Avoiding the collapse of development finance

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Avoiding the collapse of development finance

This article is part of a series in which OECD experts and thought leaders – from around the world and all parts of society – address the COVID-19 crisis, discussing and developing solutions now and for the future.

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In 2019, the OECD warned that the global development finance system in support of the UN Sustainable Development Goals was at risk of default, with serious consequences. The COVID-19 shocks to this flawed development finance architecture is causing it to crumble.

External flows to low- and middle-income countries are projected to drop by USD 700 billion in 2020 compared to 2019. This would be a shock almost two-thirds larger than that of the Global Financial Crisis of 2008-09, where inflows declined by USD 425 billion. OECD projections indicate that even in the most optimistic scenario, global FDI will drop by at least 30%, with flows to developing countries likely falling more strongly. Remittances, a stable and growing source of foreign income for developing countries until earlier this year, could fall by USD 100 billion. Domestic pressures will erode tax revenues, which were already insufficient.

The human toll will be severe. Although estimates vary, the most extreme forecast is that half a billion more people could fall into poverty. The current crisis will exacerbate existing health and societal inequalities. The number of people facing acute food insecurity is likely to double.  

The result of the pre-existing fragile system proves that it will not be enough to build development finance “back” to the way we were pre-COVID. We need to focus on building it better from the start. Global investment in sustainable development has to be fairer, greener and more resilient against shocks before they hit.

Read the OECD Policy Brief Developing countries and development co-operation: What is at stake?

Read the OECD Policy Brief Developing countries and development co-operation: What is at stake?

Public development finance remains at the core

Over the medium and longer term, public finance will remain essential, not only because of its purpose, but also its dependability. In 2019, official development assistance (ODA) rose for all countries compared to 2018, reaching USD 153 billion. Looking back at 60 years of data we find that, while ODA doesn’t provide the largest volume of external financing to developing countries, it has been the most stable source, smoothing the impact of the economic crises of the past. Declines in GDP growth in donor countries do not lead to inevitable declines in ODA; a sense of solidarity, a recognition of need and other geopolitical factors seem to be more influential.

Looking ahead to ODA performance in the coming years, amid the worst recession in living memory, these findings suggest three possible scenarios: ODA budgets could rise to meet the need created by the COVID-19 crisis; budgets could hold steady at recent levels despite global slowdown in growth; or, budgets could decline in line with contracting donor economies. Despite the unique challenges posed by the COVID-19 pandemic, past trends suggest that ODA can be resilient in 2020 and 2021. It may even increase, depending on political leadership.

Graph: OECD

Developing countries are also looking to donors for debt relief. The OECD estimates that the debt standstill agreement among G20 Finance Ministers would bring substantial liquidity support: provided both creditors and borrowers were to participate fully, the agreement could result in USD 25.3 billion for low- and middle-income countries in 2020. If multilateral development banks participate, this could add an additional USD 9.2 billion. Yet two elements of this debt standstill agreement remain in question: first, this level of finance will only materialise if all actors are in; and second, this access to liquidity defers payments, and we will need to watch closely the impact on future debt levels. 

Building better: public development finance needs to be protected, stepped up and reimagined

The COVID-19 recovery forces a choice between reinforcing trajectories that work against sustainability, or enabling resilience for developing countries. Support for brown industries, such as coal and gas, will push governments to build back to pre-COVID conditions. Donors can play a significant role to resist the bias for old solutions by fleshing out the economic opportunities of a sustainable recovery aligned with the 2030 Agenda and the Paris Agreement: environmental, social and governance (ESG) shocks lower the long-term value of assets, and finance that accounts for ESG risks have outperformed benchmarks in the current crisis; estimates from the International Labor Organization indicate the transition to low-emissions, climate-resilient economies would net 18 million jobs and simultaneously support the 1.2 billion jobs, primarily in developing countries, that depend on direct ecosystems services; and the World Bank estimates that every dollar invested into climate-resilient infrastructure averages a four-dollar return that safeguards productivity gains and job creation infrastructure supports.

Official finance and policy changes can also play a larger role in mobilising private finance for the COVID-19 recovery, working to prevent any green-washing. As rising risk premiums diminish the attractiveness of emerging and developing markets for private capital in the short term, the case for public finance intervention becomes stronger. Development finance institutions will have to step up their efforts to attract investment in the medium term and offer de-risking strategies in the sectors hit hardest by the crisis, such as agriculture, health or water and sanitation. The recovery could also be an opportunity for them to recalibrate their portfolios and reassess existing blended finance models and instruments in order to scale up support for sustainable development.

Now is the time for a strong, sustainable and inclusive recovery by Dimitri Zenghelis and Nick Stern, Grantham Research Institute

Now is the time for a strong, sustainable and inclusive recovery by Dimitri Zenghelis and Nick Stern, Grantham Research Institute

The case for donor responsibility and opportunity, despite the challenges at home

Despite serious domestic challenges, donor countries have a responsibility to continue supporting developing countries’ sustainable development. This responsibility is not only to cushion the blow of collapsing external finance tied to donor countries’ crisis externalities (drops in trade, consumption, tourism, etc.), but also to throw sand in the wheels of widening economic divergence. Global economic growth over the last decade has been driven by the same countries that will now be hardest hit.  This means that as the global economy recovers, there is not only a special responsibility to reinvest in them, but also an acknowledgement that developing countries are essential partners for future economic security. Joseph Stiglitz recently argued that, “The recovery packages can either kill two birds with one stone—setting the global economy on a pathway towards net-zero emissions—or lock us into a fossil system from which it will be nearly impossible to escape”. Global development finance has the mandate to kill three birds: COVID-19 global economic downturn; climate change; and poverty and inequalities. But time is running out to take aim and action on today’s recovery investments. 

Related Topics

Tackling COVID-19 Sustainable Development Goals Finance

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