82800 THE WORLD BANK GROUP Financing for Development Post-2015 October 2013 Financing for Development Post-2015 October 2013 Contents Acknowledgments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . v List of Acronyms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . vii Executive Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ix Introduction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 Section 1:  What Will It Take to Achieve Development Outcomes? . . . . . . . . . . . . . . . . . . . . . . 3 A Global Development Cooperation Framework . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Good Policies and Sound Institutions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Financing Global Public Goods. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 Section 2:  Mobilizing Domestic Resources . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 Improving Taxation Capacity. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 Harnessing Sustainable Streams of Natural Resource Revenue. . . . . . . . . . . . . . . . . . . . . . 10 Improving Expenditure Efficiency. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 Subsidy Reform. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 Procurement. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 Curbing Illicit Financial Flows. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 Section 3:  Better and Smarter Aid. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 Aid’s Contribution to Development . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 The Growing Complexity of the Aid Landscape. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 New Donors: Emerging Market Economies (EMEs) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 New Actors: Private Philanthropy and Vertical Funds. . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 Aid Effectiveness: An Ongoing Effort. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 Towards a More Catalytic Role for ODA. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 Section 4:  Private Finance for Development . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 Private Financial Flows to Developing Countries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 Mobilizing Long-term Infrastructure Finance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 Removing Existing Bottlenecks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 Mainstreaming the Use of Guarantees and Risk Insurance . . . . . . . . . . . . . . . . . . . . . . 25 A Catalytic Role for the Public Sector . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 iv Financing for Development Post-2015 Section 5:  Emerging, Inclusive and Innovative Sources of Finance . . . . . . . . . . . . . . . . . . . . 29 Emerging Sources . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29 Bond Financing and Local Currency Bond Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29 Institutional Investors, including Sovereign Wealth Funds. . . . . . . . . . . . . . . . . . . . . . . 30 Diasporas. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 Finance Sector Development and Financial Services for Small and Medium Enterprises (SME) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32 Examples of Innovative Financing for Development. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33 Raising to Scale Pull Mechanisms and Advance Market Commitments. . . . . . . . . . . . . 33 Carbon Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 Resources-for-Infrastructure Deals in Fragile States. . . . . . . . . . . . . . . . . . . . . . . . . . . . 35 Diaspora Bonds. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36 Financial Transaction Taxes. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37 Conclusion. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39 Acknowledgments This volume was written by staff of the World Bank Group (WBG) as an input to the UN-led consultations on the post-2015 development agenda. This was prepared under the overall guidance of Mahmoud Mohieldin, the President’s Special Envoy, and the Poverty Reduction and Economic Management Vice Presidency, with comments and contributions from across the WBG and the WBG Task Force for MDGs and Post-2015. UNDESA, IMF, AsDB, and the Executive Secretariat of the High-Level Panel on Post-2015 commented on the outline and earlier presentations. Gilles Alfandari led the team that prepared this report, under the guidance of Linda Van Gelder and Marilou Uy. Contributions were received from Dilek Aykut, Robert Beschel, Jeff Chelsky, Christian Eigen-Zucchi, Havard Halland, Astrid Manroth, Claire Morel, Ulf Narloch, F. Halsey Rodgers, Fiona Stewart, Faraz Usmani, and Ralph Van Doorn. Many others inside and outside of the World Bank provided helpful comments and suggestions, including Issam Abousleiman, Olga Akcadag, Philippe Ambrosi, Yuvan Beejadhur, Jacob Burke, Andrew Burns, Demet Cabbar, Grant Cameron, Karan Capoor, Michael Chaitkin, Massimo Cirasino, Christopher Delgado, Julia Dhimitri, Grahame Dixie, Mark Dutz, Leslie Elder, Vivien Foster, Stéphane Guimbert, Poonam Gupta, Julius Gwyer, Guy Hutton, Johanna Jaeger, Mabruk Kabir, Aphichoke Kotikula, Jarl Krausing, Nick Manning, Dino Merotto, Gary Milante, Lucio Monari, Mark Nelson, Kyran O’Sullivan, Doug Pearce, Veronica Piatkov, Sonia Plaza, Amédée Prouvost, Lois E. Quinn, M. Zia Qureshi, Dilip Ratha, Lilia Razlog, Francesca Recanatini, Robert Reid, David Rosenblatt, Jordan Schwartz, Peer Stein, Derek Strocher, Jemina T. Sy, Christopher Thomas, Nigel Twose, Zenaida Uriz, Nancy Vandycke, Jos Verbeek, and Debrework Zewdie. The production and design of the report was by Maureen Shields Lorenzetti and by The Word Express. List of Acronyms AML/CFT Anti-Money Laundering/Combating the IDA International Development Association Financing of Terrorism IEA International Energy Agency BRICS Brazil, Russia, India, China, South Africa IFC International Finance Corporation CDM Clean Development Mechanism IFF Illicit financial flows Ci-Dev Carbon Initiative for Development IFFIm International Finance Facility for CSO Civil society organization Immunization DAC Development Assistance Committee IPP Independent power producer DFI Development finance institution LIC Low-income country DFQF Duty-Free Quota-Free MDB Multilateral development bank DPL Development Policy Lending MDG Millennium Development Goals DRM Domestic resource mobilization MDRI Multilateral Debt Relief Initiative EITI Extractive Industries Transparency MIC Middle-income country Initiative MIGA Multilateral Investment Guarantee EPFR Emerging Portfolio Fund Research Agency ETS Emission trading schemes MSME Micro, small, and medium enterprises FCS Fragile conflict-affected state ODA Official development assistance FDI Foreign direct investment ODI Overseas Development Institute FTT Financial transactions tax OECD Organisation for Economic Co-operation GDP Gross domestic product and Development GEF Global Environment Fund OOF Other official flows GFI Global Financial Integrity PPIAF Public-Private Infrastructure Advisory GIF Global Infrastructure Facility Facility GNI Gross national income PPP Public-private partnership GPEDC Global Partnership for Effective Develop- PRG Partial risk guarantee ment Cooperation RfI Resources-for-Infrastructure GPFI Global Partnership for Financial RGGI Regional Greenhouse Gas Initiative Inclusion RPW Remittance Prices Worldwide HIPC Heavily Indebted Poor Country SWF Sovereign wealth fund IATI International Aid Transparency Initiative UNFCCC United Nations Framework Convention IBRD International Bank for Reconstruction on Climate Change and Development Executive Summary A s we approach the 2015 deadline for the Mil- Aid has been essential to helping low-income lennium Development Goals, the international countries accelerate economic growth and lift people community is elaborating a new framework to from extreme poverty over the last few decades. For promote sustainable development for all beyond 2015, many developing countries, ODA—and the reforms which will build on achievements to date and address it supports—needs to continue to be a stable source new challenges arising from an evolving and complex of development financing; especially for the poorest landscape. Three major trends are emerging: first, most economies and fragile states with limited or no access of the poor live in middle-income countries and many to capital markets. It represents the biggest financial live in high-income countries. Second, the Eurozone inflow to fragile states, after remittances and foreign crisis and turmoil in MENA demonstrate that devel- direct investment (FDI). ODA is expected to remain oped and developing countries alike are confronted a critical input to achieve the new development goals. with the difficult task of generating growth and creating Financing a transformative development agenda jobs. Moreover, beyond the financing needs associated will require that available resources be used more effec- with these protracted crises, the impact on a number tively and strategically to catalyze additional financing of traditional donors reduces the volume of available from official and private sectors. Developing countries official development assistance (ODA). Third, trade, will need to step up efforts to finance their own devel- finance and other links among emerging market and opment by improving domestic resource mobilization, developing economies are growing. This shift offers op- including by strengthening tax administration, better portunities for new, mutually beneficial partnerships. harnessing natural resource revenue, and curbing illicit The ability to adequately finance a post-2015 de- financial flows. The public sector has a catalytic role velopment framework depends on many factors. First, in attracting private sector financing, such as for scal- we need global development cooperation that attracts ing up infrastructure investments. This paper reviews aid from diverse sources, emphasizes domestic re- a range of existing and potential financing sources and source mobilization, and capitalizes on the potential tools: bond financing, institutional investors, dias- of the private sector. Second, the success of cooper- pora bonds, pull mechanisms, advance market com- ation requires good polices (and the capacity to im- mitments, resources-for-infrastructure deals, climate plement them), and credible institutions to increase finance, and more. Not all of these options are feasi- the impact of scarce resources and leverage addition- ble for all countries; the challenge lies in establishing a al resources from both domestic and foreign, public supporting country-level policy framework and credi- and private sources. The relative significance of each ble commitment to build domestic capacity and com- source, and the associated leveraging challenges, will bat poverty in order to expand the options available. differ between low-income countries and fragile and Domestic resource mobilization. The ability to mobi- conflict-affected states, middle-income countries with lize domestic revenues reduces aid dependency and can limited market access, and middle-income countries raise country creditworthiness. Low-income countries with market access. still struggle to increase domestic revenue mobilization x Financing for Development Post-2015 in the face of high levels of capital flight and limited Pull mechanisms for development, which involve capacity to collect revenues from multinationals, par- ex-post economic incentives for innovation to ticularly those engaged in natural resource extraction. solve a well-defined problem. By linking payments Inefficient public expenditures and investments fur- to the actual impact of an innovation, they can lay ther compound the problem. Progress is needed in the foundations for a self-sustaining, competitive expanding tax coverage, strengthening accountability, market for the relevant product. and increasing expenditure efficiency. A number of African countries have adopted the Emerging donors. A diverse group of countries has resources-for-infrastructure (RfI) financing mod- been gaining prominence in the aid landscape, partic- el to overcome limited capital market access and ularly upper middle-income countries. These countries domestic capacity constraints. Under RfI, oil or include the BRICS (Brazil, Russia, India, China and mineral extraction rights are exchanged for turn- South Africa), which account for 25 percent of glob- key infrastructure, complementing standard tax al gross domestic product (GDP) and 40 percent of and royalty regimes. the world’s population, Saudi Arabia, South Korea, Diaspora resources (via diaspora bonds and re- and Turkey. They are ramping up their development mittance-backed bonds) could help finance infra- engagements through a broad range of channels and structure projects. The annual savings of develop- activities. Their increasing ODA is a relatively small ing country diasporas—US$400 billion by some part of a larger trend in external financial flows to other estimates—represent a hitherto untapped source developing economies. These new partners may help of financing for development. meet development needs not addressed by traditional Linking climate finance and development finance donors. can enhance development impact by allowing the Private finance for development. Achieving develop- fight against poverty to take climate effects into ment goals will require the mobilization of resources account and vice versa. Comprehensive carbon from private sources, including FDI, bank loans, cap- pricing policies, the removal of inefficient fuel ital markets, and private transfers (e.g., remittances). subsidies, and cap-and-trade schemes are promis- For most developing countries, FDI is the preferred ing options to mobilize larger and higher-return private financing modality given its potential to investments. strengthen productivity and growth, and help diversify the economy. Although many developing economies The role of the World Bank Group and regional de- have enjoyed increased access to international capital velopment banks. The World Bank Group and its re- markets over the past decade, there is an increasing gional counterparts can add value through a combina- mismatch between available financing and investment tion of technical expertise, prudent risk management needs. This is partly due to fragile market conditions policies, application of clear standards to project de- in the wake of the global financial crisis, which con- sign, execution, and corporate governance, a long-term strain the availability of the type of long-term finance perspective, and cross-country experience. Multilateral needed to support productivity-enhancing investment. development banks (MDB) can bring financing part- Accessing long-term finance for infrastructure is criti- ners into specific deals, for example, in the form of cal and will require greater attention to investment in syndications or through co-financing arrangements. project preparation and policies and instruments that Generally, the MDBs’ stamp of approval and role as can lower risk and strengthen the confidence of inves- an “honest broker” in disputes can help to reassure tors over a long-term horizon. investors and contribute to a project’s viability, which Innovative sources of finance. Development partners in turn reduces the cost of engagement, including to are helping to develop new tools to help generate fi- private investors. MDBs can also contribute to extend- nancing for development. The paper discusses a number ing maturities of private flows to finance productive of these: investments. Executive Summary xi These are just some of the ways that developing working to catalyze new funding. This will require countries and their partners can respond to the evolv- greater attention to domestic resource mobilization ing challenges of financing for development. Available and making countries more attractive destinations for resources are expected to continue to fall far short of both ODA and private sector resources by improv- development needs, implying that policy makers will ing the underlying conditions for development and need to make better use of existing resources while growth. Introduction T his paper is a contribution to UN-led efforts In addition to financing, progress toward each to articulate a Post-2015 Development Frame- MDGs also requires supporting policy and institu- work, building on the Millennium Declaration tional reforms that boost growth and improve service and Millennium Development Goals (MDGs). It fo- delivery. In its Post-2015 Agenda report, Realizing the cuses on the challenge of financing development goals Future We Want for All, the UN System Task Team and complements the extensive work conducted by the acknowledged that “in the global debate, the MDGs United Nations1 and other institutions, including the led to overemphasizing financial resource gaps to the World Bank Group.2 detriment of attention for institutional building and This exercise was prompted by the report of the structural transformations”. The Post-2015 HLP’s re- High-Level Panel (HLP) of Eminent Persons on the Post- port emphasizes the importance of “creating a glob- 2015 Development Agenda,3 which provides sound and al enabling environment and catalyzing long-term concrete recommendations for International Financial finance”. Institutions (IFI) to enable global investment in long- No quantity of financing—grant, concessional, or term prosperity for all. The HLP report acknowledges non-concessional—is sufficient to achieve ambitious the connection between the MDGs and the inter- development goals without a supporting country-level national community’s ability to support them, given policy framework and credible commitment to build market failures in mobilizing financing for develop- ment in low- and middle-income countries and the consequent importance of leveraging official-sector 1  Including the series of annual MDG Gap Task Force Reports, resources and expertise to attract and scale up private World Economic and Social Survey, 2012: In Search of New De- financing. velopment Finance and more recently the Post-2015 UNTT For many developing economies (particularly Thematic Think Piece on Financing for sustainable development in the global partnership beyond 2015; documents prepared on fragile states), ODA and the reforms it supports con- Financing for Development for the fourth HLP meeting in tinue to be critical to mobilize and catalyze resources Bali, Indonesia, 24–27 March 2013. from other sources. When the MDGs were adopted, 2   See, for example, the 2013 European Report on Development. ODA was already falling short of the level required for Innovation with Impact: Financing 21st Century Development, success. Today, ODA budgets are under even greater and Bill Gates’ Report to G20 Leaders for the Cannes Summit, in pressure due to the tepid global economy and heavy November 2011, as well as the Global Monitoring Report 2013, fiscal burdens on many major donors. Even if the UN’s the 2013 Global Development Horizons (Capital for the Future: 0.7 percent ODA-to-GNI target and the 2008 G8 Gle- Saving and Investment in an Interdependent World), and the Long-Term Investment Financing for Growth and Development: neagles pledges were achieved, and non-DAC (Devel- Umbrella Paper, presented to the Meeting of the G20 Ministers opment Assistance Committee) donors contributed of Finance and Central Governors in Moscow (February 2013). additional resources, ODA alone would still fall short 3   A New Global Partnership: Eradicate Poverty and Transform of the resources needed to achieve the next set of de- Economies through Sustainable Development. United Nations, velopment goals. May 2013. 