Financing for development: What is at stake?

World Bank President Jim Yong Kim signs documents for approved projects for Vietnam during his visit to the country in July 2014. One of the issues in development financing that need to be addressed in 2015 is the "missing middle" problem, where countries that have reached middle-income status such as Vietnam, suffer from premature withdrawal of grant-based aid. Photo by: Dominic Chavez / World Bank / CC BY-NC-ND

Government and civil society representatives from around the world will converge on Addis Ababa, Ethiopia, in July this year to discuss how to fund a new set of sustainable development goals that are broader and more ambitious than their predecessors.

This is potentially a very big “deal.” However, advance expectations for such massive gatherings are understandably muted, given the diverse array of actors and sometimes sharply divergent interests involved, alongside the sheer scale and complexity of the challenge.

There are four big topics in development finance where we feel concrete progress is nonetheless both desirable and feasible in 2015.

1. External assistance in the form of grants needs to be reallocated more firmly toward more vulnerable and less creditworthy countries. We include public finance for climate change action in this major shift.

2. The international community needs to address the "missing middle" problem, whereby countries that reach middle-income status suffer badly from the premature withdrawal of grant-based aid thereafter. These declining levels of external support are not matched by a proportional rise in tax revenues, at least not until much later in their development path. Their access to external loans on “harder” terms also fails to pick up the slack. Net lending by market-terms windows of multilateral development banks has been flat for decades (outside of temporary spikes during major financial crises), while the number of countries eligible for this funding has been expanding.

3. The success of the SDGs ultimately depends on the private sector, including millions of small enterprises and households, but we cannot just assume that private interests are automatically aligned with the SDGs. Government declarations that the private sector should provide hundreds of billions in additional funding will not impress public opinion much in 2015, if ever they did in 2000.

4. Addis needs to overcome the impasse that climate change funding and development finance debates seem stubbornly stuck in. However much we pay lip service to the idea that public contributions by advanced economies to climate mitigation in the developing world must be “new and additional” to aid, the reality is that they remain overwhelmingly financed by development budgets. So there are real trade-offs to be faced while we wait for big new sources of finance to kick in.

Our new report, “Financing the Post-2015 SDGs: A Rough Road Map,” proposes four specific recommendations to address these issues.

1. Two complementary principles for allocating development finance.

We suggest two complementary principles for the allocation of development finance: The first is to focus international grants on the most vulnerable and least creditworthy countries, especially those with low domestic tax capacity. The second is to boost access to market-related finance for many countries that are actually doing rather well on these counts.

Developing countries face several years of relatively benign global capital market conditions, offering unprecedented opportunities to tap them for major investments in sustainable infrastructure as well as social progress and global public goods. International grants should, and can, be reserved as much as possible for the least creditworthy countries.

2. A new international target for market-related official finance.

We recommend a new international target for market-related official finance that encourages new providers such as China and India, as well as Organization for Economic Cooperation and Development countries, to increase this type of support.

Just 0.5 percent of lender gross domestic product would correspond to some $170 billion a year from G-7 countries, and as much again from emerging economies. Put another way, at least 1 percent of developing country GDP, or roughly $230 billion each year, could be raised through such channels, going a considerable way to leveraging sustainable infrastructure needs of $1 trillion or more.

To boost market-related lending by multilateral development banks (including recent entrants such as the Asian Infrastructure Investment Bank), we propose a thorough reassessment of the system of development banks and the process by which countries "graduate" from one set of terms to another. Multilateral banks are also encouraged to leverage the receivables in their "soft" windows to help improve their overall equity base — as the Asian Development Bank is now doing — and to address weaknesses in delivery, such as insufficient speed and flexibility.

3. Track how public support catalyzes private investment.

To incentivize private finance and help align it with the SDGs, we argue for a serious effort to track how public support catalyzes private investment, for example by establishing basic metrics for identifying when and how much private funding is directly associated with a public stake.

There are other areas too where this public-private engagement can and should be accelerated, notably through guarantees, contingent finance and insurance; targeted project preparation support; subsidy and price reform; and portals, hubs and global partnerships for specific investment categories.

4. Reserve climate change grant aid for adaptation.

Given the sheer scale of climate mitigation investment needs, grant aid for climate change should be reserved, as far as possible, for adaptation. To the extent that grants are provided for mitigation, they should be used for demonstration purposes in less developed/less creditworthy countries, with market-related publicly intermediated loans, at current low interest rates, leveraging private resources for the rest.

Adaptation funding should meanwhile continue to target those most vulnerable to climate change, notably least developed countries and small island development states, for whom we propose a new international minimum target of 50 percent of public concessional adaptation assistance.

These proposed specific but feasible international responses go “with the grain” of how the world is changing, and yet would allow participants at Addis to talk — responsibly — about large numbers, and to accelerate the achievement of the new development goals.

Will you be attending the SDG funding conference in Addis Ababa in July or watching with interest from afar? What are your expectations for the talks in terms of their impact on global development financing? Have your say by making a comment below.

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About the authors

  • Odi guy2

    Homi Kharas

    Homi Kharas is a senior fellow and deputy director for the Global Economy and Development program at the Brookings Institution. Formerly a World Bank chief economist, Kharas studies policies and trends influencing developing countries, including aid, the emergence of a middle class, the food crisis, global governance and the G-20. He served as lead author and executive secretary of the secretariat supporting the High Level Panel advising the U.N. Secretary General on the post-2015 agenda.
  • Annalisa prizzon

    Annalisa Prizzon

    Annalisa Prizzon is a research fellow within the Center for Aid and Public Expenditure at the Overseas Development Institute. At ODI, Annalisa is currently leading the portfolio analyzing the implications of the new development landscape at country level. Before joining ODI, she was an economist at the OECD Development Center and at the World Bank. She holds a doctorate in economics and public finance with a focus on external debt sustainability in low-income countries.
  • Odi guy

    Andrew Rogerson

    Andrew Rogerson is senior research associate at the Overseas Development Institute. His main area of interest is the changing architecture of development cooperation, publishing extensively on the subject. Previously, Rogerson worked at the OECD and advised its development assistance committee; was head of the human development group at the U.K. Department for International Development; and spent 26 years on the staff at the World Bank.