have been set up, inter alia to fight climate change and (b) those bilateral development finance institutions which operate in a sub-optimal way.

Let us look first at the latter: The UK’s BII, the DFC of the USA, BIO of Belgium or IFU of Denmark and many other of the bilateral development finance institutions remain unleveraged and thus, from a balance sheet perspective, less efficient.

One frequent argument against leveraging is that it would prevent from taking risks on the asset side, for instance reducing the equity investments that those institutions can make. This is not the case: this is not a zero-sum game. EBRD, IFC and others do both. The unleveraged bilateral Development Finance Institutions only need to look at their neighbors to see how things can be done differently: the Dutch FMO (equity EUR 3.5bn, balance sheet EUR 10bn), the French AFD (equity EUR 8.8bn, balance sheet EUR 64bn) or the German KfW (equity EUR 37bn, balance sheet EUR 555bn) all efficiently leverage their equity via borrowings in the international capital market and thus achieve much higher business volumes – more bang for each equity buck.

Another inefficient use of capital can also be found in some multilateral funds:

The Green Climate Fund is an example of an institution that operates below its capacity. With USD 12.5 billion committed (and only USD 3.5 billion disbursed after 10 years of operations), it now needs to ask member countries for replenishments in order to continue and grow its operations. Rather than asking the Fund to optimize its balance sheet and follow the recommendations of the G-20 report, governments simply pour more money into the pot, which is clearly a sub-optimal use of scarce development resources.

Another example is IFAD, the International Fund for Agricultural Development, which was set up to lend its equity in concessional loans to the poorest countries in order to support smallholder farmers.

Loans for less poor Upper Middle-Income countries are priced with reference to a floating interest rate (Euribor or SOFR), leading the fund to decide that such loans could be funded out of borrowings. Consequently, IFAD set up the policies and infrastructure, enabling it to obtain two AA+ ratings so that it could start borrowing in the capital markets to leverage its equity. Now other lower income countries can also obtain such floating rate funding in addition to their allocated slice of concessional funding which comes from the fund’s equity. IFAD’s leverage ratio is still extremely low, but the institution is now set up to expand its lending and have a greater outreach and impact. As negotiations over IFAD’s replenishment are starting, now is the time to make use of this leverage.

That leaves the question about IDA, as the institution’s leverage is very low.

But IDA’s loans are to the greatest extent on concessional terms, which are not linked to market rates. Only an expansion of non-concessional lending could be funded by additional borrowings as IDA’s long term fixed funding rates (via swaps) are significantly higher than its concessional lending rates. Both IFAD and IDA show that there is a limit to leverage not only from a prudent financial management and ratings perspective but also from a lending perspective, as only those loans that are linked to market interest rates can realistically and without significant losses be funded by borrowings whereas no-interest or extremely-low interest concessional loans have to be funded by the institutions’ equity.

Nonetheless, all DFIs, be they MDBs, bilaterals or funds, should analyze and define their optimal leverage ratio based on their product blend and on prudent financial considerations. It is essential if they are looking to grow their lending businesses beyond current levels and increase their impact on pressing issues in the fields of economic development, poverty reduction and climate finance, where much more needs to be done and cannot be achieved under current conditions, with limited, unleveraged resources.

From the Summit to camp-base: what happened in Paris?

Posted on July 20, 2023September 5, 2023 by Martin Kessler

Since 1981, a peculiar tradition has taken hold in France on June 21st, the summer solstice and the longest day of the year. It is the day of “La Fête de la Musique”, when musicians show up and perform, from amateurs on tiny street corners in a joyous cacophony to famous performers on stages set-up in all major public squares.

It was fitting that the “New Global Financing Pact”, the summit on climate and development finance organised by French President Macron, took place on the next two days, June 22nd and 23rd 2023. The Summit had all the features of experimental jazz: powerful soloist moments, interspersed sentiments of pointlessness and disorientation, brilliant improvisation, instants of disharmony. At the end of such a concert, the sentiment was that not much concrete has been accomplished, but that something happened, a dialogue, even if the participants did not always listen to each other, often sung past each other, and were mostly not playing in the same key.

1. Some harmony but dwarfed by dissonances

Before diving into the concrete outcomes, it is important to stress how different this Summit was, and this difference might be the most interesting and productive aspect. It was unique in that developing and emerging countries had a broad and diverse voice at the highest levels.

About 50 Heads of State were present, from countries of different sizes and levels of income. In that, it was unlike G20 Summits, which only gather large economies; or the Spring and Annual Meetings of the IMF and the World Bank, which bring Finance Ministers together to focus on more technocratic issues. At the same time, it was more structured and concrete than discussions which can be heard at UN General Assemblies. In Paris, the discussion was often technical, but also integrally political.

Interestingly, it was a space of unusual dialogues across diverse countries, and was taken seriously by large emerging countries, and this convening power is important, at a time where the G20 continues to have difficulties going over geopolitical tensions. The participation of China and Brazil at very high levels, and the importance and articulate voices of leaders from Africa, South Asia, and Latin America, have clearly shown that such discussions are useful.

While representation from the richest countries was disappointing, president Macron compensated by chairing a dynamic closing session on a first name basis, bringing into the discussion very outspoken leaders from the global South, in addition to the Prime Minister of China, and influential Northern leaders such as Janet Yellen, Wolfgang Schmidt, and of course Kristalina Georgieva and Ajay Banga.

The summit's main success was to consolidate the new narrative, with leaders from around the world agreeing that progress on poverty reduction and on the environment were inextricably related. Across speakers, there was a broad consensus that climate and poverty were converging problems, and that the South had a major role to play in solving this problem.

LISTEN TO THE VOICES OF THE GLOBAL SOUTH:

WATCH OUR SELECTION OF KEY MOMENTS, WITH:

Mia Mottley, William Ruto, Luiz I. Lula, Nana Akufo-Addo, Hakainde Hichilema, Shehbaz Sharif, Antonio Guterres, Cyril Ramaphosa, ABDEL Fattah el-sisi, Abiy Ahmed, Macky Sall, Kristalina Georgieva, Akinwumi Adesina, Ajay banga, Laurence Tubiana, Ranil Wickremesinghe, Ilan Goldfajn, Mohamed Bazoum and Emmanuel Macron

There was also a broad agreement that the current global institutions are not up to the task and need a major overhaul. While Secretary Yellen focused on the MDBs – the World Bank, and regional banks -- Southern leaders, as well as UN SG Gutierrez, called on the governance of the IMF and of the UN to become more democratic and representative of a diverse world.

There was finally an agreement that cooperation among all countries from the North, South, and East are needed to achieve these common aims.

But beyond those agreed principles, the most visible outcome of the Forum was to highlight the abundance and severity of disagreements, especially along the North/South divide. Advanced economies tend to take a long-term perspective: how can we be ready for 2050, and maybe make some progress by 2030? Developing countries are much more focused on the now: they feel that the house is burning, and that they need to find solutions now to urgent problems that cannot wait.

Whether about potential climate shocks, like Barbados, or the debt burden like Ethiopia, Kenya or Ghana, countries from the South have been rocketed by a long series of shocks, and they want relief now, which a global financial safety net dominated by advanced economies, is not providing.

