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Canada and the Financing for Development process

Credit: Results Canada

by Aniket Bhushan

Published: June 26, 2015

This update on the emerging Financing for Development (FFD) agenda, and Canadian perspectives surrounding the same is informed by a recent roundtable organized by Canadian civil society organizations, and exchanges with those involved in the negotiation process. It builds on our past work on FFD.

State of play

Both post 2015 and FFD agendas at an advanced stage, with very little time and space remaining to influence the process and outcome. As is typical with UN negotiations however, dotting the “i’s” and crossing the “t’s” could well go to the eleventh hour, if not beyond.

As far as the Sustainable Development Goals (SDGs) are concerned, goal areas and targets are being imported verbatim from the Open Working Group proposal. Which means the unwieldy 17 goals and 169 targets are very likely to form the basis of the eventual framework, or (worse) adapted as they stand. The G77 developing countries in particular are highly resistant to change in the OWG package. Even though in several areas the framework is inconsistent with sector specific targets and plans (e.g. in the education sector). Resistance (oddly) also extends to further specifying placeholder targets (x, y % improvements etc. which the OWG document is replete with).

Changes are however expected to the preamble.

Means of Implementation

Given the broad nature of the SDGs perhaps more clarity and realism could be expected from the Means of Implementation (MOI), which include financing for development (FFD) and implementation (and follow-up) work-plans.

MOI discussions are fast becoming a parallel process, with lack of clarity on how they will feed into and integrate with the SDGs.

Follow on at national, regional levels have become even more important (given the agenda is so broad). It is expected that a high level forum at UNESCO will decide on follow on processes, including regional and national (country based) plans, monitoring and assessments. This represents a huge area of work – setting the agenda is relatively easier than monitoring progress along the same.

Mismatches between the SDGs and FFD

Developing countries increasingly want to frame the discussion as one about “North – South” flows and largely official flows (ODA). Whereas developed countries have pushed all along for a “holistic” and “universal” agenda. For e.g. developed countries have been quick to point out just how much the financing for development landscape has changed. ODA flows are shrinking as a share of overall flows between the ‘North’ and the ‘South’ as foreign direct investment, remittances, financing from non-traditional development partners (such as philanthropic and private foundations) increasingly make up a larger share.

It is up to interpretation whether these processes are a “debate about everything” i.e. holistic universal agendas, or primarily North – South transfers. However, advocates of a more universal/holistic approach have clearly garnered a greater share of the discourse, especially as reflected in the OWG and other proposals.

While it is easier to frame the SDGs in universal/holistic terms (i.e. frame as a global agenda that applies to all countries), it is far more complicated to apply those same principles to the practical means of implementation discussions (i.e. articulating who is responsible for what).

Canada and Financing for Development (FFD)

Canada has already publicly shared its take on post 2015 priorities. The core priorities for Canada (unsurprisingly) remain: maternal and new born child health (MNCH), job creation and sustainable economic growth, and accountability.

Furthermore, no additional aid money is expected from Canada, and no change to targets (or lack thereof; i.e. unlike other donors such as the UK, Canada has never explicitly set an ODA/GNI target and that is not expected to change).

Moreover, in its priority areas at least such as MNCH, Canada can claim that (a) it is already exceeding self imposed benchmarks, and (b) has already set further commitments (such as the extension of MNCH from 2015 to 2020).

ODA targets

Canada is nevertheless being pushed to adopt an ODA/GNI target.

Discussions surrounding targets (other than the oft repeated 0.7% of GNI) have centered on 0.15% of GNI to least developed, fragile, landlocked countries. These have been backed by those already meeting or close to the target.

For reference, the share of Canadian aid to the poorest countries – LDCs and LICs – is about 37%. And Canada’s ODA/GNI ratio is around 0.24%. Together these imply around 0.08% of Canadian GNI goes towards aid for the poorest countries. In other words Canada would need to nearly double the level of aid to the poorest countries to be in line with the 0.15% target.

It is unlikely that 0.15% of ODA/GNI to least developed, fragile, landlocked countries will feature in the FFD text, rather, a goal of 50% of aid to LDCs has a better chance of inclusion. This is a target Canada is not that far away from. At recent peak aid levels (2010, 2011) Canadian aid to the poorest countries (LDCs and LICs) ranged between 40% and 42%.

These sorts of targets may be only mildly useful from a programming perspective but have been more important for aid advocates. A key question facing civil society (in Canada and elsewhere) is whether it makes sense to continue focusing on the 0.7% GNI target, especially in the Canadian context. After all this would imply a nearly 3x increase in aid from current levels to around $14 billion a year, which seems implausible to say the least in the current fiscal context (or any fiscal context)!

