Four challenges when it comes to reporting debt relief as ODA
The body in charge of maintaining and improving the quality, comparability and relevance of DAC statistics on development cooperation will meet informally this week. Civil society is calling for greater transparency when it comes to reporting debt relief as ODA.
This week there will be an informal meeting of the Organisation for Economic Co-operation and Development (OECD) Development Assistance Committee (DAC) Working Party on Development Finance Statistics (WP STATS). This is the body in charge of maintaining and improving the quality, comparability and relevance of DAC statistics on development cooperation and other resource flows to developing countries.
A bit of a background
The system for reporting ODA loans was last reformed in 2014, with the introduction of the ‘grant equivalent system’. Through this new system, donors could no longer report the full amount of a loan as ODA and repayments could not be deducted as they happened. The new system became operative in 2018. Under the new methodology, when a loan is provided its grant equivalent is calculated using a discount rate to account for the fact that money loses value, reducing the value of future repayments on a loan. To account for the risk of these loans not being repaid, the discount rates include (in addition) a risk premium depending on the income level of the creditor country, broadly reflecting the higher risk lenders would take.1 The result of this new system is that the amount of ODA that is reported in any given year already includes a ‘bonus’ for the eventuality that a loan will go sour.
It was not anticipated that the grant equivalent system would apply to loans to be combined with additional reporting of ODA for debt relief. As the DAC itself acknowledges “given that the new system would value upfront the risk of default on ODA loans, the eventual forgiveness of these loans would no longer be reportable as a new aid effort”.2
Debt levels were already at historic highs and the Covid-19 pandemic has pushed them even higher. According to the International Monetary Fund (IMF), the average debt ratios for 2021 are projected to rise by 10 per cent of Gross Domestic Product (GDP) in emerging market economies, and about 7 per cent in low-income countries. As a result, emerging market economies and low-income countries have limited capacity to carry additional debt. And yet, the DAC agreement made in July risks encouraging a rising number of loans in the years to come.
Some may ask what this DAC agreement has to do with the current escalating debt crisis? Let’s take as an example the Debt Service Suspension Initiative (DSSI) adopted by the G20 back in April this year. A total of 46 countries requested to join the DSSI. Their aggregated debt service vis à vis Paris Club creditors (which is almost the same membership of the DAC) is US$1.99 billion for 2020 and US$2.74 billion for 2021. We can expect that any debt rescheduling or cancellation for these 46 countries will impact on ODA figures in the coming years. The new DAC rules allow members to report any debt rescheduling or cancellation as ODA, which opens the door for DAC members to increase their ODA figures without increasing their ODA budgets in absolute terms.
The four problematic effects
1. The agreed method generates inflated ODA figures
There are political reasons for pursuing the reporting of debt relief as ODA. The more transactions donors could include as ODA, the better their statistics would look relative to the United Nation’s 0.7 per cent of Gross National Income target per country. And the better the statistics look, the less pressure donors face to scale up their ODA budgets in real terms and their contribution to eradicate poverty and inequalities. With the new agreed rules, DAC members will be able to claim ODA for debt relief without any actual money being mobilised. Furthermore, these generous rules lead to double counting - more details in this blog.
2. Delaying debt relief increases ODA that can be reported
The methodology to calculate how much ODA can be reported for debt relief uses the grant equivalent risk-adjusted discount rates. The discount rates are used to calculate the ‘present value’ (at the time of debt treatment) of the original loan and measure the value of the amounts due, including interests and arrears. The effect of applying these rates to calculate the current value of the due amount is that, year after year, the value of the money decreases at a high rate, beyond inflation rates (of approximately an average of 2 per cent). The lower the value of the money that is still due, the more ODA the creditor country can report at the end of that year. Thus, if a credit has a maturity of 20 years, from an ODA reporting point of view, it would be much more interesting for the creditor country to grant debt relief at year 15 rather than at year 5 – the later debt relief is granted, the higher amounts of ODA can be reported.
3. As much ODA can be reported for rescheduling a loan than for forgiving a loan
The new methodology allows the reporting of ODA for both the cancellation of loans and the rescheduling of loans. Thus, creditor countries have all the incentives to reschedule debt payments rather than cancelling them. On the one hand, they can already report ODA in the year of treatment of debt rescheduling. On the other hand, they can continue to receive payments back. Furthermore, we don’t know how long a loan can continue to be rescheduled for and how long the creditor country can report ODA for it.
4. The methodology encourages the provision of loans to lower-income countries
The agreed rules aim to encourage debt relief (rescheduling or forgiveness) to lower-income countries – the methodology uses the grant equivalent risk-adjusted discount rates to calculate the amount of ODA to be reported when debt relief is granted and these are higher for lower-income countries (9 per cent). Thus, creditor countries will be able to report higher volumes of ODA when debt relief is granted to lower-income countries. However, there are as many incentives to provide loans to lower-income countries in the very first place for the very same reasons – the amount of ODA the creditor country can report at the moment of extending the loan and if debt relief needs to be granted are higher for lower-income countries. However, what these countries with the most fragile economies need is ODA in the form of grants.
The way forward
With the recently agreed debt relief rules, the benefits in terms of how much ODA could be reported out of loans are so important that, going forward, providers of ODA are incentivised to give loans where grants would be preferable - see more rational about it here. At this week’s informal meeting of the DAC WP STATS, DAC members will be adopting the reporting instructions of the agreement made. We hope members will also take this opportunity to discuss and agree the preparatory steps for the monitoring of the impacts of this agreement on ODA. And we hope they will make clear commitments to review the agreement in 2023, as stated in the July 2020 agreement. This review should also include the re-evaluation of the ‘risk-adjusted discount rates’ agreed in 2014 and their relevance in a context where debt relief is also reported.
The top priority for DAC members should be to ensure that the systems in place promote responsible and sustainable financing in the first place. Eurodad will monitor how this agreement is implemented and its impact on ODA figures, while calling for increased transparency in any future discussions. The negotiations for this agreement were shrouded in secrecy and no documents were made publicly available, seriously constraining active and constructive contributions from CSOs and other stakeholders. We hope that this practice will be revised going forward.
1 On top of the IMF/World Bank 5 per cent discount rate, the grant equivalent method includes an ex ante adjustment anticipating the default risk of 1 per cent for upper middle-income countries, 2 per cent lower middle-income countries and 4 per cent for low-income countries. Thus, the discount rate for upper middle-income countries is 6 per cent, that of lower middle-income countries is 7 per cent and that for low-income countries is 9 per cent.