President Ruto referred several times to the fact that the Bretton Woods system emerged in a few weeks, but that institutional reforms now take decades. The President of Ghana, as chair of the V20, highlighted the need to take into account climate prosperity. Mia Mottley said the role of bureaucrats – and think-tanks for that matter! – is to bring those perspectives closer. President Sisi reminded the audience that if the $100billion/year pledge on climate finance was met in 2015, the planet would be in much better shape today. All Southern leaders warned that if cooperation does not improve fast, then as emphasized by president Ramaphosa, it would not even be worth their time to keep coming to global summits, much less cooperate on climate.

2. Outcomes: vague and vaguer

Beyond this ambitious forum of Heads of States, what were the outcomes? We can read them through the four documents published on the official website: a “Paris Agenda for People and the Planet” endorsed by 17 countries, coherent but somewhat misleading, a “Chair’s summary of dicussions”, a hodge-podge of significant advances, ambitious principles, already adopted measures, and promising ideas, a “Roadmap” which materializes those principles into the series of meetings over 2023-24, and a “Vision Statement” for MDBs.

Outcomes

This has been said over and over again, so no need to belabour this point: the numbers on most of the outcomes do not add up. While the summit was not about fundraising, there were some expectations that key processes would be unlocked by the flurry of conversations before and at the Summit. It was not the case, and the numbers announced all require a little bit of window dressing. In qualitative terms, the objectives do match the ones that were discussed half-a-year before in our seminar with major experts in development finance, but we would have hoped that the preparation would have made those commitments more specific.

The G20 pledged in October 2021 that it would reallocate $100 billion in SDRs. While Paris announced that the mission was accomplished, this is disingenuous for several reasons: first, because this include $20 billion from the US which require Congressional approval; and second because even with an enlarged RST, only $80 billion can be channelled through the IMF, leaving $20 billion still hanging. While the call for using the African Development Bank’s hybrid capital proposal resonated several times, no country has yet confirmed it could participate. The SDR bond could emerge as a possibility for countries which are limited by technical or legal constraints but this was not mentioned either.

MDB’s expansion remains work in progress. Secretary Yellen proposed an objective of an increase of $200 billion over 10 years. This is a useful target, which includes the $55 billion proposed by World Bank in its roadmap. It is also .. not ambitious at all! Total lending by MDBs has increased by the same absolute amount between 2015 and 2020, from $500 to $700 billion. The new goal for 2030 would amount to a 28% total increase over 2020… when global inflation in 2022-23 adds up to 16% already.

The ambition of a leverage ratio of $1 of private capital mobilized by $1 of MDB investment seems strangely off. As noted by Charles Kenny, this would mark a renunciation of the “billions to trillions” strategy. Moreover, such an aggregate goal would not just happen by itself, but it requires instead the development of specific tools that can mobilise the private sector without undue cost in terms of MDB capital. The performance so far with blended finance has however been quite disappointing, in spite of overambitious promises made in Glasgow at the COP26. So at best work in progress, but with so far, little progress to show for.

Pause clauses for vulnerable countries announced by the World Bank will help in their automaticity, especially for those mostly dependent on official lending. The specificities of the pilot will be important, but this will be a useful test of those instruments at a greater scale than before. This is one of the few tangible progress announced in Paris, but at the end, these are gains at the margin, as opposed to fundamental advances in improving poor countries’ ability to attract capital.

Country-specific outcomes, which negotiations were accelerated by the Summit were at the end the main source of progress: the successful conclusion of the official creditors debt restructuring deal with Zambia is a major advance for the G20’s Common Framework, after three years of difficult negotiations that saw Zambia stuck in default; and the JETP signed with Senegal is an important sign that after encountering difficulties in South Africa, there is life to this potentially crucial instrument for climate finance mobilisation.

Intentions

That said, while those agreed outcomes can be disappointing, the summit also led several leaders to state their intention, which will become important in the agenda. For some of these, priorities of leaders in developing countries have been heard, and will be highlighted in the months to come.

The urgent need to replenish IDA was forcefully demanded by Ethiopia's PM Abiy Ahmed and several other African leaders, and it was explicitly mentioned by Ajay Banga and supported by Emmanuel Macron. This has been a longstanding priority of African finance ministers and will be the first big test on fundraising for Banga. We have suggested that the new Crisis Facility could help do some fundraising for post-restructuring countries even pre-replenishment.

Similarly, the depletion of the PRGT’s subsidy account under rising interest rates and large commitments should be tackled, and this was repeatedly stated at the highest level.

Any ambitious action plan for the World Bank will have to combine recapitalization and balance sheet optimisation measures, as we noted last year, a principle adopted by Emmanuel Macron in his concluding account as well.

With a roadmap

Perhaps the most important outcome document is the roadmap, clearly showing where this ad-hoc summit could see some of its ambitions realized. 2023 and 2024 have important milestones where decisions can formally be adopted, which was not the case in Paris.

The objectives inscribed in the Chair’s summary might not all translate into reality, but they open a space for ambition that could influence the next two years, crucial as ever, for environment and poverty.

Could a new World Bank fund help solve the debt stalemate?

Posted on June 22, 2023September 5, 2023 by Martin Kessler

A proposal for a World Bank led Trust Fund dedicated to countries having addressed their debt distress situations and confronted to the needs to enhance growth recovery and prioritize green transition projects.

The war in Ukraine, the second major global shock in less than two years had particularly large effects on developing countries. Accelerating inflation, exchange rate depreciation and declining private inflows have put considerable pressures on already fragile macroeconomic frameworks.

As a result, debt crises will continue to accelerate and move from relatively small economies to larger emerging markets. Yet, as recent experiences have shown, debt restructuring tends to be a slow and uncertain process, subject to both geopolitical disputes and brinkmanship as well as complex dynamics with private creditors.

Countries that have gone through holistic debt restructuring processes generally continue to operate under tight fiscal constraints for a certain number of years. The post-restructuring fiscal consolidation period is often coupled with limited access to international finance related to a scarcity of affordable sources of funding compatible with the contemplated debt trajectory. This may affect the conduct of growth enhancing projects essential for the countries to pursue their green transition and/or create jobs. The difficulty to bounce back from a restructuring explains why countries tend to delay the reckoning, often increasing long-term costs.

This note argues that the World Bank could play a much more important role in unlocking new financing for post-debt restructuring countries to foster a more growth and resilience-enhancing path. We propose to build on the new “Crisis Facility” set-up by the World Bank last month in order to meet the budget short-falls of the Crisis Response Window, with more ambitious targets, but also more ambitious impact which could appeal to donors.

In previous notes, the Finance for Development Lab argued that 1. IDA’s financing model is at risk due to its exposure to countries at high-risk of debt distress, shifting its commitments from credits to grants and making it less sustainable; 2. That IDA financing for high-risk countries was less effective when other creditors tend to obtain more debt service than new loans, thus equivalent of a soft bailout by the World Bank; 3. That the World Bank could provide more new loans for countries in restructuring to unlock the stalemate between Paris Club creditors, China, and private creditors, provided those creditors accept deep enough haircuts restoring debt sustainability.

How would the World Bank deliver new funds?

First, the Fund would constitute the sole instrument through which Multilateral Development Banks (MDBs) participate in debt restructuring processes. Such an initiative would contribute to moving away from the interpretation of MDBs Preferred Creditor Status as not respecting “Comparability of Treatment”, to a fairer interpretation of Comparability of Treatment that take grant elements and the amount of new money provision into consideration. In that perspective, it could resolve the protracted debt restructuring processes we have been witnessing over the last three years while preserving MDBs preferred creditor status.

