In July 2015, heads of state, finance ministers, foreign ministers, and ministers for development cooperation will gather in Addis Ababa, Ethiopia for the third United Nations International Conference on Financing for Development. The Addis Conference seeks to identify funds to support the post-2015 Sustainable Development Goals (SDGs). This conference will be fundamentally different from earlier FfD conferences held in Monterrey in 2002 and Doha in 2008. In 1980 low and middle income countries received $32 billion of ODA and $7.6 billion of FDI, but by 2013 those countries received $133 billion of ODA and $735 billion of FDI. As global incomes rise, emerging donors have taken on a much greater role in development. Developing countries’ themselves have gained a greater ability to finance their own development as private sector economic activity in the developing world continues to grow. Below we have outlined some of the ways development finance has changed to respond to a new set of challenges and development realities.
A New Role for Traditional Donors
While ODA and traditional development financing remain important catalysts for development, donors that were once the main sources of financing for developing countries increasingly find themselves playing a complementary rather than unilateral role. Private financial flows have increased rapidly and ODA and public funding for donor organizations have increased at a more limited rate. As a result, traditional donors are finding new ways to leverage their funds to create maximum impact, often through encouraging private sector growth.
Development Finance Institutions (DFIs) such as the International Finance Corporation (IFC) and the U.S. Overseas Private Investment Corporation (OPIC) are instruments to this end. Most DFIs provide loans or take equity positions in areas too risky for private financial institutions. They also advise investors on how to operate in unconventional investment areas, effectively jump starting private sector activity that would otherwise be missing. DFIs have proven to unlock markets that conventional investors may never uncover alone, for example sub-Saharan Africa’s mobile phone market.
Emerging Donors and Access to Capital
As traditional donors look to employ their resources in novel ways, emerging donors like China, Brazil, and Turkey have become significant providers of ODA and other sources of development finance in their own right: emerging donors contribute an estimated 7 to 10 percent of global aid flows, and account for an increasingly significant portion of other financial flows to developing countries. Emerging donors are setting up new instruments to leverage their growing development resources, and moving forward it will be crucial for all donor countries and multilateral organizations to collaborate on meeting future development financing challenges.
Developing countries themselves are less dependent than ever on ODA as their access to private investment and global capital markets that were previously out of reach have increased. FDI flows to low and middle income countries have surged to nearly 100 times their 1980 levels, and about 25 developing countries are rated as investment grade according to Fitch Ratings.
Governance, Domestic Resources, and Investment Climate
Notably, developing countries themselves have become significant sources of development financing. While ODA to sub-Saharan Africa totaled about $54 billion in 2012, domestic resources (tax revenues) in the region were roughly ten times greater at $530 billion. As such, donors need to fund programs that foster good governance and improve institutional capacity for handling domestic sources of revenue. Promoting good governance can also be a part of developing countries’ efforts to create more attractive environments for foreign and private investment: companies are wary to invest in places where contracts may not be adequately enforced or where officials expect bribes, and improving governance and rule of law can be key to allaying private investors’ fears.
Natural resources will continue to provide an outsize portion of revenue for many developing countries, particularly in sub-Saharan Africa where 16.9% of GDP is attributed to natural resources compared to 3.3% in high income countries. Thus, managing these revenues will remain an important part of development financing for the foreseeable future.
While the development landscape has changed significantly in the last few decades, traditional and emerging donors are responding by utilizing existing funds effectively, collaborating with emerging donors who bring substantial new sources of development financing to the table, and by encouraging private sector growth through a focus on good governance and efficient management of domestic and natural resources. Taken together, these new sources of financing and a new focus on domestic resources and private sector growth will help donors and investors alike meet their future development financing goals.
On April 23, 2015 CSIS will host its first ever Global Development Forum, a full day conference featuring leading global experts and practitioners who will discuss the world’s most critical development challenges and opportunities. See the full agenda, including a discussion on development financing, and register here.
Photo courtesy of Tom Page under a creative commons license.