Climate Windows in Multilateral Aid

Jim Yong Kim, the World Bank President (“Oh doctor, doctor…”) had “The Phrase that Pays” at the recent IMF-World Bank Spring Meetings 2014: “We know we cannot end extreme poverty by 2030 without tackling climate change”. Dr Kim´s statement, to be sure, begs the question why the World Bank (and others, such as the Gates Foundation or the OECD) is so cocksure about ending poverty by 2030? As a matter of prerequisite and logic, ending poverty would imply that ´we can tackle climate change´ over the next fifteen years. This is highly unlikely. Still, should and can concessionary finance by the multilateral development banks be used to tackle climate-change and disaster-risk management and adaption? Not all would agree, and not just for the risk of mission creep on the part of the multilateral development banks (Reisen, 2010)[1].

 

Inge Kaul, who was one of the first to mainstream the critical importance of enhanced provision of global public goods (GPGs) for reducing poverty (Kaul, et al. 1999)[2], says no. She has recently criticized tapping ODA funds for provisioning of GPGs such as climate-proofing development, an issue for which advanced countries have prime responsibility (Kaul, 2014)[3]. It is thus inappropriate to take climate financing out of ODA – there is need to top up ODA with climate finance. A little table that juxtaposes the major differences between GPG provisioning and ODA summarizes Kaul´s position.

 

Table 1: Some Differences between Provisioning GPGs and Development Cooperation

Source: Inge Kaul (2014)

 

 

The OECD Creditor Reporting System does not allow exploring the sectoral breakdown of multilateral ODA. An earlier study (Reisen et al., 2004)[4] that had explored bilateral ODA for how much was being allocated to regional and global public goods had indeed found evidence of “aid diversion” from traditional poverty targets. For the five-year average of the period 1997-2001, the OECD Development Centre study had shown that 30% of bilateral ODA could be classified as global or regional public goods, each contributing 15% to total ODA flows. The offset coefficient between GPG-related ODA and traditional aid was calculated at 25%, which confirmed partner concerns that GPG-devoted ODA was not entirely additional but partly reduced funds for poverty reduction. Another concern – that GPG-oriented ODA would crowd out aid to the poorest countries – was not confirmed, however.

 

These results would confirm tensions between deleting the under-provision of international public goods (where a maximum effect per ODA dollar is reached by earmarking) and recipient countries’ “ownership” (where free transfers maximize the utility of the ODA dollar for the poor). They would also support the quest for separating traditional ODA and spending on the provision of international public goods, to both maximize “ownership” of ODA partner countries and the provision of international public goods.

 

The argument of “aid dispersion” has been refuted, however.  

• First, by those who stress the inseparability of poverty reduction and GPG provisioning and stress the co-benefits of GPG-related ODA[5].  One example advanced is supporting fragile states to establish sound public institutions, which in turn will contribute to poverty reduction and simultaneously deprive international terrorism of a breeding ground. Mitigation of and adaptation to climate change as well as disaster prevention and management are increasingly viewed as a prerequisite to sustaining past successes in global poverty reduction. As part of the post-2015 development goals, a United Nations Secretary General’s High Level Panel recently recommended that building disaster resilience be made a target under the new headline goal on ending poverty.
• Second, by those who look for existing institutions that can be trusted to deliver in a world devote of first-best solutions. Global summits, commissions and proposals to deal with climate change have been endless – and so far ineffective. In the absence of first-best solutions, such as an effective UN climate change convention, multilateral institutions and development agencies can provide second-best solutions by compensating for the lack of global agreements for sharing the burden to provide for global public goods. Multilateral development banks are appreciated for their ability to provide effective financial and technical services. These capable global institutions that can provide long-term finance to meet critical physical and social infrastructure needs regionally and globally and they can serve as critical knowledge hubs.
   
   An important side effect of mainstreaming climate change into development cooperation would be the need for multilateral donors to integrate vulnerability to environmental and global risks into their allocation criteria of concessional flows. By implication, the weight of performance-based allocation and the reliance on policy and governance assessment (through the CPIA) would need to shrink. Donors have been reluctant to change so far, despite criticism and long debate: performance-based assessment gives high weight to policy and governance assessment (through CPIA) and ignores the vulnerability or distance of poor countries from development goals such as the MDGs. Inclusion of policy-independent, structural indicators into the allocation mechanism would make multilateral concessional finance more transparent, stable, predictable and less procyclical.
   