Second, this kind of surge funding would not be allocated arbitrarily but conditional on a successfully debt restructuring. In doing so, it would not substitute for the need of a rapid growth in the balance sheet of IDA, but provide a resource for countries in debt distress. It would not seek to substitute to needed debt restructuring but to provide post program funding. This could be achieved by funding specific projects with high public returns such as climate adaptation.

Third, this is initiative would also come as way to address the urgent call from debtor countries to have the appropriate means to grow out of debt in post restructuring contexts and meant their developmental imperatives. A reform of IMF program frameworks could support such an evolution, as argued by Reza Baqir, Ishac Diwan and Dani Rodrik.

Fourth, under reasonable hypotheses on losses by other creditors, we estimate that new required IDA financing would be between $2 and $5 billion over three years, according to our calculations considering the ability to leverage donor contributions. In other words, this would be in line with current fundraising efforts.

A risk is, of course, that this initiative would be used to provide existing creditors eligible to the restructuring with more generous terms?

On the one hand, providing additional concessional financing would alleviate Balance of Payment and fiscal constraints . On the other hand, these funds are supposed to be additive to the existing identified mix and therefore impact external debt and debt service indicators. The channel through we would like to see this facility affect the restructuring terms is mainly through growth. Therefore, the growth impact will be a key selection factor. the amounts and the type of projects financed by this new lending should be calibrated such that its net impact on the interest rate/growth differential is negative (r-g<0).

The underlying operational obligation is that the positive impact of the external and fiscal constraints outweighs the additional burden on the DSA indicators, up to a certain quantum of IDA funding.

Alternatively, we could envisage that such post-programme funding would not be accounted for in the programme DSA (neither in the needs related to the projects, nor in the financing), to ensure additionality.

The forthcoming June Paris Summit, which has put forward the link between debt, multilateral finance, and the climate crisis, could be the right place for a renewal of the role of IDA.

8 reasons to support a new International Green Bank

Posted on June 7, 2023September 5, 2023 by Hafez Ghanem

In a new policy Note, Hafez Ghanem, FDL distinguished fellow, makes the case for establishing a new "Green bank", which would have the legitimacy, the size and the financial instruments to meet those challenges.

The world has reached a climate crossroads and revolution in climate finance is long overdue. The latest Intergovernmental Panel on Climate Change (IPCC) report made it crystal clear: “The choices and actions implemented in this decade [ie by 2030] will have impacts now and for thousands of years”.

Countries of the Global South (outside of China) will need to spend more than one trillion dollars a year by 2025, and more than two trillion dollars a year by 2030 on adaptation and mitigation., according to the Songwe-Stern report.

DOWNLOAD POLICY NOTE No.8

How can the Green Bank go beyond "business as usual"?

This notes provides eight reasons to support the green the proposed Green Bank.

Urgency

There needs to be a true revolution in climate finance. A new institution would send a strong signal that the international community is ready to tackle the huge and urgent needs for climate action.

Institution and politics

Bretton Woods Institutions simply to not have the mandate, nor the credibility to undertake such a drastic effort.
The Green Bank would provide a platform for governments, private sector and civil society to dialogue and work together, hence it would mobilize strong political support across the North and South to advance the climate agenda;
Commitments by international organizations on climate change matters may be prone to shift to reflect political changes in their host country, the Green Bank’s governance structure would protect it from such changes;
By providing a strong voice for countries of the South in its governance, and by separating funding for climate--and thus protecting general development funding by MDBs--it will ensure the South’s buy-in and full implementation of needed reforms, programs and projects.

The financial case for a green bank

The essential challenge which faces recent proposals, including for instance the proposed “Mitigation Trust”, is the ability to mobilize the private capital needed to reach sufficient scale. Private sector participation in Green Bank’s capital means that less will be required from governments, and the presence of private sector representatives in governance structure should help inform decisions to attract private investments in countries of the Global South;
The Green Bank could be the instrument for the international community to respond to the Bridgetown Initiative and the promise made at COP27 by making use of innovative financing like green bonds, interest rate buy-downs, carbon credits, and green taxes;
Unlike most MDBs, Green Bank lending would not require a sovereign guarantee and thus would not add to sovereign debt.

The geopolitical rationale:

In the present geopolitical climate of superpower competition, an institution focused on a single issue that is important for all humanity could be a useful platform for international cooperation. Climate change is a challenge for all of humanity East and West, North and South. It is a possible area where all countries can put their rivalries aside and focus on cooperating to save human civilization. Green Bank could be a platform for cooperation between rival powers, and thus make a small contribution to better understanding and a reduction of tensions.

Questions and objections:

There are many natural objections and questions to this proposal:

"There are too many climate funds": the Green Bank would be a drastically different institution than all existing climate funds, sometime subsuming their function (and thus recommending to close some of them).
"It would take too long to set up a new institution": this is not necessarily true: starting with a coalition of the willing and not waiting for global consensus could be feasible rapidly.
"It separates development from climate": no, as the idea behind Green Bank is to protect development finance while mobilizing additional resources for climate. It is not to separate climate and development work.
"The World Bank should take this role." the Green Bank would work closely with Bretton Woods Institutions and regional MDBs, but its functions would remain different, with a primary, and indeed single focus on mobilising finance for climate. The World Bank would continue taking the lead on development work and coordinating the work of other institutions— including Green Bank—through its support to country platforms. There is a possible option to create the Green Bank within the World Bank, which would allow to rely on its staff and expertise. In this case, the Green Bank would still need to be institutionally protected from poltiical meddling, and to have the private sector and CSOs in its board.

Hafez Ghanem is a distinguished fellow at the Finance for Development Lab.

He is a development expert with more than forty years’ experience (including 31 years at the World Bank) in policy analysis, project formulation and supervision, and management of multinational institutions. He has worked in over 40 countries in Africa, Europe and Central Asia, Middle East and North Africa, and South East Asia. He is currently a senior fellow at the Policy Center for the New South in Morocco, and a non-Resident Senior Fellow at the Brookings Institution in Washington DC.

IDA in the debt crisis

Posted on May 19, 2023September 5, 2023 by Ishac Diwan

Exploring feasible deals through comparability of treatments and new loans

BY ISHAC DIWAN, BRENDAN HARNOYS-VANNIER and Martin Kessler

DOWNLOAD POLICY NOTE No.6

Several low-income and lower-middle income countries with access to concessional World Bank financing are now negotiating a debt restructuring program, which entails the sharing of losses by the different creditors. The goal of this note is to estimate the size of losses, at the current juncture of the debt crisis, and how they can be distributed among the different types of creditors.

We also consider how the MDB system can play a more prominent role in this context. There have been suggestions to put MDB’s preferred creditor status in question. In this paper, which focuses on the role of IDA, we propose instead to view its participation as providing new loans and estimate a possible envelope. We start by identifying countries that require debt restructuring and estimate the amount of debt reduction needed to bring them back to a sustainable path. In a second step, we distribute financial contributions across creditors. One contribution of this paper is to propose alternative approaches to Comparability of Treatment: not only as proportional reduction in present value claims, but by requesting a higher contribution from non-concessional lenders.

