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.
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.
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. For some heavily stressed donors of the Eurozone, a discount rate of 10% might actually be too low these days.
 Reisen, H. (2007), “Is China Actually Helping Debt Sustainability in Africa?”, G-24 Policy Brief. No.9
 Young, L. (2002), “Determining the Discount Rate for Government Projects”, New Zealand Treasury Working Paper 02/21, Wellington.