2 Financing for Development Post-2015 domestic capacity and combat poverty. In the absence The paper is structured as follows. Section 1 out- of these factors, the question of resource mobilization lines elements of what it will take to achieve develop- is moot. A supporting policy and institutional envi- ment outcomes—the importance of a global devel- ronment can not only enhance the effectiveness of opment cooperation framework, the role of targeted, development spending, but also catalyze additional evidence-based policies and sound institutions; and resources from the official and private sectors. Indeed, the mobilization of resources for global public goods. when it comes to policies, donor assistance, and pri- Section 2 focuses on how best to support developing vate-sector resources, the whole is greater than the sum countries in mobilizing domestic resources for devel- of the parts. Reflecting this, any feasible approach to opment, by boosting taxation capacity, harnessing financing post-2015 development goals requires a two- natural resource revenue, improving expenditure ef- pronged strategy—first, to significantly enhance the ficiency, and curbing illicit financial flows. Section 3 impact of available resources, and second, to increase examines issues of aid effectiveness and considers ways those resources. This paper highlights the importance for development actors to provide better and smarter of domestic policies and capacity building to enhance aid. Section 4 discusses trends in private financial flows the impact of available resources on development and to developing countries and the growing mismatch poverty reduction, including with support from the between available financing and investment needs. It donor community and IFIs. It is in supporting poli- then turns to strategies for mobilizing financing for cy reform and capacity building—rather than through long-term infrastructure. Finally, section 5 explores a direct financing—that donors and development insti- range of emerging and innovative sources of finance, tutions like the World Bank Group can often have the and the role an inclusive financial system can play to biggest impact. promote development. What Will It Take to Achieve Section Development Outcomes? 1 A Global Development Cooperation and donor resources by arguing that all stakeholders— Framework governments, civil society, and the private sector—need to cooperate and take action to activate new, reliable The United Nations’ development agenda beyond sources of financing (Box 1.1). A similar conclusion 2015 calls for a renewed global partnership to foster can be found in the report6 prepared by the Secretariat a number of transformative and mutually reinforcing of the Post-2015 High Level Panel, which highlights actions that apply to all countries, including: poverty “the pitfalls of trying to assess financing at the recip- eradication, tackling exclusion and inequality, wom- ient country level from a “needs” approach, without en and girls’ empowerment, the provision of quality also considering policy changes, institutional improve- education and lifelong learning, better health, climate ments, and other parts of the development strategy. In- change mitigation and adaptation, managing environ- stead, financing must be understood as one component mental challenges, inclusive and sustainable growth of a strategy that includes private sector efficiency and and decent employment, the end of hunger and mal- public sector productivity improvements”. nutrition, addressing demographic challenges, enhanc- ing the positive contribution of migrants, meeting the Good Policies and Sound Institutions challenges of urbanization, peace building and effec- tive governance.4 Given concerns with the availability Targeted, evidence-based policies and sound in- of financing from many of the traditional providers of stitutions help determine progress on each of the ODA, what is needed is an integrated discussion of MDGs. A decade of Global Monitoring Reports7 by the development goals and the associated financing frame- IMF and World Bank, provides compelling evidence work. Will there be enough resources for safety nets, that with the right policy and institutional reforms, infrastructure, health, and education? Are the resourc- ODA can be used more effectively to make progress es available sufficient to address current problems of towards MDGs. food security, water scarcity, water pollution, land deg- radation, access to energy? To what extent will climate adaptation increase the cost of achieving new goals 4  UN, A life of dignity for all. Report to the Secretary-General, and maintaining progress on existing goals? The new A/68/202, 26 July 2013. 5   Gates, Bill. Financing 21st Century Development, November, framework for development cooperation should also 2011. See http://www.thegatesnotes.com/G20. provide means to improve the mobilization and alloca- 6   Background Paper for the Post-2015 HLP meeting in Bali, tion of resources for sustainable development. Summary of Financing for Development, March 2013. In his report to G20 Leaders in 2011,5 Bill Gates 7   Go, Delfin S. and José Alejandro Quijada. Assessing the Odds addresses the mismatch between needs and government of Achieving the MDGs. WPS5825. World Bank, October, 2011. 4 Financing for Development Post-2015 Box 1.1:  Innovation with Impact: Financing 21st Century Development, The Gates Report to G20 Leaders In a report prepared at the request of the French Government during its 2011 G20 Presidency, Bill Gates discusses many of the topics relevant to the financing of a post-2015 development framework. The report emphasizes the significant potential to achieve greater impact with money that is already being spent, calling on countries to use public-private partnerships to enhance their capacity to evaluate their own development spending. The report highlights the importance of ODA and the need for traditional donors to meet their commitments. ODA will generate an estimated an additional US$80 billion annually starting in 2015. Gates points out that countries outside of the OECD donate an estimated $18 billion annually, and urges them to maintain their support as a share of their rapidly growing GNI, while aiming to increase that per- centage over time. Written in the midst of the global financial crisis, Gates acknowledges the pressure on aid budgets but maintains that ODA represents a very small part of government expenditures and that cutbacks would do irreparable damage to global stability, the growth potential of the global economy, and the livelihoods of millions of the poorest people. At the same time, Gates argues that developing countries’ domestic resources will be the largest source of funds for development. Therefore, to maximize impact, it is essential that domestic resources be mobilized on a larger scale and spent more effectively on key priorities, particularly in agriculture and health. Improving natural resource information and management is key to improving domestic resource mobilization. However, to point to domestic resources as the largest source of financing for development does not free major economies of their re- sponsibilities. Rather, it implies that they also have a duty to help poor countries raise more revenue by passing legally binding transparency requirements for mining and oil companies listed on their stock exchanges to ensure that natural resources in developing countries are better managed, among other things. Gates also calls for a “natural resource charter” to increase transparency in land, timber, and other natural resource related deals. The report highlights the importance of bolstering investment in infrastructure, drawing on the potential of the private sector, sovereign wealth funds, and diaspora communities, and supports explicit taxing of carbon, including through shipping and aviation fuels as proposed by the World Bank and IMF. Gates also notes the revenue-generating potential of financial transactions taxes at a low rate and on a large base, and of tobacco taxes, with countries allocating a portion of revenues to global health initiatives (on a sliding scale according to per capita income). The cost of achieving any development goal recent World Bank research10 notes that there is con- depends on the efficiency with which the objec- siderable scope to improve social protection outcomes tive is pursued, taking into account the quality of without increasing the overall fiscal deficit. This can underlying policies and practices. For instance, the be achieved by reallocating untargeted and inefficient undersupply of infrastructure in developing economies energy subsidies to social safety net programs. Box 1.2 has been estimated at around US$1 trillion per year provides another illustration, in the case of education, through 2020, with an additional US$200 to US$300 of how learning outcomes can be improved with the billion per year to ensure that infrastructure invest- right institutions without increasing spending. ments are low emitting and climate resilient8 (Figure Simply increasing public spending is unlikely to 1.1). But these costs can be reduced by making more lead to better outcomes in countries suffering from efficient use of existing infrastructure and improving poor governance. Improved fiscal transparency, for ex- project quality and management. The McKinsey Glob- ample, can have a positive impact on government bud- al Institute and McKinsey’s infrastructure practice have gets in several ways. Transparency can facilitate taxpayer outlined practical steps to boost productivity in the in- frastructure sector by as much as 60 percent, thereby lowering spending by 40 percent for an annual saving 8  World Bank, IFC, and World Economic Forum. Tackling the Infrastructure Finance Deficit, January 2013. of US$1 trillion. Over the next 18 years, this would 9   McKinsey Global Institute, Infrastructure productivity: How be the equivalent of paying US$30 trillion for US$48 to save $1 trillion a year, January 2013. trillion worth of infrastructure.9 10   Fiszbein, Ariel, Ravi Kanbur and Ruslan Yemtsov, Protec- Similar lessons on cost efficiency emerge from tion, Poverty and the Post 2015 Agenda, WPS6469, World Bank, other sectors. In human development, for instance, May, 2013. What will it take to Achieve Development Outcomes? 5 Figure 1.1:  Annual Infrastructure Investment Needs in Developing Countries Will Be Substantial for the Next Two Decades, with the Greatest Needs in East and South Asia (US$ billions) a. Total Infrastructure Needs, 2010–30 b. Regional Infrastructure Needs, 2030 1,000 350 900 Water 300 Sanitation 800 Fixed 250 700 600 200 Mobile 500 150 400 100 300 Transportation 50 200 100 Power 0 AFR EAP ECA LAC MNA SAR 0 2012 2015 2018 2021 2024 2027 2030 Water/Sanitation Telecoms Transportation Power Source: World Bank, Global Development Horizons, 2013. Box 1.2: Spending More Is Not Enough to Improve Students’ Learning Outcomes. Invest in inputs and institutions. Beyond getting children and youth into school, education systems should promote learning and skills acquisition for all. Evidence shows that additional expenditures have not often been sufficient to improve learning for all. There is no ques- tion that providing adequate levels of schooling inputs—whether school buildings, trained teachers, or textbooks—is crucial to educational progress. The increase in inputs in recent years has made it possible to enroll millions more children in school, and this effort should continue wherever inputs remain inadequate. But improving systems also requires ensuring that inputs are used more effectively. Merely spending more, without changing the way education systems work, does not automatically translate into more learning. Think systemically. Strengthening education systems means aligning their governance, management of schools and teachers, financing rules, and incentive mechanisms, with the goal of learning for all. Policymakers need to recognize that they have tools to reform the system beyond providing more resources (or, where appropriate, in conjunction with providing more resources). Thinking systemically means look- ing at all the determinants of learning beyond the formal K-12 system—early childhood development (ECD), non-formal learning, private schools—and adopting policies and programs to align them. Increase accountability for performance and focus on results. Support accountability structures that are clear, measured, and mon- itored, with a feedback loop between inputs and results. Invest in and use information and knowledge. Too often, policymakers and education professionals lack key information about how and how well the system is operating—especially in terms of learning outcomes and the quality of policies and service delivery. Information allows them to “turn on the lights” and determine how to improve learning outcomes. Data-gathering, analytical work, and practical evidence can help answer questions like: Are children and youth acquiring the knowledge and skills that they need? What are the strengths and weakness of the system, relative to its own goals and international benchmarks? Which interventions have proved most effective in achieving outcomes? 6 Financing for Development Post-2015 compliance and willingness to pay and contribute to a Duty-Free Quota-Free (DFQF) access to the markets of better investment climate. It also has a significant and G20 countries could increase national incomes in LICs positive impact on FDI flows, sovereign spreads and on average by 0.5% of GDP. These income gains could credit ratings, thereby having a multiplier effect on the rise to 1% of GDP if a DFQF initiative were comple- volume of resources available for development. mented by transparent and simple rules of origin.13 A DFQF access initiative could lift three million people in Financing Global Public Goods least developed countries (LDC) above the poverty line. Implementation costs would be minimal, and re- Global public goods (GPGs) are at the intersection of moval of tariffs on LDCs could be achieved through national development priorities and global interests, “stroke of the pen” policy changes. Although there where common opportunities and shared risks increase would be costs associated with implementing the pro- mutual interdependence. While the development posed liberal rules of origin, the impact on G20 im- community should work cooperatively to produce ports would be limited. If complemented by simple, GPGs, it must also identify how financing can be transparent, and liberal rules of origin and measures mobilized to ensure adequate supply of GPGs. Many to reduce trade costs for firms and farmers in LDCs, a donor countries have increased the portion of their broad trade initiative by the G20 could boost national ODA dedicated to global public goods. There have incomes of LDCs by 1.3 to 1.5 percent on average. been recent discussions about a transition of ODA to This is substantial, even with a conservative estimate “global public investments”, particularly to address cli- that ignores the impact that a reduction in trade costs mate change and fight infectious diseases, and recent could have in generating new trade flows (e.g., pene- innovations in financing GPGs (section 5). Howev- tration of new markets, development of new exports). er, funding remains short of needs. Under provision Climate change will affect all developing coun- of GPGs—preserving the environment, controlling tries, and the poorest and most vulnerable will be hit communicable diseases, enhancing developing country the hardest. Climate variability and change can have participation in the global trading system—dispropor- severe implications for countries’ economic prospects tionately impacts the poor. They must be considered in and poverty reduction efforts, posing high risks to national and regional development strategies. ecosystems, eroding agricultural productivity and Infectious disease is an excellent example of a food security, and threatening fragile human settle- case where the social benefits of addressing challeng- ments and vulnerable groups.14 Without ambitious es of a global nature exceed their cost. Neglected vac- action we could experience a +2ºC (+3.6ºF) world cines (e.g. against malaria), limited access to affordable in our lifetime and significant climate and develop- essential medicines, overuse of antibiotics, the disincen- ment impacts are already being felt, notably with ex- tives of drug companies to develop new more resistant treme weather events resulting in widespread human antibiotics, all threaten the global fight against poverty.11 suffering and increasing economic damage across all Innovative mechanisms can be introduced to finance purchases and expand local production of medicines.12 An open, transparent, and rules-based multilat- 11   World Economic Forum. Global Risk 2013 (Section 2 in eral trading system is a GPG, and most countries will particular). 