Focusing on the 73 IDA clients, our results show that, under a set of simple assumptions, 19 to 23 countries will need some kind of debt restructuring to bring back the present value of public debt to levels which can be considered as sustainable. Total face value of debt varies between $230 billion and $374 billion, and we estimate that the total reduction needed in present value stands between $31 and $76 billion. Those are large, but manageable numbers. The key question is thus: how to split those losses? While in terms of stocks, MDBs is the largest creditor sector, followed by the private sector and China, their loans are much more concessional. How can this be taken into account?

We then estimate the distribution of the burden of debt reduction, including IDA’s share, according to two different Comparability of treatment rules. Comparability of Treatment aims at ensuring that all participating creditors should be treated similarly. A traditional interpretation of this term seeks to apply haircuts among creditors on the basis of the distribution of their debt’s present value. While we accept this line of reasoning, we believe however that this is not sufficient, especially in the context of poorer countries where the range of grant elements among creditors is very large.

We thus develop a new fair rule for comparability of treatment, which we think is needed when countries obtained loans with a wide range of concessionality levels. The goal is to equalize the level of concessionality after debt restructuring, thus requesting larger losses from less concessional lenders.

In this scenario, what would be the appropriate financial contributions from IDA? We estimate that support to its clients with new flows would require and additional credit allocation of $1.5 billion / year over the next three years under a "fair burden sharing" scenario, a manageable effort, equivalent to 20% of the normal country allocation scenario.

DOWNLOAD POLICY NOTE No.6

China Development Finance | Seminar Summary

Posted on May 17, 2023September 5, 2023 by Martin Kessler

The Finance for Development Lab’s first China conference took place over two days (27 & 29th March 2023), aiming to build a better understanding of the country’s key challenges as a leading provider of finance to developing countries. Day 1 focused on the macroeconomic aspects of Chinese lending, whilst Day 2 discussed the new objectives of China’s lending operations and approach to development finance in today’s context of increasing debt levels and pressing climate and nature-related challenges. A summary paper of the discussions has been published here.

Download Summary Paper

Watch the recordings

" The Common Framework, being a case-by-case approach to debt restructuring, cannot be industrialised like the Heavily Indebted Poor Countries (HIPC) Initiative. There needs to be a win-win approach to the debt crisis (…), a consensus on what constitutes a cut-off date for a country in default and for a process to define a capital state.”

Guillaume Chabert, IMF

" (There is) increasing difficulty of developed countries to access markets at reasonable rates, leading to more competition for capital flows. The World Bank has announced more flexible lending policies and the use of guarantees to access formal markets, but there is still little appetite for recapitalising or changing the rules in some Asian countries.”

Simon Cueva, former Minister of Economy and Finance of Ecuador

" Chinese creditors are hesitant to participate in debt restructuring when they feel that privileged creditors and non-creditors are pushing major creditors to pay the bill (...). A timely solution requires a fair and equitable burden sharing by all creditors.”

Dr Jin Zhongxia, People's Bank of China

The seminar opened with a Keynote Address by Dr Jin Zhongxia, Director General of the International Department of the People's Bank of China

Day 2 opened with a Keynote Speech by Dr Justin Lin, Dean of the Institute of New Structural Economics, and a dialogue with Bert Hofman, Director of the East Asia Institute at the National University Singapore

Download Dr Jin Zhongxia's talking Points

Followed by a discussion with Dr Deborah Brautigam, Director of the China Africa Research Initiative (CARI) at Johns Hopkins University

Four Research papers were presented:

Paper 1:

--> Comparability of Treatment, by Gong Cheng (BIS) and Aitor Erce (INARBE)

The paper discusses debt relief games and the interaction between different types of creditors, specifically the Paris Club, the private sector, and China. It proposes to build indicators or coincidence to investigate historical restructuring data and how different creditors interacted among themselves. The focus is on de facto inter-creditor coordination, rather than on the application of Comparability of Treatments (CoT).

Download Presentation

Paper 2:

--> Use of SDRs by China for the development of African countries, by Etsehiwot Kebret and Hannah Ryder (Development Reimagined)

The paper discusses China's commitment to reallocate 10 billion US dollars of its Special Drawing Rights (SDRs) to African countries, which accounted for around 25% of its new SDR allocation, the largest proportion of SDR locations committed to reallocate by any country in the IMF.

The paper suggests innovative ways to reform the system, exploring 5 options to re-channel China's SDRs to Africa.

Download Presentation

Paper 3:

--> Christoph Nedopil Wang, Director of the Green Finance and Development Center, Fudan University: "Can tripartite cooperation with China mobilise green project finance in the global South?"

The research examines the intersection of project infrastructure and finance, with a particular focus on green infrastructure finance. The paper feeds into the broader discussion on how to accelerate green infrastructure project funding in emerging countries, with an emphasis on addressing the environmental, social, and governance (ESG) challenges for tripartite cooperation between China, international institutions, and host countries.

Paper 4:

--> Tianshu Sun (CAITEC) and Wei Shen (Institute for Development Studies) on: "Horizontal Fragmentation and Coordination Vacuum in China’s Foreign Aid System"

The paper focuses on the integration of climate and nature considerations into public financing. It examines the fragmentation and coordination vacuum in China's foreign biodiversity aid. Protection of nature as a focus of Chinese development assistance really took off in the run-up to the 15th Conference of the Parties for biodiversity hosted by China in 2021 and co-hosted by Canada in 2022. The initial goal of this research was to look at what China has been doing in terms of international development supporting biodiversity. Interviews were conducted with institutes involved in such projects.

LINK TO Summary Paper

Options Paper for Channeling China’s SDRs to Africa

Posted on April 27, 2023September 5, 2023 by Hannah Ryder

In August 2021, the International Monetary Fund (IMF) announced its largest allocation of Special Drawing Rights (SDRs) worth 650 billion USD to boost global liquidity and support member countries in their post-COVID-19 recovery. Just three months later, in November 2021, at the Eighth Forum on China-Africa Cooperation (FOCAC) in Dakar, Chinese President Xi Jinping committed to reallocate 10 billion USD (or one quarter) of its SDR allocation to the African continent, the first country to commit SDRs to African countries specifically.

In the 2021 global allocation, the African continent as a whole received a mere 33 billion USD, or 5% of the total allocation while high-income countries such as the United States, which received 117 billion USD, received much more. This unequal distribution, which is due to the IMF’s age-old quota system, is not the only example of a financial mechanism that disproportionately impacts low-income countries.

Just recently, Japan announced that it will be channeling 40% of its SDRs to needier countries. Over the next few months, there will be several opportunities for China and other countries to make announcements for reallocation through the instruments explored in this report. In May, AfDB will be hosting their annual meetings, the Paris summit will be held in June and the World Bank/IMF Annual Meetings will be held in October in Marrakech. The world is watching to see what countries will be doing next.

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5 options FOR CHANNELING CHINA's SDRS TO AFRICA

As the international community grapples with the polycrisis witnessed in our world today, the need for greater financing and a reform of the international financial system has never been more dire. SDRs, as a financial instrument, have been a point of much debate and contention over the last few years, mainly due to the need to maintain its reserve asset status and in relation to that, the challenges and limitations of reallocating SDRs outside of the IMF, in particular through Multilateral Development Banks (MDBs).

Developed in partnership with the Finance for Development Lab, DR's new report, titled “Options Paper for Channeling China’s SDRs to Africa” explores five options for China to reallocate its SDRs to the continent.

