Too little aid is flowing into Africa from the developed world to make agreed poverty reduction targets a reality. James Eedes assesses the state of capital inflows.

The critical importance of aid to Africa is underscored by the World Bank’s latest Global Development Finance report which states that bilateral aid grants to sub-Saharan Africa totalling $13.9bn were equal to net capital inflows of debt and equity last year. In other words, aid grants accounted for 50% of net inflows into the region.

Compare that with Latin America and the Caribbean, where aid grants of $2.9bn last year were equal to just 5% of net capital flows of debt and equity. Or the average for all developing countries, where aid grants were equal to 17% of net flows of debt and equity.

Further breakdown of these numbers is revealing. Net inflows of foreign direct investment (FDI) into sub-Saharan Africa totalled $8.5bn – 6.3% of net FDI to developing countries. While this represents a modest improvement on 2002, the total is dominated by key projects in a few countries, particularly in the oil and gas sectors. The largest recipients of FDI in Africa were Angola ($1.7bn) and Nigeria ($1.3bn) as international investors pumped money into the oil industry.

To put this in perspective, China, the largest recipient of FDI worldwide, had inflows of $53.5bn, and Mexico and Brazil attracted net inflows of $11.5bn and $10.1bn respectively. And, despite noting that African countries were engaged in a “far-reaching process of improving their policies and institutions”, the report warned: “Investment risks remain high and business environments poor.”

Net portfolio equity flows into sub-Saharan Africa totalled $500m, almost exclusively into South Africa. Despite world-beating equity market returns in other African markets, constraining factors such as weak regulation, poor market infrastructure and poor liquidity keep offshore investors out.

Private debt flows to sub-Saharan Africa rebounded from a $2.2bn outflow to a $3.4bn inflow, driven principally by net inflows of bond proceeds. Again, South Africa leads the way.

Overall, sub-Saharan Africa was able to attract net private flows of just $12.4bn in 2003, a sharp increase on 2002 but below historical levels. More significantly, the total accounted for just 6.2% of net private capital flows to developing countries. The stark reality is that Africa is not attracting sufficient capital to generate the required levels of growth to reduce poverty.

Too little aid

Against this backdrop, it is encouraging to detect tentative signs that the developed world is heeding the call for more aid to poor countries but by any reckoning it is still hopelessly too little to meet the Millennium Development Goals. Underdevelopment, in turn, prevents countries and markets from maturing to attract private sector flows, constraining economic growth. Nowhere else is this more acute than in Africa.

The World Bank estimates that to meet the Millennium Development Goals, global aid volumes would need to rise by $50bn. The $6bn increase in aid in 2002, the most recent data, is misleading: $1bn of this went to Afghanistan and Pakistan while $3bn reflects debt relief, meaning a net increase in aid to developing countries of just $2bn.

There is some movement, however. In the EU, additional official development assistance (ODA) pledges from member states, excluding the accession countries, over and above what was agreed at the Barcelona Summit in 2002, could mean that ODA as a percentage of gross national income (GNI) will rise from 0.35% in 2002 to 0.44% by 2010 on average for each member state. This would raise total ODA to $44bn – if promises are kept.

According to the European Commissioner for Development and Humanitarian Aid, Poul Nielson, the EU remains committed to reaching the UN goal of 0.7% of GNI.

Significantly, sub-Saharan Africa will probably be a major recipient of the increased European aid. The region received 41% of EU member states’ aid in 2001, and G8 countries – Canada, France, Germany, Italy, Japan, Russia, the UK and the US – pledged at the Kananaskis summit in 2002 and reaffirmed at the 2003 Evian summit to spend at least 50% of new resources for development on African countries.

EU expansion threat

That said, EU enlargement threatens to nudge Africa off the spending agenda. A report by the development agency ActionAid International says that the EU’s expansion east with 10 new member states from May 1 will increase the union’s focus on its neighbouring region, with significant resources allocated to promote regional development and integration. The report is based on interviews with MEPs, the European Commission and officials from member states.

Louise Hilditch, who heads ActionAid’s European office in Brussels, says: “The report clearly indicates that security, trade and new neighbour policies will require more resources. Yet the largest net contributors to the EU budget – Britain, Germany, Sweden and the Netherlands – are proposing fewer.”

The US has proposed an increase in foreign aid through two channels. The Millennium Challenge Account (MCA) should provide $5bn a year in additional aid to developing countries. The funding will be based on 16 economic and political indicators, including control of corruption, rule of law, primary education completion rate, country credit rating, and trade policy.

But there are concerns about the geographical distribution of aid under the MCA. “A significant drawback is a methodology that severely limits the number of countries that can qualify over time, even if country performance improves significantly,” says KY Amoako, executive secretary at the UN Economic Commission for Africa. “I believe MCA eligibility criteria should be expanded to allow more African countries to compete fairly for its funds.”

By one reckoning, only three African countries would qualify for aid, due to poor performance on governance and policy indicators. The most optimistic hope is that up to eight countries might be included: Benin, Cape Verde, Ghana, Lesotho, Madagascar, Mali, Mauritania and Senegal. US President George W Bush was due to announce eligible countries after The Banker went to press.

