Blended finance and the new aid rules: a risky mix?

Last week’s UN Financing for Development Forum showed that blended finance – using aid money to mobilise finance from other sources, especially the private sector – continues to top the agenda for many of the big players in development finance. 

In fact, upcoming decisions in Paris and Brussels are likely to confirm blending as a much bigger part of Official Development Assistance (ODA) than ever before. 

In Paris, the Organisation for Economic Cooperation and Development’s Development Assistance Committee (OECD DAC) will shortly decide on new aid rules that allow greater official support to the private sector, including blending, to be counted as ODA. 

Meanwhile in Brussels, the European Commission is currently in the process of negotiating with the European Parliament and the Council of Ministers over the regulation that will govern the new External Investment Plan. The plan sets up a new investment fund called the “European Fund for Sustainable Development” (EFSD) to target Africa and the EU Neighbourhood region. The EFSD will see more than €3.3 billion of EU money invested in existing blending instruments. The fund will also focus on offering guarantees to support the activities of private companies in developing countries, and leveraging additional financing, particularly from the private sector. 

Under the OECD’s proposed reform of the aid rules, EU Member States will potentially be able to count much more of this money as ODA.

The rhetoric behind blending

There are many definitions of blending, and many associated theories of change. But most have at their core the idea that:
  • An injection of aid money can create more favourable conditions for investors, adding value by encouraging them to support development projects that might not otherwise be commercially attractive, or by making existing commercial projects more development-friendly; and 
  • This in turn will deliver outcomes that contribute to the Sustainable Development Goals (SDGs). 
The reality

On the surface, this logic is very appealing. But the most recent evaluation of blending as a way of delivering EU aid adds to a growing body of analysis, including a Eurodad and Oxfam report on blended finance, the 2014 European Court of Auditors report, and the Eurodad report “A dangerous blend?”. All of these suggest the reality is much more complicated than the nice words around blending would seem to indicate.

Two key points are worth highlighting from the 2017 evaluation of EU blending: 
  • Injections of aid money did not always show any added value: The evaluation found that in almost half of the cases examined, there was no clear reason articulated for the use of blending. That’s a lot of European development budget that could have been used with a clearer development rationale. There is indeed a huge risk of subsidising projects that would have happened anyway.
  • Blending did not focus on the poorest – it failed on the SDG pledge to leave no-one behind
Worryingly, the evaluation found that blending projects had not placed a strong enough emphasis on poverty reduction: “The projects selected for blending did not emphasise the pro-poor dimension and especially in the earlier years were not as closely aligned with national policies as they could have been.” Furthermore the projects didn’t pay attention to critical aspects such as job and gender: “job creation was generally not part of the expected objectives to be reached at design stage” and “gender was rarely targeted.” 

Underlying the evaluation findings there is one fundamental problem with the blending agenda: decisions on private sector development and subsidising private companies are key economic policy choices that should be made at the country level, which in turn increases developing country ownership of their own development path. In practice, blending entails a policy choice that represents a huge opportunity cost: every ODA euro spent on blending means less money to support basic public services or other interventions proven to empower the most marginalised. A greater focus on blending also means a controversial shift of ODA from grants to debt- creating instruments that many countries cannot afford. 

In response to these findings the Commission have mentioned several times (in the seminar organised to present the results of the evaluation and again this week in the public consultation on the EIP) that changes have been already made, mainly in the way that financial institutions must justify the need for a grant in the application form. Although the EC argues otherwise in front of MEPs, CSOs are still very concerned, and have argued repeatedly that the Commission have yet to produce evidence of pro-poor development outcomes to justify the expansion of blending through the EIP. 

What’s next?

This doesn’t mean blending has no place in the overall development financing portfolio. But it does mean that, as Eurodad and a coalition of other civil society organisations have warned, much more thought needs to be given to the risks and opportunity costs. And in particular, since the new ODA rules are likely to incentivise greater use of blending, it’s essential that they include strong safeguards against some of the downsides.

Eurodad, together with its members and partners, have developed detailed recommendations for decision makers working on the EIP, and the ODA rules on support to the private sector. These are:
  • All finance mobilised through blending should be required to meet development effectiveness principles, including those on transparency and accountability. This should include a scoreboard of indicators that can be used to assess all projects in advance. The scoreboard for each individual project should be systematically disclosed.
  • The EU should establish a centralised grievance mechanism for all EIP projects, to ensure accountability for breaches of international social, environmental, human rights and labour standards. 
  • An exclusion list should be introduced, to ensure blended finance projects respect human rights, climate and environmental obligations and commitments.
  • Ensure that the objectives of the EIP are fully aligned to the SDGs.
  • The OECD DAC should not finalise the new aid rules until:
    • Concerns over the calculation methodology and transparency of reporting have been addressed; and
    • Plans are in place to monitor the risks associated with the new rules, and to revise them if necessary. In particular, close attention should be paid to the risk of opening the door for more aid to be ‘tied’ to firms in donor countries, to the detriment of the local private sector.
Proponents of blended finance argue that the ambition of the SDGs means we cannot afford to wait before stepping up blending, and that the new ODA rules will incentivise it. But with a growing body of evidence highlighting the risk that blended finance poses to the wider SDG agenda, the costs of rushing in could be even greater – all the more since the Southern governments who will be most directly affected have been largely sidelined from the decision-making process.

With decisions on both the regulation of the EIP and the new ODA rules anticipated before the end of July, the next few weeks are a crucial opportunity for European decision makers and OECD DAC members to help prevent blending from stirring up trouble in the future.