issues in scaling-up of development aid flows benu schneider the views expressed are those of the...

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$)


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 %


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


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


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


▬ 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 %


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


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)


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


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


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


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


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

issues in scaling-up of development aid flows benu schneider the views expressed are those of the...

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