issues in scaling-up of development aid flows benu schneider the views expressed are those of the...
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Issues in Scaling-up of Development Aid Flows
Benu Schneider
The views expressed are those of the author and do not necessarily represent those of the Financing for Development Office, Department of Economic and Social Affairs, UN
Commonwealth Secretariat, London, 7 March 2007
ODA rose 31.4% to
$106.5 bn in 2005 or 0.33% of GNI (largely due to debt relief to Iraq and Nigeria and Tsunami aid)
G8 pledged to double aid to Africa by 2010 to $50 bn;
$150 bn are needed to reach the MDGs by 2015;
At 0.36% of GNI by 2010, ODA remains below the 0.5% achieved in early years of DAC and below the 0.7% target
Recent Trends in ODA
Issues in ODA flows
Aid is concentrated in a few selected countries
Aid flows in some cases are large relative to the size of the economy
Surges in aid flows have been problematic in spite of a country’s best efforts at macroeconomic management under IMF surveillance and policy advice
Issues in ODA flows (contd.)
Aid flows – uncertain, volatile and herding among donors Management of surges of aid flows similar to managing
surges in private capital flows Management in low income countries is exacerbated by
underdeveloped financial sector Costs of surges illustrated with the case study of Uganda,
Mozambique. Ghana and Tanzania. Sterilization of donor inflows through sale of government
paper led to massive build-up of domestic debt and a rapid increase in interest payments on domestic debt.
Sterilization of inflow through sale of foreign exchange to the banking sector led to high outflows of foreign exchange through the banking sector as there was little demand for foreign exchange in the domestic country.
Proposal for a new mechanism to intermediate donor flows
Selectivity
30%
35%
40%
45%
50%
55%
60%
65%
1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004
Share of top 20 Aid Recipients in Total Aid Flows (bilateral, net)
Percentage of Recipient Countries Accounting for 90% of Aid
Concentration of ODA in recipient countries, 1981-2004Top 20 recipients received more than half of net bilateral ODA
Less than 50 % of aid recipients received 90 % of all aid from DAC donors.
Concentration of ODA
ODA as % of GNI
0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
12.00%
14.00%
16.00%
18.00%
20.00%
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
Sub-SaharaAfricaUganda
Source: OECD/DAC
Source: WESS 2005
Herding
Herding behavior can be detected by the divergence of actual changes in ODA relative to average behavior. If all donors follow average behavior, the difference between actual and average behavior is zero and there is no herding. A value greater than 0.1 indicates significant herding.
This figure analyses the behavior of 10 large and 13 small donors and confirms the existence of herding.
Collective deviation of flows of ODA among donors, 1981-2004
0.093381
0.113381
0.133381
0.153381
0.173381
0.193381
1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003
MEANLSV MEANLSVSMALL MEANLSVBIG Linear (MEANLSV)
VolatilitySize is not the only important aspect of ODA — predictability is equally important
Aid selectivity causes volatility similar to that of private capital flows to emerging market economies
The gap between aid commitment and aid disbursement reduces predictability
0%
5%
10%
15%
20%
25%
30%
Sub-SaharanAfrica
Ghana Mozambique Tanzania Uganda
Capital and Aid Flows Average as a percent of GNI from 1999 - 2004
Private Net Transfers
Remittances
Foreign Direct Investment
Portfolio Equity Flows
Aid
Source: GDF
Financial Intermediation of Donor Flows
Donor Flows
Timing Uncertain Budgetary Support
Deposit with Bank of Uganda
Fiscal Deficit
Project aid intermediated through the commercial
banking system
Additions to liquidity through build up of
reserves and additions to liquidity when the government starts
spending
•Excess liquidity hinders the development of the inter-bank segment and evolution of the short-term reference rate.
•Leave no incentives for the development of money market instruments. It also hinders the development of a secondary market in government securities.
•Encourages banks to use treasury bill and foreign exchange mainly for asset management instead of loans to
the private sector.