12   For example, through the creation of patent pools and the benefit from liberalization. With supporting capacity building efforts, increasing developing country access use of flexibilities and public health safeguards in the World Trade Organization agreement on Trade-related Aspects of In- to markets for agricultural goods and other products tellectual Property Rights. of importance and removing non-tariff measures with 13   World Bank. Opening Markets for the Poorest Countries: As- discriminatory restrictive impact have significant de- sessing the Effects of Duty-free Quota-free Access to the G20, 2011. velopmental and poverty reduction potential, particu- 14   World Bank , Turn Down the Heat: Climate Extremes, Re- larly for low-income countries (LIC). In particular, full gional Impacts, and the Case for Resilience, 2013. What will it take to Achieve Development Outcomes? 7 Box 1.3: Climate Finance The World Bank and other development partners have argued that Climate Finance and Development Finance are strongly interrelated and must not be separated. The fight against poverty must take climate effects into account and vice versa, while leveraging respective financial flows. In 2011, the World Bank coordinated a joint paper with the IMF, the OECD, and RDBs, Mobilizing Climate Finance, which was prepared at the request of the G20. While the paper listed a range of financial instruments from a variety of sources, international and domestic, public and private, including the emerging Green Climate Fund, progress achieved in securing financial resources for low-carbon and climate-resilient development has been somewhat limited. The Climate Policy Initiative estimates that climate-related bilateral ODA grew from US$9.5 billion in 2009 to US$23 billion in 2010 (a significant portion of total ODA), largely as a result of the US$30 billion “fast-start” commitment for 2010–2012 by developed countries. The same study estimates the total climate finance flows from all sources in 2010 at US$343–385 billion of which 74 percent come from the private sector and 21 percent from development finance institutions. About US$172 billion (equivalent to 47 percent) come from financed projects in developing countries, notably in Brazil, China and India. What concrete steps can countries take to mobilize long-term climate finance? Given the complementary nature between public and private capital, public funds can be invested so as to catalyze climate finance from the private sector on a larger scale. Mobilizing Climate Finance estimates that a public finance of US$36–73 billion could trigger an additional US$150–340 billion in climate finance from the private sector. Comprehensive carbon pricing policies, such as carbon taxes or emissions trading combined with the auctioning of allowances, are viewed as a promising option to mobilize larger investments. Pricing policies are designed to incorporate environmental externalities into investment decisions, thereby altering incentives so as to make low-carbon technologies more competitive and to level the playing field. They can also be structured so as to raise new financial resources that can then be reinvested in green infrastructure. regions. Against this backdrop, financing to address data”. Without relevant development data, no evidence climate change is not growing fast enough. Global based policy making or managing for results can be climate finance flows were estimated to be at US$364 undertaken. While the availability of data has im- billion per year in 2011, with developing countries proved in many developing countries, there is still accounting for some US$171 billion, while much scope at the country level to build and improve sta- larger amounts are needed to engage and maintain tistical capacity. Supporting better software and da- countries on a sustainable and inclusive development tabases, improving measurement and data collection, pathway.15 Significant efforts, ingenuity and capacity broadening open-data access, improving methods for are required to achieve this transformation and cov- development-relevant analyses of data generated by er additional costs and risks of climate action, shift governments, firms and individuals, and more system- investments to greener alternatives, and mobilize atically evaluating the impact of policies will strengthen additional resources—mostly private—to fill the fi- countries’ capacity to learn from and monitor the re- nancing gap (see Box 1.3). Beyond climate change, sults of their development efforts. It will also strength- attention should be given to global biodiversity and en countries’ understanding, adaptation and use of other environmental issues, such as the preservation knowledge and the promotion of continuous learning of marine stocks. societies. The emphasis proposed here is on interdisci- Open access to knowledge, technology and ideas plinary collaboration at a global scale to improve the from the rest of the world to be able to adapt them quality and availability of development data, and speed to local conditions is another global public good. A up the adaptation of knowledge to local contexts. critical aspect of success in development strategies over the last few decades has been the ability for some coun- tries to develop knowledge to meet local needs and the 15   Climate Policy Initiative, The Landscape of Climate Finance, use of new technology to produce and interpret “big 2012. Section Mobilizing Domestic Resources 2 D eveloping countries need to take the lead in Figure 2.1:  Tax Revenue (as a percentage of GDP) mobilizing the financing necessary for their by Country Income Group, 1994–2009 development. Earlier this year, the Post-2015 HLP Secretariat16 noted that: Domestic revenues mobi- 35 lization of emerging and developing economies amounted 30 to US$7.7 trillion in 2012, having grown by 14 percent 25 annually since 2000. That is to say there is over US$6 20 trillion more each year coming into developing country 15 Treasuries compared with 2000. These buoyant domes- 10 tic revenues have also lowered aid dependency and raised 5 country creditworthiness for official and private non-con- 0 cessional loans, thereby having a multiplier effect on the 1994 1998 2003 2009 volume of resources available for development. In 2010, for example, Sub-Saharan African countries collected High Income Middle Income Low Income nearly US$10 in own-source revenue for every dollar of foreign assistance received.17 Source: World Bank classification and World Development Indicators. Nevertheless, increasing domestic revenue mo- bilization (DRM) remains a challenge for many governments, particularly in low-income countries. significant difference in lower-income countries, Low tax-to-GDP ratios are exacerbated by high levels where tax revenues account for only about 10 to14 of capital flight and limited capacity to collect reve- percent of GDP, one-third less than in middle-income nues from multinationals, particularly those engaged countries and far below the 20–30 percent of GDP in natural resource extraction. Inefficient expenditures reached in high-income countries (Figure 2.1). further compound the problem. Progress will be need- Low-income countries differ from their high-in- ed on expanding tax coverage, strengthening account- come counterparts in their formal tax structures and ability, and increasing expenditure efficiency. Many of tax collection capacity. LIC tax bases tend to be quite these efforts are likely to generate positive externalities. narrow, reflecting the smaller share of the formal sector For instance, efforts to address problems in transfer in employment and business activity. Large informal pricing will reduce illicit financial flows and improve economies and agricultural sectors are rarely taxed. revenue collection. Improving Taxation Capacity 16   Summary of Financing for Development, Bali meeting, March 2013. Broadening the tax base, improving tax admin- 17   See “Public Resource Mobilization and Aid,” in Africa Eco- istration, and closing loopholes could make a nomic Outlook, 2010. 10 Financing for Development Post-2015 As Table 2.1 illustrates, LICs have the lowest are ostensibly meant to support growth and other so- tax-to-GDP ratio, although there has been some im- cioeconomic objectives, their impact is often difficult provement over the last two decades. For this group, to predict and the foregone revenue may significantly the average ratio of taxes to GDP increased from 10 exceed the value of the benefits gained.20 percent in 1998 to 13.6 percent in 2009. The share In the end, even a well-designed tax regime is of taxes as a percentage of GDP is almost 6 percent- only as efficient as the administration in place to im- age points higher and rising for MICs. High-income plement it.21 Tax administrations in developing coun- countries have the highest tax-to-GDP ratio, collect- tries are often staffed with poorly trained and poorly ing two to three times more taxes as a share of GDP paid officials. They may have rigid structures that do than LICs.18 not encourage an integrated approach to different Aggressive transfer pricing, which can inflate prof- tax categories. Low salaries, in combination with pa- its in low-tax jurisdictions and lower profits in high- per-based systems with little oversight or differenti- tax jurisdictions, is a problem affecting developed and ation of functions, create incentives for corruption developing nations alike. According to one widely and tax evasion. Staff in large taxpayer offices are fre- quoted estimate, the amount of tax revenue lost by de- quently paid on par with other tax administrators and veloping countries to abusive transfer pricing averaged equipped with only basic IT infrastructure, although between US$98 billion and US$106 billion annually the requirements for such positions are highly com- from 2002 to 2006.19 There is growing awareness of plex and specialized. the risks posed by transfer pricing in developing coun- In light of these challenges, how can reforms in tries, but thus far, few have been able to develop the tax policy and administration best be achieved? Inter- capacity to effectively combat it. national organizations and bilateral aid agencies have Revenue mobilization is also frequently ham- provided technical tax advice to developing coun- pered by the preferential treatment granted to specif- tries for many years. Looking forward, it is essential ic taxpayers through targeted tax deductions, credits, that tax reforms are seen as egalitarian, socially just exclusions, or exemptions. Although these incentives and fair in distributing the tax burden. This will also require that challenges posed by informality are ad- dressed, including by identifying ways to tax the in- Table 2.1: G  reater Taxation Capacity in MICs formal sector and by improving financial records for than in LICs such businesses. Country Tax Revenue as % of GDP (2004–2011) Harnessing Sustainable Streams of LICs Natural Resource Revenue Congo, Republic of 9.3 Ethiopia 9.4 Capacity constraints often prevent developing Uganda 10.6 countries from effectively and efficiently obtaining Zambia 18.0 Bangladesh 7.6 Pakistan 12.3 18   World Bank. World Development Indicators. Sri Lanka 16.0 19   Hollingshead , Summary: The Implied Tax Revenue Loss from MICs Trade Mispricing, Global Financial Integrity, 2010. These fig- Colombia 11.0 ures must be treated with some caution since they are based Bulgaria 26.7 on models for assessing the loss of tax revenues which are still being developed. Vietnam 24.9 20   Keen and Mansour, Revenue Mobilization in Sub-Saharan South Africa 21.8 Africa: Challenges from Globalization, IMF, 2009. Source: World Development Indicators. 21   Bird, Tax challenges facing developing countries, 2008. Mobilizing Domestic Resources 11 revenues from extractive industries.22 Investments in the necessary infrastructure.25 For many countries, in- natural resources commonly involve high sunk costs vesting the financial resources required to effectively for a project that can last decades. Rents can be sub- run the tax administration, with resources sufficient to stantial and represent a large share of the home coun- train and retain highly qualified specialists, would be try’s GDP and government revenue.23 Moreover, gov- repaid many times over. ernments are usually dealing with large multinational Additionally, countries need to manage their companies, with recourse to highly qualified lawyers natural resource wealth in a way these assets can and the capacity to engage in transfer pricing and ag- generate revenues in the long-run. For renewable re- gressive tax planning.24 Tax and royalty-based regimes sources, this means not harvesting beyond the regrowth negotiated with mining companies, are frequently per- rate. Revenues from non-renewable resources should ceived as unfair to the home country. Raising taxes and be reinvested so as to build long-term wealth and to royalty rates is not always easy, especially given that contribute to post-2015 development. Natural Capi- developing countries need to take into account invest- tal Accounting (NCA) is a useful tool for countries to ment promotion objectives and often have limited ca- inform decisions on natural resource use so as to gener- pacity to negotiate the licensing of extraction rights. ate sustainable revenue streams. The World Bank-run Natural resource-rich developing countries Wealth Accounting and Valuation of Ecosystem Ser- could improve their capacity to negotiate fair con- vices (WAVES) partnership helps countries to adopt tracts in extractive industries. To help developing NCA as currently implemented in Botswana, Colom- countries retain more of their natural resource rents, bia, Costa Rica, Madagascar, and the Philippines. governments could pursue initiatives like the Ex- tractive Industries Transparency Initiative (EITI) that Improving Expenditure Efficiency promote greater transparency in revenue flows and contract disclosure. Governments will require support Considerable resources could be realized from public to: (i) build capacity for qualified negotiation of the sector efficiency gains and reallocated towards devel- licensing of extraction rights, whether in-country or opment objectives. Strengthening public expenditure outsourced; (ii) establish well-equipped large taxpay- and investment management can help limit waste and er offices, or separate tax units for the extractive in- graft and improve the quality of public expenditure, in- dustries, offering conditions that are competitive in cluding through better selection, design, and manage- recruiting and retaining highly specialized staff; (iii) ment of public investment projects, thereby improving deepen cooperation and information sharing with tax the enabling environment for investment. Reforms administrations of resource-rich developing countries, in subsidy regime and procurement in particular can in order to confront aggressive tax planning by multi- nationals in the extractives sector; and (iv) ensure that relevant ministries have the specialist capacity and lab- 22   World Bank and Centre for Exploration Targeting. Source oratory equipment to undertake physical verification Book on How to Improve Mining Tax Administration and Collec- of ore grades, quantity, and price. The World Bank, for tion Frameworks. Forthcoming. example, is providing support for EITI implementa- 23   IMF. “Revenue Mobilization in Developing Countries”. tion through the EITI multi-donor trust fund and for March 2011. 24   Okonjo-Iweala, Ngozi, “Good Governance of Natural Re- contract negotiations through the Extractive Industries Technical Assistance Facility and the new Africa Ex- sources”, HLP Working Paper Series, January, 2013, discusses the potential role of the global community in the governance tractive Industries Facility. of natural resources. On the positive side, since the extractive sectors in 25   Calder, Jack. “Resource tax Administration: Functions, Pro- most countries consist of only a small number of very cedures and Institutions“ in Philip Daniel et al., The Taxation of large taxpayers, revenue administration can be under- Petroleum and Minerals, Principles, Problems and Practice. Rout- taken by a few highly specialized staff equipped with ledge: London and New York, 2010. 12 Financing for Development Post-2015 increase public expenditure efficiency and allow more Figure 2.2:  World Subsidies to Fossil-Fuel spending supporting progress in poverty reduction. Consumption Subsidy Reform 600 Subsidy reform is one of the main areas in which 500 public resources can be redirected to more effective 400 USD billion uses. It is not only important for mobilizing domestic 300 resources but also for getting incentives right. While it 200 is important to remove harmful subsidies, increasing 100 subsidies for activities with positive externalities might 0 be the proper course of action. An extensive body of 2007 2008 2009 2010 research has demonstrated that food and fuel subsidies are often poorly targeted and end up disproportion- Oil Natural gas Coal Electricity ately benefiting the wealthy and middle class. The IEA has noted, for example, that only an estimated eight Source: IEA, World Energy Outlook, 2011. percent of the fossil fuel subsidies throughout the de- veloping world in 2010 went to the poorest 20 percent Figure 2.3:  Share of Fossil-Fuel Subsidies of the population.26 Earlier analysis noted that the bot- Received by the Lowest 20% Income tom 40 percent of the income distribution received on Group, 2010 average no more that 15–20 percent of the total value of these subsidies.27 LPG Gasoline Diesel A first step requires removing harmful subsidies, thereby freeing public resources that can then be di- 6% 6% 5% rected towards investments with higher social returns. Energy subsidies—particularly fossil fuel subsidies— are costly, and these costs are quantifiable and can be Electricity Natural gas Kerosene measured. According to the IMF, pre-tax subsidies for petroleum products, electricity, natural gas, and coal reached US$480 billion in 2011 (0.7 percent of global 9% 10 % 15 % GDP or 2 percent of total government revenues). Total subsidies amounted to US$1.9 trillion (2.5 percent of global GDP or 8 percent of total government revenues). Source: IEA, World Energy Outlook, 2011. Despite their negative environmental impacts, in many countries subsidies artificially increase the incentives for effective outreach strategy; and political will to see the using fossil fuels. The main beneficiaries often have po- reform through.28 Such reforms should also be framed litical power and lobbying capacity to oppose reforms. within a broader set of energy sector reforms. Yet Furthermore, the removal of subsidies needs to be com- plemented by safety nets, new pricing solutions or com- 26   International Energy Agency (IEA), World Energy Outlook, pensatory transfer to avoid adverse impacts on the poor. 2011. 