Soft loans, as opposed to commercial loans,
carry a grant element which reflects the financial terms of a loan: interest
rate, maturity and grace period. The grant element is a measure of the
concessionality, or softness, of an ODA loan. High risk spreads imposed on poor
countries, the leverage effect of soft loans per dollar of aid money, and the
evidence on stimulating tax revenues and growth advocate in favor of soft loans[1].
France, Germany, Japan and also Brazil and
China have a long tradition of soft loans and important national development
banks that provide them. Neither the US nor the UK have established such
institutions, to my knowledge. It is perhaps not too surprising, therefore,
that attacks on development loans and banks have originated from there.
In 2000, an influential US Congress Report of
the International Financial Institution Advisory Commission (better known as
the “Meltzer Commission”), had concluded that that development assistance
should be administered through performance-based grants rather than (soft)
loans. A year earlier, the heavily indebted poor country (HIPC)
initiative had resulted in the cancellation of multilateral debt to a selected
group of poor countries. The Meltzer Commission report based its message on the
´equivalence theorem´. In principle, a soft loan can be bought up by a private
investor and then sliced into a market loan and a grant; hence the term
grant/loan equivalence. The Meltzer Commission intended to weaken the World
Bank; its message implied that multilateral development bank could be closed
and be replaced by a mix of grants and private loans.
The next attack on (soft) loans was
orchestrated by the Western donor cartel as China was accused of “freeriding” on
the development efforts deployed by the international community and impairing
debt sustainability in low-income countries (notwithstanding the fact that
China has also granted debt relief). It was argued that corruption is enhanced,
democracy impaired, and debt tolerance weakened by China’s financing practices.
All these claims have not withstood empirical evidence as China´s loans have
been cheaper than US loans and, most importantly, have been earmarked for
infrastructure investment and relieved poor countries´ binding growth
constraint[2].
The most recent attack, perhaps unconsciously,
comes from former DAC chair Richard Manning and current DCD director John Lomoy.
Both seem to agree, Manning in his 9 April letter
to the Financial Times
in which he reflects that ODA accounting better should move to the UN (!), and
Lomoy in OECD Insights blog, that “there
is a need to revisit these calculations to ensure that they reflect the current
markets terms”. Both would be well advised to familiarise themselves with the
CRS directives or the glossary
of terms and concepts. Under “Grants Element”, they would have read:
“Reflects the financial terms of a commitment:
interest rate, maturity and grace period (interval to first repayment of
capital). It measures the concessionality of a loan, expressed as the
percentage by which the present value of the expected stream of repayments
falls short of the repayments that would have been generated at a given
reference rate of interest. The reference rate is 10% in DAC statistics. This
rate was selected as a proxy for the marginal efficiency of the domestic
investment, i.e. as an indication of the opportunity cost to the donor of
making the funds available.”
To be sure, in recent years, long-term interest
rates in most OECD Member countries have fallen well below 10 per cent, so the
25 per cent grant element level has become easier to attain. But to qualify as
ODA, loans must still be concessional in character, i.e. below market interest
rates. The discount rate of 10 per cent has no relation to the current market
interest rate, but was chosen as an estimate of the opportunity cost of public
investment for donors, which in turn can be approximated by the donors’ social
opportunity cost to public spending on ODA[3].
For some heavily stressed donors of the Eurozone, a discount rate of 10% might
actually be too low these days.
[1] Cohen, D., P. Jacquet und H. Reisen (2006), After Gleneagles: What Role for Loans in
ODA?, OECD Development Centre
Policy Brief No.31.
[2][2] Reisen, H. (2007), “Is China Actually
Helping Debt Sustainability in Africa?”,
G-24 Policy Brief. No.9
[3] Young, L. (2002), “Determining
the Discount Rate for Government Projects”, New Zealand Treasury Working
Paper 02/21, Wellington.