Timing and volume of
government spending of donor funds for
budgetary support is uncertain
Interest rate and exchange rate volatility
Affects balance
sheets of the banking
system
Take off of credit
to private sector
Uganda:Financing of the Budget (million shs)
-1700000 -1200000 -700000 -200000 300000millions of shs
Overall deficit (including grants)
Overall deficit (excluding grants)
Net External Financing
Domestic Financing
Source: Bank of Uganda
Ghana Financing of the Budget
-1000 -800 -600 -400 -200 0 200 400 600
2000
2001
2002
2003
2004
million US$Source: Bank of Ghana
Mozambique Financing of the Budget
-20000 -15000 -10000 -5000 0 5000 10000
1999
2000
2001
2002
2003
2004
billion meticaisSource: IMF
Tanzania Financing of the Budget (million TZS)
-2000000 -1500000 -1000000 -500000 0 500000 1000000
2001
2002
2003
2004
2005
Million TZSSource: Bank of Tanzania
■ Domestic Financing ■ Foreign Financing ■ Budget Deficit without Grants ■ Budget Deficit
EXCESS RESERVES
GHANA
0
1000
2000
3000
4000
5000
1990Q1 1992Q2 1994Q3 1996Q4 1999Q1 2001Q2 2003Q3
Bil
lio
ns
US
$
Excess Reserves
Required Reserves
MOZAMBIQUE
0100020003000400050006000700080009000
1997
Q4
1998
Q2
1998
Q4
1999
Q2
1999
Q4
2000
Q2
2000
Q4
2001
Q2
2001
Q4
2002
Q2
2002
Q4
2003
Q2
2003
Q4
2004
Q2
2004
Q4
Bil
lio
n U
S$
Excess Reserves
Required Reserves
TANZANIA
0
100
200
300
400
500
600
Bil
lio
n U
S$ Excess Reserves
Required Reserves
UGANDA
0
100
200
300
400
500
600
700
1990Q1 1992Q2 1994Q3 1996Q4 1999Q1 2001Q2 2003Q3
Bill
ion
US
$
Excess Reserves
Required Reserves
Source: GDF
“The main challenge to monetary policy continued to be the management of excess liquidity injections, resulting from government expenditure.”
Bank of Uganda, Annual Report 2004/2005, p. 16.
Monetary and exchange rate policy geared
to managing liquidity to keep inflation low and maintain competitiveness by
Sale of foreign exchange (round-tripping of flows as banks invest them abroad)
Sale of treasury bills
Uganda Commercial Banks liabilities in forex and external assets and forex lending to resident private
sector
0
50
100
150
200
250
300
350
400
450
500
2000 2001 2002 2003 2004 2005
mil
lio
n U
S$
Commercial banks forex liabilities(million US$)
Commercial banks external assets(million US$)
Forex lending to resident privatesector (million US$)
Source: Bank of Uganda
Tanzania Foreign Assets and Foreign Liabilities of Commercial Banks
0
100
200
300
400
500
600
700
1997 1998 1999 2000 2001 2002 2003 2004
milli
on U
S$
Source: Bank of Tanzania
Ghana Foreign Assets and Foreign Liabilities of DMBs
0
100
200
300
400
500
600
Dec-03
Jun-04
Aug-04
Oct-04
Dec-04
Jun-05
Aug-05
Oct-05
Dec-05
mill
ion
US
$
Source: Bank of Ghana and World Bank WDI
Mozambique Commercial Banks Foreign Assets and Liabilities
0
2000000
4000000
6000000
8000000
10000000
12000000
1998 2000 2002 2003 2004 2005
millio
n m
eti
cais
■ Foreign Assets Commercial Banks (million)
■ Foreign Liabilities Commercial Banks (million)
Source: Bank of Mozambique
Uganda: Treasury Bills
Ratio of Treasury Bill Holdings to Money Supply (M2)
0% 20% 40% 60% 80%
99/00
00/01
01/02
02/03
03/04
04/05
Treasury Bills (million shs)
0 200000 400000 600000 800000 1000000 1200000 1400000
Jun-01
Jun-02
Jun-03
Jun-04
Jun-05
millions shs
Ratio of Treasury Bills to Grants
0% 50% 100% 150%
00/ 01
01/ 02
02/ 03
03/ 04
04/ 05
T r eas ur y
B i l l s / A i d
i nfl ows %
T r eas ur y
B i l l s / G r ants %
Source: Bank of Uganda
Uganda External and Internal Debt Interest Payments (million shs)
0
50,000
100,000
150,000
200,000
250,000
97/98 98/99 99/00 00/01 01/02 02/03 03/04 04/05
milli
on s
hs
Interest on External Debt
Interest on Internal Debt
Source: Bank of Uganda
Ghana Treasury Bills/Grants
0% 50% 100% 150% 200% 250% 300% 350% 400%
2003
2004
Tanzania Treasury Bills/Grants
0% 50% 100% 150% 200% 250% 300% 350%
2002
2003
2004
Source: Bank of Tanzania and IMFSource: Bank of Ghana
Mozambique Tbills/Grants
0% 10% 20% 30% 40% 50%
2002
2003
2004
Source: Bank of Mozambique and World Bank GDF
Mozambique Tbills/M2
0% 10% 20% 30% 40%
2002
2003
2004
Source: Bank of Mozambique and GDF
Tanzania Treasury Bills/M2
0.0% 10.0% 20.0% 30.0% 40.0% 50.0% 60.0% 70.0% 80.0%
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