27   Independent Evaluation Group, “Climate change and the Subsidy reforms can be successful as illustrated in World Bank Group. Phase I—An Evaluation of World Bank Iran, in 2010, when extensive public communication Win-Win Energy Policy Reforms”, Washington, D.C.: World was combined with a safety net program of direct cash Bank, 2008. transfers. The success of subsidy reforms depends on 28   See Zlatko Nikoloski, “The Political Economy of Ener- their timing, analysis of their social impact, design of gy Subsidies: Country Narratives”, Washington D.C.: World alternative support measures; early introduction of an Bank, 2011. Mobilizing Domestic Resources 13 subsidy reforms are likely to be highly contextual and in Mexico, Chile, South Korea, and Poland, from will be particularly challenging in countries already which other countries can learn from. The expand- struggling with social unrest (including many fragile ed use of country systems by multilateral donors can and conflict-affected states). provide additional incentives for many countries to undertake procurement reforms and for the donor Procurement community to support them. Another area for potential savings is procurement. Beyond subsidy and procurement reform, there are Every year, developing countries purchase trillions of additional opportunities to streamline and improve ef- dollars’ worth of goods and services. In Mexico, for ficiency of public expenditures. In many countries, im- example, public procurement costs around US$55 bil- proving public sector administration and the efficien- lion annually, or around 8 percent of GDP. A recent cy of state-owned enterprises still provides significant set of innovative procurement reforms allowed the gov- scope for expenditure rationalization. Likewise, there ernment to realize US$650 million in savings between is much scope in many countries, especially MICs, to 2009 and 2011. By some estimates, these reforms could improve efficiency and service delivery in the social sec- ultimately generate an annual savings of around 15 per- tors by systematically measuring outputs and outcomes cent of government purchases, or roughly US$8 billion across service providers and using the findings to im- per year.29 Beyond increasing value for money, good prove the performance of the weaker ones. The latter is practices in procurement can bring additional benefits a relatively new agenda in high-income countries, and to developing countries, including the development of MICs in particular have a good opportunity to make a domestic industries and services; better service delivery, strong start, including by learning from the experiences e.g., through sound management of PPP contracts in of other countries. Furthermore, reforms to improve several sectors (health, education, power distribution, public financial management can also play an import- and water and sanitation); and transparency, includ- ant role in increasing expenditure efficiency across sec- ing through public participation in procurement at the tors, as well as enhancing the confidence of donors and local level through community driven development encouraging other sources of development financing. approaches. Procurement reforms can be difficult and compli- Curbing Illicit Financial Flows cated to achieve. They can be technically demanding and meet with resistance from various vested interests. Illicit financial flows (IFFs) are outward cross- Reforms may require new legislation, identifying and border capital flows of illegal origin. IFFs encompass: eliminating antiquated regulations, and intervention (i) funds obtained through drug trafficking, smug- throughout the entire project cycle, from design to gling, fraud and any other serious crime; (ii) the pro- planning, tendering, contract execution, and comple- ceeds from corruption, bribery and embezzlement; and tion. Many developing countries struggle with weak (iii) tax evasion. The term can also refer to practices capacity, small economies with poorly developed do- such as transfer pricing (or mispricing), which falls in mestic markets, and limited options for economies of a gray area, but is not illegal. scale and competition. Estimates of the magnitude of IFFs from develop- Yet progress is possible on a variety of fronts. ing countries vary. One widely cited estimate places the This is particularly true in the area of e-procurement, flow from developing or transitional countries between which can make procedures more transparent, pro- mote higher levels of participation, make it easier 29  See World Bank, “Mexico Slashes Rules, Focuses on Results to track down anomalies, and generate data more Instead,” and World Bank, “Mexico Federal Procurement Sys- efficiently. An emerging body of good practice ex- tem Saves Room for Social Programs,” http://www.worldbank. ists, including framework agreements, consolidated org/en/news/feature/2012/05/07/mexico-federal-procurement-sys- purchases, as well as a legacy of successful reforms tem-saves-money-for-social-projects.print. 14 Financing for Development Post-2015 US$539 and US$778 billion annually.30 According to Other approaches aim to reduce international fi- Global Financial Integrity (GFI), a Washington-based nancial flows directly rather than targeting their un- NGO, IFFs from developing countries in 2010 ranged derlying causes. Such efforts can focus on improving from US$859 to US$1,138 billion. GFI maintains transparency in declaring revenues and payments by that the developing world lost a staggering US$5.86 multinational corporations, tightening the regulation trillion in the decade from 2001–2010, although such of tax havens and secrecy jurisdictions, or strengthen- figures are disputed.31 According to GFI, Asia account- ing efforts to curb money laundering.33 In particular, ed for 61 percent of total illicit flows from the develop- governments working with private companies should ing world during this period, followed by the Western ensure beneficial ownership information on legal en- Hemisphere (15 percent); the Middle East and North tities and legal arrangements. This is crucial to halt Africa (10 percent); developing Europe (7 percent); illicit financial flows, promote anti-corruption, recov- and Sub-Saharan Africa (7 percent). Even if the actual er stolen assets, and combat terrorism financing, tax funds were only a fraction of this magnitude, the sums evasion, and other financial crimes. The Lough Erne involved are huge. IFFs could be larger than official agreement (June 2013), which commits G8 nations development assistance and foreign direct investment to collaborate more intensively against global tax eva- combined. sion and avoidance schemes, provides a good example There is little doubt that such outflows have a per- of what countries can do. Recent progress under the nicious impact on development. They contribute to a auspices of the OECD to promote a standard for the reduction in both the domestic resources and tax reve- automatic exchange of information between govern- nues available for productive purposes. Indirectly, they ments and financial institutions is a step in the right can impact domestic investment, interest rates, and in- direction, but for many developing countries, signifi- flation. An estimated 80 percent of IFFs involve trade cant technical assistance and capacity building will be mispricing—an area notoriously difficult to identify needed before they can fully benefit from enhanced and prove—and the boundary between illegal pricing transparency. and aggressive strategies for tax minimization is often blurry and contentious.32 Country efforts to address IFFs need to occur at 30   Baker, Raymond, Capitalism’s Achilles Heel: Dirty Money and two levels. The more complex and difficult path in- How to Renew the Free Market System. Hoboken, NJ: John Wi- volves tackling the underlying dynamics that help ley & Sons, 2005. drive such flows. Here, the problems are both exten- 31   See Dev Kar and Sara Freltas, Illicit Financial Flows from sive and pervasive, ranging from kleptocratic regimes, Developing Countries: 2001–2010, http://iff.gfintegrity.org/doc- to political instability, to weak tax administration and uments/dec2012Update/Illicit_Financial_Flows_from_Devel- chronic evasion, to unfavorable exchange rates and oping_Countries_2001-2010-HighRes.pdf. For a discussion of constraints on currency conversion, to a lack of an at- the methodology and veracity behind these numbers, see Peter Reuter, Draining Development?, Washington, D.C.: The World tractive investment environment and opportunities at Bank, 2012. home. While it is possible for countries to make prog- 32   For an interesting discussion of the challenges involved in ress along each of these dimensions, gains typically do addressing trade mispricing, see Volker Nitsch, “Chapter 10: not come quickly, and there is often a significant lag Trade Mispricing and Illicit Flows” in Reuter, 2012. between institutional improvements and public per- 33   On this point, see Peter Reuter, “Chapter 15: Policy and ceptions and behavior. Research Implications of Illicit Flows” in Reuter, 2012. Section Better and Smarter Aid 3 O ver the last few decades, aid has played an es- countries. Net ODA from the 25 member countries of sential role in helping LICs to accelerate eco- the OECD’s Development Assistance Committee (DAC) nomic growth and lift people from extreme grew by about 37 percent in real terms between 2004 poverty. Official Development Assistance (ODA) pro- and 2010, reaching an all-time high. Of this amount, 60 gressed significantly over that period, and countries el- percent went to LICs and 40 percent to MICs. The larg- igible for support from the Interantional Development est donors in 2012 were the United States, the United Association (IDA) achieved a significant reduction in Kingdom, Germany, France, and Japan. By 2012, Den- absolute poverty, from 58 percent of the population in mark, Luxembourg, the Netherlands, Norway, and Swe- 1981 down to 38 percent in 2008. den continued to provide 0.7 percent or more of their Today, aid remains essential in countries where GNI as ODA. However, these five countries accounted private investment is limited, particularly in LICs and for only 11 percent of total aid from DAC members. A fragile states, which struggle to attract private inves- number of other donors increased their ODA contribu- tors, including in infrastructure.34 With nearly 1 bil- tion,35 while the UK stepped up its efforts to meet its lion people still expected to live in absolute poverty by Monterrey commitment by 2013, despite an aggressive 2015, ODA will remain a critical input to achieve new domestic austerity policy. development goals by 2030. Official sources of development financing, including from multilateral development banks Aid’s Contribution to Development (MDBs), also played a countercyclical role in the wake of the global financial crisis (Figure 3.1). Today, ODA has been a relatively stable source of develop- more than 30 LICs are receiving assistance amounting ment financing for the poorest economies with lim- to over 12 percent of their GNI per year, with ODA ited or no access to international capital markets. grants representing almost 60 percent of their total net The Monterrey Declaration (2002) rightly identified the comparative advantage of aid: “ODA plays an essen- tial role as a complement to other sources of financing for 34   In 2011, while US$390 billion of net FDI and US$250 development, especially in those countries with the least billion in net bonds and credits went to developing economies, capacity to attract private direct investment… For many LICs only received about US$13.5 billion in private commer- countries in Africa, least developed countries, small island cial flows (and US$1.4 billion official non-concessional net developing states and landlocked developing countries, disbursement). Africa has attracted only about 9 percent of developing world PPP investments by number of projects in ODA is still the largest source of external financing and is the last decade (Public-Private Infrastructure Advisory Facility critical to the achievement of the development goals and (PPIAF)). Of the top 15 infrastructure investors in 2010 and targets of the Millennium Declaration and other interna- 2011, none committed capital in Sub-Saharan Africa outside of tionally agreed development targets.” the Republic of South Africa. Over the last two decades, ODA per capita has 35   Korea increased its contributions by almost 18 percent, and, been maintained and sometimes increased in these to a lesser extent, Australia, Luxembourg, Austria, and Iceland. 16 Financing for Development Post-2015 Figure 3.1: Aid’s Counter-Cyclicality that it helped spur the MDG implementation. To- day, debt relief is winding down. The HIPC Initiative is nearly complete. Of the 39 countries that have been US$ millions per capita (2010 prices) 0.14 assessed eligible or potentially eligible under the Ini- 0.12 tiative, 35 have already reached the completion point, 0.10 including Côte d’Ivoire, Guinea, and the Comoros in 0.08 2012, while Chad is the only country in the interim 0.06 phase between the decision and completion points. 0.04 Only three eligible countries—Eritrea, Somalia, and 0.02 Sudan—have yet to start the process of qualifying for 0.00 debt relief under the Initiative. 1990 1994 1998 2002 2006 2010 External debt relief has been a critical compo- nent of financing the MDGs. Debt relief under the Fragile States Small States Heavily Indebted Poor Countries combined heavily indebted poor country (HIPC) and multilateral debt relief initiatives (MDRI) and from Source: OECD DAC, 2012. the Paris Club has substantially lowered debt service requirements, creating space for increased social and other poverty-reducing expenditure (Figure 3.3). For financial flows. Even after taking into account private the 36 post-decision point countries, poverty-reducing transfers, ODA represents 40 percent of total financial spending increased by about two and half percentage flows to fragile states (Box 3.1). While aid accounts for points of GDP (or from 6.3 to 8.8 percent of GDP), a much smaller share of total development finance in between 2001 and 2011, while debt service payments middle-income countries, it has remained a valuable declined by about 2 percentage points of GDP during resource to help finance social service delivery and cat- the same period (from 2.9 to 0.9 percent of GDP). alyze additional private and official flows. The substantial alleviation of debt burdens in recipient Looking forward, debt relief is unlikely to con- countries combined with new ODA disbursements in- tribute to Post-2015 financing to the same extent creased fiscal space and provided impetus to growth. Box 3.1:  Financing Fragile and Conflict-Affected States ODA represents the biggest financial inflow to fragile states, followed by remittances and FDIa (Figures Figure 3.1.1: Gross 3.2). The vast majority of the top 20 most aid-dependent countries are classified as fragile states. Half of Financial Flows to all ODA to fragile states goes to only seven countries and remains volatile: every fragile state has had at least one aid shock in the past 10 years. With domestic policy space severely limited, FCSs may have to Fragile States, 2010 turn to the international community for assistance. Total USD: 125 Billion The 2011 World Development Reportb has demonstrated how targeted external financial aid can be effective in supporting countries to transition out of fragile situations. A Development Policy Lending (DPL) retrospective conducted by the World Bank in 2013 confirmed that despite high risks, related FDI mainly to the macroeconomic framework, weak economic governance, low technical capacity, weak in- 22% Remittances stitutions, and limited policy dialogue, general budget support through grants can carry high returns in 38% FCSs, with varying objectives, ranging from “quick wins” to long-term policy reforms, but often with a ODA focus on security, justice, and jobs. 40% a  OECD. Fragile states: Resource Flows and Trends, 2013. b  World Bank. World Development Report, 2011. Better and Smarter Aid 17 Figure 3.2: Average Poverty-Reducing now equivalent to 0.29 percent of donors’ combined Expenditure and Debt Service in HIPCs gross national income, falling significantly short of the Monterrey commitment. 11 10 The Growing Complexity of the Aid 9 Poverty-Reducing 8 Expenditure/GDP Landscape Percentage of GDP 7 6 The emerging aid landscape is evolving, becoming 5 increasingly complex and interconnected. ODI pro- 4 posed a new taxonomy of development assistance flows37 3 2 in 2013 (Table 3.1), distinguishing between traditional Debt Service/GDP 1 and non-traditional development assistance flows. 