The Monterrey Consensus on Financing Development recognised the importance of official development assistance (ODA) as a complementary source of financing development, especially for low-income countries where domestic savings fall short of investment needs and where foreign investment flows are low. It recognised that ODA, if utilised appropriately, can help to expand economies and the domestic private sector and if invested in essential services and infrastructure, can contribute to reducing poverty and economic growth. Consequently, it called for substantial increases in ODA and for effective partnerships to channel these resources in developing countries to achieve the MDGs (Millennium Development Goals). In particular, it urged those developed countries that had not reached the target of 0.7 per cent of GDP (gross domestic product) allocation to ODA to do so speedily. It also called for measures to improve the quality of ODA, including aid untying, policy space for developing countries and more efficient administration of aid.

The Monterrey Consensus was reached against the background of aid recovery on the back of relatively robust growth in OECD (Organisation for Economic Co-operation and Development) countries but also fresh wounds from the Asian financial crisis, about which developed countries felt a degree of responsibility. The conditions, as we approach Doha, could not be more different.

ODA OPTIMISM

ODA flows reached a peak in 1990 (at 0.33 per cent of GNI (gross national income) of OECD DAC (Development Assistance Committee) countries) following a decade of intense lending to Africa and the bailing-out of a number of large countries that had suffered severe debt crises. In the 1990s, the declining need to make payments to Cold War allies coincided with an increasing number of sceptical analyses of the poverty-reducing impact of aid, and aid began to fall both in real terms and as a percentage of rich country GDP. In 1997, ODA hit a trough, at 0.22 per cent of GDP of DAC countries and stayed at this level to the eve of Monterrey.

Since then ODA rose both in real terms and as a percentage of donor income, reaching a new peak in 2005. In this year of aid optimism, perhaps best captured by the celebrity and NGO-led global mobilisations surrounding the G8 meeting in Gleneagles, Scotland, the OECD projected that gross ODA would rise steadily from US$80 billion in 2004 to US$130 billion in 2010, calling it 'the largest expansion of ODA [aid] … since the committee was formed in 1960' (OECD 2005). The G8 committed to ensuring that by 2010, gross ODA would increase year on year by US$50 billion. Perhaps even more significantly, for the first time, many developed countries set up timetables and road maps to reach their targets of 0.7 per cent of GDP/GNI allocated to ODA.

UNFULFILLED PROMISES

The situation two years later was much less upbeat. Although gross ODA did increase, the change was a modest US$24.5 billion cumulatively against the annual US$50 billion target. Most of the increase was channelled into debt relief for Nigeria and Iraq. Indeed, a year following Gleneagles, gross ODA actually dipped, declining significantly in the G7 countries by 8.7 per cent. The steepest declines were in Italy (30 per cent), the USA (20 per cent) and Japan (9.6 per cent). Only the UK saw a significant increase (13 per cent), the rest coming from non-G7 countries (6.1 per cent).

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Source: OECD, DAC

THE POOR HAVE BEEN AIDING THE RICH

Gross ODA doesn’t tell the complete picture. Measured in net terms (gross repayment of official loans provided as ODA), official flows to all developing countries have declined sharply, and became negative in 2002, reaching US$32 billion in 2007, according to IMF (International Monetary Fund) figures. Between 2002 and 2007, developing countries transferred cumulatively an amount of US$563 billion in ODA to developed countries. Net flows to low-income developing countries however are marginally positive, but nowhere on the scale necessary to reduce poverty substantially.

The scale of negative resource transfers (from developing to developed) is even more staggering measured in terms of total net transfers (see Table 1).[1] Put differently, developing countries became net-capital providers to rich countries, and not the other way round as theory predicts. Cumulatively, this amounted to US$2,577 billion in the period 2002–07. Add to this the volume of capital flight, especially illicit capital flight from developing countries (estimated annually between US$150–$250 billion), and the scale of 'reverse aid' is staggering.

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COMPELLING NEED BUT HIGHLY UNRELIABLE

As we meet, the need for enhanced ODA cannot be more compelling. Many low-income countries are not on-track to fulfil a significant number of the MDGs at the time when the external conditions are turning onerous. I refer in particular to the volatility in capital markets risking a reversal of private capital flows, soaring prices of food and energy (especially for net food and energy importers) and the adjustment costs that will be imposed on countries moving towards a low-carbon growth path in view of climate change. Indeed, given the responsibility of developed countries in greenhouse-gas accumulation, and the right of poor countries to develop, a development-friendly climate agreement should impose an immense carbon debt on rich countries. Add to these the collapse of the value of the dollar, which threatens to wipe out the savings (reserves) of many poor countries (typically denominated in dollars). In addition, upward pressures on interest rates in the euro economies and in the UK threaten to increase debt burdens and the cost of capital.

