Issues in Scaling-up of
Development Aid Flows
Benu Schneider
The views expressed are those of the author and do not necessarily represent those of the
Financing for Development Office, Department of Economic and Social Affairs, UN
Second Committee Panel Discussion
on 20 October 2006, New York
Recent Trends in ODA




ODA rose 31.4% to
$106.5 bn in 2005 or
0.33% of GNI
(largely due to debt
relief to Iraq and
Nigeria and Tsunami
aid)
G8 pledged to
double aid to Africa
by 2010 to $50 bn;
$150 bn are needed
to reach the MDGs
by 2015;
At 0.36% of GNI by
2010, ODA remains
below the 0.5%
achieved in early
years of DAC and
below the 0.7%
target
Paris Declaration on Aid Effectiveness
Adopted at the Paris High-level Forum in 2005
Partner countries & donors committed to:
• Implementing Partner Commitments and 12 Indicators
of Progress covering (i) Ownership, (ii) Alignment, (iii)
Harmonization, (iv) Managing for results, and (v) Mutual
accountability;
• Periodically monitoring progress;
• Several efforts, such as encouraging ownership of
development strategy by untying aid, or monitoring,
already made good progress;
• But Declaration lacks targets to tackle volatility of
aid, herding behaviors and selectivity;
Issues in ODA flows
Aid is concentrated in a few selected
countries
Aid flows in some cases are large relative
to the size of the economy
Surges in aid flows have been problematic
in spite of a country’s best efforts at
macroeconomic management under IMF
surveillance and policy advice
Issues in ODA flows (contd.)
 Aid flows – uncertain, volatile and herding among donors
 Management of surges of aid flows similar to managing
surges in private capital flows
 Management in low income countries is exacerbated by
underdeveloped financial sector
 Costs of surges illustrated with the case study of Uganda,
Mozambique. Ghana and Tanzania.
 Sterilization of donor inflows through sale of government
paper led to massive build-up of domestic debt and a rapid
increase in interest payments on domestic debt.
 Sterilization of inflow through sale of foreign exchange to the
banking sector led to high outflows of foreign exchange
through the banking sector as there was little demand for
foreign exchange in the domestic country.
 Proposal for a new mechanism to intermediate donor flows
Selectivity
Top 20 recipients
received more than half
of net bilateral ODA
Concentration of ODA in recipient countries, 1981-2004
65%
60%
55%
Less than 50 % of aid
recipients received 90
% of all aid from DAC
donors.
50%
45%
40%
35%
30%
1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004
Share of top 20 Aid Recipients in Total Aid Flows (bilateral, net)
Percentage of Recipient Countries Accounting for 90% of Aid
Concentration of ODA
ODA a s % of GNI
20.00%
Sub-Sahar a
Afr ica
Uganda
18.00%
16.00%
14.00%
12.00%
10.00%
8.00%
6.00%
4.00%
2.00%
0.00%
1995
Source: OECD/DAC
1996
1997
1998
1999
2000
2001
2002
2003
2004
Herding
Collective deviation of flows of ODA among donors, 1981-2004
0.193381
0.173381
0.153381
0.133381
Herding behavior can be
detected by the divergence of
actual changes in ODA relative
to average behavior. If all
donors follow average behavior,
the difference between actual
and average behavior is zero
and there is no herding. A value
greater than 0.1 indicates
significant herding.
0.113381
0.093381
1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003
MEANLSV
Source: WESS 2005
MEANLSVSMALL
MEANLSVBIG
Linear (MEANLSV)
This figure analyses the
behavior of 10 large and 13
small donors and confirms the
existence of herding.