Source: Bank of Tanzania
Ghana Treasury Bills/M2
0% 10% 20% 30% 40% 50% 60%
Dec-03
Jun-04
Aug-04
Oct-04
Dec-04
Jul-05
Sep-05
Nov-05
Source: Bank of Ghana
INTERNATIONAL RESERVES
0
500
1000
1500
2000
Mil
lio
n U
S$
1995 1997 1999 2001 2003
GHANA
0
200400
600
800
10001200
Mil
lio
n U
S$
1995 1997 1999 2001 2003
MOZAMBIQUE
0
500
1000
1500
2000
2500
Mil
lio
n U
S$
1998 1999 2000 2001 2002 2003 2004
TANZANIA
0200400600800
100012001400
Mil
lio
n U
S$
1997 1998 1999 2000 2001 2002 2003 2004 2005
UGANDA
Source: GDF Source: GDF
Source: GDF Source: Bank of Uganda
Ghana Interest Payments on Domestic and External Debt
0
500
1000
1500
2000
2500
3000
2000 2001 2002 2003 2004 2005
Billi
ons
of C
edis
Source: Bank of Ghana
Mozambique Interest Payments on Internal and External Debt (mdc)
0
200
400
600
800
1000
1200
1997 1998 1999 2000 2001 2002 2003 2004 2005
(mdc
)
Source:Bank of Mozambique
Tanzania Interest Payments on Domestic and Foreign Debt
0
20000
40000
60000
80000
100000
120000
140000
160000
180000
200000
2001 2002 2003 2004 2005
mill
ion
TZS
Source: Bank of Tanzania
▬ Domestic Interest Payments
▬ Foreign Interest Payments
Investment in treasury bills in the Ugandan economy and private sector credit as a percentage of GDP
0%
2%
4%
6%
8%
10%
12%
14%
99/00 00/01 01/02 02/03 03/04 04/05
Treasury Bills/GDP %
Private Sector Credit/GDP %
Source: Bank of Uganda
Uganda Assests of the commercial bank system as a percentage of GDP
0%
2%
4%
6%
8%
10%
12%
99/ 00 00/ 01 01/ 02 02/ 03 03/ 04 04/ 05
T r easur y Bi l l s
For eign E xchange
Assets Abr oad
P r ivate Sector
Cr edi t
For ex lending to
pr ivate sector
Source: Bank of Uganda
Classification by aid absorption and expenditure
Not Spent Partly Spent Mostly Spent Fully Spent
Not absorbed Ghana (0,7) Tanzania (0, 91)
Partly absorbed Ethiopia (20, 0) Uganda (27, 74) Mauritius
Mostly absorbed Mozambique (66, 100)
Fully absorbed
Source: IMF (2005). The Macroeconomics of Managing Increased Aid Inflows: Experiences of Low-Income Countries and Policy Implications
NOTE: “Spent” variable = Non-aid fiscal balance deterioration as percent of incremental aid inflow “Absorb” variable = Non-aid current account deterioration as percent of incremental aid inflow
Excess liquidity hampers financial market development
Excess liquidity hampers the development of the short-end of the market
Absence of term money market Segmented financial markets so that liquidity
shortages/surpluses are not efficiently intermediated through money, capital, forex, and government securities market
91 T-Bill rate virtually the reference rate for lending and deposit rates
Interest rate structure does not reflect the differences in liquidity, maturity and risk
Lack of activity in secondary market due to ample liquidity
Lack of opportunities to lend in foreign currency
Lack of opportunities to build assets in foreign currency
Both the above lead to round-tripping of capital flows with banks holding assets abroad
Investment in treasury bills and assets abroad reduce the incentive to lend
Uganda Government Recurrent Revenue
0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
12.00%
14.00%
16.00%
18.00%
20.00%
97/98 98/99 99/00 00/01 01/02 02/03 03/04 04/05
0
200000
400000
600000
800000
1000000
1200000
1400000
1600000
1800000
2000000
mill
ion
shs
Rate of change recurrent revenue
Recurrent Revenue (million shs)
Source: Bank of Uganda
Uganda Treasury Bill YieldsMean T-Bill Yields
0
5
10
15
20
25
2000 2001 2002 2003 2004 2005
percen
t
91 days
182 days
273 days
364 days
Source: Bank of Uganda
Note: No issuance of 278 days T Bills in 2005
Uganda Monthly Interest Rates
0
5
10
15
20
25
30p
er cen
t
91 days
182 days
273 days
364 days
Source: Bank of Uganda
Ugandan experience
Overestimation of absorption and ability to raise domestic revenue in the expenditure framework
A build of internal public debt negating the positive effects of debt relief
Short-term choice between higher inflation or higher public debt
Limit to the sale of foreign exchange by the authorities as there is very little demand for foreign exchange and banks invest it abroad. There are exposure limits to banks holding assets abroad, thereby posing a limit to the amount of foreign exchange the banks can buy.