0 Aid from OECD-DAC donors, including 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012p 2013p 2014p 2015p 2016p 2017p through contribution to multilateral agencies, has become a less important source of development fi- Sources: HIPC documents and IMF staff estimates. nance at the global level, despite growing rapidly Note: For detailed country data and projections, refer to the forthcoming IMF- over the 2003 to 2009 period. ODI estimates that World Bank Heavily Indebted Poor Countries (HIPC) Initiative and Multilateral Debt Relief Initiative (MDRI)—Statistical Update, March 2013. total development assistance grew from US$64.8 billion in 2000 to US$173.3 billion 2009. In 2009, Given the budget constraints confronting many non-traditional assistance accounted for US$53.3 bil- DAC donors, a substantial increase in ODA is un- lion (equivalent to 31 percent of the total), up from likely in the near future. The ongoing economic crisis US$5.3 billion (or 8 percent of the total) in 2000. has contributed to a tightening of aid budgets, with a After an increase in lending in 2009 and 2010, six percent drop in real terms since 2010. While aid other official flows (OOF) are now less dynamic and flows increased to North Africa in response to the Arab one of the most volatile components of the interna- uprising, aid flows to LICs fell for the first time in over tional development financing system. When account- a decade in 2011. Net ODA flows were USD133.7 ing for OOF, which are not sufficiently concessional to billion in 2011, 2.7 percent less than a year earlier in real terms, reversing the rising aid trend since 1997.36 ODA fell even more in 2012, reaching US$128.3 bil- Aid flows excluding one-off debt. 36   lion (in constant 2011 dollars and exchange rates), a ODI. Greenhill, Romilly, Annalisa Prizzon and Andrew 37   decline of 6 percent from the ongoing financial cri- Rogerson. The age of choice: developing countries in the new aid sis and consequent tightening of aid budgets. ODA is landscape. A synthesis report. Working Paper 364, January 2013. Table 3.1: Taxonomy of Development Assistance Development Assistance Flows TDA NTDA Other flows (not considered) Traditional bilateral cooperation Non-DAC flows Domestic resource mobilization Traditional multilateral cooperation Philanthropic and institutional giving Export credits Social impact investment DFIs (excluding those covered in OOFs) Global vertical funds Private remittances Public climate finance FDI Korea Other private flows OOFs Source: ODI, The age of choice: developing countries in the new aid landscape, 2013. 18 Financing for Development Post-2015 qualify as ODA (such as loans from the International Figure 3.4:  ODA from Saudi Arabia, South Korea, Bank for Reconstruction and Development (IBRD)), and Turkey, 2003–2009 total development assistance has grown from US$77.1 (Gross disbursements, US$ billion) billion to US$213.5 billion between 2000 and 2009 and non-traditional flows from US$17.6 billion 6 0.9 (22.8%) in 2000 to US$93.5 billion (43.8%) in 2009. 0.8 5 0.7 During that time, several non-DAC donors and 4 0.6 private institutions have grown to a significant size, 3 0.5 namely China and India; philanthropists such as the 0.4 2 0.3 Bill and Melinda Gates Foundation or the Ford Foun- 0.2 1 dation; and social impact investors, such as the Shell 0.1 0 0.0 Foundation and the Acumen Fund. 2003 2004 2005 2006 2007 2008 2009 New Donors: Emerging Market Economies Saudi Arabia Turkey South Korea (EMEs) (Secondary Axis) (Secondary Axis) The last decade saw a diverse group of countries gain Source: DAC Annual Reports and IDS Statistics. prominence in the aid landscape: non-DAC members of the OECD and EU; upper middle-income countries (in Latin America, the Middle East, and East Asia); and Figure 3.5:  ODA from Non-DAC Donors Excluding other developing countries. Many are ramping up their BRICS, 2003–2009 development engagements through a broad range of (Net disbursements, US$ billion) channels and activities. This includes the BRICS group of countries (Brazil, Russia, India, China, and South 10 Africa), which account for 25 percent of global GDP 8 and 40 percent of the world’s population, and Saudi 6 4 Figure 3.3:  Estimated Aid from BRICS, 2003–2009 2 (US$ billion) 0 2003 2004 2005 2006 2007 2008 2009 5 Arab EU, Non- OECD, Non- Other Non- 4 Countries OECD Donors DAC Donors DAC Donors 3 Source: OECD DAC and Zimmermann, Felix and Kimberly Smith, More Money, 2 More Actors, More Ideas: For Development Co-operation, Journal of International Development, 2008. 1 0 2003 2004 2005 2006 2007 2008 2009 Arabia, South Korea, and Turkey. The boost in ODA from the new actors illustrated in figures 3.3, 3.4 and China India Russia Brazil South Africa 3.538 captures only a small piece of the upward trend in external flows contributing to development.39 Source: Brautigam, Deborah, China’s African Aid: Transatlantic Challenges – A Report to the German Marshall Fund of the United States, International Development Program, School of International Service, American University, 38   These estimates are only available until 2009. Washington, DC, 2008; and Smith, Kimberly et al, Beyond the DAC: The Welcome Role of Other Providers of Development Co-Operation, OECD DAC, 39   World Bank. Finance for Development: trends and Opportuni- DCD Issues Brief, May 2010. ties in a Changing Landscape, CFP Working Paper, 2011. Better and Smarter Aid 19 Overall, by 2011, the annual concessional flows overwhelmingly dependent on traditional ODA pro- from emerging economies to LICs was roughly esti- viders. Some have reached a critical size. The Global mated to be between US$12–15 billion, which rep- Fund to Fight AIDS, Tuberculosis, and Malaria has resented between 10 percent and 15 percent of the secured pledges totaling about US$30 billion since its amount of aid provided by developed countries (the creation in 2002, 95 percent of which come from the higher range including non-concessional OOF).40 This public sector. Over 60 percent of the pledges have been is close to the order of magnitude of the IDA, which paid to date. The Global Environment Fund (GEF), provides around US$16–17 billion a year in grants a partnership between 182 countries, international and highly concessional loans. China, which contrib- agencies, civil society, and private sector has provided utes about half of total aid flows from the BRICS, has US$11.5 billion in grants since its creation in 1991 grown its technical assistance grants at an annual rate of and leveraged US$57 billion in co-financing for over 25–30 percent, reaching the annual amount of US$67 3,215 projects in over 165 countries. billion, with about 40 percent of these combined flows New development partners are breaking out of going to Sub-Saharan Africa and about 60 percent the mold of traditional ODA financing, promoting being directed to the development of economic infra- their own economic and strategic interests, while at structure.41 The share of development finance coming least partially meeting needs not addressed by tra- from the EMEs may continue to rise, if only because of ditional donors. This flexibility is often made possible their increasing share in the world economy.42 by different transparency and safeguard standards than those governing traditional donors. Rather than grant New Actors: Private Philanthropy and Verti- financing for budget support and health, education, cal Funds and social infrastructure, new actors frequently offer The new aid landscape has evolved to include a concessional or semi-concessional loans emphasizing number of foundations and non-governmental or- physical infrastructure development.44 For instance, ganizations. Private aid today amounts to approxi- the Public-Private Infrastructure Advisory Facility mately US$60–70 billion per year, equivalent to nearly (PPIAF) study indicates that non-traditional partners half the net ODA disbursed in one year by all OECD- contribute 38 percent of total infrastructure financing DAC members. The US dominates philanthropic pri- (US$8 billion in 2006), the same order of magnitude vate flows to the developing world with US$39 billion as private participation in infrastructure financing, and transferred in 2010.43 Philanthropy has been growing significantly greater than traditional ODA financing fast, with more than 100 billionaires meeting Bill Gates’ challenge to leave at least half of their wealth to 40   World Bank Dialogue Series with New Development Part- charity over time. Private philanthropy to fragile states ners: Learning from National Experiences and Building Global has increased in recent years, as well as South-South Partnerships, June 22–23, 2012, New Delhi. philanthropic flows, particularly in the Arab world. 41   World Bank Dialogue Series with New Development Part- Vertical funds are multi-stakeholder global pro- ners: Learning from National Experiences and Building Global grams that provide earmarked funding for specified Partnerships, June 22–23, 2012, New Delhi. purposes. They have proved very effective to channel 42   China and India combined are expected to represent about assistance to core but chronically underfunded devel- half of the world’s GDP by 2050. 43   The 2012 Index of Global Philanthropy and Remittances, opment sectors, such as disease eradication or climate change. However, the proliferation of vertical funds Hudson Institute Center for Global Prosperity. 44   G24 Secretariat. Financing Development in Africa: the Grow- has not always been conducive to aid effectiveness, ing Role of Non-DAC Development Partners, 2008. creating distortions, particularly in low-capacity envi- 45   World Bank. V. Foster, et al., Building Bridges: China’s ronments with weak planning and budgeting systems. Growing role as Infrastructure Financier for Africa, PPIAF, 2008. Many of these were created in the hopes of attract- 46   Kharas, H. The New Reality of Aid. Washington, DC: The ing substantial private contributions, but all remain Brookings Institution, 2007. 20 Financing for Development Post-2015 (US$5 billion or 22 percent of total financing).45 development finance. Global aid effectiveness princi- Moreover, non-traditional financiers are mainly con- ples and objectives have been defined in the Paris Dec- centrated in power and transport sectors, whereas tra- laration (2005), the Accra Agenda for Action (2008), ditional donors are also a dominant source of financing and the Busan Outcome Document (2011), all sharing for water and sanitation, and the private sector is the a focus on improving country ownership, transparency, dominant source of financing for telecommunications. and results. Reflecting the growing share of non-ODA Thus, beyond increasing the volume of resources, new actors, the international aid effectiveness architecture actors engaged in South-South cooperation are playing has evolved from a focus on donor harmonization and a complementary role, entering the areas left out of alignment to a broader approach of inclusive devel- traditional financing with the greatest need. opment partnerships. The Global Partnership for Ef- fective Development Co-operation (GPEDC) created Aid Effectiveness: An Ongoing Effort at the 4th High Level Forum on Aid Effectiveness in Busan (2011) brings together multi- and bilateral do- Aid has become increasingly fragmented and ear- nors, emerging economies that are both recipients and marked, increasing its complexity, volatility, and providers of development cooperation, recipient coun- the administrative burden for aid recipients, poten- tries (including fragile and conflict affected states), the tially decreasing its effectiveness.46 The average size private sector, CSOs, and parliamentarians. of donor-funded transactions has declined from close Since 2005, several analyses of aid effectiveness to US$3 million in 1997 to about US$1.3 million in at the global and institutional levels have been con- 2009, while the number of donor activities reached ducted. At the global level, the Paris Declaration Mon- about 120,000 in 2009.47 Earmarked multilateral and itoring Survey 2005–2010 assessed progress on 13 bilateral ODA is estimated to account for over 40 per- indicators against their 5-year target. While only one cent of total ODA. Earmarking can help raise financing indicator met its target at the global level (strengthen for specific issues that may be high priority for donors capacity by coordinated support), country ownership and rally public support for aid, but it is less predict- (evidenced by the number of countries with sound able than performance-driven aid, may reduce reform national development strategies and results-oriented incentives, skew resources towards specific items and monitoring frameworks) increased substantially. The away from other, more critical priorities, and under- survey identified the need for further progress in using mine country ownership by altering the priorities that country systems, harmonizing donor procedures, re- countries place on specific programs.48 At the same ducing aid fragmentation, and improving aid predict- time, an estimated 70 percent of all ODA channeled ability. Building on the Paris Declaration indicators, through multilateral institutions remains core, i.e. is the GPEDC is developing a Monitoring Framework of not earmarked.49 According to several external assess- the Global Partnership for development effectiveness, ments of multilateral institutions, the effectiveness of including updated targets for 2015 on selected indi- core multilateral aid continues to improve, including cators of the Paris Declaration survey and additional in areas such as value for money and a focus on results indicators for private sector and civil society participa- and development impact. tion, gender equality, and transparency. Relative to traditional donors, new actors operate Significant progress has been achieved in aid according to a very different set of motivations, inter- transparency and accountability, notably since the ests, and experiences. As a result, their approach gen- erally involves mutually beneficial, integrated packages 47   World Bank. Finance for Development: Trends and Opportu- combining ODA with trade, investment, and other nities in a Changing Landscape, CFP Working Paper, Nov. 2011. commercial deals. 48   World Bank. The Demand for IDA17 Resources and the Strat- In this context, improving aid effectiveness egy for their Effective Use, IDA 17 Paper, June 2013. plays an important role in attracting new sources of 49   OECD/DAC, 2012 DAC Report on Multi-lateral Aid. Better and Smarter Aid 21 creation of the International Aid Transparency Initia- direct lending capacity going forward, and the fiscal tive (IATI) in Accra in 2008. Based on an open data constraints of many of their major shareholders, it is standard, IATI aims to increase the transparency and increasingly important for MDBs to fully utilize their accountability of aid by publishing aid data from aid catalytic role and leveraging potential to mobilize addi- providers, aid users, and civil society on a timely ba- tional financing from diverse sources. In countries that sis. To date, 116 organizations have published their struggle to attract private investment, such as fragile or aid information to the IATI registry.50 Ongoing work small states, official finance remains critical. It can also aims to strengthen links between IATI and partner play an important complementary role, by supporting countries’ aid information management systems, pub- improvements in project quality with development lish detailed geographical information on aid projects impact, and in so doing encourage private investors to (geo-mapping), and develop a common, open trans- engage in productive investments. parency standard51 in line with Busan commitments. Towards a More Catalytic Role for ODA www.iatiregistry.org. 50   The common standard is in the process of being developed 51   In all likelihood, the impact of the economic crisis on based on IATI and the OECD’s Creditor Reporting System aid will persist for several years. Faced with limited (CRS) and Forward Spending Survey (FSS). Box 3.2:  Collaborating across the World Bank Group (WBG) to Leverage Investments for Energy Generation The Kenya Private Sector Power Generation Support Project Development Challenge In recent years, Kenya has been facing severe power shortages, which have put pressure on the country’s economic growth aspirations and its efforts to improve the day-to-day lives of Kenyans. Only 25 percent of the population has access to electricity, and rural grid access is only 5 percent. Scaling up access to electricity and ensuring reliable power supply are key elements of Vision 2030, the Government’s national development strategy to promoting economic development, growth and competitiveness, and creating jobs. In the wake of the ongoing global economic and financial crisis, it was challenging for the Government of Kenya (GoK) and Kenya Power (KPLC), the national utility, to mobilize the resources needed to publicly finance new investments in electricity generation to help meet critical power shortages. The key was to attract the private sector to develop and implement the projects and mobilize long-term commercial financing. However, despite extensive energy sector reforms with improved governance and a strong track record of sustaining previous Independent Power Producer (IPP) projects supported by Development Finance Institutions, private investors were hesitant to invest in the energy sector, partly due to their perception of the high level of political risk in Kenya. Investors expected that the GoK would offer sovereign guarantees as part of the security package to attract investment for energy generation. Given the tight macroeconomic environment and debt ceiling agreed as part of an IMF-supported program, the GoK wanted to optimize its use of security instruments to attract investors, including commercial banks that had not provided support to earlier rounds of IPPs. The GoK approached the World Bank to explore options to overcome these challenges. WBG Response to Challenge The World Bank leveraged scarce IDA resources through Partial Risk Guarantees (PRG) in the amount of US$166 million equivalent (involving an IDA allocation of US$41.5 million) to back-stop liquidity support for certain ongoing payment obligations from Kenya’s national power utility to private project developers. IDA involvement enabled KPLC to offer security arrangements on favorable terms under their agreements with the IPPs. Under the structure approved by the Board in February 2013, IDA support is complemented by MIGA guarantees to cover the relatively larger amounts required in the event that the specific IPP projects were terminated. The complementary risk mitigation structure was able to provide the necessary comfort to investors and commercial lenders, with minimal resort to sovereign guarantees. In addition, IFC stepped in to provide long-term financing for two of the four IPPs, which is generally unavailable for long-term infrastructure projects in Kenya. WBG support unlocked a total financing package of US$623 million, including US$357 million in private sector investment and lending. 