There are bigger problems with targets like 0.7. The target is a historical artifact based on assumptions that no longer hold true (using the same assumptions closer to present day financial flow conditions gives an aid goal of around 0.01% of advanced economies GDP towards aid in the poorest countries and implies negative aid flows to the developing world as a whole, according to Clemens and Moss). But perhaps more importantly these targets have their roots in and are justified by a model, the Two Gap Model (Harrod-Domar-Chenery), that is no longer considered credible.

Beyond ODA

One area Canada will continue to focus on instead is ‘blended finance’, i.e. finding ways to creatively use public sector resources such as ODA to leverage or otherwise crowd-in private capital. This is in line with and builds on leadership of the Redesigning Development Finance Initiative, recent announcement (and approval) of the establishment of a new Development Finance Initiative (not institution) under the auspices of Export Development Canada with a targeted capitalization of $300 million over 5 years, smaller experiments such as the proposed Global Finance Exchange (GFx) which Canada is also championing. (More on these below).

South-South

An area of contention within FFD is so called South–South cooperation. Major ‘southern’ or emerging countries, in particular China and India, have long held that South-South cooperation is qualitatively distinct and therefore not subject to ODA norms or OECD-DAC standards. Canada and other DAC donors of course have an incentive to see emerging South-South players move towards good governance, good practice, transparency and accountability standards such as they are within the DAC club.

While South-South has always sounded great on paper, it has real limits in practice. For one there are vastly different capabilities across players, with China being the obvious outlier in terms of its vast footprint already across developing regions well beyond its Asian sphere (i.e. Africa, L. America). Cultural affinity and shared experience are not always a positive and can even be a hindrance to effective cooperation. For those concerned with policy coherence in DAC country development cooperation (e.g. incoherence between trade and investment objectives and development objectives), these concerns are arguably even more acute in the case of South-South cooperation where often relations between developing countries are more adversely competitive (e.g. China, S. Korea, India and others may do ‘South-South’ cooperation with developing countries in Africa, but may compete more directly with the same in advanced economy export markets).

Taxation and Domestic Revenue Mobilization

One area where there seems to be more consensus and agreement in FFD is domestic resource mobilization. This is perhaps no surprise as it is an area that has seen a lot of work since Monterrey and Doha (see our past projects for instance). It is also somewhat intuitive. Developing countries need to collect more in the form of taxes and non-tax revenues from their own citizens and businesses and this will reduce reliance on aid. Donors spend relatively little on aid to taxation capacity, have started to realize that even small amounts of aid in this area can have a big payoff, and in an era of relative aid scarcity (both in terms of donor fiscal space, and good ideas and modalities to spend money on) aid to taxation is attractive.

It is expected that the “Addis Tax Initiative”, which will enhance tax related aid and technical cooperation, will be announced at the Addis conference.

Canada is likely to support the initiative (other supporters include Netherlands and the United States). In fact the US has made domestic resource mobilization one of its two key priorities for Addis (the other being open data).

Expanded use of aid to taxation capacity and policy is very much in keeping with our own research and recommendations on taxation and foreign aid (most recently published by UNRISD as part of the Road to Addis series).

While goals and targets in the area of taxation have long been discussed, no explicit goal (i.e. tax/GDP ratio) is expected to feature in the final FFD document. Tax cooperation issues more generally (such as related to avoidance, transfer pricing, mis-invoicing, capital flight and tax havens) are bogged down in institutional issues surrounding where these should be deliberated, whether in a UN intergovernmental body (as the G77 developing countries are pushing for) or amongst tax experts (as advanced countries argue).

Innovative development finance: more questions than answers, more buzz than substance (so far)

As mentioned, Canada is playing a leading role in the innovative development financing space. The main argument underlying these efforts is that ODA alone will be insufficient to meet the vast financing needs associated with the Sustainable Development Goals. Recent estimates place these at around $1 trillion a year.

Broadly, Canadian efforts can be summed up as various modes of ‘blended financing’ where public resources are used to leverage or crowd-in private capital. The key assumption, often repeated by policymakers and advocates alike, is that the key constraint to stimulating private investment in the poorest countries (or riskiest markets) is not the expected rate of return, but a question of how to mitigate risks or change risk perceptions.

With these in mind the tools one naturally gravitates towards are well known: first-loss provisions, guarantees, and other means by which to subsidize risk.