Volatility
Size is not the only
important aspect of ODA
— predictability is
equally important
Aid selectivity causes
volatility similar to that of
private capital flows to
emerging market
economies
The gap between aid
commitment and aid
disbursement reduces
predictability
99
/0
0
00
/0
1
01
/0
2
02
/0
3
03
/0
4
04
/0
5
Uganda:Financing of the Budget (million shs)
Overall deficit (including grants)
98
/9
9
Overall deficit (excluding grants)
Net External Financing
97
/9
8
Domestic Financing
-1700000
-1200000
-700000
-200000
millions of shs
Source: Bank of Uganda
300000
Source: Bank of Uganda
01/05/2001
01/04/2001
01/03/2001
01/02/2001
01/01/2001
01/12/2000
01/11/2000
01/10/2000
01/09/2000
01/08/2000
01/07/2000
01/06/2000
01/05/2000
01/04/2000
01/03/2000
01/02/2000
01/01/2000
01/12/1999
01/11/1999
01/10/1999
01/09/1999
01/08/1999
01/07/1999
Shilling billions
Uganda: Commercial Bank Reserves
250,000
200,000
150,000
EXCESS RESERVES
REQUIRED RESERVES
100,000
50,000
0
Mozambique Financing of the Budget
Ghana Financing of the Budget
2004
2004
2003
2003
2002
2002
2001
2001
2000
2000
-1000
-800
-600
-400
-200
1999
0
200
400
600
-20000
million US$
-15000
-10000
-5000
billion meticais
Source: Bank of Ghana
Source: IMF
Tanzania Financing of the Budget (million TZS)
■ Domestic Financing
■ Foreign Financing
■ Budget Deficit without Grants
■ Budget Deficit
2005
2004
2003
2002
2001
-2000000
-1500000
-1000000
-500000
M illion TZS
Source: Bank of Tanzania
0
500000
1000000
0
5000
10000
“The main challenge to monetary
policy continued to be the
management of excess liquidity
injections, resulting from government
expenditure.”
Bank of Uganda, Annual Report
2004/2005, p. 16.
Monetary and exchange rate policy geared
to managing liquidity to keep inflation low
and maintain competitiveness by
Sale of foreign exchange (round-tripping of
flows as banks invest them abroad)
Sale of treasury bills
Uganda Commercial Banks liabilities in forex and
external assets and forex lending to resident private
sector
million US$
500
450
Commercial banks forex liabilities
(million US$)
400
Commercial banks external assets
(million US$)
350
Forex lending to resident private
sector (million US$)
300
250
200
150
100
50
0
2000
Source: Bank of Uganda
2001
2002
2003
2004
2005
Mozambique Commercial Banks Foreign Assets and
Liabilities
Ghana Foreign Assets and Foreign Liabilities of DMBs
600
12000000
10000000
400
million meticais
million US$
500
300
200
100
0
De
J
Au
O
cungct03
04
04
04
Source: Bank of Ghana and World Bank
WDI
De
c04
J
un05
Au
g05
O
ct05
De
c05
Tanzania Foreign Assets and Foreign Liabilities of
Commercial Banks
6000000
4000000
2000000
0
1998
Source: Bank of Mozambique
2000
2002
2003
2004
■ Foreign Assets Commercial Banks
(million)
700
■ Foreign Liabilities Commercial Banks
(million)
600
million US$
8000000
500
400
300
200
100
0
1997
1998
Source: Bank of Tanzania
1999
2000
2001
2002
2003
2004
2005
Uganda: Treasury Bills
Treasury Bills (million shs)
R a t io o f T re a s ury B ills t o
G ra nt s
Jun-05
Jun-04
Jun-03
Jun-02
04/ 05
Jun-01
0
200000 400000 600000 800000 1000000 1200000 1400000
03/ 04
millions shs
Ratio of Treasury Bill Holdings to Money Supply (M2)
02/ 03
04/05
0 1/ 0 2
03/04
02/03
01/02
00/ 01
00/01
0%
50%
10 0 %
15 0 %
99/00
0%
Source: Bank of Uganda
20%
40%
60%
80%
Uganda External and Internal Debt Interest Payments (million shs)
250,000
Interest on External Debt
Interest on Internal Debt
200,000
million shs
150,000
100,000
50,000
0
97/98
Source: Bank of Uganda
98/99
99/00
00/01
01/02
02/03
03/04
04/05
Ghana Treasury Bills/Grants
Tanzania Treasury Bills/Grants
2004
2004
2003
2003
2002
0%
50%
100%
150%
200%
250%
300%
350%
400%
Source: Bank of Ghana
Mozambique Tbills/Grants
2004
2003
2002
0%
10%
20%
30%
40%
Source: Bank of Mozambique and World Bank GDF
50%
0%
50%
Source: Bank of Tanzania and IMF