The report examines reallocation through

(1) bilateral transfers
(2) the African Development Bank’s Hybrid Capital Instrument, Africa Growing Together Fund and Climate Action Window
(3) The IMF’s Poverty Reduction and Growth Trust (PRGT) and Resilience and Sustainability Trust (RST)
(4) the World Bank (WB) and
(5) the Liquidity and Sustainability Facility (LSF)

The report assesses and scores these five options against bespoke criteria that take into consideration both Chinese and African developmental priorities. The authors conducted six interviews with officials working directly or have worked directly with the different options explored in the paper as well as reviewing and analyzing dozens of documents and publications from a range of MDBs, think-tanks and research institutions. The report brings to light African and Chinese views on SDRs and discusses the debate around reallocation through MDBs and the benefits of such reallocation.

After scoring the five options against those criteria, two options- reallocation through the African Development Bank and reallocation through the Liquidity and Sustainability Facility came out with the highest points. What distinguishes these options is that these instruments have a clear SDR reallocation process, these instruments support many African countries and they put African priorities, ownership and agency first.

Reforming the Multilateral Development Banks (MDBs)

Posted on February 25, 2023September 5, 2023 by Aurore Sokpoh

This blogpost was written in collaboration with participating think tanks from the Amplifying African Voices Initiative and jointly published

Now is the time to build momentum for meaningful MDB reforms that address Africa’s needs

Co-convened by the African Center for Economic Transformation (ACET) and the Finance for Development Lab (FDL), the third meeting of African think-tanks, under the Amplifying Africa Voices Initiative, specifically focused on MDB reforms (January 31).

The absence of African voices in the conversation on global financial architecture issues increases the urgency of this initiative.

The number and frequency of crises of all sorts (climate change, COVID-19 pandemic, geopolitical conflicts) has increased in recent years and underlines the urgency to find ways to overcome some of the most pressing global challenges of our time. International responses so far have been disappointing and lessons from the past have not yet been properly assimilated.

The G20, the international development community, and CSOs have repeatedly called for in-depth reforms of Multilateral Development Banks (MDBs). Indeed, whilst the latter may be uniquely qualified to address today’s crises with strong country-specific programmes, their approaches and fiscal impact need to be improved and concessionary funding has to be scaled up in order to effectively address the development challenges ahead.

MDBs play a unique role in tackling today’s global development challenges while maintaining vital country-level programmes.

The estimated needs to respond to shocks, finance development and the SDGs, and address to climate challenge run in the trillions. It is estimated that the new global challenges will require a tripling of financing from the MDBs, a doubling of bilateral aid, and a massive rise in the flow of private capital.

To succeed on all of these challenges, it is perceived that the role of MDBs is central. They have a financial model whereby all member countries – even developing economies - are shareholders. Contrary to many developing countries to which the markets have currently closed their doors, MDBs are able to borrow from capital markets. This leverage effect has allowed the World Bank Group’s International Bank for Reconstruction and Development (IBRD) to lend over $750 billion in loans from 1944 to 2020 with a capital of $18 billion provided by the 189 member countries.

Given the scale of today’s new global challenges, MDB financing will need to be increased significantly.

Concessional financing represents around $200bn a year, which is clearly insufficient considering that climate financing alone requires $2 trillion per year. There is a view that MDBs are overly constrained constrained by mandates and are too focused on protecting their capital base. Over time, a push by MDB non-borrower shareholders has led MDBs to focus on low-income countries (LICs) and to withdraw middle-income countries (MICs) from MDB concessional lending. This was due in part to the fact that MICs economies were growing, providing them access to international capital markets. In particular, during the Covid-19 pandemic, concessional lending to LICs rose sharply while the rise in non-concessional finance for MICs was much lower. MDB lending is seen by many as not aligned with the priorities of emerging economies, and it comes with high costs related to policy conditionalities, rigid safeguards, and lengthy processes.

THE INDEPENDENT REVIEW OF MDBS’ CAPITAL ADEQUACY FRAMEWORKS (CAF)

To address pressing financing needs, the G20 called in July 2021, for an Independent Review of MDBs’ Capital Adequacy Frameworks (CAF). The question is whether MDBs could leverage its capital even more. The panel’s view is that it does.

To do so, it recommended strategic shifts in five areas of the capital adequacy frameworks to maximise the impact of MDBs capital. These included adopting more efficient management of capital and risk, defining risk tolerance more precisely, relying more on callable capital, increasing the rate of financial innovations, and engaging in a closer dialogue with credit rating agencies. They further recommended creating an enabling environment for reform through greater transparency and information. The CAF report suggests that these actions could allow MDBs to substantially increase available funding by $1 trillion while protecting the World Bank’s AAA credit ratings.

Following the CAF Report, shareholders during the 2022 WB/IMF Annual meetings called on the World Bank to produce an “Evolution Roadmap”. In December 2022, the World Bank released its roadmap with a focus on the need to broaden and redefine poverty appropriately, while also revisiting the “shared prosperity goal”. The roadmap broadly accepted to deepen engagement with Middle-Income Countries, increase financial capacity, and work harder to catalyse private capital and raise domestic resource mobilization. It also warned that such reforms cannot lead to much more financing in the absence of a capital increase.

During the discussion, think tanks and experts stressed that the report lacked ambition and innovation. It also failed to focus sufficiently on the need for a parallel scaling up of finance to poor countries. This is reflected in insufficient stress on finding the right balance between financing global public good investments related to mitigation, and resilience enhancement – in particular with regards to food security. Higher level of disbursements will require major changes in safeguards, legislation, governance and human capacity. Capacities for national planning and donor coordination as well as learning and evaluation will also need to be enhanced. But equally, to ensure new financing is effectively used, Nationally Determined Contributions (NDCs) need to become more disciplined and more ambitious.

Currently, the dialogue on how to leverage MDB capital is mostly a G20 political dialogue and there are three key issues to be resolved:

How to ensure the LIC agenda continues to advance as the unit cost of development increases, particularly considering climate change adaptation and mitigation.
With regards to MICs, how to ensure that climate lending does not come at the cost of other development goals.
Even if it gets expanded, how can climate financing match the borrowing needs.

In all of this, it is critical to ensure that African voices are influencing the design of the reforms

It is time for a new institution with equal participation or a new African-led and focused financing instrument. A proposal for the creation of a new climate finance institution was discussed. It would bring together governments, the private sector, and civil society representatives and where the Global South would have an equal voice to the Global North. Some policy institutes have noted there might not be a need for new organisations, but rather closing down some existing ones with overlapping mandates could be more effective. That said, attracting funding from the private sector remain a big challenge. Establishing a new instrument focused on climate may more easily attract funding from the private sector, provide incentives for carbon credits, elicit political will and create a channel to sell green bonds.

The discussion highlighted the political economy of how to affect the international financial architecture for development. Unprecedented global financial resources were spent on the Covid-19 response and now Russia’s war in Ukraine. But many in Africa feel insufficient resources have been allocated to the continent, which is leading to dissatisfaction and anger. Some policy institutes felt that reforming the international financial institutes is an impossible task as it is a zero-sum game. If one party gains more voice or voting rights, then another party loses its voice or voting rights. Others are more optimistic. But all agree that for African perspectives to have a chance of influencing these debates, there is need for a much stronger effort at articulating what Africa collectively wants to see out of this reform.