With the budget implementation bill (Bill C-39) having received royal assent, the signature initiative tabled in the budget document – the new Development Finance Initiative housed at EDC – is now on firm footing.

Here are things we know about Canada’s proposed DFi:

~ Targeted capitalization of the initiative will be $300 million over 5 years.

~ This is “new” and “additional” money; and it is not coming out of ODA. (In future years however, if the initiative is successful, there is nothing to say ODA resources could not be leveraged in this way).

~ The initiative does not sit within the department responsible for international development (DFATD) but within a crown corporation with no explicit development, poverty reduction or sustainable development mandate; and the role of the international development minister is primarily in a “consultative” (as opposed to decision making) capacity.

~ The initiative will not focus solely on Canadian businesses or investments, but may take direct exposure in developing countries and foreign firms.

What we do not know is more important and interesting:

~ How will the initiative market itself? $300 million over 5 years is small even for international development folks. From a private sector perspective it may be too small to garner meaningful investor attention.

~ A likely answer to the above question is that the eventual corpus will be much larger because public money can be leveraged. If so, what is the targeted leverage ratio (8x to 10x)? Would the initiative aim for pure financial leverage (raising money through investors) or does it function more by crowding-in other similar players (which would be more like pooling money with other DFIs, not really leverage in the financial additionality sense). While it may be dismissed as wonky this is an important issue as the level of financial additionality across DFIs varies greatly and has been questioned. IFC for instance has a 3x ratio, while EBRD 1x.

~ How will EDC and DFATD interface, and what about the role of others (chiefly Finance Canada, which signs the biggest development finance cheques from Canada)?

~ What sense do we have of potential deal-flow and investor appetite? What sort of analysis was undertaken in these areas? And what was the response from the Canadian business/financial community? Indeed, a basic question is what the prospective investor base looks like (does it include Canadian pension funds for instance?) So far there is very little by way of response from Canadian business implying the ‘getting noticed’ problem may be real. On deal-flow select examples (be it Grand Challenge Canada, or a deal between Sarona Capital and Mennonite Economic Development Associates undertaken by former CIDA) are often cited, but so far there is little reference to how scalable the pipeline is.

~ How might governance and oversight function? Basics include governance within Canada such as institutional structure, corporate governance and reporting; more complex are questions surrounding what principles guide positions taken in eventual end markets or companies, or principles that guide the investment process more generally.

~ What sort of reporting standards can we expect? Much of our development envelope is now covered by ‘open data’ standards. This has increased the availability of basic information about what takes place where. It would be a shame it this initiative is held to very different standards than the transparency and accountability standards Canada ascribes to as part of its global commitments such as through the Open Government Partnership.

~ How will the initiative conduct impact assessments? Will it apply one of the existing frameworks (such as the IFCs development outcome tracking system) or will it develop its own parameters?

There are of course several more questions. Others have already pointed out that the devil is in the details, and that certain basic principles such as placing poverty reduction at the heart of the mandate, need to be adhered to.

Important issues that are underplayed

~ The proposition that the main barrier to greater private investment in developing countries is ‘risk perception’ can be questioned. Basic economic theory tells us that at the right price (or return premium) risks do get priced in. When they do not, there is often a good reason (like the project is just not ready to be invested in). The point being there can be real reasons not to invest and it is not simply a matter of ‘perception’. The bigger assumption one can question here is whether public sector players, and donors at that, are really better placed than private markets in pricing risk?

~ Is subsidizing risk the answer? Subsidizing risk – which is the approach most DFIs gravitate towards because it is what they understand best (as pointed out here) – may in fact miss the point completely. Systematically subsidizing risk can create distortions that can have a detrimental long-term impact. Add to this donor incentive to generate quick wins especially from a fledgling new and innovative approach, and the terrain is further complicated.

~ There are at least two, far more serious constraints than perception, that limit investment in poor countries (as pointed out here): the first is mismatches between the types of investment products available and the investment requirements of various investors. One of the key factors that limits capital flows to poor countries and riskier markets is that the largest institutional investors are governed by strict rules as to what they can and cannot invest in and how. In most cases, credible financial instruments and products to facilitate investment in poor/risky markets simply do not exist at scale to move the needle for big investors. Second, perhaps the most important constraint of all, is that poor countries lack the local capacity to promote investment and package bankable deals. This role is played by the local financial community, i.e. those that have a deep understanding of both the local context and finance. The fact that this sector barely exists across many of the poorest countries is the main constraint to increased investment.

Those designing the Canadian DFI would do well to encourage debate on these and other tough issues if this welcome Canadian initiative is to have real and sustainable development impact.

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