This OpEd was initially published on
Levels of deprivation are acute, infrastructure is inadequate and capital is in short supply. In 2012, 43 percent of people still lived in extreme poverty in the LDCs (based on the US$ 1.90 a day or less poverty line).
LDCs are intrinsically extremely vulnerable to economic and environmental shocks and are less able to mobilize and attract the significant amount of finance needed to implement the 2030 Agenda than other developing countries. Tax revenues are weak (at on average just 18% of GDP) and private investment is limited. Where private investment does exist, it remains heavily concentrated in a few resource-rich African LDCs. Many LDCs therefore remain heavily reliant on Official Development Assistance (ODA).
In 2014, LDCs received about USD 41 billion in ODA from OECD donor countries, a share of total aid that has unfortunately declined over recent years. It is clear however that ODA and domestic revenues alone will not be sufficient to fund the large-scale investments needed to achieve the SDGs in the LDCs. In this context, how can LDCs make use of a broader suite of financing instruments now available to support their development? And how can donors help them in this effort?
Over the last 15 years, new financing instruments have emerged both within and in addition to ODA. These include: ‘blended’ finance; guarantees; green bonds; local currency loans; diaspora financing vehicles; impact investing; performance-based loan contracts, and; insurance, amongst others. But beyond a handful of cases, these approaches have not been widely used in the LDCs
‘Blended’ finance represents one strategy to mobilize additional resources for investments in sustainable infrastructure. In these types of mechanisms, aid resources are used to leverage additional sources of finance, both domestic and international. Grants are ‘blended’ with other public or private sources of finance such as loans, risk capital and/or equity typically for infrastructure, energy or private sector development projects. Blended finance projects can help ‘stretch’ scarce development aid resources further. Guarantees also have the potential to make investments in LDCs more attractive for private investors by altering the risk/return profile of the investment.
One example is the French Development Agency’s SUNREF programme which supports local financial institutions to finance the ecological transformation in the energy, water and agriculture sectors. Financial support and technical know-how provided through the project helps local banks to identify promising green investments and to structure an attractive offer (maturity, interest rate, investment premium) to local investors. The technical assistance component was key to the success of the programme and it has also disseminated best practices.
These types of instrument call for new forms of partnership between government, international development agencies and private investors, and require transparency. Such arrangements are not always easy to implement and require extensive external support, especially at the beginning. They do however have the potential to scale up the resources available for infrastructure financing.
In addition to financing for long-term sustainable development investments, LDCs also need support to manage volatility and shocks more effectively, and to make their economies more resilient. LDCs are amongst the most vulnerable countries in the world to shocks and stresses and they typically have more limited capacities to cope. The Ebola health crisis in West Africa is one recent case in point.
Many multilateral and bilateral lenders now offer a variety of risk-management products that enable countries to hedge their exposure to different kinds of risk, including interest rate risk, currency and commodity price risks and weather-related risk, allowing borrowers to plan efficient responses to shocks and stresses and to optimize their debt management strategies. Examples include GDP-linked sovereign bonds, counter-cyclical loans, the inclusion of ‘hurricane’ or ‘catastrophe’ clauses in loan contracts, weather-related insurance schemes and lending in local currencies, amongst others.
Recent research by UNDP simulated the possible benefits of adopting GDP-linked loan contracts for LDCs’ external debt with official multilateral and bilateral creditors, who are their main creditors. Under these types of contracts, debt service is allowed to rise in times of high economic growth when tax revenues are higher but they fall during periods of economic slowdown. The results showed that debt service would have fallen by almost 8% over the 2003-2014 simulation period potentially allowing states to maintain essential expenditures in more difficult times.
Countercyclical loan instruments implemented by AFD – where it is agreed ex-ante that debt service will automatically be allowed to fall, or become zero, in periods when external shocks strike – implemented in Mali, Tanzania, Mozambique, Senegal and Burkina Faso may also help countries to manage risk and volatility. Looking forward, other bilateral and multilateral lenders could explore use of such approaches. Initiatives such as the Africa Risk Capacity Insurance Company Ltd, a sovereign–level mutual insurance company established by the African Union, represent promising instruments to cover risks related to extreme weather events and natural disasters, particularly in the field of food security.
While these types of financial instruments have the potential to bring new solutions to the financing of Agenda 2030 in the LDCs, they will not be effective unless they are adapted to the specific needs and circumstances of each country and fully support national development strategies. Expanding financing to the LDCs – in ways that make sense to them – will be critical if we are to remain true to the SDG promise to “leave no one behind”.