22 Financing for Development Post-2015 MDBs and bilateral donors can enhance their example, the World Bank helped to establish a num- impact by supporting improvements in business and ber of regional risk pooling initiatives in small island investment climate that can facilitate access to private developing states to secure catastrophe coverage on the sources of finance. In addition, innovative financing international reinsurance market at an attractive price, mechanisms can play an important catalytic role and underwritten by IDA. Climate finance is witnessing help attract new sources of financing, especially from new approaches to finance low-carbon energy access the private sector. Using ODA as credit enhancement in LDCs and with private sector participation, such as (for instance, through the World Bank’s partial risk and the World Bank’s Carbon Initiative for Development partial credit guarantees and MIGA’s guarantees) has (Ci-Dev). Other innovations for leverage include proj- catalyzed private sector finance for infrastructure proj- ect bond credit enhancements and equity tranches ects in countries that investors and commercial banks covering first loss provisions. would otherwise have judged too risky (Box 3.2). For Section Private Finance for Development 4 Private Financial Flows to Developing Figure 4.1:  International Capital Flows to Countries Developing Countries, 2012 (in US$ billions and as a % of total flows) Achieving Post-2015 development goals will re- quire the mobilization of resources from private Other private, sources including FDI, bank loans, bond issuance, 7.1, ODA & OOF, Short-term debt flows, 1% 14.1, institutional investors and private transfers (notably 1% 126.7, remittances, estimated to be approximately US$400 13% billion in 2012). The good news is that globally, there are ample savings, amounting to US$17 trillion, and Banks, 71.5, liquidity is at historical highs.52 The challenge will be 7% to direct savings to support the achievement of global development objectives. FDI inflows, Bonds, FDI is a dominant private financing modality 600.1, 143.3, 60% in most developing countries. It is vital for private 14% sector productivity and growth and can help to di- versify the economy. By comparison, official inflows, Portfolio equity inflows, 44.4, net of debt repayment, only accounted for 1 percent 4% of international capital inflows in 2012 (Figure 4.1). Net FDI inflows to developing countries are projected Source: Long-term financing for growth and development. G20 Umbrella Paper, to rebound by 17 percent to US$697 billion in 2013 Feb. 2013 and Global Economic Prospects, 2013, World Bank. Note: FDI inflows are net of disinvestments by non-residents. Debt Inflows and reach close to US$800 billion in 201453 as global are debt disbursements net of repayments. Official flows include bilateral and economic growth is anticipated to accelerate modestly. multilateral lending and are not equivalent to ODA. Data on official capital inflows are “debt enhancing official assistance”, and thus not the same as ODA, Over the past decade, many developing econo- which is concessional in character with a grant element. mies have demonstrated an increasing ability to ac- cess international capital markets. International long- term debt flows to developing countries—bonds and a group, LICs have seen an increase in private capital syndicated bank-lending with at least five years of ma- flows, with flows reaching their highest level, nearly 4.5 turity—increased four-fold from 2000 to 2012 (Figure percent of aggregate GDP, in 2011, despite a 17 percent 4.2). However, the global financial crisis led to a sharp contraction in long-term international debt flows, with 52   World Bank. “Capital for the Future: Saving and Invest- a protracted retrenchment in global banking lending, ment in an Interdependent World”. Global Development Hori- particularly affecting MICs (by 2009, private capital zons, 2013. flows to MICs were at about half their 2007 level). As 53   MIGA. World Investment and Political Risk, 2012. 24 Financing for Development Post-2015 Figure 4.2:  International Long-term Private Debt Mobilizing Long-Term Infrastructure to Developing Countries Finance 400 2.0 Removing Existing Bottlenecks 350 Unlocking long-term finance for infrastructure is 300 1.5 critical to achieving the development goals. Despite 250 potentially high socio-economic rates of return, infra- US$ billion % of GDP 200 1.0 structure projects in many countries are often not fi- 150 nancially viable, with expected revenues frequently un- 100 0.5 able to cover project costs given existing tariffs. Time 50 horizons—infrastructure projects often have very long 0 0.0 pay-back periods, ranging from 15 to 25 years- do not match investors’ preference for short-term funds. Giv- 00 11 10 01 03 02 09 12 08 07 05 04 06 20 20 20 20 20 20 20 20 20 20 20 20 20 en the unattractive risk-return profiles of many long- Bonds Bank Lending % GDP (right axis) term investments, the actual duration of investors’ portfolios can be fewer than 10 years. Moreover, many Source: World Bank Development Prospects Group (DECPG). investors are driven by annual performance measures. Only a few developing countries have developed capital markets or banking institutions with the ability cut in FDI inflows and a sharp contraction in bank to transform short-term deposits into long-term prod- lending, as financial market volatility spread globally. ucts.55 Infrastructure finance is a highly specialized area Nevertheless, the world is experiencing a grow- of finance, traditionally dominated by European banks. ing mismatch between available financing and in- Deleveraging as a result of the global financial crisis and vestment needs. Much of the developing world has incentives created by Basel III regulations (to increase limited access to long-term financing through capital the amount of regulatory capital for loans and dampen markets. Across the developing world, only twenty the scale of maturity transformation risks) is reducing MICs have the ability to access private capital markets banks’ appetite for financing projects in developing at the national level. The rest of the developing world’s countries.56 governments as well as most sub-national governments Few infrastructure sectors recover costs easily. It is have little or no market access, severely constraining rare to be able to charge full-cost tariffs. Telecommu- the public provision of infrastructure. nication services are an exception and the success in The problem is compounded by fragile market setting adequate user fees has been behind the massive conditions in the wake of the global financial crisis, expansion of the sector. Yet user fees raise the concern which are constraining the availability of the kind of affordability in poor countries, where energy or of long-term finance needed to support productiv- transport expenditure can take a large share of the in- ity-enhancing investment for sustainable growth.54 comes of poor households, raising challenging political Lending is retreating as banks recover from the global economy issues. financial crisis and adjust to tighter regulatory require- ments—including Basel III. Historically, during crises, 54   Umbrella paper on Long-Term Investment Financing for banks restructure their balance sheets by cutting back on Growth and Development, prepared by the World Bank and lending. Investors search for safer and more liquid assets, other International Organizations for the G20, 2013. and usually sell off emerging-market debt perceived to 55   World Bank. Inclusive Green Growth, 2012. be higher risk. This fallout from the most recent global 56   Umbrella paper on Long-Term Investment Financing for financial crisis was compounded by regulatory changes Growth and Development, prepared by the World Bank and that raised capital ratios and liquidity buffers. other International Organizations for the G20. Private Finance for Development 25 Besides capital needs, the limited flow of bankable The official status and financial structures of projects because of underinvestment in project prepa- MDBs allow for greater absorption of both default ration represents a major obstacle to public-private and political interference risk, making their engage- partnerships for infrastructure. Improving the quality ment particularly useful in the early stages of a deal. of project pipelines with sufficient project preparation, MDB guarantees can help draw private capital into including economic, financial, technical and environ- higher-risk projects, providing coverage to finan- mental feasibility studies, is critical to clearing the way cially and economically viable projects that would for private sector participation.57 be unlikely to happen without protection against Bankable projects also require adequate legal or non-commercial risks, and enable investors to access guarantees framework for capital mobilization. These funding on more advantageous terms and condi- challenges are particularly acute for new and emerging tions. MIGA and the insurance arms of other MDBs technologies, which carry higher risks that are often offer coverage for a number of types of political risk: difficult to measure and price. New technologies can currency inconvertibility and transfer restriction; have high operating expenses and are often riskier in expropriation, war, terrorism, and civil disturbance; the early stages of development. This is particularly breach of contract; and non-honoring of sovereign true of most green technologies. financial obligations. Risk-mitigation tools, such as guarantees, can be Mainstreaming the Use of Guarantees and structured to limit the level of risk that investors are Risk Insurance exposed to, including country or convertibility risk. Private capital is attracted by the right combination of For instance, India’s Solar Power Guarantee Facili- risk and return. Heightened market and investor un- ty (US$150 million) covers up to 50 percent of the certainty means that large pools of capital sit relatively payment default risk on commercial bank loans of up idle with few financial interlocutors to deploy in in- to 15 years to private sector developers of small solar frastructure. This calls for greater attention to policies power projects. Modern financial instruments include and instruments that can lower risk and strengthen the first loss guarantees in equity or debt funds. As an al- confidence of investors over a long-term horizon. Shar- ternative to charging a fee for first loss guarantees, gov- ing risk with the private sector to enhance the viability ernments participate in the “equity tranche” of a prod- of investments is one area in which official lenders and uct in return for taking the first loss risk. In doing so, MDBs have the capacity to contribute. they provide a first loss guarantee to private investors, Governments can manage risks to reduce vulner- while allowing taxpayers to share in potential upside ability, particularly from exogenous shocks. Multilat- returns associated with the investment. Alternatively, erals can play a major role on the advisory (capaci- de-risking instruments include currency loans or li- ty and strategy building) and financial sides to help quidity facilities, swaps, and derivatives. countries reduce their vulnerabilities. The provision of credit, saving, and insurance products can facili- A Catalytic Role for the Public Sector tate additional private funding for development, and Given the limited ability of the public sector to sup- mitigate the negative consequences of crises. IBRD port long-term investments, finding new and better has developed catastrophic risk insurance to transfer ways to attract private-sector financing is critical. disaster risk from the government to the financial Scaling-up infrastructure investments, therefore, can market, therefore increasing developing countries’ fi- only happen if governments ensure that incentives, nancial resilience. Examples include catastrophic risk pricing, and regulations are aligned. insurance pools for homeowners’ protection in Ro- mania and Turkey, livestock insurance pool for herd- ers’ protection in Mongolia, and market-based crop Infrastructure Action Plan, Submission to the G20 by the 57   insurance in India. MDB Working Group on Infrastructure, 2011. 26 Financing for Development Post-2015 Outsourcing, concessions, private-public partner- The most direct demonstration of the catalytic ships, privatization, and the promotion of social en- role involves actively bringing financing partners into trepreneurship can increase efficiency and crowd-in specific deals, for example, in the form of syndications private sector resources for development purposes. At or through a co-financing arrangement. Using MDBs’ a macro or sectorial level, governments can facilitate preferred creditor status and financial structures helps FDI by providing stable and predictable enabling busi- investors to obtain funding sources on more advan- ness environments. Improvement of the investment tageous terms and conditions. MDBs generally have climate often involves a variety of reforms, including strong balance sheets and the ability to structure and competition policy, consumer protection, property reduce risks for private funders. Generally, the MDB and creditor rights, trade facilitation, judicial reform, stamp of approval and role as an “honest broker” in fiscal transparency, and market reforms. disputes can reassure investors and contribute to a The reluctance of the private sector is often due to project’s viability. This may be the result of a sense market failures, such as problems arising from asym- that the official sector is well-positioned or possesses metric information or lack of investor experience with the necessary resources to defend its interests in the particular types of investments, economic activities, or event that the terms of the investment are not respect- countries. Closing private investors’ financial viability ed. As a result, multilateral support can reduce the cost gap (i.e. between costs and expected revenues) is one of the whole funding package, including from private way to do it, by using public resources complemented investors. by legislative and institutional improvements to facil- In some cases, such as in syndications, MDBs can itate project preparation, risk reduction, and capital even provide partners with a similar level of creditor provision. status vis-à-vis official creditors, in the event that the Interventions at the project selection and prepa- borrower runs into repayment difficulty. Moreover, ration stage can help expand the pipeline of bankable IFI participation in syndications contributes to extend projects through effective planning, quality design, rig- maturities of private flows to developing countries, orous project selection, and sound management. Pub- which is essential to finance productive investments lic funds can be used to provide initial seed funding to (Figure 4.3). explore the viability of projects, based on transparent Public entities can take equity stakes directly in criteria. Public funding of feasibility studies and oth- a project or indirectly by investing in private equity er project preparation costs, which typically average funds. Funds of funds provide an interesting new fi- 5–10% of total project costs, amounting to hundreds nancing instrument through which a public entity of millions of dollars for large infrastructure projects, invests a relatively small amount of long-term cap- can crowd-in private investment. Without some public ital in a range of private, professionally-managed financing of these up-front costs, projects will never funds. A hybrid of debt and equity capital from a become bankable. mix of sources can be leveraged through mezzanine MDBs have a unique catalytic role to play.58 They financing. can add value to their client through a combination of To overcome their financing constraints without technical expertise; prudent risk management policies; a general capital increase, MDBs are exploring these credible application of well-understood standards in options. The World Bank Group, in particular, is re- project design, execution, and corporate governance; viewing conditions to establish a Global Infrastruc- a long-term perspective; and cross-country experience. ture Facility (GIF). Financial Intermediary Funds MDBs, in association with other official-sector enti- (FIFs) provide useful lessons on how to establish ties, can also help overcome capacity bottlenecks and information constraints. In a number of countries, this Umbrella paper on Long-Term Investment Financing for 58   is done quite efficiently through Project Preparation Growth and Development, prepared by the World Bank and Facilities (PPFs). other International Organizations for the G20. Private Finance for Development 27 Figure 4.3:  Percent of International Syndications funding mechanisms outside of IBRD and how to to the Private Sector in Developing design initiatives that encompass customized, inclu- Countries where an IFI Participated, by sive governance structures; innovative features to help Income Level and Maturity, 2007–2012 leverage core funding to reach scale; and a diversity of instruments to meet the financing needs of cli- 45 ents. For example, capital contributions from inter- 41 40 ested shareholders could be leveraged through bond 35 30 29 issuance. 