Given that G20 members India, Brazil and South Africa are/will serve as presidents of the G20 in the next three years, there is an opportunity for African think-tanks to build momentum on the financing agenda by deepening and filling the void of African voices on these topics. Concrete proposals need to be advanced to inform African leaders. This is even more urgent given the African Union (AU) is seeking a seat at the G20.

Two tracks of ways forward

Workable solutions for global financial architecture reforms need to come from the continent. It will come down to strategies combining public goods and national development plans. The challenge is how to structure new instruments to address the current crises and provide solutions where governments fail to do so.

The African economic policy institutes have discussed two tracks of research.

The first relates to proposals for structuring a new instrument.
The second focuses on leveraging what is already happening on the ground in Africa. In this way, and with a strong African voice in global fora, the new global financial architecture can reflect on Africa’s priorities.

Amplifying Africa Voice is an initiative of the African Center for Economic Transformation (ACET) and Finance for Development Lab (FDL) to improve knowledge sharing and joint analysis among African economic policy institutes on the global financial architecture agenda. The second technical session on African perspectives on the MDB reform was held on January 31, 2023.

Supercharging Multilateral Development Banks

Posted on September 2, 2022September 5, 2023 by Martin Kessler

How can Multilateral Development Banks (MDBs) maximise the impact of their financial resources?

The role of MDBs in achieving global Sustainable Development Goals has steadily grown over the years, reaching $800 billion of loans in developing countries. Today’s overlapping crises make them even more necessary, but the exact way in which their resources should be mobilised is certainly giving rise to heated debates. In the 2010s, MDBs were seen as a way to mobilise private finance towards development projects, thus focusing on “derisking” investments and aligning private finance to sustainable objectives. While some experiments may have worked out successfully, we are still nowhere near the promised “billions to trillions” MDB contribution to financing for development.

An alternative approach seems in the making : last month,notwithstanding a certain amount of drama, the G20 Indonesian Presidency released an independent review on MDBs’ Capital Adequacy Frameworks (CAF). The report provides recommendations on leveraging MDBs further while retaining their triple-A rating, thus keeping their ability to borrow at low interest rates on global markets. Written by a group of experts, including several former MDB officials, the report proposes a new, rather radical goal: raising MDB lending capacity “several hundred billion dollars” in the long run, with a suggested implementation start date in the next 12 to 24 months.

The objective of this blog post is to provide some context MDBs and how their role has evolved. Some key points are:

In the post-Global Financial Crisis environment, with relatively abundant development finance, MDBs were able to grow their role. They have become even more obvious in the current crisis and proposals to improve Capital Adequacy Frameworks are an important step forward. One risk that needs mitigating is that shareholders may see it as a substitute to raising more resources.
An important implicit point of the CAF report is that it changes the approach to private finance mobilisation. The “cascade” or “blended finance” approach did not meet initial expectations, and channelling private finance through MDB’s balance sheets could be much more potent quantitatively.
The report proposes a clear path to implementation, based on existing experiments. On some aspects, however, it remains timid. In particular, more thinking is required regarding the approach to liquidity regulations.
Finally, one should not believe that the adoption of such recommendations would only imply changes at a few desks in isolated risk management units and Credit Rating Agencies. Leveraging more would most certainly require significant change in the kind of projects MDBS invest in as well as the kind of countries they work with.

Revising Capital Adequacy Frameworks should not come at the cost of lower investment in MDBs

The role of Multilateral Development Banks has significantly evolved over the past 20 years. The 13 largest MDBs have about $800 billion in aggregate development assets in develpoing countries[1]. Of these $800 billion, about $700 billion are lent to governments, and the remainder to the private sector. Raising MDBs’ aggregate balance sheets by “several hundred billion dollars” would therefore mark a major shift in the global development finance architecture.

It would accelerate an existing trend: MDBs lending has progressively increased in the past decade, from $400 billion in 2010 to $700 billion in 2020[2], mainly concentrated in Lower Middle-Income Countries (LMICs) (Chart 1).

In relative terms, the importance of MDBs as a share of funding received by developing countries has declined: the rise of China and bond markets may have eroded their role, but the observation mostly applies to Upper Middle Income countries. In contrast, their lending portfolio for LMICs has only slightly declined (from 35% of total borrowing in 2010 to about 28% in 2020), and has remained broadly stable for Low Income Countries (LICs), at 40% of their total borrowings[3].

What will the future hold? The growing importance of MDBs was made possible thanks to multiple capital increases, notably at the Asian Development Bank in 2009 (by 200%), the International Bank for Reconstruction and Development in 2018 (more than doubling its equity), the African Development Bank in 2019 (by 125%), and multiple International Development Association replenishments.

What the CAF report does is that it offers a new proposal to keep growing the role of MDBs: in addition to new capital infusion, MDBs can leverage more in order to increase their lending headroom. However, some might be concerned that such a strategy would not come in addition to shareholder support, but as an alternative. Indeed, one should not forget that capital increases require complex and protracted negotiation processes (the last IBRD General Capital Increase, was, for instance, linked with data manipulation of the Doing Business report). Could Balance Sheet Optimisation be a convenient way to avoid, or at least, delay, new capital increases?

This should not be the case: the sources that supported development finance in the last decades are likely to slow down. The Belt and Road Initiative is in a relative standstill, other bilateral partners such as the OECD Development Assistance Committee (DAC) members are reducing or maintaining their support, with possible displacement effects from the war in Ukraine. It is unlikely that private sector lending will return to its levels of the past decade. MDBs should provide low-cost finance to their clients, and accelerate the role of their balance sheet.

2. Is there a blending vs. leverage trade-off?

The CAF report has also a more implicit premise, which could mark an important shift in the thinking around private finance mobilisation for development. The latter has become the lynchpin of financing strategy since the mid-2010s. World Bank “Cascade” or “Maximising Finance for Development” (MFD) strategies sought to leverage sources of official finance, often concessional, in order to raise private resources. This approach has mostly failed to materialise: leverage effects are small, often below 1 (there are exceptions, such as policy-based guarantees, which tend to have leverage effects between 1 and 3) whilst the share of sustainability-oriented funds in developing countries remains tiny. They are also procyclical: private finance mobilized fell sharply during the COVID-19 crisis[4], while MDBs funding peaked.

Private finance to developing countries, especially in Low and Lower Middle-Income countries, is expensive, whether under the form of project-finance, or loans to governments. MDBs have been remarkable in obtaining much lower rates and passing them to their clients. Borrowing through MDB-issued bonds allows for larger volumes of mobilization, reaching the scale that blended finance projects have struggled to reach. Note that these two approaches do not necessarily contradict each other – they are aimed at different kinds of investors. However, there are some trade-offs to consider. Increasing leverage might not imply a loss of the treasured AAA rating, but it might raise, all else equal, the cost of funds for MDBs. To compensate, MDBs will need to increase the quality of their assets, and thus reduce the share of riskier investments often associated with blending (first-loss provisions, mezzanine tranches, etc.).

These trade-offs will depend on exactly how balance sheet expansion is achieved, but a shift in strategy and emphasis is very likely.

3. A smart strategic approach grounded in existing experimentation

Third, the value of the report is to provide a clear path to implementation. One key constraint to implement such solutions is the lack of harmonised approaches to risk appetite by MDBs. Internal risk assessment models by MDBs tend to be conservative and ignore callable capital in their financial decisions. In addition, the three main Credit Rating Agencies apply different methodologies, which means that to retain their AAA rating, MDBs have to satisfy the most conservative approach.

