The complementary role of official development finance: some observations & recommendations

Current financial resources available to governments in developing countries, combined with development finance from multilateral and bilateral donors are not sufficient to achieve the United Nations Sustainable Development Goals (UN SDGs). UNCTAD estimates an annual SDG financing gap of USD 2.5 trillion, which explains the importance of mobilising non-developmental sources of capital – both private and public – for development. The ambitious SDG agenda requires, however, “not only just more money”, but also a “global change of mindsets, approaches and accountabilities”. In other words, it requires a redesign of the international aid architecture.

The OECD Development Assistance Committee (DAC), which is the most important international forum for the international aid architecture, has made some important changes that have an impact on the development finance community and other providers of finance for developing countries. These changes include a new definition of Official Development Assistance (ODA) and the development of new products and methodologies to measure the mobilisation of non-developmental sources of capital. Unfortunately, the new ODA definition and other measures undertaken or considered by the OECD DAC do not adequately take into account the potential negative impact of new aid regulations on other official (public) and private sources of capital that are available for developing countries.

Currently the OECD DAC is discussing how ODA can be used to encourage mobilisation of private sector sources of capital. This concerns a discussion on Private Sector Instruments (PSI), which includes loans, guarantees and equity investments. The focus of the current discussion is to determine the so-called ODA component (i.e. aid subsidy) of these PSI-instruments. Very arbitrary calculation methodologies are suggested to distract the ODA subsidy from these financial instruments. This aid component could subsequently be reported as ODA, which will likely imply an increase of the ODA performance of OECD DAC donors. The intention of the OECD DAC is to seek first an agreement on these ODA aid subsidy calculations and at a later stage a discussion will take place on the complementary role of ODA.

A challenge in all these OECD DAC discussions is that the entire new ODA framework is discussed in complete isolation without properly taking into account market realities and the potential negative impact of new regulations on alternative (non-ODA) sources of capital that are available to developing countries. Instead of crowding in non-developmental sources of capital ODA may crowd out these alternative sources. It is in the interest of the donor community and the SDG agenda at large to use scarce subsidised aid financing only for projects in countries that do not have adequate access to financing that requires no or less official support. The higher the aid subsidies involved the more prudency is needed to avoid crowding out.

In other words, a clear understanding on the complementary role of ODA and other forms of official finance is critical and urgently needed to enhance aid efficiency and aid effectiveness and achieve the UN SDGs.

The article, The Complementary Role of Official Development Finance: Some Observations and Recommendations, describes recent ODA changes and provides some “food for thought” on the complementary role of ODA and other forms of official finance that are available to developing countries. Clarity on “additionality” of official finance, which includes not only ODA, multilateral and bilateral development finance, but also official export credits and official untied investment loans, is critical to assist in an effective and efficient alignment of various forms of finance that benefit from official support. Such an alignment can contribute substantially to enhanced cooperation between various official financiers and the achievement of the UN Sustainable Development Goals.

By Paul H.J. Mudde
Consultant of Sustainable Finance & Insurance

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