Researchers at the Brookings Institution are advocating grading the performance of African governments relative to other countries in the region. In this way, countries on the right track would not be excluded. Eligibility is also hampered by practicalities. Data are scarce, particularly for the poorest countries, where reliable information on “number of days to start a business”, for instance, may be missing.

In addition to MCA, the US government has pledged $15bn over five years to 14 countries in sub-Saharan Africa and the Caribbean to prevent new HIV infections, provide antiretroviral treatment to those infected, and offer care for sufferers and AIDS orphans.

World Bank staff estimates suggest that if MCA and HIV/AIDS commitments are honoured, US aid could increase from 0.13% of GNI in 2002 to 0.2% by 2006. Realising this increase depends, however, on the willingness of the US Congress to allocate funds. Even with sufficient appropriations, the timetable for disbursing funds may be optimistic, given the difficulties in making such programmes operational.

Researchers at the Center for Global Development found that for the MCA, the Bush administration has requested $1.3bn for 2004; data from the Congressional Budget Office (CBO) suggest only $130m will be spent. For the AIDS initiative, the administration has requested an additional $450m; CBO data suggest only $45m will be spent.

As with all discussions about development, it has to be emphasised that no single intervention will put Africa on a sustained growth path and effectively combat poverty. Donor commitments and actual aid flows have to be seen in the context of progress on other fronts, principally trade liberalisation and debt relief. On aggregate, the developed world is still doing too little, too slowly to meet the globally agreed poverty reduction targets.

Novel solution to tap capital markets for development funds

Estimates suggest that development assistance must be doubled and focused on the poorest countries if the Millennium Development Goals (MDGs) are to be met, an increase of at least $50bn a year. So far, even the most optimistic pledges from donor countries will mean a yawning resource gap between what is needed and what is provided.

Difficult challenges require novel solutions, which is why UK chancellor Gordon Brown’s idea of tapping the capital markets for development funds is attracting serious attention.

Underpinning the proposal is the recognition that for investments to provide sustainable progress they must take place across different sectors simultaneously. Education, health, access to water, roads and other infrastructure for growth must be tackled at the same time to ensure a lasting exit from poverty.

Mr Brown’s International Financing Facility (IFF) is, by design, a stable financing vehicle that could provide the critical mass of additional and predictable funding needed to make lasting progress in all these areas.

Proactive solution

It represents a proactive solution to a crippling problem: while donors may be committed to reaching the target of 0.7% official development assistance (ODA) to gross national income (GNI), the inescapable reality is that fiscal constraints do not allow them to increase aid levels in the short to medium term. The IFF would be complementary to donors, addressing the immediate need for resources to meet the MDGs as donors move towards the 0.7% ODA/GNI target.

The facility is a financing mechanism that would provide up to an additional $50bn a year in development assistance between now and 2015. It would work by leveraging in additional money from the international capital markets by issuing bonds, based on legally-binding, long-term donor commitments. Bondholders would be repaid using future donor payment streams. As donor pledges would be legally binding, failure by a donor at any time to make any of the payments would be viewed by the financial markets as a sovereign default.

The facility would disburse resources through existing multilateral and bilateral mechanisms. In all likelihood, this would favour grants over loans, to avoid debt sustainability concerns, and would be conditional on implementing and maintaining prescribed reform policies.

In theory, the IFF has numerous advantages. First, it provides additional resources upfront, meeting the resource needs necessary to help achieve the MDGs. Second, it locks in the political commitment of donors to Monterrey pledges. Third, it provides the predictability and critical mass of aid needed for simultaneous and sustainable investment in developing systems across sectors, tackling the causes rather than the symptoms of poverty.

Fourth, it could achieve a step-change in aid effectiveness through donor agreement to high-level aid principles, such as untying aid. Presently, most aid is “tied”, meaning that funds are tied to contracts using suppliers from the donor country, leading to inefficiency and poor knowledge flow to developing countries.

Based on consultation with the financial community, it is anticipated that the interest rate on IFF bonds would be similar to that of other multilateral agencies, such as the World Bank. For instance, at an interest rate of 5%, the IFF would disburse $500bn of aid over a 15-year period, with donors making $720bn of payments to the IFF over a 30-year period.

Deep bond markets

The international market for bonds similar to those that the IFF would issue is very deep. In 2002, for instance, funding programmes in AAA bonds issued by US agencies (Fannie Mae, Federal Home Loan Bank and Freddie Mac), along with KfW, the European Investment Bank, the International Bank for Reconstruction and Development, the regional development banks and Caisse d’Amortissement de la Dette totalled about $1060bn, of which $360bn was in international capital markets.

Since the proposal was launched it has been well received. Significantly, the UK has the presidency of the G8 and the EU in 2005, which could provide an opportunity to direct the agenda of the world’s wealthiest nations. In May, UK prime minister Tony Blair chaired the first meeting of his government’s Commission for Africa, promising to make Africa a “focal point” for the G8. The timing could not be better to turn the IFF into reality.

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