Yet ODA is unreliable, volatile and highly cyclical. It rises and falls with economic conditions in rich countries. It is extremely sensitive to global financial stability and perceptions of stability. Moreover, as a foreign policy instrument, it rides on the waves of changing political moods. Doha couldn’t be happening at a worse time in relation to harnessing ODA, with projected downturns in some of the biggest trans-Atlantic economies, in particular the US and the UK, following the banking crisis in the UK and the sub-prime loan crisis in the United States and fears of a contagion effect. On top of this, public confidence in the political leadership of key countries is waning, with the end of the Iraq war (a major sink of public resources) not in sight. Add to this what appear to be xenophobic reactions to China’s role in the world and the cocktail for a global environment for enhanced ODA does not look pretty.

WHAT CAN BE DONE ABOUT ODA?

This does not suggest taking the pressure off the rich countries from fulfilling their obligations which they took on as part of an international agreement, which ought to be enforceable. Developing countries after all have been held to their side of the bargain in the form of painful economic and political reforms. Yet the reality is that developed countries have often treated their side of the bargain as voluntary and to be discarded when inconvenient. There are no practical mechanisms to effectively enforce the fulfilment of commitments, in spite of the rhetoric of mutual accountability. How could this be rectified?

One approach is to push for the enforcement of summit agreements in international law. This is of course complex, risky and requires collective action among developing countries. A complementary approach is to transform aid commitments into debt obligations, governed by the same international law that regulates international debt. In this way, unfulfilled commitments (in terms of actual disbursements) will accumulate into deferred obligations attracting interest. Gordon Brown’s International Finance Facility (IFF) was an example of how to operationalise this. The IFF sought to commit the G8 countries by raising money immediately in the capital markets on the back of the public budget. Both measures require that developed countries lend themselves to undertaking these commitments in the way that they do in relation to trade agreements. As we are all know, the rich countries refused to be drawn into the IFF in a serious way and there is little developing countries can do practically.

The treatment by developed countries of their ODA commitments as voluntary undertakings leaves developing countries with limited options. One option is the need to build and sustain domestic political constituencies and public opinion favourable to international development in developed countries. This is particularly crucial in periods of economic downturn or cycles in which the leadership is less pro-aid. This is of course difficult for G77 governments to do directly, but is something which NGOs – North and South – do best. The global debt movement and the trade justice movements have proved this. It is in the interest of G77 countries that they narrow the distance with their own civil society groups. More importantly, they need to build the trust of their citizens in the value of aid, which means effective and accountable expenditures.

But it also suggests two other equally important related priorities: the need to focus more on aid-quality issues and the urgent need to address the systemic issues underpinning global finance. On aid quality, I will emphasise the need to be unflinching in the demand for an end to policy conditionality and the liberalisation of public procurement systems, usually attached to loans, grants and debt relief. The Paris principle of better aid coordination has unfortunately been translated in practice into mechanisms by which donor agencies govern domestic budgets, often undermining fledgling parliaments and democratic accountability generally.

The key systemic issues I will emphasise include effective developing country voices in institutions that regulate capital flows, increased South–South collaboration to establish complementary institutions to regulate, mobilise and deploy capital for investment, and collaborative measures to minimise illicit capital flight.

ALTERNATIVE MECHANISMS FOR MOBILISING CAPITAL

The difficulty of enforcing ODA commitments, combined with the scale of financial outflows from developing countries, suggests a shift of emphasis in two ways: exploring alternative and innovative means of mobilising development finance and urgent steps to stem illicit outflows. On the former, we highlight opportunities in Sovereign Wealth Funds (SWFs), and in relation to the latter objective we refer in particular to the need for a transparent, fair and accountable international tax system.

MOBILISING SOVEREIGN WEALTH FUNDS TO FIGHT POVERTY

The 2002 Monterrey Consensus recognised a fundamental role to international capital flows and international financial stability in supporting countries to meet their development goals. Improved economic conditions in developing countries have driven a surge in net private-capital flows in recent years, particularly foreign direct investment (FDI), though current and prospective global market conditions are likely to reverse this trend, as already happened in the past.