Increasing the import content of investments require the assured continuation of donor flows
The signaling mechanism through the PRSP, PRGF, PSI, and CPIA leads to concentration of aid flows.
Risk of reversal of donor flows in Uganda
Amendment to the constitution to allow Museveni’s third term and arrest of Museveni’s rival Dr. Besigye caused withholding of aid by United Kingdom, the Netherlands, Norway and Sweden.
There is close watch on government response to post-election civil unrest and further aid cuts are possible.
On the risk of reversibility of aid flows in countries with aid dependent budgets
Time-consistent policies alone cannot reduce the risk of reversibility of donor flows as reversibility is determined by political factors as well
A smooth transition to domestically financed budgets requires continuation of donor flows in the medium term
Risk of huge fiscal and output contractions if aid flows go down with the risk of losing gains in poverty reduction
Increase domestic savings in the interests of long-term viability.
Augmentation of domestic revenue to avoid a sudden contraction of the economy.
The partial use of donor funds for export diversification, infra-structure development and financial sector reforms import content of investments essential to shield the economy from their liquidity impact and as a secondary effect increase the demand for credit by the private sector.
Keep volatility in interest rates in check to encourage take-off of credit.
Policy response
International financial architecture is not well designed to control the volatility and herding of private capital flows from the supply side
….. but donor flows emanate from the official sector
International cooperation should aim at designing a framework that takes care of surges, volatility and herding behavior emanating from donor behavior
Proposal for a new mechanism to intermediate donor flows
Proposal: Establish a donor funded investment account outside the country for development– To mitigate volatility of donor inflows– To mitigate impact on liquidity through build-up of
reserves and increased government expenditure– Example: Norway
Who will be in control of such a fund?– Board set up by donors, consisting of officials from
the Ministry of Finance and Central Banks– Portfolio management entrusted to BIS– Donors can set up indicators to control spending
Proposal for a new mechanism to intermediate donor flows (contd.)
The role of treasury bills:– Every converted donor dollar impacts monetary base– Central Bank must fine tune timing of inflow, financing
of fiscal deficit, and liquidity situation– Dual role of treasury bills:
• Source of funding for poverty reduction (in addition to initial dollar conversion)
• Mopping up of liquidity after the multiplier has been in operation, minimizing impacts on M2
Additional benefit: development of domestic bond market and other sectors of financial sector
Proposal for a new mechanism to intermediate donor flows (contd.)
Implications of investment fund for central banks– A central Bank can draw down on resources
according to economy’s liquidity situation and timing of expenditure
– Allows for longer-term strategy for poverty reduction, independent of political climate or disbursement negotiations
– Current trade-off between social sector spending and macro-stability can be avoided
– Condition: unused funds in a financial year must be allowed to contribute to stock-building
Proposal for a new mechanism to intermediate donor flows (contd.)
The road ahead: multi-stakeholder dialogue and research– Donor community, IMF and World Bank are
recommended to engage in dialogue and reach an agreement on this crucial issue
– Donors need to understand full implications of donor funds in an economy
– Further research needed• To investigate concrete operation mechanisms of the
proposed investment fund• More generally, to design a new framework for financial
intermediation of donor flow