Concessional lending unwrapped

Added 12 Dec 2013
Recent discussions at the OECD DAC level have brought to light donor reporting practices that could potentially inflate aid significantly. This article raises issues about the reporting of concessional loans as ODA showing how profit-marking loans are putting the developmental logic of the system into question and how ambiguous rules have opened the system to abuse. A forthcoming Eurodad report assesses these donor practices in greater detail and provides clear recommendations to ensure that reporting requirements have a genuine developmental logic and are not open to abuse by donors.

Concessional loans, known as loans that qualify as Official Development Assistance (ODA), were recently discussed at an expert workshop hosted by the OECD-DAC Working Party on Development Statistics (WP-STAT). This workshop gathered officials from member states as well as representatives from partner countries’ governments, multilateral and bilateral institutions and a few civil society organisations, including Eurodad, in order to present how this form of finance is perceived among different stakeholders.

Despite taking place away from the media spotlight in Europe, ongoing discussions such as the one held during the workshop about the reform of concessional lending conditions will have key development implications. In June 2014, it is expected that the DAC Secretariat will make a proposal to DAC members on a clearer definition of concessionality requirements. This proposal will have serious repercussions on both the quantity of aid that donors provide to developing countries and the incentives for donors to deliver aid in the form of traditional grants or debt-based instruments such as loans. 

Loans where a profit is made are reported as development assistance 

As explained in a previous article, the DAC uses a 10% interest rate benchmark to assess whether a loan includes a ‘grant element’ of at least 25% and therefore can be reported as ODA. As interest rates have dropped sharply due to the ongoing financial crisis, this reference rate no longer reflects reality as illustrated by the graph below. The current benchmark allows donors to borrow at low rates (on average at 2 per cent) and then re-lend to developing countries at higher rates while reporting these loans as ODA. What is even more disconcerting is that the profits made from the returns on these loans are inflating ODA. 

Aid amounts are inflated 

Civil society has long been fighting against inflated aid because it goes against donors’ aid quantity commitments. The current methodology for ODA reporting is problematic because it inflates aid in four ways: 

Interest on loans are counted as development assistance:

Currently, aid figures do not provide a genuine picture of resource flows to and from developing countries because interest repayments are counted as ODA. In 2012, developing countries had to repay 590 million euros as interest on loans to EU institutions and EU governments. Ninety-one per cent of this amount came from three donors: EU institutions (€248 million), Germany (€174 million) and France (€120 million). These significant amounts were counted as ODA while they should have been deducted from net ODA figures.

The high reference rate in use overvalues concessionality:

It is striking to see how concessionality levels vary when using a lower benchmark than the DAC 10% reference rate such as the IMF’s (used in a different context, as part of debt sustainability assessments). In the graph below, we see that grant elements of major loan-giving donors would be significantly lower if a lower benchmark was used. In 2010, concessional elements given by France, Germany and Japan were valued at $504 million, $603 million and $3.1 billion respectively, that is 50% less than when the OECD-DAC 10% criteria is used. 

Source: Devinit Discussion paper on Official Development Assistance loans, p.6

The whole loan counts as ODA, not only the concessional element:

Loans provided by donors have different degrees of concessionality; some provide an average grant element of 45% such as France while others reach 75% such as Japan. However, all loans above a 25% grant element are equivalent to 100% development assistance in DAC statistics because the full value of a loan is reported as ODA rather than the grant element only. This does not provide an accurate picture of donors’ respective efforts. 

No official subsidy is currently required for bilateral loans:

Under current rules, some donors such as the EU, France and Germany have been reporting loans made from funds raised on financial markets where no official subsidy has been added as development assistance. In addition, they have considered that risk-mitigating instruments that support the loans -such as sovereign guarantees and the absence of remuneration for credit risks- are good enough justifications for reporting a loan as concessional.

The DAC rules should be strengthened with an official subsidy requirement, otherwise other donors could be incentivised to start reporting in a similar way. This dangerous potential domino effect would inflate aid figures by a significant amount as a large share of external financing now counted as Other Official Financing (OOF), $20 billion in the case of bilateral aid and $50 billion per year for multilateral institutions, would then be reported as ODA.

The issues raised above show how the reporting of concessional loans as ODA is not based on a clear developmental logic and is open to abuse due to inadequate or ambiguous rules. Eurodad’s forthcoming report will help clarify what these concessional lending requirements are and provides clear recommendations on how they should be revised to ensure that lending is only used when it can provide good developmental outcomes. These recommendations include: deduct interest on loans from net aid; replace the current reference rate with a more relevant benchmark in determining the grant element of ODA loans; report only the concessional element of loans and not the full loan amounts; and specify in the revised rules that loans should include a budgetary effort in the form of an official subsidy to qualify as ODA.