Financial Economic Analysisof the

International Financing Facility

Randall DoddFinancial Policy Forum

John RuthrauffInteraction

January 26, 2005

www.financialpolicy.org

I. Summary of IFF ProposalIn order to better meet the MDGs by delivering greater amounts of aid in the next ten years, the IFF will borrow against future aid flows by issuing bonds in international capital markets.

The IFF will issue bonds that will be collateralized by commitments and pledges of aid from donor governments.

The delivery of greater amounts of aid in the near term will greatly facilitate the achievement of MDGs – which in all likelihood will not otherwise be accomplished – by delivering key amounts of development finance.

The IFF is designed as a neutral financing mechanism to facilitate the delivery of aid by donor countries.

http://www.hm-treasury.gov.uk/documents/international_issues/int_gnd_intfinance.cfm

II. BackgroundEven new, higher aid commitments are not high enough to achieve MDGs. Without additional aid, it is almost certain that we will fail to hit MDGs.

One reason is that aid is stretched out over many years while MDG targeted are 10 years away.

Poor countries will likely fail to achieve sustainable growth because they cannot achieve and sustain sufficient levels of balanced investment. Investment needs to be balanced between health, education, public infrastructure and plant and equipment.

Current insufficient amounts of investment mean that an increase in investment can raise the return on investment. Too little new investment leaves overall investment unbalanced and therefore less efficient. Lower returns on investment will harm prospects for sustainable growth.

II. Background -- UNBALANCED INVESTMENT

Capital

Labor

High Output

Low Output

II. Background – INSUFFICIENT LEVELS

Growth rate

Investment/Output

Developed Economy

Developing Economy

III. Financial Analysis• The IFF provides a solution to the financing shortfall, and to

the resulting unbalanced investment.• It does so by raising large amounts of new funds over the

next 10 years.• Interest cost of borrowing must be offset by gains from higher

returns on “balanced” investment.• Implication: if social-economic returns are not higher than

market rate of interest, then front-loading is not justified.• Prospect of “failed” investment requires a back-up plan.

III. Financial AnalysisIFF functions much like a familiar home mortgage

Payments

Time

Mo

rtga

ge

prin

cipa

l

0 1 30

Interest paymentsPrincipal payments

III. Financial AnalysisCosts and Problems1. It is a risk or gamble that the front-loaded funds will be used

efficiently so that they generate higher returns that justify the future borrowing costs.

2. Imperfect commitment levels by donor governments.3. Capital markets are likely to discount the imperfect

commitments by donor governments and thereby raise borrowing costs.

4. This will be foreign currency exposure by the IFF because the currency denomination of the bonds will be different than that of donations. Alternatively, hedging costs of shifting risk will add cost to borrowing.

5. The political problem of how to control the leveraged funds and their allocation.

IV. Conclusions1. It is a risk, but we almost certain to fail to reach MDG if

something special more is not done.2. It assumes high level of commitment performance, but if

commitments are truly forthcoming then likelihood of achieving MDGs is also more likely. In other word, the IFF is less needed.

3. --

FINI