25 23 24 25 22 21 20 15 13 14 10 4 6 8 5 0 1 to 5 years 5 to 10 years 10+ years Lower Lower Middle Upper Middle BRICT Source: International Finance Institutions and Development through the Private Sector, IFC 2011 Emerging, Inclusive, and Innovative Section Sources of Finance 5 Emerging Sources Figure 5.1:  Infrastructure Investment Financing Modes Have Changed Over Time Given the scarcity of bank lending for infrastructure, and Will Likely Favor Greater Bond the development of non-bank financing for infrastruc- Financing in the Future (US$ billions) ture is now emerging as the new imperative. Interna- tional financial markets present a largely untapped pool of capital to finance infrastructure; and insti- Bonds Loans (projected) tutional investors have the potential to provide an ($434.3) ($3,807) additional source of long term finance. Bonds ($54.5) Bond Financing and Local Currency Bond Markets 2001–11 1990–2000 International bond flows to developing countries with 2012–22 maturity of at least five years have increased steadily Loans (projected) ($246.2) since 2009 as conditions for bond financing have be- come particularly favorable for middle-income coun- Loans tries. Bond flows rebounded after the global financial Bonds ($884.2) (projected) crisis, especially in Latin America and emerging Europe, ($5,033) more than offsetting the reduction in bank lending. The surge in bond issuance was partly the result Source: World Bank projections, supplemented with calculations using data of policy-induced low interest rates and quantitative from Dealogic Bondware and Loanware. Note: Infrastructure financing is calculated as a share of cumulative investment easing in high-income countries, which prompted a financing needs during the respective time periods. Total values, in billions of search for yield by global investors. It also arose from current dollars, are given in parentheses. Projections for 2012–22 are based on the assumption of similar growth rates between the second two periods as the recognition of the economic potential of many de- between the first two periods and zero inflation. The cumulative infrastructure veloping countries with improved credit-quality, which investment bill for 2012–22 is US$8.8 trillion. induced many institutional investors to buy securities issued by adequately rated emerging markets, and ben- In emerging market and developing economies, efit from long-term returns from infrastructure. The local-currency bond markets (LCBMs) present a po- World Bank’s 2013 Global Development Horizon Re- tentially important vehicle for developing the domestic port (Figure 5.1) expects bond financing to grow rap- idly as a source of development finance for countries LICs are receiving less than 0.5 percent of their GDP in 59   securing a credit rating at or above investment grade.59 bond financing. 30 Financing for Development Post-2015 investor base and mobilizing domestic savings to sup- Figure 5.3: T  otal Assets by Type of Institutional port public and private sector investment in productive Investors in the OECD, 1995–2011 assets. The development of LCBMs can help promote (US$ trillions) a deeper and more efficient financial sector, reducing transaction costs and facilitating risk management. 30 28.8 LCBMs in these countries have shown resilience in the 25 24.3 midst of capital volatility and international market in- 20 20.2 US$ trillions stability and have been among the best performing asset 15 classes over the last few years (Figure 5.2). The viability 10 of LCBMs for long-term investment depends critical- 5 ly on policy credibility and commitment, including 1.8 through the establishment of the right macroeconomic, 0 1995 1997 1999 2001 2003 2005 2007 2009 2011 institutional, and regulatory preconditions.60 Investment Insurance Pension Other (1) Institutional Investors, including Sovereign funds companies funds Wealth Funds With their growing assets under management and their Source: OECD Global Pension Statistics, Global Insurance Statistics, and Institu- tional Investors databases, OECD estimates. ability to provide long-term finance, institutional in- vestors, such as pension funds, insurance companies, mutual funds, or sovereign wealth funds have potential as pools of non-bank capital for emerging markets in- Wealth Funds (SWFs), with assets under management frastructure. In OECD countries, institutional inves- at end 2011 exceeding US$5 trillion. Emerging mar- tors held over US$70 trillion in assets as of December kets are home to some of the largest SWFs in the world. 2011 (Figure 5.3). Many of these investors are moving Traditionally, institutional investors have been towards socially and environmentally responsible in- considered sources of long-term capital with invest- vestment strategies. Also growing rapidly are Sovereign ment portfolios built around the two main asset class- es, bonds and equities, and an investment horizon tied to the often long-term nature of their liabilities. Figure 5.2:  Emerging Market Fixed Income Fund Investor exposure to alternative assets has been grow- Inflows by Hard and Local Currency ing, reflecting an appetite for diversification, a search (in US$ billions) for yield, and the attraction of valuation methods for unlisted assets. Despite this, it is estimated that less 60 than 1 percent of institutional investors’ portfolios are 50 allocated to infrastructure investments. 40 Some of the explanations for this situation include: 30 weaknesses in the enabling environment and lack of 20 ‘bankable’ projects; the capacity of institutional inves- 10 tors, which often lack the experience to analyze infra- 0 structure investments; and a lack of suitable investment –10 –20 2008 2009 2010 2011 2012 60  Guarantees for local currency bonds are also available to fa- cilitate local capital market development, such as those provid- Blend Currency Hard Currency Local Currency ed by the UK’s GuarantCo. In addition, IFC issues local cur- rency bonds in a number of regions, including Central Africa, Source: Emerging Portfolio Fund Research (EPFR) to kick-start the development of local currency bond markets. Emerging, Inclusive and Innovative Sources of Finance 31 vehicles structured to provide institutional investors resources are transferred through informal channels.61 with the risk-return profile they require. Infrastructure These resource flows are more than three times ODA, investment in developing markets poses an additional acting as a lifeline to the poor and boosting growth and set of challenges—from sovereign risk to regulatory is- development. sues. Moreover, the global economic downturn is likely The cost of sending remittances remains too high. to have had a lasting impact on the fund management In 2008, recognizing the huge amount of resources used industry and the long-term asset allocation strategies in making these transfers and the importance of cost of institutional investors by encouraging more cautious in determining the amount migrants send, the G20 investment strategies and a greater focus on portfolio articulated the “5 by 5 objective,” to lower the global risk management in the coming years. average cost of making remittances to below 5 percent While some leading institutional investors are grad- within 5 years. The average cost of sending remittanc- ually increasing their exposure to infrastructure and oth- es, including fees and exchange rate margins, has fall- er real assets, the vast majority of these investments are en by 20 percent since 2005 to 9 percent (US$18) in concentrated in their home markets. This could change, 2012 for a remittance of US$200, as measured by the given the current low interest rate environment in ad- World Bank’s Remittance Prices Worldwide (RPW) vanced economies and the volatile stock markets in re- database.62 While this cost reduction saved remitters cent years necessitating higher portfolio diversification. (and their families) over US$8 billion last year alone, it SWFs could potentially channel institutional and is not enough. Meeting this goal implies an additional sovereign non-bank capital into infrastructure invest- reduction of four percentage points from the 9 per- ment. Other structures, such as country funds, are used cent average cost currently, which could boost resource to invest in infrastructure while reducing poverty and flows to developing countries by over US$16 billion facilitating technological adaptation and diffusion. For annually. For some countries, the remaining margin is example, rural energy funds have been set up in coun- considerable. South Africa, for instance, remains the tries such as Bangladesh, Mali, Senegal, and Sri Lanka. most expensive sending country in the G20, with an At the same time, many developing countries are average cost of remittances of 20.56% (US$40.1) for currently reforming and developing their pension sys- a remittance of US$200. Evidently, significant barriers tems to introduce funded pillars that could provide to cost-effective remittance services continue to exist. local currency sources of long-term financing. Pension Competition is essential for lowering the cost of fund assets in developing economies currently amount sending remittances. Large remittance corridors by vol- to US$2.5 trillion, which is expected to rise to US$25 ume tend to have a greater number of money transfer trillion by 2050. However, institutional investors exist operators and more competition, leading to lower pric- to provide pensions and vital coverage and support in es and more transparency. This is reflected in persistent difficult times. They should not be forced to invest in differences between the simple average remittance cost infrastructure projects with limited economic viability and the weighted average, which is weighted by the for broader social or development considerations. size of bilateral remittance flows. The global weighted average has generally been declining over the past few Diasporas years, and reached an all-time low of 6.9 percent in the Global diaspora resources represent another key source of funding for development. There are an estimated 61   Between 25 percent (CIS—Commonwealth of Indepen- 215 million migrants in the world, and in 2012, they dent States) and 49 percent (Sub-Saharan Africa) of respon- sent about US$529 billion in officially recorded remit- dents report the receipt of remittances through people rather tances to their countries of origin. Of this, developing than official channels such as banks or money transfer compa- countries received over US$401 billion in remittances, nies (Source: Gallup World Poll). and the figure is projected to grow to US$515 billion 62   See Remittance Prices Worldwide—Issue No. 5, March by 2015. Actual remittances are much higher, as many 2013 at http://remittanceprices.worldbank.org. 32 Financing for Development Post-2015 first quarter of 2013. Prices are decreasing in bigger enterprises must rely on their limited earnings to pursue volume corridors, but remain high in smaller remit- promising growth opportunities.64 tance markets, involving transfers to smaller countries This can contribute to persistent income inequal- that are typically far more dependent on remittances as ity and slower economic growth. There exists huge a share of GDP. untapped potential in developing countries: around More needs to be done to lower the cost of send- 29 percent of savers worldwide and more than half of ing remittances, especially by increasing transparency savers in 55 economies which report having saved or and boosting competition. Money transfer operators set aside money in the past 12 months did not use any continue to reduce their prices and are also the most formal or semi-formal savings mechanisms such as for- transparent—with 98 percent disclosing full informa- mal financial institutions or informal savings clubs.65 tion to their customers. For banks and post offices, Improve SMEs’ access to finance will help create the figures are only 76 and 45 percent, respectively. more economic opportunities. Access to finance is a Competition will be helped by improved disclosure major constraint to growth for entrepreneurs in LICs. requirements, as contained in the US Remittance Access to credit and payment services is crucial for Transfer Rule (to take effect in October 2013).63 self-employed business, as well as small- and medi- Technological advances in mobile telephony and in- um-size enterprises. Broader access to financial services ternet-based mechanisms are also boosting competi- would help the estimated 400 million micro, small, tion. Still, meeting the requirements of Anti-Money and medium-sized enterprises in developing countries Laundering/Combating the Financing of Terrorism to prosper. They need unconstrained financial access (AML/CFT) regulations without imposing undue to expand their activities, take on new workers, and costs remains challenging, as they discourage com- generate income. mercial banks from acting as correspondent banks There are 420–510 million micro, small, and me- for money transfer operators. Exclusive contracts be- dium enterprises worldwide, of which 360–440 mil- tween national post office networks and leading mon- lion are in emerging markets. When asked to list their ey transfer operators also appear to be stifling compe- main constraints to growth, access to finance tops the tition in several remittance corridors. list for entrepreneurs in lower-income countries. Glob- ally, fewer than 30 percent of these firms use external Finance Sector Development and financing, of which half are underfinanced. The total Financial Services for Small and Medium unmet need for credit among MSMEs in emerging Enterprises (SME) markets is estimated at US$2.1–2.5 trillion, approxi- mately 14 percent of the total GDP of these countries. Promoting financial deepening and inclusion could SMEs pose a difficult challenge for financial in- accelerate private-sector growth, an important driver stitutions everywhere, but particularly so in lower- for poverty reduction and fostering shared prosper- income countries. Unlike larger corporates, they offer ity. Financial institutions facilitate economic growth very little public information, and rarely keep accounts by mobilizing savings and allocating these savings to in standard and comprehensive formats (much less au- the most productive investments. There exists a large dited formats). SMEs possess limited fixed assets, and body of evidence finding a strong, positive relationship between financial sector development and growth. A 63   See Migration and Development Brief 20, April 2013 at well-developed and inclusive financial system also has www.worldbank.org/migration. positive impacts on equality by providing poorer indi- 64   See also United Nations Secretary General’s Special Advo- viduals with savings opportunities and much-needed cate for Inclusive Finance for Development (UNSGSA), Finan- credit. Without inclusive financial systems, poor peo- cial Inclusion in Post-2015 Development, 2013. ple must rely on their own limited savings to invest in 65   World Bank, The Global Financial Inclusion (Global Fin- their education or become entrepreneurs—and small dex) Database. Emerging, Inclusive and Innovative Sources of Finance 33 few LICs have legal and regulatory environments that encourage the use of movable assets (equipment, in- Box 5.1: ProCredit Group ventory, accounts receivable, etc.) as collateral. SMEs also need “high touch” services, involving physical ac- ProCredit Group was established in 1998 to invest in both cess points, while in most LICs expanding financial socially responsible and commercially viable microfinance in- institutions’ points of presence is limited to relatively stitutions. After consolidating its position in the microfinance market in many countries, the Group began financing small expensive new branch construction. businesses with the aim of diversifying its portfolio. They also The Global Partnership for Financial Inclusion began a program of establishing new banks in emerging mar- (GPFI) recently identified a wide range of new busi- kets specialized in micro and small business lending. With ness models providing financial services to fill this gap support from KfW, DEG, Commerzbank, IFC and EBRD, the Group established ProCredit Holdings to support this growing in a cost-effective manner. Their list includes: i) legal network, which now comprises 22 banks (21 in emerging mar- and regulatory reforms; ii) improvements to financial kets). As of 31 December 2011, the Group had over 1 million markets infrastructure (financial information supply); business clients, and over 558,000 outstanding loans to MS- and iii) financial services innovations involving new MEs, with less than 3.8 percent portfolio at risk (30 days). This products and new institutional relationships. Success- includes over 335,000 clients in Mozambique, Ghana and the Democratic Republic of Congo. ful models share common characteristics: they reduce costs to serve, using technology and other means; cross-sell multiple products to SME customers; use ad- vanced risk management techniques to maximize the risk/reward balance; and involve strong institution- in development; or (ii) deliver financial solutions to al focus on this specific market segment. Institutions development problems on the ground.66 This section implementing these models include microfinance focuses on some well-established innovations as well institutions reaching up-market (such as the ProCre- as more recent experiments being developed to help dit Group), commercial banks reaching downwards generate financing for developing countries, including (DFCU Leasing), and a host of non-bank financial in- through the mobilization of private funds. These con- stitutions and large firms that command supply/value cepts can help raise development resources by tapping chains (Box 5.1). new markets or developing products. Countries promoting SME access to finance more successfully, in general, have regulatory frameworks that Raising to Scale Pull Mechanisms and enable a range of financial products and institutions, Advance Market Commitments including leasing and factoring. These countries have Pull mechanisms for development involve the ex-post invested in financial markets infrastructure, improved provision of economic incentives for innovation where credit information services, strong movable assets sys- the aim is to solve a specific, well-defined problem. By tems (including on-line registries), broad electronic linking payments, in a commensurate and generally payments options (including mobile phone payments proportional fashion, to the actual impact of an inno- channels), and efficient, balanced insolvency rules. vation, they lay the foundations for a self-sustaining, competitive market for the relevant product. One of Examples of Innovative Financing for the earliest and most famous pull mechanisms was the Development longitude prize, a reward of up to £20,000 offered by the British government in the 18th century for the dis- Innovative development finance involves non-tradi- covery of a method for the precise determination of tional applications of solidarity, PPP, and catalytic mechanisms that (i) support fundraising by tapping new Navin Girishankar: Innovative Development Finance: From 66   sources and engaging investors beyond the financial di- Financing Sources to Financial Solutions. CFP working paper mension of transactions, as partners and stakeholders No.1. World Bank, 2009. 