The evolving landscape for external development financing: what African policy makers must know

This article is based on the African Center for Economic Transformation (ACET) synthesis report, “Mobilizing and Managing External Development Finance for Inclusive Growth: Six Countries’ Experiences and Lessons”. 

by | Dec 22, 2017

Over the last decade or so, few countries have been able to match Rwanda’s aggressive pace to diversify, grow, and transform its economy. It is widely recognized as a leader in Africa’s economic transformation. It also leads in another way: the growing share of non-traditional development assistance in its development financing framework. Consider that Chinese grants to Rwanda between 1971 and 2011 totaled $170 million, but since 2004 the number already is about $115 million, invested in 39 different projects.

“Over the last decade or so, few countries have been able to match Rwanda’s aggressive pace to diversify, grow, and transform its economy.” – Edward K.Brown Click To Tweet

Meanwhile, India has cooperated closely with Rwanda in the public and private sectors, mainly in education, health, and small and medium enterprises in science and technology. It also has accorded preferential loans for hydroelectric projects and education centers. Non-traditional development assistance still accounts for a relatively small overall share of external development finance in Rwanda (averaging 6 percent between 2005 and 2014), but it represents something much larger—a seismic shift in how countries are being developed.

Around the world but especially in Africa, the external development finance landscape is evolving rapidly. Traditional official development assistance (ODA) continues to decline, particularly in countries that need it the most. On the other hand, emerging economies—notably Brazil, China, India, Russia, Singapore, South Africa, Taiwan (China), and the Arab states—are fast becoming important players in global finance (though in some cases also sparking debate over their motivations). Also on the rise is the involvement of non-state actors—especially international philanthropies, such as the Bill & Melinda Gates, Rockefeller, and MasterCard foundations—who see aid as a means to increase the supply of global public goods to improve human development, not just financial assistance. And thanks to improved macroeconomic balances, rising commodity prices, falling sovereign debt, and low global interest rates, many African countries over the past decade have ventured into the global capital market to issue Eurobonds.

Policy making

These and other changes have created an array of choices for countries beyond traditional aid. But with new opportunities come new questions. For instance, how are countries accessing external finance amid the changing landscape? How have the changes affected the relative importance of ODA and its composition at the country level? How are country systems (institutional structures, processes and coordination) adapting to mobilize and manage resources—and to ensure financial sustainability?

Relevant lessons can be drawn from the experiences of six countries recently studied by ACET: Burkina Faso, Ghana, Rwanda, Tanzania, Uganda and Zambia. The study covered the years 2005-2014. While all circumstances are unique, these six form a fair and geographically diverse representation of African countries with development experience in the past decade.  Their experiences, when taken together, provide some clear takeaways to better understand the ramifications of the new landscape.

External finance is on the rise, but the shift from traditional ODA to other flows, including the private sector and non-traditional donors, is pronounced—and potentially problematic. For example, by 2014, the share of international private capital flows as a percentage of total external finance in Ghana was 82 percent, dwarfing ODA. Yet ODA remains necessary as it is still the leading funding source for critical sectors like education and health—sectors where the new funders are typically disengaged or loudly absent. Even with new sources of financing, the precipitous drop in ODA—a 61 percent plunge in Ghana, for instance—remains a major concern for countries as they work to transform.

Foreign direct investment (FDI) and remittances are driving EDF growth. In Ghana and Rwanda, FDI increased at a compound annual growth rate of more than 50 percent. Remittances more than doubled in all six countries. By and large, countries are still searching for the best ways to leverage remittances for growth, though some, including Rwanda and Uganda, are designing instruments to channel these flows to foster entrepreneurship and innovation.

Terms and conditions are shifting from concessional to non-concessional financing. The rising volume of FDI, Eurobonds, and remittances are beginning to tilt the scale in favor of loans (though the trend is more evident in lower middle-income countries). That’s because loans are a larger part of the financing picture from the emerging, non-traditional donors, including Brazil, China, and India.

Rising debt is posing sustainability challenges. Since countries have increased access to a raft of new funding instruments, whether Eurobonds or public-private partnerships, they are showing a steady desire to borrow more liberally for major investments, such as infrastructure projects. Ghana and Zambia, for instance, have floated the most Eurobonds over the last four years—five and three, respectively—but neither country has strategic documents assessing the risk and options of accessing international capital markets. Government debt-to-GDP ratio is on the rise, and the increasing debt burdens risk reaching unsustainable heights unless properly managed.