  Assessing vulnerability which is independent of present policy is needed both to identify the most vulnerable poor countries and to design criteria for the allocation of international resources. Two kinds of vulnerability and the corresponding indices can be considered:

• Structural economic vulnerability (as measured by the UN Economic Vulnerability Index, EVI), the UN index thought to replace the non-transparent performance index CPIA. EVI is a composite consisting of 50% ´exposure´ (size, location, agricultural share) and 50% shock intensity (both natural and trade)[6].
• Physical Vulnerability to Climate Change Index (PVCCI), an indicator developed by Patrick Guillaumont (2013)[7] at the Fondation pour les Études et Recherches sur le Développement International (FERDI). PVCCI consists of 50% ´risks related to progressive shocks´ (flooding due to sea level rise; increasing aridity) and 50& ´risks related to the intensification of recurrent shocks´ (rainfall; temperature)[8].
   
  EVI would be used for the allocation of development assistance, PVCCI for the allocation of adaptation resources. As scope and time horizons differ, a separate climate window ruled by PVCCI should be pursued. Poverty related allocation of concessional finance should gradually move away from performance-based allocation, especially to the extent that the focus is on fragile least developed countries.
   
  The devastation brought to the Philippines by typhoon Haiyan in November 2013 has been understood as a wake-up call for multilaterals to deal with extreme weather events that could have their roots in climate change. The Asian Development Bank recently estimated that developing countries need massive investments to transition to a low carbon, climate resilient development path: Incremental investments are estimated to be between $140 billion to $175 billion per year for mitigation in all developing countries, and $40 billion per year for adaptation in developing countries in Asia and the Pacific[9]. Concessional resources can only contribute a tiny part to these investments. Innovative approaches involving a mix of financial instruments are needed. This includes concessional loans, equity investment, subordinated or mezzanine loans, credit enhancement of bond issues, and first loss facilities and guarantees. Dr. Kim´s statement then was indeed “The Phrase that Pays”: provision for dealing with climate change should be added to traditional ODA, not (even partially) replace it.
   

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[1] Helmut Reisen (2010), “The multilateral donor non-system: towards accountability and efficient role assignment”, Economics - The Open-Access, Open-Assessment E-Journal, Kiel Institute for the World Economy, vol. 4(5), pages 1-22.

[2] Inge Kaul (1999), Global Public Goods: International Cooperation in the 21st Century, UNDP: New York City.

[3] Inge Kaul (2014), “'The Donors’ Dilemma' - Time to Think in Terms of Global Public Policy”, Global Policy, 11^th February.

[4] Helmut Reisen, Marcelo Soto, Thomas Weithöner (2004), "Financing Global and Regional Public Goods Through ODA: Analysis and Evidence from the OECD Creditor Reporting System," OECD Development Centre Working Papers 232, OECD Publishing.

[5] See Moira Feil, Mario Stumm &  Jürgen Zattler (2013), ), ´Pay Attention to Co-Benefits´, D+C, September. 

[6] A detailed presentation of EVI can be found in Patrick Guillaumont (2011), The concept of structural economic vulnerability and its relevance for the identification of the Least Developed Countries and other purposes

(Nature, measurement, and evolution), UN-DESA, CDP Background Paper No. 12, ST/ESA/2011/CDP/12 ,September.

[7] Patrick Guillaumont (2013), “Measuring Structural Vulnerability to Allocate Development Assistance and Adaptation Resources”, FERDI Working Paper No. 68, Ferdi: Clermont-Ferrand, March.

[8] For detail, see P. Guillaumont and C. Simonet (2011), “Designing an Index of Structural Vulnerability to Climate Change”, FERDI Working Paper I.08, March.

[9] ADB (2013), Financing Adaptation and Mitigation in Asia and the Pacific, 18. Nov 2013

 

Capital Market Access as IDA Eligibility Criterion – Worthless and Dangerous

In 1960, private capital flows to poor countries were unimportant relative to trade; they were fairly tranquil and consisted mostly of direct foreign investment. That year, IDA was established in recognition of the fact that, for many of the poorest countries, private capital and market based multilateral sources of financing were not adequate. From the start, demand for IDA resources outstripped supply. Hence the need to ration demand for concessional finance through defining eligibility criteria. Apart from the concept of relative poverty, as measured by GNI per capita below an agreed threshold, IDA eligibility and graduation criteria were constructed around the absence of creditworthiness to tap private capital markets.

 

Five decades later, creditworthiness has arguably lost any positive and normative value as an eligibility and graduation criterion for screening the access to multilateral concessional finance. It might equally be dropped. Moreover, capital market access has also been very difficult to predict since the early 1980s. It is an inappropriate determinant for graduation scenarios. These lessons are explained by the radically changed nature of private capital flows to developing and emerging countries, both LICs and MICs.

