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Can the EU effectively “blend” external assistance grants and loans?

01-04-2011

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Blending  – the complementary use of grants and loans in external assistance to increase the volume of development finance – has emerged rapidly and is now common practice in development finance. The EU is currently considering establishing a “EU platform for external cooperation and development”, i.e. a mechanism for blending grants and loans. There is, however, currently a limited evidence base on the effects of blending. Whilst a sizeable literature exists about the theoretical use of loans and grants, there is little on how it works in practice, which methodology or procedure works best and whether a certain governance model is more effective in reaching its objectives. With respect to the EU’s existing blending facilities in particular, we face challenges because the majority have only been operational for less than three years.

The European Parliament’s Development Committee on 22 March held an exchange of views with the European Commission and experts on blending as a way to increase the impact of EU development policy (link: http://www.europarl.europa.eu/en/see-and-hear/).  MEPs were also provided a copy of the European Think-Tanks Group’s recent study on EU Blending Facilities: Implications for Future Governance Options
which reviews the existing EU blending mechanisms, comparing their different governance arrangements, drawing lessons from each, and considers the pros and cons of possible future governance options for blending operations.

MEPs heard a presentation from a representative of Germany’s KfW promotional bank which has a window for development cooperation. They aim to support sustainable sectoral projects that foster environment for change and build capacity of partner institutions.  The representative outlined examples of water purification and provision/access programmes in Egypt and Uganda. The focus of projects is on improving infrastructures, institutions and services. The European Commission and the European Investment Bank (EIB) are involved in these projects.  He explained that their blending mechanism is a flexible instrument which can support large-scale projects and can also provide customised financing to create good environments for sector reforms taking into account the financial capacity of partners.  It improves aid effectiveness by increasing donor coordination, division of labour and by reducing transaction costs for partners. It also increases EU visibility he said.

A representative of the European NGO network Eurodad, which has experience in monitoring blending, questioned the emerging EU consensus to move from a grant-focused approach towards a blended grant and loans based instruments, focused on using development funds to leverage (private) investment. A distinction between blending grant and non-grant resources, which can be channelled to either the public or private sector, and blending grants and loans to lend and invest in the private sector needs to be made she said.  She also stressed the need to look at what funds are currently available to support developing countries.  In the wake of the global financial crisis, when official development assistance is falling, there has been a massive increase in blending to the former by concessional lending arms of multilateral organisations like the World Bank. Added-value for EU multilateral aid could come from not following these market trends, but instead to fill the gaps that other sources of development finance cannot fill, i.e. providing grant resources which are not forthcoming from other sources. She argued that the focus should be on the poorest of the poor and that private sector lending and investment so far has failed to reach the poor.

The Eurodad representative also argued that if EU aid is to be blending then this should be done via the international financial institutions with experience and who are best placed to most effectively deliver funds.  In this regard she noted that there is limited development experience within the EIB and that funds managed and co-managed by the EIB are not scoring highest on delivery of aid to the public sector. EIB financing instruments are used more for private sector finance (70% of the ACP investment facility funding goes to the private sector for example). While support to the private sector is important, it is also the role of the EU to ensure a balance with support to the public sector she said. There are also no developing country shareholders on the EIB to provide accountability for public sector funding.  She also noted that the World Bank have advised that an increasing share of EU official development assistance will subsidise the private sector, something that not even the World Bank does, as it claims that this could create market distortions and does not create sustainable business.

Civil society organisations, she said, have the impression the EC is suggesting that more multilateral EU aid is blended with private finance to leverage private sector lending and investments.

Eurodad research on other multilateral lending organisations has identified a lack of clarity on how lending complies with aid effectiveness principles she told MEPs. And mechanisms to measure the development impact of funds are not doing a great job she said. A big share of this type of investment goes to rich countries’ multinational companies. So the rationale to strengthen private sector is flawed if you look at where the money is going she argued. Currently ongoing research doing a similar analysis for EIB facilities using the EU budget and European Development Fund (EDF) is finding similar results. Financial intermediaries used to channel money to SMEs are not the best suited to deliver the best development results as most are private equity firms needing 17-20% returns. Many companies and financial intermediaries are also in tax havens. So its hard to see how these can deliver development she said.

Before all these problems are addressed, she argued that no more EU ODA should be blended with non-grant resources to lend and invest in private sector companies operating in developing countries.

