After the crisis: The state of EU development finance

Added 21 Apr 2011

By Oygunn Brynildsen, Bodo Ellmers, Jeroen Kwakkenbos and Nuria Molina.

This week the European Commission released the “EU Accountability report on Financing for Development” – an EC staff working document informally known as the “April Package.” Formerly entitled the “Monterrey Survey” – its original aim was to monitor the commitments made at the at the 2002 UN conference on Financing for Development in Monterrey – the report analyses the progress made by the EU and its Member States to fulfil their commitments for more and better financing for development.

It covers a broad range of issues, including:

  • aid quantity and quality,
  • support for private investments and other private capital flows,
  • developing country debt, and
  • tax matters and illicit financial flows.

The staff working document is accompanied by the Communication “Enhancing EU Accountability on Financing for Development towards the EU Official Development Assistance Peer Review”, an input by the European Commission to the upcoming meeting of the EU’s Foreign Affairs Council.

EU misses 2010 aid target by €15 billion but remakes promise to deliver 0.7% in future: will it deliver?

The European Union was a massive €15 billion off reaching its collective interim target to provide 0.56% Gross National Income (GNI) as Official Development Assistance (ODA) in 2010.  Although the new Communication reaffirms the commitment to provide 0.7% GNI as ODA by 2015 and claims to try to reach the missed interim target “as soon as possible,” it is clear by now that this will take massive collective efforts.

The Commission proposes two ways to improve Member State compliance with the EU’s aid targets:

  • It calls on Member States to commit to further aid increases through multiannual timetables (at best enacted in national legislation)
  • It calls for an annual ODA peer review at the EU council.

Setting a new deadline in 2012 for an interim target was discussed, but unfortunately it was not included in the final document.

A new political push to scale up aid is badly needed because, as the Commission points out, “there is a delay equivalent to about 25 years on the path to 0.7%, as ODA is projected to increase at an annual rate of 0.01% of GNI.” Although EC proposals to make this push happen are welcome, without a renewed political push aid targets won’t be achieved before 2035, with obvious consequences for the world’s poor.

Aid effectiveness is progressing at slow motion

In the context of current debates on how to deliver high-impact aid, the report rightly points out that progress on aid effectiveness commitments is crucial to contribute to more value for money.  Unfortunately, the progress report finds that “although some improvements have been made, enhanced efforts are needed to maximise the impact of aid.” This is diplomatic EU language to convey deep concerns about the implementation of the aid effectiveness agenda.

Stopping attaching policy conditions to development aid and increasing the use of recipient country systems are two areas where implementation is lagging behind.  While it is broadly acknowledged that conditionality undermines developing country ownership and effective aid, only 5 EU donors reduced the number of conditions, and only 7 have made them public. These are commitments that EU governments made in Accra in 2008 and that were supposed to be implemented immediately.

Regarding increasing the use of country systems, the document acknowledges that little progress has been made. Member states recognise that a lack of knowledge by their staff, the labour intensity needed and the urgency to disburse (using country systems takes more time at the beginning) are blocking progress on this area. These are constraints on the donor side that donors should urgently address if they are to meet their aid effectiveness commitments. Moreover, the report does not acknowledge the recent OECD critique of many EU donors that are still tying a share of their aid to the condition that it is spent on goods from the donor country, which clearly impedes making progress towards using country systems. Failing to address this practice seriously reduces value for money and undermines the development effectiveness of EU aid.

Already scarce ODA is diverted from public sector to subsidise the private sector

Using aid to leverage private flows is becoming the new mantra of the European Commission. In a context of “restricted resources,” the report calls for mobilising all possible sources of financing for development, including export credits (and) investment guarantees, as instruments to leverage assistance aimed at stimulating inclusive growth and investment.”

 In addition, the Commission also re-states their intentions to scale up the blending of loans with grants to stretch out stalling aid budgets. Although the report recognises that blended aid can both support public or private investments, actually this type of financing is mentioned under the chapter on private sector, shining a light on the fact that the EC’s main intention is to use blending to support private sector investments. 

Using aid to subsidise the private sector requires a careful assessment: aid is increasingly scarce while development financing for private sector investments in the South has massively increased in recent years through the expansion of private sector lending arms of multilateral and bilateral development banks. This broader picture questions the need for using yet more aid resources for this purpose.  Moreover, funding private sector investments requires sound transparency and accountability mechanisms, as well as strict mechanisms to reconcile the poverty focus of aid with the for-profit objectives of the private sector. So far, the EC and the European Investment Bank have not put in place any such mechanisms, hence making aid for the private sector a risky business- the development outcomes of which are no means assured.   

