Rules on loans as aid are changing — with potentially significant consequences

The Development Assistance Committee of the Organization for Economic Cooperation and Development is overhauling the rules on how donor lending is counted as aid. In future, only the grant element rather than full value of the loan will be counted as official development assistance and repayments will no longer be subtracted from donors’ ODA. In addition, there will be new thresholds for lower- and middle-income countries to determine which loans count as ODA. These rules were proposed in 2014 and are due to be in full force by 2018.

While this may seem a pretty technical issue, it represents possibly the biggest change ever in the way ODA is measured and so has real implications for the development community. First, the new rules will significantly affect the overall levels of ODA reported by some donors. Secondly, it is possible that the rules will create incentives for different lending habits to MICs and LICs; we must monitor the potential impact of these changes on donor behavior towards developing country recipients.

The possible implications of these changes remind us of the importance of looking beyond headline ODA figures to understand what is really going on.

What exactly is changing?

According to the old rules, loans with a grant element over 25 percent have their full face value counted as ODA. With the new rules, only the grant element itself will be counted.

In addition, the 25 percent threshold is changing. Loans to LICs and least-developed countries will only count as ODA if they have at least a 45 percent grant element. For lower-middle-income and upper-middle-income countries, loans need a 15 percent and 10 percent grant element, respectively, to count as ODA.

So, if $10 million is given to an LIC with a 46 percent grant element, $4.6 million will be counted as ODA, whereas previously the full $10 million would have been counted as ODA. If $10 million is given to an LIC with a 44 percent grant element, zero will be counted as ODA, whereas previously the full amount — being over the old 25 percent threshold — would have been recorded.

Finally, under the old rules, repayments on loans in the years following were subtracted from donors’ ODA; under new rules, no deductions will be made.

What are the implications for donors?

While OECD predicts that the rule changes to ODA loans will have a marginal effect on overall levels of reported ODA, a close examination shows there are large differences between individual donors, which becomes starkly apparent when you apply the new rules retrospectively to aid given in 2013.

For example, Japan’s already relatively concessional ODA loans — and the fact that repayments will no longer be subtracted — means that the $11.6 billion Japan reported as ODA in 2013 would have instead been $18 billion if the new rules had been in force in that year: over 50 percent higher.

On the other hand, ODA from Germany and France — which give loans with a much lower average grant element and have lower repayment levels on existing loans — would have been reported as $700 million and $400 million lower, respectively.

There is currently a lack of evidence on the way reporting rules influence donors’ ODA allocations; however, it is certainly possible that these changes will impact donor decision-making.

What are the implications for developing countries?

A key concern surrounding any changes to the amount and the terms of loans to developing countries has to be the existing state of indebtedness in those countries and the sustainability of their debt obligations. Although the total debt of developing countries has grown considerably since 2005, with aggregate debt stocks more than doubling in the period in both LMICs and UMICs, debt as a percentage of gross national income has — on average — actually fallen due to economic growth.

However, it would be wrong to be complacent about this trend, especially as developing countries are increasingly accessing more nonconcessional finance from other sources. When donors give ODA in the form of loans, it is important that these loans do not serve to burden the recipient with an unsustainable level of debt. Loans should, in light of this consideration, only be used as an instrument of aid in cases where the recipient’s existing debts are manageable and where more lending will not put the country at risk.

Some donors have increased their ODA loans much faster than grants in recent years, and the new rules — which make it easier for loans to MICs to count as ODA — could add impetus to this trend. In theory, this could mean more money becomes available for highly concessional lending — including grant-based lending — to LDCs.

Some aspects of the rules, however, mean that a donor can count more ODA for a loan to an LDC or an LIC than if the same loan were advanced to an MIC. This could create a perverse incentive to give more loans to the poorest countries. With a backdrop of a possible increase in the existing targets for ODA to LDCs, it is clearly important that donor lending is monitored in light of these new rules.

In addition, important elements, such as in the area of debt relief, have yet to be agreed. In the past, the measurement of debt relief has tended to overstate the amount of ODA given by donors by including accrued interest in the amount of debt relief “given.” Reforms in the measurement of the value of debt relief in the ODA statistics should therefore accompany these rule changes.

While DAC reforms are in some important respects a fairer measure of ODA loans than is currently the case, there is still work to be done. Development actors, particularly those focused on debt, must keep a close eye on the impact on ODA lending and use this opportunity to push for these reforms to include other important elements such as debt relief.

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