34 Financing for Development Post-2015 a ship’s longitude which was effectively won by John The pilots implemented have a scalable business mod- Harrison for his invention of the marine chronometer. el. Furthermore, AgResults will call upon the ingenuity Pull mechanisms for development, with their and drive of the private sector to identify and execute emphasis on ends rather than means, are particularly the most effective and efficient strategies to achieve de- well-suited to the task of overcoming market failures velopment outcomes. By linking payments to demon- impeding the establishment of commercial markets for strated results, the initiative is built to guarantee impact agricultural innovations in developing countries. There and maximize value for money. are two major failures: (i) the failure of markets to re- Advance market commitments gained recognition flect the social value (i.e. capture positive externalities with the June 2009 launch of the US$1.5 billion pi- associated with) of such innovations; and (ii) imperfect lot for pneumococcal vaccines, to provide incentives, information, which is responsible for low consumer de- through per-unit subsidies, for pharmaceutical com- mand for, as well as low public and private investment panies to adapt and produce vaccines for use in devel- in, a given innovation. To address these market failures, oping countries. By end-2012, supply contracts were pull-mechanisms for development will typically pro- awarded to GlaxoSmithKline and Pfizer Inc. and 6.9 vide payments to multiple, competing private sector million vaccines were delivered to 9 countries. In ad- actors over a certain period of time conditional on their vance market commitments, public financing is used products meeting certain specifications and achieving to subsidize the cost of drugs, for instance, not just a certain level of take-up in the target market. These produced for but actually demanded by target mar- payments, while generally made directly to firms, effec- kets in developing countries—no orders, no subsidies. tively operate as a consumption subsidy (because pay- They are truly a results-based mechanism. ments are linked to levels of consumption and bring The International Finance Facility for Immuniza- down costs to consumers) that eliminates the gap be- tion (IFFIm) uses long-term pledges from donors to tween the unit price firms must charge to recoup their sell ‘vaccine bonds’ in capital markets, making large research and development, production, promotion, volumes of funds immediately available for GAVI68 and distribution costs, and the price that consumers, programs. Approaches like IFFIm, the first aid-financ- given adequate information on all of the benefits of the ing entity to attract legally-binding commitments of product, are willing to pay. In essence, pull mechanisms up to 20 years from donors, can offer the “predictabil- for development seek to overcome a price barrier for ity” that developing countries need to make long-term consumers, while leaving production, marketing, and investment planning decisions, in this case for immu- distribution strategies to the private sector. nization programs. The AgResults Initiative67 is a new pull mechanism developed by Canada, the US, the UK and Australia— Carbon Markets working in partnership with the Bill and Melinda Gates A relatively novel instrument to generate climate Foundation, the World Bank, and Dalberg, a global finance can be found in cap-and-trade schemes, development advisory firm. It uses public financing which set a limit to the overall emissions, thereby to reward agricultural innovation in developing coun- creating carbon credits (emission allowances). Any tries and, in the process, build sustainable markets for surplus carbon credits can be traded at carbon markets, agricultural inputs, products, and services that benefit thereby generating a new revenue stream. Similarly, the poor, while pulling private investment and techno- project developers can invest in low-emissions proj- logical innovation. While it is a small contribution to ects (so far mainly renewable energy, energy efficien- the estimated US$83 billion a year investment required cy, waste management, and reforestation) generating to meet the world’s food needs in 2050, it proved ca- pable of achieving sustained development impacts, as 67   AgResults: Innovation in Research and Delivery. Concept evidenced by improved food security and increased note. World Bank, 2012. smallholder incomes, and better health and nutrition. 68   The Global Alliance for Vaccines and Immunization. Emerging, Inclusive and Innovative Sources of Finance 35 carbon-offsets which can be sold at voluntary carbon competitive than existing ones. In the EU, ETS (the markets—to private consumers and companies who price per ton of CO2) has fallen below US$$10 per want to reduce their carbon footprint. ton. This is also due to an oversupply caused by emis- The Kyoto Protocol to the UNFCCC laid the sion allowances being determined before the economic groundwork for a global carbon market that offers crisis. Emission allowances were determined before the a cost-effective way to reduce the greenhouse gas crisis based on more optimistic macroeconomic sce- (GHG) emissions of industrialized countries through narios. Carbon markets face various other challenges, the Clean Development Mechanism (CDM) and Joint such as the uncertainty about national level mitiga- Implementation mechanism (JI) and international tion goals (including sector-specific emission targets) emissions trading. The Clean Development Mecha- and the future of an international climate finance re- nism (CDM) alone generated transactions of about gime supervising market mechanisms after 2020 to be US$27 billion between 2002 and 2010, while lever- agreed by 2015 under the UNFCCC. aging green investments of about US$125 billion in developing countries.69 Resources-for-Infrastructure Deals in Fragile The total value of the carbon market reached States US$176 billion in 2011, as compared to US$159 bil- The RfI financing mode has been adopted by some lion in 2010. While the market size of CDM and JI countries, mainly in Africa, to overcome obstacles is relatively small (ca. US$23billion), the majority of related to limited capital market access and domes- carbon market values has been generated through na- tic capacity to implement large infrastructure proj- tional and regional allowance markets (ca. US$148.8 ects. Under RfI, oil or mineral extraction rights are billion). Most of it is coming from the European exchanged for turnkey infrastructure, complementing Union emission trading schemes (ETS) (ca. US$147.8 standard tax and royalty regimes. Here, infrastructure billion). project financing is backed by future oil or mineral In addition, domestic and regional carbon market revenues, with financing frequently taking the form initiatives have gained increasing traction in both de- of export credit. Projects have included roads, regional veloped and developing counties. There are also small- railway lines, water supply projects, telecommunica- er markets, such as the Regional Greenhouse Gas Ini- tions, hydropower dams and plants, and other electri- tiative (RGGI) New Zealand ETS, emerging national cal power infrastructure. Much of Angola’s post-war schemes in Australia and South Korea and sub-national infrastructure reconstruction took place under RfI, ETS in several countries (e.g., Japan, the United States, and significant commitments exist in DRC. The value Canada, and Brazil). China has just launched its first of signed resources for infrastructure swaps (RfI) in Af- pilot carbon market in Shenzhen province. rica alone amounts to at least US$28 billion, although At the same time, the urgency of the climate the value of actual completed and ongoing contracts change agenda has supported the emergence of a new is likely to be significantly lower, as several of the con- profile of buyers, aiming at filling part of the space tracts are reportedly stalled or have been abandoned.71 left from compliance buyers. Some developed country administrations and private companies have demon- strated interest in purchasing credits to meet domestic 69   Mobilizing Climate Finance, a paper prepared under the co- GHG emission reduction targets or social responsibili- ordination of the World Bank Group at the request of G20 Finance Ministers, 2011. ty objectives. Yet the size of voluntary markets remains 70   Based on World Bank, State and Trends of the Carbon Mar- limited at about US$573 million.70 ket, Washington DC, 2012. Overall, however, the size of the carbon market 71   Foster, Vivien, William Butterfield, Chuan Chen, and Na- remains relatively small when compared to mitiga- taliya Pushak (2008). Building Bridges: China’s Growing Role as tion and adaptation needs. Additionally, carbon pric- Infrastructure Financier for Africa. Trends and Policy Options es remain too low to make green technologies more (PPIAF). Washington, DC: World Bank. 36 Financing for Development Post-2015 While RfI has significant potential as a financ- be applied to select and appraise projects. Reserving ing source, it also carries considerable risks and a share of the contract value for appropriate legal and challenges on both the private sector and govern- financial counsel for host governments, as well as for ment sides. From the private sector viewpoint, infra- independent supervision of construction, would con- structure investments under RfI add to the high initial tribute to ensuring that countries engaging in RfI re- sunk costs involved in mine and offshore oil field de- ceive the benefits to which they are entitled. velopment, frequently running into the billions of dol- Ultimately, RfI is likely to remain a second-best lars. The future revenue streams that back these invest- solution in most contexts where public procurement ments are subject to political, market, geological, and systems have the capacity and integrity to handle large other types of risk, and on the infrastructure side there infrastructure investments, and financing can be se- are risks of cost overruns. From a government perspec- cured otherwise. However, given the large investments tive, the greatest concern is that, if projects are not ap- in mineral and oil extraction in many fragile states, propriately valuated both on the mining and the infra- RfI may, if implemented according to appropriate structure side, the country risks forgoing a significant standards, hold considerable potential as a source of share of potential benefits from the extractive project. financing where other sources are scarce and govern- Assuming that appropriate valuation is undertaken, ment implementation capacity is low. according to agreed international standards, risks still arise from the uncertainty of future commodity prices Diaspora Bonds and geological estimates of oil and mineral reserves. It Diaspora resources—via diaspora bonds and remit- is therefore essential that financing commitments are tance-backed bonds—have the potential to finance complemented by appropriate extractives tax and roy- projects such as railways, roads, power plants, and alty regimes. educational institutions. The annual savings of the di- Assuring the quality of RfI-financed projects, in- asporas from developing countries—US$400 billion cluding compliance with pre-specified standards, can by some estimates—represent a hitherto untapped be a challenge for governments with little experience in potential source of financing for development ef- implementing large infrastructure projects. Since con- forts. The African continent alone holds an estimated struction companies working under RfI agreements US$52 billion in potential development finance.72 are not paid by the government, but by the financial It makes economic sense to think about channeling institution backing the agreement, the government some of those savings into development efforts in may have less leverage to ensure contract compliance. poor countries. If one in every ten diaspora members, Contractual liabilities thus need to be structured in a rich or poor, could be persuaded to invest US$1,000 way that companies can be held accountable, on the in their own country, developing countries could po- basis of independent third-party supervision. Finally, tentially raise US$20 billion a year for development to ensure enduring benefit from RfI-financed projects, financing. capacity needs to be built for operation and mainte- Mobilization of diaspora investments is possible nance, whether by public or private sector solutions, through the issuance of a diaspora bond, a retail sav- or a combination of the two. ing instrument marketed to the diaspora members. To be effective, compliance with the above requi- A developing country government or reputable private sites necessitates RfI licensing and contracting process corporation can tap into the wealth of relatively poor to be consistent with standards for transparency and migrants by selling such bonds in small denominations accountability. Contracts need to be tendered on a (from US$100 to US$1,000). The bonds could be sold competitive basis,based on a pre-defined list of gov- in larger denominations to wealthier migrants, diaspora ernment infrastructure projects, to reveal the real val- ue of the exchange. To avoid “train lines to nowhere,” 72  Ratha, Dilip and Sanket Mohapatra. Preliminary Estimates standards for public investment management must of Diaspora Savings, World Bank, February 2011. Emerging, Inclusive and Innovative Sources of Finance 37 groups, or institutional investors. Diaspora bonds can Proponents of the FTT point to its strong reve- tap into the emotional ties—the desire to give back—of nue-raising potential. The European Commission the diaspora, and potentially help lower the cost of fi- initially estimated that the implementation of an EU- nancing for development projects back home. Since the wide FTT would raise approximately €57 billion a diaspora savings are mostly held as cash under the mat- year.73 The European initiative will impose a 0.1 per- tress or in low-yielding bank accounts in the diaspora cent tax for securities and 0.01 percent tax for deriva- host countries, offering an annual interest rate of 4 or 5 tives, on all transactions with an established link to the percent on diaspora bonds could be attractive. FTT zone. Trading in securities, bonds and shared, is A diaspora bond would have a greater chance expected to generate about one third of this revenue, of success if the proceeds were to finance projects with taxing derivatives contributing the remaining two which interest overseas migrants, such as housing, thirds. However, these funds will go into consolidat- schooling, hospitals, and community infrastructure ed revenue of countries paying the tax although some projects that could benefit them and/or their families, CSOs have advocated earmarking this for develop- or their region in their homeland. It also fits with the ment purposes. concept of delivering results. It would pay a develop- The existence of a potentially large untapped ing country to do its homework beforehand and hold source of revenues in a global environment charac- consultations with diaspora groups on their interest. terized by spending cuts is attractive. While holding It would be vital to build a knowledge base about the a neutral view on FTTs, the World Bank has never- size, income, and wealth characteristics of the diaspora theless acknowledged the potential for diversion of fi- groups in key destination countries. Currently, such nancial transactions from countries with FTTs to those information is not easily available. that do not have them, and the importance of coor- dination across major international financial centers Financial Transaction Taxes to be most effective in implementing FTTs. However, The use of a Financial Transactions Tax (FTT) as a without a clear commitment to channel resources into source of financing for development is highly contro- the achievement of development goals, this cannot be versial. While the EU intends to introduce one soon seen as a source of financing for development. among 11 of its members, only a fraction of its pro- ceeds are likely to be allocated to development out- http://ec.europa.eu/taxation_customs/resources/docu- 73   side the region. ments/taxation/other_taxes/financial_sector/fact_sheet/reve- nue-estimates.pdf Conclusion T his paper has attempted to sketch a blueprint in more actors and instruments, while continuing to for financing development in a world with in- build on enhanced aid effectiveness. creasingly scarce concessional resources and in The challenge for individual developing countries an environment where access to long-term financing is to make themselves more attractive destinations for for development has become more difficult. Undeni- resource from the private-sector and donors. They can ably, aid has helped low-income countries to accelerate do this by improving the effectiveness with which ex- economic growth and lift people from extreme pover- isting resources are used, enhancing domestic resource ty, and it will continue to be an important source of mobilization and by making strides to develop and ac- development financing for many countries. But with cess new sources of financing. This will require a foun- heavy fiscal pressures on major donors, constrained dation of good polices, supported by the institutional MDBs, and a weak global recovery, the approach to capacity to implement them. It is along these lines that financing development needs to evolve by bringing international partners can make the greatest contribu- tion to financing development in the years ahead. THE WORLD BANK 1818 H Street, NW Washington, DC, 20433, USA www.worldbank.org