EU has a responsibility to make taxation effective to mobilise domestic resources

The EC’s continued commitment to enhance financial transparency and to create an “effective, efficient, fair, and sustainable tax system” to mobilise resources for development is most welcome.

In particular, ongoing efforts to require “EU listed companies to disclose financial data on a country-by-country basis (as a) powerful tool for parliaments and civil society to hold multinational enterprises and governments to account for the revenues paid and received” could represent a breakthrough in the fight against tax evasion. However, the report fails to make a bolder call to propose a country-by-country reporting standard for all companies operating in all sectors. The EC must ensure that the legislative proposals on this matter are broad in their coverage and detailed in the financial information required, if they are serious about clamping down on tax evasion by companies operating in developing countries.

Other key issues addressed by the report include transfer pricing rules, non-cooperative jurisdiction and tax information exchange.

Despite the acknowledgement that enhanced global regulation on these issues helps developing countries to mobilise revenues, the report also points that Member States’ “support for this remains rather limited.” They tend to rely on OECD current processes (such as the Global Form) and rules (on transfer pricing) which civil society groups deem very limited in their scope and in their potential to genuinely address developing countries’ needs.

Likewise, Member States overly rely on International Financial Institutions such as the IMF and the World Bank (Doing Business report) to monitor tax competition and provide advice on tax reform. These institutions “received by far the most financial support.” Excessive reliance on the IMF to provide advice on these matters is problematic due to the past track record of the institution in advising regressive tax reforms. Despite recent change at the IMF, the dismissal of the United Nations in providing advice on this area is disappointing.

Responsible lending and new debt restructuring requires comprehensive approach

The recognition of increased debt vulnerabilities in low-and middle income countries following the financial crisis and the need to step up efforts to prevent new debt crises is most welcome. The report points out that “the risk of possible debt distress … will have to be taken into account when increasing the use of blending loans and grants in support of developing countries.” It also states that “to avoid new debt crises, support for improved capacity for sound debt management and for responsible lending and borrowing practices are needed.”

Almost half of the Member States see a need to “reform the international architecture for the restructuring of sovereign debts in order to deal with potential cases of debt distress in low-income countries.”  While last year Member States did not see any need for the Commission to take a role in initiating discussions on alternative debt restructuring for developing countries, this year’s report stresses the need for the EU to develop a common position on this matter. The EU position should take into account that efficient and lasting solutions to debt crises require a comprehensive approach (treating all debts in one single operation) and that a credible and fair debt work-out mechanism needs to be independent of creditors. 

Reform of the IFIs: Europe still needs to get its act together

Eurodad welcomes the EU’s recognition that Europe needs to do more and better to improve developing countries’ voices and votes on the boards of the International Financial Institutions (IFIs), and their access to IFI resources . However, the EU’s Communication only re-states the EU’s commitment to support the swift implementation of the agreed reforms for the World Bank and the IMF and makes a vague call to “strengthen (EU) coordination in the international financial institutions to speak with a single voice on key concerns.” Consolidation of EU representation at the IFIs is clearly off the table. 

Interestingly, the staff working document goes beyond the Communication by recognising that “the 2010 reforms do not fully address the existing agenda,” including regarding the lack of sufficiently open and competitive selection process for the IMF’s Managing Director. It is interesting that this issue is highlighted precisely at the moment when rumours are spreading about the potential stepping down of Dominique Strauss-Khan from the top position at the IMF. 

On the issues of EU consolidation at the IFIs, Member States seem to think that “existing coordination mechanisms (are) sufficient; and (they) need to preserve specific separate interests of individual (EU) shareholders.”

In sum, the report and the Communication cover EU performance on a wealth of development finance issues including welcome progress on the area of tax and debt, and worrying news on stalling aid budgets and piecemeal progress to make EU aid genuinely effective for development. The strong emphasis placed on domestic resource mobilisation and the use of aid to leverage private flows does not manage to hide the fact that the EC is trying to compensate in this areas on what is failing to deliver on its aid commitments. Even more concerning are EU plans to use aid to mobilise private finance without having proper guarantees in place to ensure that this source of financing is fit to deliver development outcomes for the world’s poor.

The EU faces a crucial turning point to define its role as a global actor. It can choose to take bold steps and become a progressive force for effective development, or it can choose to continue business as usual with a mix of welcome leadership in areas such as tax and debt, and a contrastingly less welcome appetite to follow market trends in their rush to leverage private finance without ensuring that this will deliver for development. Now more than ever the EU should be coherent by ensuring that some of its policies do not offset gains achieved in others: this is the only way to become a credible, effective and legitimate global development actor.