Background Briefings
LOANS OR GRANTS: IDA’S CONCESSIONAL LENDING ROLE
The US has proposed that up to 40% of IDA’s future resources (50% of its operations in ‘IDA-only’ countries) should take the form of grants rather than concessional loans. They argue that grants rather than loans are appropriate for the poorest countries, for financing health, education and other social investments. This note explains why the UK is opposed to the US’ proposal.
IDA’s Concessional Lending Role
The UK believes that there are important arguments for retaining the character of IDA as a provider of highly concessional loans to poor countries. In particular:
- The current system makes effective use of the limited aid funds available. 40% of IDA’s resources come from reflows on previous IDA loans. If IDA provided grants, this gap would have to be filled by a substantial increase in donors’ contributions. It seems reasonable to assume that there will be an ongoing need for IDA finance; on this basis, we should be taking a long-term view. The World Bank estimates that donors would have to provide IDA with additional cash injections of $30 million per year for the first 10 years; $570 million a year for the second decade; $1.8 billion a year for the third decade; and $3.5 billion a year for the fourth decade. These extra resources would be purely to maintain IDA support at its existing level. Although the UK’s own aid budget is increasing, the overall trend in development assistance is downwards. In this climate, it is unrealistic to assume that it will be possible to sustain a substantial grant window within IDA. We also believe that any extra funds would be better spent on expanding the level of aid.
- Maintaining IDA as a lending institution promotes effective cooperation between donor agencies, as well as selectivity and efficiency within
agencies. IDA is only one part of the international development system. It is important that it works in partnership with other grant-based agencies such as the United Nations, the European Development Fund and bilateral donors, not in competition with them. A clear and selective strategy for IDA and effective collaboration amongst agencies are two of the great reforms we have all worked for in the past few years. IDA provides a long-term perspective, which is essential in development. It also puts the borrowing country in the driving seat, which enhances country ownership. A substantial grant window within IDA would undermine the increased effectiveness that we have achieved in recent years.
- We do not accept that IDA’s current terms are always inappropriate for interventions in health or education, or that cheaper finance would encourage countries to invest in these areas more. Investments in social sector interventions can produce very high rates of return (the return on girls’ education is particularly high). Offering IDA on softer terms might be an incentive to countries to increase their borrowing overall, but it would not necessarily increase their expenditure in target sectors. Instead of dictating priorities, we should be encouraging developing countries to set their public expenditure priorities through national consultation processes – which is the great advance of the Poverty Reduction Strategy (PRSP) process. This must use sound investment appraisal that takes full account of economic and social benefits.
In our view, IDA assistance should only be provided on grant rather than loan terms where there is an objective case for doing so. There is a consensus amongst all donors that grant support should be provided to support post-conflict countries and regional aspects of interventions to combat infectious diseases. In both cases, there is a clear role for IDA, and it would be very difficult or impossible for the institution to extend assistance on loan terms. The arguments for IDA support on grant terms for most other types of interventions are weak. Since countries do not make any repayments on an IDA credit for the first 10 years, they would only feel the benefit of any shift from grants to loans in 10 years’ time. There are other ways to provide more direct and immediate assistance where it is needed.
Can Poor Countries Service IDA Loans?
Borrowing is part of responsible economic management, and is needed by poor countries. Not all countries can service market rate loans, which is why IDA was set up. The loans it offers are on highly concessional terms, with a 10-year grace period, repayments over the next 30 years, no interest, and only a small service charge of less than 1%. In net present value terms, IDA’s loans are already 2/3 grant. Contrary to some suggestions, IDA loans are repaid. The default rate is less than 5%. For this 5% we need to look at the causes – they are often poor governance or external shocks. We need a clear, coherent approach to these problems, but shifting IDA to grants is not the answer.
Where countries need or want support for specific interventions on 100% grant terms, they are other sources available (70% of all resources to developing countries are already provided on grant terms). IDA’s role is to provide a bridge between these grants and non-concessional borrowing and, in due course, access to private credit; it enables its clients to demonstrate their commitment to fiduciary responsibility. If the poorest countries are never able to look forward to responsible borrowing then they will remain locked in underdevelopment.
Some people have expressed concerns about the impact of IDA loans on the debt sustainability of countries emerging from the heavily indebted poor countries (HIPC) debt relief initiative. This is to misunderstand the working of the HIPC initiative and of IDA loans. HIPC is designed to reduce past debt to sustainable levels. If poor countries exiting from HIPC cannot even service new debt on IDA terms, then HIPC will have failed. We should not plan for failure: we must and can ensure it succeeds. We recognise that some countries have been affected by the global economic slowdown and the events of 11 September. There is a mechanism to consider additional assistance for such countries within the HIPC process. The UK strongly supports this mechanism. It is a much more immediate way to help than converting new IDA loans into grants, which would only have an impact on debt servicing in 10 years’ time.
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