“Traditional official development assistance (ODA) continues to decline, particularly in countries that need it the most.”– Edward K.Brown Click To Tweet

A slow response

Most countries are proving slow to act. While many have prepared new aid policies or action plans to reflect the changing landscape, implementation has generally been poor, and institutional reforms to accommodate the new policies have been lacking. The lack of integration poses long-term risks for governments trying to manage grants and loans while also raising their own internal resources. Until recently, policy and legal frameworks for mobilizing development finance have remained largely the same. The weaknesses in current frameworks have become more evident with the changing composition and terms.

“External finance is on the rise, but the shift from traditional ODA to other flows, including the private sector and non-traditional donors, is pronounced—and potentially problematic.”– Edward K.Brown Click To Tweet

Countries generally have no standards, protocols or dedicated structures for dealing with new finance actors. Nor do they have specific policies and strategies for engaging emerging state or non-state partners but official documents and reports define expectations and future strategic directions in most countries. So although the emerging state partners—particularly China, India, and Brazil—are seen to be more responsive to the countries’ economic growth and transformation agendas, dealing with them is just as challenging as with traditional partners. Engagements are often ad hoc and often have been outside countries’ public financial management systems.

But a slow response isn’t the same as no response, and action is being taken. In 2016, Ghana passed legislation to integrate all financial laws into one overarching law to address persistent weaknesses in managing public funds. Tanzania has prepared a new development cooperation framework, while Zambia has established a new Ministry of National Development Planning with two main functions: to mobilize external resources and oversee and coordinate its development cooperation efforts.

The way forward

The evolving landscape and the choices open to recipient countries have implications for engagement in the global aid architecture. Not least, they raise questions about the traditional principles of aid effectiveness: ownership, alignment, harmonization, and managing for results. They also raise questions about the future of development cooperation among traditional and non-traditional donors, between recipient countries and providers, and about the financing of regional projects and programs.

However, just as the accumulated experiences offer lessons, they also offer a path forward. Here are four key recommendations for recipient governments in Sub-Saharan Africa as well as for their development partners to best adapt to the new financing reality.

  • To counter declining ODA, countries must take advantage of new parameters for development finance that have emerged in the context of the post-2015 agenda. Countries will have to embrace the Addis Ababa Action Agenda that sees the range and composition of development finance as evolving rapidly beyond the limits of ODA to include domestic resource mobilization, non-concessional development bank finance, foreign direct investment, and reclaiming illicit capital flows. This will also require limiting the contracting of public debt to what can be sustained given expected growth rates. The IMF/World Bank Debt Sustainability Framework should provide guidelines for such a dynamic growth-debt equilibrium.
  • To improve donor coordination, countries will have to be more strategic in sourcing and managing external financing. Having a single coordinating body at the global level is increasingly intractable. Instead, development effectiveness should revolve around the recipient government’s processes and capacities. Governments should make their own strategic choices and manage donors strategically at the implementation level. This will require building strong country systems around a robust national transformation agenda with a well-articulated public investment program
  • To bring the new actors on board, countries will need a different approach. It will be crucial for countries to define a clear strategy and policy framework for engagement with non-traditional donors, as well as to explore informal channels of dialogue—not necessarily structured. At the same time, all actors must be “open” to engaging, including traditional development partners
  • To strengthen aid management systems, countries must leverage technology. Countries should adopt a single data gathering and reporting platform, or they should harmonize current platforms to ensure comparability. At the same time, it will be crucial to build smart platforms to help mobilize and manage resources, ensure financial integrity, and promote transparency and reliable reporting. Rwanda offers a good example of coordinated aid management through its Development Assistance Database and a system that captures not only loans and grants but other financial flows from the new actors. Its effort at district and sectoral levels also stands out, using a monitoring and evaulation framework that involves all actors: the government, development partners, civil society, and the private sector.
“Governments should make their own strategic choices and manage donors strategically at the implementation level.”– Edward K.Brown Click To Tweet

Written By

Dr. Edward K. Brown

Director, Policy
Advisory Services

African Center for Economic Transformation (ACET)

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