She outlined the following recommendations for the Development Committee on what should be addressed in the European Parliament’s report:

    1. Call upon the EC to conduct a mapping of trends of multilateral and bilateral aid to assess where scarce grants resources are most needed;
    2. Stop using EIB managed facilities as the default option; carefully assess the effectiveness of different IFIs in delivering blended aid in order to take evidenced-based decisions on where EU aid can have the highest positive impacts;
    3. Call for an independent and thorough assessment of past experiences with EIB facilities that channelled EDF resources to ACP countries. This external evaluation should be genuinely independent, and include methodological concerns from a broad range of stakeholders (i.e. the WB IEG evaluation in 2007 found that 40% of IFC projects did NOT have a positive development outcome);
    4. Whether EU aid if finally channelled to EIB managed facilities or to other IFIs, the EP must not authorise any aid contributions to private sector lending and investment until the problems outlined above are addressed:
  1. i.     Compliance with aid effectiveness principles;
  2. ii.     Sound development outcomes tracking systems;
  3. iii.     Operational policies that ensure that aid is channelled to poor country companies;
  4. iv.     Phase out use of financial intermediaries which cannot prove the positive development impact of their portfolio;
  5. v.     Strengthen due diligence to stop any aid flowing to companies or investments domiciled in tax havens.

The Head of Infrastructure from the European Commission’s DG DEVCO stressed to MEPs that EU development policy is the driver for blending facilities. The focus now is on inclusive growth and poverty eradication. The EC is try to support with these blending instruments, the priorities of EU action plans and thematic policy priorities. They are complementary to regional, national and local strategies.  Its not just one tool, its complementary to the other tools that the EC have on national programmes, like EDF and regional programmes.  The focus now is on transport, energy, water, regional infrastructure, environment, including climate change, education and health, and private sector support is a focus but mainly in those countries where the appetite for long term finance for education and health is larger.  This means grants are used in traditional developing countries for these sectors he said. Capacity to mobilise additional funds make them suitable for leveraging loans and partner countries’ own contributions. It means EU grants for direct investments will be able to bring other financing to the table. And it will hopefully also be able to bring and attract financing from financing institutions and private sector to areas and sectors in countries where they would otherwise not go he said.

Debt sustainability and crowding out are concerns the EC are working to address. IMF article 4 consultations in delegations in countries the EC work with are part of national policy dialogue so the EC has a good insight in debt sustainability criteria applied and where and when to use blending or work with grants to work with investments for infrastructure or otherwise to ensure no high indebtedness.

On project related principles, the EC want the projects to be technically and financially sound he said. Feasibility studies and appraisal process need to be part of application packages where grants from the European financing institutions are applied for. Conditions for sustainability apply in grant application process

Risk mitigation and assessment is part of appraisal process and specific implementation risks are considered as well as efficiency effectiveness of procurement process and implementation, supervision and impact monitoring he said.

The added-value as the EC sees it is the leverage effect – the ability of the EC to be involved in financing of larger scale infrastructure and other schemes with several financing institutions. The increasing concessionality and the implementation of donor coordination, bringing together European financing partners together with EC is in line with division of labour and harmonisation procedures of the Paris and Accra agendas aid effectiveness agendas he stressed. Joint visibility of European operations also increases EC and European visibility by blending he said.

The EC is uses country systems where possible. The approach is harmonized by pooling resources and using leading financiers procedures. It enhances coordination between EU donors.  And reinforces dialogue on regulatory reforms, transparency and good governance in countries, led by delegations, or participated in by them

Blending is not the one default option for future he stressed to MEPs, it is to be combined with sound policy dialogue. Application will be differentiated in vulnerable countries where income can be generated, but more generally in middle-income countries where more suitable conditions for long term finance to be accepted. The understanding is that blending is to be subordinated to development policies of the EU, in line with the outcomes of the green paper, through enhanced policy dialogue and brining private and private sector into financing of interventions to implement policy objectives. The idea is to use existing facilities as much as possible, scaling up to higher levels of grants updated with combinations of loans of financing institutions where possible he said.

The Development Committee’s rapporteur, Filip Kaczmarek, will now update his draft report on increasing the impact of EU development policy

(http://www.europarl.europa.eu/meetdocs/2009_2014/documents/deve/pr/859/859937/859937en.pdf) based on these discussions. In the debate, he stressed the importance of fresh money and choosing partners and projects carefully based on experience to date in blending.

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Comments

Greg

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2013-07-03 16:19:35

The EU has to be careful here, not to use leverage to make beneficiary countries more indebted, after all, it is over-leverage of households in the US and businesses/banks in Europe that cause the financial mess we are in, besides, using capitalistic methods to fund devleopment projects should not blur the need to do social good PLUS although the EIB will lead the consortium of lenders (including private lenders), the private sector will always have far more clever people to game the system, probe for loop holes and take advantage of gaps to maxmimse thir profits (as they should) and I do not think the EIB nor the EU are up to the task - guess why investment bankers always can stay two steps ahead of government regulators - if you play peanuts, you get....

Economic Transformation and TradeEuropean external affairsDevelopment Finance and TaxationEU Development Policy and PracticeBlendingEuropean Union (EU)