100%
150%
200%
250%
300%
350%
Ghana Treasury Bills/M2
Mozambique Tbills/M2
Nov-05
2004
Sep-05
Jul-05
Dec-04
2003
Oct-04
Aug-04
2002
Jun-04
Dec-03
0%
0%
10%
Source: Bank of Ghana
20%
30%
40%
50%
60%
Tanzania Treasury Bills/M2
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
0.0%
10.0%
20.0%
Source: Bank of Tanzania
30.0%
40.0%
50.0%
60.0%
70.0%
80.0%
10%
20%
Source: Bank of Mozambique and GDF
30%
40%
Mozambique Interest Payments on Internal and External
Debt (mdc)
Ghana Interest Payments on Domestic and External
Debt
1200
1000
2500
800
2000
(mdc)
Billions of Cedis
3000
1500
600
1000
400
500
200
0 of
Source: Bank
Ghana 2000
2001
2002
2003
2004
2005
0
1997
1998
1999
2000
2001
2002
Source:Bank of Mozambique
million TZS
Tanzania Interest Payments on Domestic and Foreign Debt
▬ Domestic Interest Payments
▬ Foreign Interest Payments
200000
180000
160000
140000
120000
100000
80000
60000
40000
20000
0
2001
Source: Bank of Tanzania
2002
2003
2004
2005
2003
2004
2005
Investment in treasury bills in the Ugandan economy and private sector
credit as a percentage of GDP
14%
12%
10%
8%
6%
4%
Treasury Bills/GDP %
Private Sector Credit/GDP %
2%
0%
99/00
Source: Bank of Uganda
00/01
01/02
02/03
03/04
04/05
Uganda Assests of the commercial bank system as a
percentage of GDP
Source: Bank of Uganda
Classification by aid absorption and
expenditure
Not Spent
Not absorbed
Ghana (0,7)
Partly absorbed
Ethiopia (20, 0)
Partly Spent
Mostly Spent
Fully Spent
Tanzania (0, 91)
Uganda (27, 74)
Mostly absorbed
Mauritius
Mozambique (66,
100)
Fully absorbed
Source: IMF (2005). The Macroeconomics of Managing Increased Aid Inflows: Experiences of Low-Income
Countries and Policy Implications
NOTE:
“Spent” variable = Non-aid fiscal balance deterioration as percent of incremental aid inflow
“Absorb” variable = Non-aid current account deterioration as percent of incremental aid inflow
Excess liquidity hampers financial
market development
 Excess liquidity hampers the development of the shortend of the market
 Absence of term money market
 Segmented financial markets so that liquidity
shortages/surpluses are not efficiently intermediated
through money, capital, forex, and government securities
market
 91 T-Bill rate virtually the reference rate for lending and
deposit rates
 Interest rate structure does not reflect the differences in
liquidity, maturity and risk
 Lack of activity in secondary market due to ample
liquidity
Lack of opportunities to lend in foreign
currency
Lack of opportunities to build assets in
foreign currency
Both the above lead to round-tripping of
capital flows with banks holding assets
abroad
Investment in treasury bills and assets
abroad reduce the incentive to lend
20.00%
2000000
18.00%
1800000
16.00%
1600000
14.00%
1400000
12.00%
1200000
10.00%
1000000
8.00%
800000
6.00%
600000
4.00%
400000
Rate of change recurrent revenue
2.00%
200000
Recurrent Revenue (million shs)
0.00%
0
97/98
Source: Bank of Uganda
98/99
99/00
00/01
01/02
02/03
03/04
04/05
million shs
Uganda Government Recurrent Revenue
Uganda Treasury Bill Yields
Mean T-Bill Yields
25
20
percent
15
10
91 days
5
182 days
273 days
364 days
0
2000
2001
Note: No issuance of 278 days T Bills in 2005
Source: Bank of Uganda
2002
2003
2004
2005
Uganda M onthly Interest Rates
30
25
per cent
20
15
10
91 da ys
182 da ys
5
273 da ys
364 da ys
Source: Bank of Uganda
1
ar
-0
M
n01
Ja
-0
0
v
N
o
-0
0
ep
S
l00
Ju
ay
-0
0
M
0
ar
-0
M
Ja
n00
0
Ugandan experience
 Overestimation of absorption and ability to raise domestic revenue in
the expenditure framework
 A build of internal public debt negating the positive effects of debt
relief
 Short-term choice between higher inflation or higher public debt
 Limit to the sale of foreign exchange by the authorities as there is
very little demand for foreign exchange and banks invest it abroad.
