Financing for Development: An overview of the Agenda
Simon Maxwell, ODI
Benu Schneider, ODI
1. Introducing the series, the Chair, Simon Maxwell, highlighted that the UN's decision to focus on financing for development at the forthcoming High-Level Intergovernmental Event is vital in view of the trends in capital flows to developing countries. The gap between the poorest of the world and the rich has continued to widen. Various aspects of the international architecture require reform in order for developing countries to benefit from the process of globalisation. The aim of the ODI series is to initiate debate on key areas relating to financing for development in order to assess whether the UN's proposals provide the best way forward. What type of agenda would be most effective for such high level meeting, should it be a radical one or conservative, and are we addressing the relevant issues?
2. In her presentation, Benu Schneider focused on the current debate on the concept of Financing for Development where consensus is emerging among experts that there is need for an overall reform agenda both at the domestic and international level. She pointed out that an important aspect of the UN background report is the identification of key areas where developing countries need technical assistance to build capacity to enable them to benefit from globalisation. This is important because financing for development is a complex issue and the current debate considers not only the supply side of official development assistance, but also matters relating to global liquidity, volatility and other forms of funding such as private capital flows. In fact the whole issue should be understood in the context of a discussion of reforms emanating both in developing countries and the international financial architecture.
3. An analysis of the trends in financing for development in the past 30 years reveals that not only has there been a decline in net capital inflows to developing countries in recent years, but the characteristics, composition and distribution of external financing have also undergone fundamental shifts. During the same period there has been a considerable shift in the relative importance of different categories of private capital flows to developing countries and a particular trend is the increase in the significance of FDI.
Benu Schneider summarised the trends as follows:
(i) 1975- early 1980s - bank credits constituted approx. 73% of total private capital inflows to LDCs, while FDI accounted for less than 10%;
(ii) 1980s, after the debt crises - bank loans collapsed to 16% and FDI's share grew to 18% becoming the largest private flow;
(iii) 1990s - revival of bank lending (especially to Asia) though it has continued to decline on net terms, FDI had accelerated rapidly slowing down sharply during the crisis years 1997/8 and portfolio investment emerged as a major form of private inflow. The period 1997-98 had the sharpest decline in capital flows to emerging markets in the wake of the Asian and Russian financial crises. Since then the flows have been highly unstable characterised mostly by short-term funds. Even though there were signs of recovery in 1999 and early 2000, high levels of maturing debt repayments (which creditors are reluctant to reschedule) have resulted in constant decline in net capital flows to emerging markets during the last 10 years.
4. In an effort to attract foreign private savings, in view of the declining ODA, developing countries have been liberalising their capital accounts. However, most developing countries have large skill gaps and require technical assistance to be able to fulfil the pre-conditions for liberalising the capital account.
5. Benu Schneider highlighted some key areas that should be examined in setting up an agenda for the reform of the international financial architecture:
(i) Issues in capital flows to developing countries. How to attract the right mix of private capital flows and official borrowings? How to deal with the volatility of capital flows?
(ii) Issues in donor flows. How to harmonise and smooth the flow of donor funds to prevent monetary distortions in developing countries. The problem of the decline in donor flows, analysis of donor fatigue, selectivity issues, the need for donors to move from project to program aid which is easier and quicker to disburse.
(iii) HIPC Initiative. Is it adequate and what are the issues beyond HIPC I & II?
(iv) Benu Schneider emphasised that it was not enough to attract private capital flows. The absorption aspect was equally important. What can developing countries do to ensure an efficient allocation and management of private capital flows and official aid in countries with weak institutions and segmented financial markets. What are the measures needed to avoid a fall in savings because of capital inflow or a rise in investment leading to an asset bubble? How can 'round-tripping' be avoided?
(v) The inter-linkages between trade and finance. Trade and exchange rates, trade and public finance, impact of tariff reduction, commodity prices and risk management, is trade finance a public good?
(vi) Reforms in the domestic and International financial architecture - Asset-liability management, orderly debt workouts, private sector participation - burden sharing; development of markets and institutions for domestic resource management, role of international organisations, global liquidity management. How to ensure successful domestic economic reforms to remove structural rigidities. Reform of the legal and regulatory framework, good governance, transparency and effective regulatory and supervisory framework; innovative sources of financing, pension and insurance funds, venture capital, loan and credit funds, and domestic bond issues.
(vii) Surveillance of advanced economies. How to manage impact on developing countries, e.g. US interest rates, global liquidity trends and their impact on availability of long term funds for developing countries; Credit rating agencies - Is it appropriate to enhance so much the role of rating agencies given the mistaken and procyclical nature of their ratings of Asian economies at the time of the crisis?
(viii) Other issues which have bearing on the debate but remain largely ignored in the UN agenda is questioning the stability aspect of FDI. It is true that FDI is more stable than other components of capital flows, but nevertheless the flows are volatile. What are the sources of volatility of FDI flows? Do these sources have implications for international financial architecture? Policies relating to supervision and regulation of offshore banks also need to be discussed in this context. After all, offshore banks did play a role in the East Asian crisis. Benu Schneider stressed the need to work out the transition period for developing countries and the role of technical assistance and donor flows in this period.