 

Notably the past three decades have witnessed an impressive range of capital flow cycles – surges (or bonanzas) being followed by ´sudden stops´ (Calvo, 1998)[1]. Private capital flows, and by implication creditworthiness or capital market access, have no predictive value for scenario analysis. Using quarterly gross flows data, Forbes and Warnock (2012)[2] construct episodes of gross capital-flow surges, stops, flight, and retrenchment. For the observation period from 1980 through 2009, they identify 162 episodes of surges, 211 of stops, 180 of flight and 203 of retrenchment in a sample of 56 mostly developing and emerging countries. They conclude that the past decade that witnessed an impressive range of capital flow cycles these waves of capital— which can amplify economic cycles, increase financial system vulnerabilities, and aggravate overall macroeconomic instability—were just a continuation of experiences in the 1980s and 1990s.

 

The drawbacks of private bank credit and portfolio equity and bond flows from a development perspective are still in place (Reisen, 1999)[3]:

• First, they suffer from three major distortions: the problem of asymmetric information causes herd behaviour among investors and, in good times, congestion problems; the fact that some market participants are too big to fail causes excessive risk taking. It is questionable therefore whether the financial markets will discipline governments into better policies; even if they were to do so, the social and economic costs may be excessive.
• Second, any shortfall in capital inflows will require immediate cutbacks in domestic absorption to restore external balance. The savings-investment balance is more likely to be achieved through cuts in investment than through higher savings in the short term, compromising future output levels. Current output levels fall to the extent that rigidities prevent resource reallocation, so that contractionary disabsorption effects outweigh expansionary substitution effects.
• Third, the expansion of domestic credit connected with unsterilized capital inflows may not be sound enough to stand the rise in domestic interest rates and the fall in domestic asset prices that go with a reversal of these inflows. The resulting breakdown of domestic financial institutions provides incentives for monetary expansion and fiscal deficits incurred by the public bail-out of ailing banks.

 

Things have worsened in the last decade: The low or negative term premium in the yield curve in the advanced economies from mid-2010 has pushed international investors into poorer-country local bond markets. By lowering local long rates, this has encouraged much increased foreign currency borrowing in international bond markets by emerging market corporations, much of it by affiliates offshore (Turner, 2014)[4]. The crucial determinant of the global financial boom-bust cycle is monetary policy in the US, which affects leverage of global banks, credit flows and credit growth in the international financial system. The close link between the US monetary stance, volatility, investors´ risk appetite and debt flows has been observed for a while now. Emerging and developing countries, whatever their exchange rate regime and even their macroeconomic policies, are natural victims with their narrow asset bases relative to investor portfolios (Rey, 2013)[5].

 

Hunger for yield has recently led to a sudden surge in borrowing by countries in a region that contains some of the world’s poorest nations.  Sub-Saharan African countries, which long have had to rely on aid to supply part of their foreign currency needs, have for the first time many been able to borrow in international financial markets, selling so-called Eurobonds, which are usually denominated in dollars or euros. In several cases, African countries have been able to sell bonds at lower interest rates than troubled European economies such as Greece and Portugal could (Sy, 2013)[6]. Table 1 shows Sub-Saharan IDA-only or IDA-blend countries that have recently tapped international bond markets.

 

Table 1: Sub-Saharan IDA Countries with Recent Bond Issues

Country	Year	Size, million $US
Angola	2012	1,000
Ghana	2007	750
Nigeria	2011	500
Rwanda	2013	400
Senegal	2009	200
Zambia	2012	750

Source: http://www.worldbank.org/ida/borrowing-countries.html ; Sy (2013).

 

We should take the IDA (2012:7) warning seriously:  “History has shown that pushing countries into market based borrowing before their economies are sufficiently robust to absorb the associated higher debt servicing costs is counter-productive and likely to lead only to situations where countries have to reverse graduate into IDA”. Africa does not have to repeat the costly experiences with her newly acquired access to capital markets that have burdened emerging and developing countries over the past three decades. Poor countries rather continue to need money with a focus on institution building, on social and on environmental impact – all requirements of successful aid effectiveness.

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[1] Guillermo Calvo (1998), “Capital Flows and Capital-Market Crises: The Simple Economics of Sudden

Stops”, Journal of Applied Economics (Nov): 35-54.

[2] Kristin Forbes and Francis Warnock (2012), "Capital flow waves: Surges, stops, flight, and retrenchment," Journal of International Economics, Elsevier, vol. 88(2), pages 235-251.

[3] Helmut Reisen (1999), "After the Great Asian Slump: Towards a Coherent Approach to Global Capital Flows," OECD Development Centre Policy Briefs 16, OECD Publishing.

[4] Philip Turner (2014), “The global long-term interest rate, financial risks and policy choices in EMEs”, BIS Working Paper No. 441

[5] Hélène Rey (2013), „Dilemma not Trilemma: The Global Financial Cycle and Monetary Policy Independence”.

[6] Amadou Sy (2013), „First Borrow“, Finance & Development, Vol. 50.2.