The report provides proposals on achieving such mobilisation and divides them into two categories:

Allowing MDBs to lend more by better taking into account their business models (in particular, giving more credit to callable capital, integrating their preferred creditor status in internal risk assessments and Credit Rating Agencies methodologies; and relieving the constraint linked to the concentration of their portfolio). This would essentially allow MDBs to better leverage their existing equity.
Experimenting with risk mitigation measures, including by securitising claims, offering various forms of non-voting capital, etc. where private lenders could directly finance some operations, especially for non-sovereign loans. A clear conclusion of the report is that some of those experimentations are already taking place in some MDBs, and that simply taking stock of the successes and adapting them to the larger MDBs could yield gains in lending headroom.

One area where the report falls short of providing such specific advice is on the models of liquidity and funding. It is well known that MDBs are required to hold large amounts of liquid assets: on average, for every three dollars lent to developing countries, one dollar is kept in ultra-liquid AA rated asset. This is due to the fact that unlike traditional commercial banks, MDBs do not have access to a liquidity backstop. They therefore have to maintain enough liquid assets to meet their short-term obligations, often defined as debt with maturity due in the next 12 months, plus next-year committed disbursements.

The report does not dive deep on this topic, but the same criticisms addressed to risk-weighting of assets could be replicated for the approach to liquidity. CRAs assessments are not coherent, leading to an alignment to the most conservative, especially considering that MDBs are often more conservative than what their own guidelines would imply. Finding ways to provide a liquidity backstop, for example through pooled provision of a line of credit, would complement efforts on capital adequacy: for an increase of $100 billion in balance sheet, the IBRD retains $30 billion in “safe” assets with no development impact, while the EIB, thanks to its ECB backstop, only retains $20 billion.

4. Beyond financial models, more leverage will probably imply drastic operational evolutions

The report rightly focuses on the issue of capital adequacy – but the implications of such a sea change are much broader. If MDBs increase in their size while retaining AAA rating, they will need to compensate by reducing risks on the asset side. By implication, this probably imposes to focus on countries with relatively high credit ratings, i.e. a subset of middle-income countries which do not have major debt sustainability problems. Low-income countries will continue to rely on grants and concessional loans, which allow less leverage, even with a new capital adequacy approach.

Is it feasible in the context of high risk to sovereign debt? In addition to raising its level of lending, MDBs would probably need to change the composition of their portfolios. While the 1990s and the 2000s saw a marked increase across the board of MDB’s client GDP per capita, the trend has stalled and reversed in many cases. There are many explanations: sluggish growth in middle-income countries such as Brazil and Mexico, but also a matter of strategy to focus on countries with less market access, for IBRD for instance. As a result, most MDBs lend to countries which are on average poorer than in 2010.

Such an evolution would have to be reversed, and operations could be geared back towards upper middle-income countries, with a focus on climate mitigation and more generally the Global Public Goods agenda. In a recent column, Rabah Arezki and Philippe Le Houerou proposed such an evolution, which could match well with more MDB leverage. This is an area with large investment needs, which makes sense, but it will also require organisational changes well-beyond finances, and adapting operational levels throughout organisations.

At the same time, this reform will improve sustainability profiles for developing countries. Substituting MDB funding to private loans will improve the debt profile of borrowing countries, by lowering interest rates from a current 7-10% for most emerging markets to 3-5% currently paid on non-concessional loans.

As far as countries are concerned, higher debt to MDBs will also mean less private borrowing: MDBs tend to set non-concessional borrowing limits, which would be more likely to be binding if their own lending were to rise significantly. In addition to shifting back to relatively richer countries, the private-sector arms of MDBs are likely to be the ones that will benefit most from leveraging balance sheets.

Concluding remarks

There will be a lot of attention on next steps of a possible implementation of the recommendations. Already, Fitch has expressed its reserves towards the possibility of downgrades if MDBs were to expand their lending ratios significantly. Ambitious reforms will require a lot of concertations among shareholders, MDBs themselves, markets and Credit Rating Agencies.

MDBs have been essential in mitigating the impact of the COVID-19 crisis, and their ability to finance the recovery to the current shock and long-term needs for climate change hinges on optimizing their financial model.

This note benefitted from insightful comments and discussions by Rabah Arezki, Hamouda Chekir, Daniel Cohen and Ishac Diwan.

[1] The report reaches a total of $1.3 trillion, but this includes the European Investment Bank’s balance sheet of $552 billion, of which the large majority is held in the European Union or the UK. Only about $40 billion is held in developing countries.

[2] In addition, MDBs provide about $4 billion of grants annually, which rose to $8 billion in 2020 due to the COVID-19 crisis, predominantly to LICs.

[3] With a decline in 2010-15, which was reversed after 2016.

[4] Hans-Peter Lankes (2021), “Blended finance for scaling up climate and nature investments", One Planet Summit report.

FDL launch conference | Summary

Posted on July 27, 2022September 5, 2023 by Martin Kessler

Opening conversation

WTO Director General Ngozi Okonjo-Iweala and Nobel prize-winning economist Esther Duflo discussed the challenges to multilateralism and growth in the 21st century, in a conversation moderated by Daniel Cohen, the chair of the Finance for Development Lab.

Ngozi Okonjo-Iweala opened the discussions by highlighting that mistrust in globalisation and multilateralism was exacerbated by the COVID-19 pandemic. She used the COVAX programme as an example of such mistrust: an important initiative which ended up with rich countries buying vaccines that were destined to the poorest.

She added that multilateral organisations are based on a system that crucially needs revamping, in order to efficiently tackle 21st century issues. In the case of climate change, the need for change is even more pressing, as impactful measures such as a global carbon price are long overdue.

“There is merit to scepticism and concerns over multilateralism but we must be careful. We can question what kind of multilateralism and globalisation we have now but we must be careful when we say we don’t need it.” 

“The multilateral system we created 70 years ago is a global public good and we must invest in it.” 

Ngozi Okonjo-Iweala

“We’d better start working on climate today because when an actual crisis occurs, it will be too late and rich countries will just fight for themselves.” Esther Duflo

Esther Duflo highlighted the interdependence between poor and rich countries when faced with a global crisis such as the COVID-19 pandemic. Commenting on global politics, Duflo regretted a “short-sighted vision of individual leaders” resulting in a lack of discipline and concrete action, which cost the world an opportunity to eradicate the virus. As she rightfully pointed out, crises are never the right moment to develop solutions.

Okonjo-Iweala concluded with remarks on global trade, stressing that the pandemic revealed a need to deconcentrate manufacturing and that a new form of globalisation should be shaped by putting the emphasis on labour force mobility. In the case of climate change, the need for change is even more pressing: impactful measures such as a global carbon price are long overdue.

Talking about the hope for economic development in the aftermath of COVID-19, Duflo also highlighted the great potential and competitive advantage of the African continent.

“There is a dream of industrialising Africa. We always talk about free flow of goods and capital but the free flow of labour is the problem. Economists never talk about that. [We need to] overcome fears of cultural issues, of race, of all these barriers.”

Ngozi Okonjo-Iweala

“We are likely to see new globalisation, less concentration in the global value chain. This could be a great window of opportunity for countries that have been excluded from global trade so far, especially by China.”