There are exposure limits to banks holding assets abroad, thereby
posing a limit to the amount of foreign exchange the banks can buy.
 Increasing the import content of investments require the assured
continuation of donor flows
 The signaling mechanism through the PRSP, PRGF, PSI, and CPIA
leads to concentration of aid flows.
Risk of reversal of donor flows in Uganda
Amendment to the constitution to allow
Museveni’s third term and arrest of
Museveni’s rival Dr. Besigye caused
withholding of aid by United Kingdom, the
Netherlands, Norway and Sweden.
There is close watch on government
response to post-election civil unrest and
further aid cuts are possible.
On the risk of reversibility of aid flows in
countries with aid dependent budgets
 Time-consistent policies alone cannot reduce
the risk of reversibility of donor flows as
reversibility is determined by political factors as
well
 A smooth transition to domestically financed
budgets requires continuation of donor flows in
the medium term
 Risk of huge fiscal and output contractions if aid
flows go down with the risk of losing gains in
poverty reduction
Policy response
 Increase domestic savings in the interests of long-term
viability.
 Augmentation of domestic revenue to avoid a sudden
contraction of the economy.
 The partial use of donor funds for export diversification,
infra-structure development and financial sector reforms
import content of investments essential to shield the
economy from their liquidity impact and as a secondary
effect increase the demand for credit by the private
sector.
 Keep volatility in interest rates in check to encourage
take-off of credit.
International financial architecture is not
well designed to control the volatility and
herding of private capital flows from the
supply side
….. but donor flows emanate from the
official sector
International cooperation should aim at
designing a framework that takes care of
surges, volatility and herding behavior
emanating from donor behavior
Proposal for a new mechanism to
intermediate donor flows
 Proposal: Establish a donor funded investment
account outside the country for development
– To mitigate volatility of donor inflows
– To mitigate impact on liquidity through build-up of
reserves and increased government expenditure
– Example: Norway
 Who will be in control of such a fund?
– Board set up by donors, consisting of officials from
the Ministry of Finance and Central Banks
– Portfolio management entrusted to BIS
– Donors can set up indicators to control spending
Proposal for a new mechanism to
intermediate donor flows (contd.)
 The role of treasury bills:
– Every converted donor dollar impacts monetary base
– Central Bank must fine tune timing of inflow, financing
of fiscal deficit, and liquidity situation
– Dual role of treasury bills:
• Source of funding for poverty reduction (in addition to initial
dollar conversion)
• Mopping up of liquidity after the multiplier has been in
operation, minimizing impacts on M2
 Additional benefit: development of domestic bond market
and other sectors of financial sector
Proposal for a new mechanism to
intermediate donor flows (contd.)
 Implications of investment fund for central banks
– A central Bank can draw down on resources
according to economy’s liquidity situation and timing
of expenditure
– Allows for longer-term strategy for poverty reduction,
independent of political climate or disbursement
negotiations
– Current trade-off between social sector spending and
macro-stability can be avoided
– Condition: unused funds in a financial year must be
allowed to contribute to stock-building
Proposal for a new mechanism to
intermediate donor flows (contd.)
 The road ahead: multi-stakeholder dialogue and
research
– Donor community, IMF and World Bank are
recommended to engage in dialogue and reach an
agreement on this crucial issue
– Donors need to understand full implications of donor
funds in an economy
– Further research needed
• To investigate concrete operation mechanisms of the
proposed investment fund
• More generally, to design a new framework for financial
intermediation of donor flow