6. Aid from UK is co-ordinated through DFID, therefore, in his presentation, Tony Faint gave a donor's perspective on the finance for development initiative. He highlighted observations on the historical trends, recent developments towards convergence, current status and finally focused on DFID's perspective.
7. While financing for development has been a controversial issue with a turbulent history most of the past 40 years, the last 10 years have seen growing convergence around three main concepts, which include opportunity/economic growth, empowerment and security.
8. However, in spite of the growing convergence, net capital flows to emerging markets have continued to decline sharply, especially after the Asian & Russian crises in 1997/98. The UN's proposal, which provides the broader agenda for the High-Level Event, is therefore timely and welcome. The secretary general's report constitutes a good basis for a well balanced perspective to review the issues set out echoing the broader agenda in preparation for the for the High Level Event. It is important to ensure that the process is broadly consultative. In this context it is worthy noting that the EU which has emerged as a force in New York is playing a major role in the preparations setting the scene for a balanced discussion of the issues.
9. Tony Faint raised a concern that the agenda proposed in the UN report is very broad. It may, therefore, require to be streamlined in order to sharpen the focus by identifying priority action areas. Furthermore, some issues that may enhance the quality and viability of the discussions and outcomes seem to have been under-played. These include: (i) Capacity building - investment in people, knowledge and skills transfer; (ii) Conflict and corruption as obstacles to poverty reduction and attracting foreign investment; (iii)The importance of selectivity in the allocation of ODA; (iv) The need for donors to harmonise their conditions e.g. untying aid; and (v) Good governance - transparency, accountability and equity.
10. Some of the key areas that DFID would like to see emphasised include the following: (i) The primary role of domestic resources and the appropriate policies to mobilise them; (ii) How to promote FDI and engage the private sector; (iii) Consolidation of a clearer understanding of the role and effectiveness of ODA and the promotion of performance based allocation; and (iv) The importance and need for LDCs to take the lead and initiative in their own development process in the context of principles of Poverty Reduction Strategy and Comprehensive Development Frameworks with the support and partnership of the other stakeholders.
Tony Faint confirmed that DFID would continue to co-operate and work closely with the other stakeholders to ensure the success of the UN high-level meeting.
11. Outputs & Outcomes. The viability of the action programme and final declaration would be enhanced if it contains a prioritised focus on a limited number of measurable outcomes. Aiming for a wholesale reform agenda of the international financial architecture, commodity price risks, global liquidity, international taxation may make it more difficult to achieve a consensus and secure the commitment of the members. In DFID's view, the way ahead must be built on the growing international consensus as it relates to financing issues in the context of the broad agenda which should be streamlined and prioritised in order to focus the outcome.
12. Concluding comments focused on the following points:
(i) The problem of how to deal with risk was highlighted - who bears the risk in the aid business, do the official guarantees take away the caution of prudential lending -hence moral hazard? The current international financial architecture seems to require discipline and corrective measures from the borrower only in the event of project failures. Due to government guarantees, most creditors seem to always recover their funds regardless of whether the project was viable or not. Should governments continue to guarantee commercial loans? It was pointed out that developing countries limit the extent to which they will provide guarantees and ensure a good balance between guaranteed and non-guaranteed loans.
(ii) Conditionality. Is it possible for donors to harmonise their requirements in order to reduce the cases of conflicting conditions imposed on developing countries by different donors? For example, donors should be encouraged to provide more flexible forms of aid such as programme funding through the budget instead of project funding which normally contains restrictive disbursement conditions.
(iii) Mobilisation of domestic resources was highlighted as one of the major problems in developing countries. Technical assistance may be crucial to help these countries to develop and manage instruments for resource mobilisation.
(iv) Principles of good governance, accountability, transparency should be applied to both donors and borrowers. This is particularly critical in the use and management of ODA.
(v) Capital flight: What are the pre-conditions for a stable management of capital inflows and outflows? Some developing countries are reluctant to liberalise capital flows because they fear that it would result in capital flight hence a loss of savings, a fall in investment and loss of income. It was pointed out that the key to a stable capital account liberalisation is to create a stable macroeconomic environment, strong financial sector with adequate regulatory and supervisory structures. It was acknowledged that most developing countries would need technical assistance to build the capacity to manage in an open economy.
(vi) Finally, there was agreement that the UN Financing for Development proposal is a good initiative that will provide a forum to for all stakeholders to develop long-term solutions. There is need however, to ensure that key ideas are incorporated to develop a comprehensive agenda. It was acknowledged that recurrent themes that had come through the presentations and discussions should be developed and recommended. These include aspects such as good governance, economic growth, opportunity, accountability, transparency, sequencing and security.
This event introduced a series discussing the UN's decision to focus on financing for development at the forthcoming High-Level Intergovernmental Event.