These large and increasing net transfers of resources from poor to rich are largely a reflection of the unprecedented accumulation of foreign exchange reserves by developing countries. International assets have tripled since 2001, with developing countries as a whole accounting for more than 80 per cent of global reserve accumulation. Their current level of reserves approaches US$5 trillion. Yet this extraordinary process of reserve hoarding does not tell the whole story, for a substantial part of the increase in foreign assets in some areas of the world has been accumulated in Sovereign Wealth Funds (SWFs). SWFs are estimated to have more than US$3 trillion of assets under management, equivalent to half of global official reserve holdings. SWFs of countries of the Gulf Cooperation Council constitute more than half of total assets managed by SWFs. These funds are on the whole additional to foreign exchange reserves, yet both phenomena are highly interrelated.

Perhaps the best solution to halting and reversing the trend of net transfer of resources from the developing world to advanced economies would require an internationally coordinated policy response to fix the international financial architecture (IFA). Some developing countries, especially in Asia, have been hoarding foreign exchange reserves chiefly to protect themselves against the risk of financial instability. Others, particularly oil-producing countries, have accumulated foreign assets mostly as a result of buoyant commodity prices. In both cases, countries are running a fixed exchange-rate regime or a managed float. Both phenomena reflect to a large extent the lack of a collective mechanism of balance-of-payments adjustment. It would therefore be of fundamental importance to reform the IFA by strengthening the voice and representation of developing countries while agreeing upon a collective insurance system.

A second-best solution would be to strengthen South–South cooperation by recycling part of the foreign exchange reserves accumulated in recent years to promote human development gains. During the last decade, developing countries have become an important source of FDI, bank lending and even aid for other developing countries, reflecting their increasing integration into the world financial markets. These capital flows are now growing more rapidly than those between developed and developing countries. This trend needs to be further supported and encouraged. However, South–South portfolio flows, in particular debt flows, are still very limited.

Portfolio debt flows in general can benefit developing countries directly, by providing financing for investment. They can be a valuable source of financing for both the public sector and large private firms. They can also benefit developing countries indirectly, by helping expand their financial sectors and deepen their capital markets. However, these flows are traditionally characterised by high volatility and reversibility, potentially generating huge costs for developing countries. Hence the need for not only increasing the size of these South–South debt flows, but also for making them stable and work in a pro-poor fashion.

SWFs have recently contributed to international financial stability by helping recapitalise international banks hit by the sub-prime crisis. They can now help fight poverty. Recently, World Bank President Robert Zoellick suggested that SWFs should invest 1 per cent of their assets in African equity markets. However, it is not clear whether such a move would have any direct developmental impact beyond that of boosting a few domestic capital markets in Africa. We alternatively suggest that the firepower of SFWs, especially but not only those in the Middle East, be combined with the globally fast-growing Islamic bond market, in particular with sukuk. Given sharia law's prohibition of interest, conventional bonds and debt instruments are forbidden in Islamic finance. Sukuk are designed to generate the same economic benefit of a conventional bond, but in a sharia-compliant manner. The market of sukuk has grown tremendously in recent years to more than US$50 billion. Sukuk issuance is not limited to Islamic countries; a growing number of Western and Asian governments and companies are increasingly using this instrument to diversify their investor base.

Sukuk are structured in a way similar to asset-backed bonds, where the payouts are based on the performance of the underlying productive assets. Instead of a fixed-interest payment, payouts to investors over the life of the bond are derived from leases, profits or sales of tangible assets. This makes sukuk a perfect instrument to finance infrastructure development, as the funds raised are used for a specific project. Infrastructure is recognised as a key ingredient in reducing poverty, increasing growth and ultimately reaching the MDGs. Billions of people still lack access to water, roads and telecommunications, and this affects their income, education and health. Developing countries need more infrastructure development. Yet there is a financing gap, as governments have very limited resources, aid is insufficient and private capital inadequate and concentrated in a few sectors.

In their search for diversification, SWFs could invest part of their wealth to finance infrastructure development in developing countries through sukuk issued by developing countries’ governments. SWFs of countries in the Gulf Cooperation Council account for more than half of total assets accumulated in SWFs worldwide. They would be key to such an investment alternative. But also Asian-based SWFs would consider putting money in sukuk. There is some evidence that sukuk provide portfolio diversification benefits for investors. Finally, their still limited secondary-market trading makes them a perfect instrument for SWFs, which are traditionally buy-and-hold investors.

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* Charles Abugre is deputy director of the UN Millennium Campaign, Africa. This article was written in his personal capacity while working for Christian Aid.
* Please send comments to [email protected] or comment online at Pambazuka News.

NOTE

[1] The net transfer of financial resources is essentially the financial counterpart of a surplus in the balance of trade in goods and services.