“There are sectors that were impossible to penetrate before and have now become options. [African countries] can leapfrog and go straight to parts of international trade that are less cornered by China.”

Esther Duflo

Panel 1: Introducing the African Liquidity and Stability MechaniSm

The first panel introduced the African Liquidity and Stability Mechanism (ALSM), a new regional financial arrangement for Africa and the first policy recommendation crafted by the Finance for Development Lab, in collaboration with our partner, Cairo-based Economic Research Forum (ERF). Brendan Harnoys-Vannier, Economist at FDL, presented the key features of the mechanism, followed by a discussion with members of the Steering Committee of FDL.

The first speaker in the panel, UNECA’s Executive Secretary Vera Songwe, underlined the need for new financial institutions to answer Africa’s liquidity and stability issues. She pointed at a global liquidity mismatch, with excess in the West and not enough in the rest of the word. African bonds cannot be used as collateral to access liquidity, a regular feature of market infrastructure in other regions. This is penalising for African countries and a factor of illiquidity, she said. This implies that high liquidity premiums are hindering financing for bankable projects. Increasing local currency financing would help reduce the impact of external shocks, such as those linked to US inflation or the war in Ukraine. The regional financial architecture needs to be more sophisticated.

“What we are trying to do is create that market infrastructure to have a level playing field. It is about using market mechanisms to level the playing field and to get African countries with strong and stable macroeconomic fundamentals into a system where they can have access to more liquidity.”

“There are lessons from East Asia which has put in place one of these regional liquidity mechanisms but it has never been used. The lesson is that when you have these in place, you get the benefit even if you don’t use them.”

Vera Songwe

Edward Brown from ACET in Ghana talked about Africa’s lack of resilience, explaining that the continent never had an economic transformation, thus making recovery from economic crises even more difficult. For instance, the transformation index developed by ACET went into steep decline since 2013, a concerning trend. The lack of transformation is not due only to a lack of liquidity: African governments need to better address the gaps in economic transformation and governance. Those two elements will be essential for economic growth.

Brookings’ Homi Kharas pointed at an “issue of differential treatment of countries because of differential access to liquidity”. Because of the COVID-19 crisis, debt levels are excessively high, thus discouraging governments to make fiscal stimuli.

He asked to put an end to a dominant narrative about African governments being the source of the problem. Stressing that more trust needs to be built, he said that financial institutions could play an intermediary role, quoting the example of east Asia. His conclusion was that African countries could benefit from the existence of an ALSM even if it is not used and that a monitoring mechanism should be also implemented for spillover issues.

"Historically high debt level is not necessarily a dangerous level from the perspective of solvency but it is a dangerous level from the perspective of liquidity. A lot of African countries are asked to cut back their levels at a time when large investments are needed more than ever in adaptation, resilience and human capital."

“In economics, it doesn’t matter what the debt value is. It is the debt overhang problem we need to resolve today. We call it the problem of fiscal space.” 

Homi Kharas

Panel 2: The role of China in development finance

Introducing the panel, FDL’s Research Director Ishac Diwan, commented on China’s evolution to becoming a major global financier, particularly in Africa, as well as a major trade partner, within the framework of its “Belt and Road” initiative.

“The amount of China’s financing is estimated at around 1 trillion dollars. China’s loan portfolio has increased rapidly over the 20 past years, especially for LICs: 100 billion dollars, which makes up 25% of the loans received by these countries – nearly equal to the amount of the debts to the World Bank.” Ishac Diwan

The objective of this panel was to answer the following question: is the involvement of China in providing loans to developing countries marked by a cooperation between two blocks, or by a competition between them?

China is eager to share its development lessons and experiences, as highlighted by Justin Lin (INSE, Peking University). In particular, investments in infrastructure were both at the heart of China’s own development and its cooperation with other countries.

Indeed, Lin stressed that the competition in the domestic and the international market is conditioned by transaction costs, of which (the lack of) infrastructure is a major component. Although the Chinese government did not provide direct financial support to the labour-intensive industry, it focused on the financing of its infrastructure to reduce the transaction cost. As a result, firms operating in labour-intensive industries made profits which they could reinvest in industrial upgrading.

“If a country wants to get rich, it should invest in infrastructure”

Justin Lin

Hannah Ryder (Development Reimagined) also emphasised Africa’s crucial need for more and better infrastructure, stressing that in work done by Development Reimagined, the needs for infrastructure investment to meet the SDGs for just four countries (Ghana, Nigeria, Côte d’Ivoire, Senegal) were estimated at around 75 billion US$, or 15% of their GDP. China's lending of $150 billion to African countries over the last 20 years, mostly on concessional terms, has been important, but we need more, both from China and G7 countries.

Ryder said that China could reallocate some of its SDRs to African countries or other local instruments, instead of focusing on external ones such as the IMF. SDRs could be channelled through the AfDB for example, UNECA’s LSF or new mechanisms like the ALSM. Ultimately, development should be seen from an African perspective.

“In Chinese lending, it is the national local law of recipients that is the real benchmark not the donor or the creditor who imposes the standards. It is up to the [recipient] government to say this is what our requirements are.”

“It is not about creditors or donors raising the bar, but Africans raising the bar and demanding more finance, better finance."

Hannah Ryder

Shang-Jin Wei of Columbia University stressed that the nature of development finance has changed, with China becoming an important receiver of debt service, up to the same level as MDBs and Private Finance and higher than the Paris Club. The developing world is now facing three global shocks: COVID-19, the rise in US interest rates, which might lead to a wave of foreign currency and banking crisis, and the War in Ukraine which is impacting the energy and food importers.

Debt should be discussed in the broader context of capital flows. Capital flows in Africa are too concentrated on debt. FDI or equity are less risky, meaning that a transition should be made from debt to these types of inflows. Other types of debt than the usual foreign currency-denominated loans have better risk-sharing properties: local currency loans and the use of innovative instruments such as commodity-linked bonds. Wei added that China prefers debt rescheduling rather than debt forgiveness even though the two can be seen as equivalent. Other developing countries can also learn from China's own experience with foreign capital flows. During its development process, it initially actively avoided foreign currency debt as much as possible.

“Thinking about China’s potential role as part of the solution” Shang-Jin Wei

Jiajun Xu (INSE, Peking University) echoed these views adding that developing countries need long-term investments with a transformative potential. After the Great Financial Crisis, emerging markets obtained responses to their calls for more flexibility and reforms in the international financial institutions. She stressed that China can play an innovative role, including by being a pillar in coordination between advanced and developing economies to avoid a debt crisis. She concluded saying that debt needs to promote the structural changes of a country in order to increase the countries’ capacity in the future while making debt sustainable in the long run.

Panel 3: Ministerial discussion

In a conversation with FDL's cofounder Hamouda Chekir, Mexico’s former Minister of Finance, Jose Antonio Gonzales Anaya, introduced a new group of former Finance Ministers brought together to discuss the impact of COVID-19 and improve the dialogue between health and finance ministries. The group will reflect on the principles of a new international financial infrastructure, based on a rigorous academic work and experience in the political realities. The most worrying factor will be the consequences of rising rates by the US Federal Reserve. With rising costs of financing and spreads, vulnerabilities will emerge. This is a "new normal", to which governments and financial markets will need to adapt.

“The power of the Fed in emerging markets is huge and every time we underestimate it”.

Jose Antonio Gonzales