If Development Finance Institutions Are Providing Aid, They Should Act Accordingly

The member countries of the OECD Development Assistance Committee (DAC) have had heated discussions over how to classify their support to private sector investments in developing countries though development finance institutions (DFIs) like the CDC or Proparco. The current compromise is that donors can count either any capital contributions to DFIs at their face value as official development assistance (ODA) (as long as they count any DFI profits taken out as negative ODA) or they can count any DFI loan with more than a 25 percent subsidy element as ODA (as long as repayments from those loans are counted as negative ODA). Either way, donors have decided that DFIs are in the aid business. And that means that DFIs should follow the principles of effective aid that DAC donors have signed up to.

These principles include:

• From the Busan Partnership Agreement: “Partnerships for development can only succeed if they are led by developing countries, implementing approaches that are tailored to country-specific situations and needs… Transparent practices form the basis for enhanced accountability… Make the full range of information on publicly funded development activities, their financing, terms and conditions, and contribution to development results, publicly available subject to legitimate concerns about commercially sensitive information.”
• From the Paris Declaration: “Donors commit to… Use country systems and procedures to the maximum extent possible.”
• From the Accra Agenda: “Donors will promote the use of local and regional procurement by ensuring that their procurement procedures are transparent and allow local and regional firms to compete. We will build on examples of good practice to help improve local firms’ capacity to compete successfully for aid-funded procurement.”
• From the Multilateral Development Bank Principles to Support Sustainable Private Sector Operations, developed with input from DFIs: “assistance to the private sector should be structured to effectively and efficiently address market failures…ensuring that a net subsidy to the project or enterprise is justified, e.g. by a clear market or institutional failure or public policy goal that is best addressed through a subsidy… Ensuring that subsidies are transparent and targeted… Supporting ‘level playing fields’ by providing an equal opportunity for funding to qualified companies on a non-discriminatory basis.”

So, what does this imply for donor DFI business models?

• DFI investments should be directed by the public policy priorities of developing countries. Investments should go to sectors and projects targeted in national industrial strategies and infrastructure plans, using the mechanisms and approaches laid out in those plans. This contrasts with the current model that predominantly relies on unsolicited proposals from firms interested in DFI support.
• DFIs should use country systems, working through national development banks. There are 230 members of the World Federation of Development Financing Institutions, suggesting this is an option in at least the considerable majority of client countries. The World Bank’s recent survey of national development banks suggests a strong focus on micro and small enterprises and (often) a major role in infrastructure finance—similar to many donor DFIs. The International Finance Corporation provides an example: it is a minority shareholder of Colombia’s Financiera de Desarrollo Nacional, an infrastructure finance institution. But it should be the norm rather than the exception for DFIs to be working with and through national policies and institutions rather than independently. There is still a role for donor DFIs to work through their own account on guarantees, regional projects, and global public goods. But what is the argument for subsidized finance to small and medium enterprises to be delivered through a donor DFI rather than a national development bank?
• DFIs should use selection procedures that level the playing field and allow local and regional firms to compete. Once targets for potential investment have been selected on the basis of the public policy priorities of client countries, DFIs should use mechanisms that ensure all firms have an equal opportunity to attract finance–primarily competitive approaches and open offers based on standard financing terms and clear eligibility criteria. This would be a radical change from the predominant model at the moment of bespoke, opaque negotiation with client firms that have offered unsolicited projects.
• DFIs should prioritize transparency. They should publish the intermediate and final beneficiaries (and beneficial owners) of their funding using International Aid Transparency Initiative standards. This should include amounts and financing terms. The IFC now publishes project-level data on the subsidy element of the investments it supports under the IDA Private Sector Window, this should become the lowest acceptable standard (and apply to on-lending). DFIs should also publish data on development results and adherence to environmental and social safeguards. At the moment, financing terms and on-lending projects in particular are hardly ever released, making it impossible for taxpayers to know how aid money is being utilized.

Thinking about the quality of DFI operations in the midst of the COVID-19 health and economic crisis may seem like a distraction, and certainly there is plenty more development finance institutions could do in response. But, if anything, the twin crises make deeper reform more urgent. Aid budgets are likely to be squeezed as donor country economies contract, while maximizing the development impact of the finance that remains is vital as poverty rates spike in recipient countries. Working in coordination with recipient country governments and institutions, and using open, competitive, and transparent funding mechanisms would be a considerable shift for development finance institutions. But if development finance institutions are in the aid business, it is a shift that is long overdue.