A New Geography Of Development Finance

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by: Helmut Reisen

Especially since the early 2000s, large emerging countries have become important providers of development funds. Shifting wealth has allowed governments to tap a bigger pool of 'transformative infrastructure finance' (Xu and Carey, 2017) and to choose from more financing options. From a long-term development perspective, infrastructure finance is arguably the most important prerequisite to close the infrastructure gap that has been identified as the major bottleneck for delivering on growth and on the SDGs, notably in Africa. Much of the new funding supply is through official bank credit outside the Paris Club framework, however. So concerns that a new debt overhang might be building in the absence of a concerted mechanism for debt prevention and resolution have become louder recently.

The rise in South-South finance is being channelled through three major vehicles: i) a rise in remittances within the non-OECD area, often resulting from oil riches; ii) growing corporate equity participation via mergers and acquisitions as well as greenfield FDI by emerging multilateral companies; and iii) an extension of bilateral and multilateral bank credit supply, notably by China. The overall rise of development funds occurred despite a downward trend of official development assistance (ODA) as a fraction of recipient countries rising GDP. Western donors, including private, had reduced in the past decades investment in infrastructure, instead devoting more attention to poverty reduction, health, good governance, and climate change mitigation.

Research at ODI (Prizzon, Greenhill and Mustapha, 2016) found total external development finance to all developing countries to have more than doubled between 2003 and 2012 to $269 billion. In 2012, development finance flows beyond ODA by DAC donors - excluding FDI and portfolio equity and remittances - accounted for $120 billion, or around 45%. 13% of this $120 billion by so-called emerging donors (13%), such as Brazil, China, the Gulf States, India, Malaysia, the Russian Federation and Thailand.

Over recent years, remittance flows - funds sent by migrants living and working abroad to their home countries - have been increasing rapidly. Booming oil prices translated in higher demand for immigrants in the construction and other service sectors of the Gulf States and Russia. While private capital mainly flows to emerging countries, remittances are particularly important in poorer countries where they can represent up to a third of GDP. India, China the Philippines and Mexico are the largest remittances receiving countries in the world. As a share of GDP, however, smaller countries such as Tajikistan (42 percent), the Kyrgyz Republic (30 percent) and Nepal (29 percent) were the largest recipients.

The top six immigration countries, relative to population, are outside the high-income OECD countries (World Bank, 2016b): Qatar (91 percent), United Arab Emirates (88 percent), Kuwait (72 percent), Jordan (56 percent), and Bahrain (54 percent). As a consequence of an upsurge in migration, remittance flows into developing countries sprung up in the 1990s, becoming another important financial resource for developing countries. During the period 1970-2000, workers' remittances to Sub-Sahara Africa had only reached 2.6% of GDP, an inflow clearly lower than its official inflows that added up to 11.5% of Sub-Saharan Africa's GDP (Buch and Kuckulenz, 2010). This was in contrast to North Africa and the Middle East that received almost 9% of GDP through remittances over the time span. By 2015, remittances represented the largest source of external finance for many developing countries, ahead of ODA and FDI. Then, worldwide remittance flows were estimated to have exceeded $601 billion. Of that amount, developing countries are estimated to receive about $441 billion, nearly three times the amount of official development assistance.

Table 1: Developing-Country FDI Outflows and Inflows, bn $

FDI Outflows

1990

2000

2008

2016

LDCs

0.0

2.1

18.4

11.9

China

0.8

0.9

55.9

183.1

Total Dev

13.1

90.0

288.6

383.4

FDI Inflows

LDCs

0.6

5.3

32.3

37.9

China

3.5

40.7

108.3

133.7

Total Dev

n.a.

233.8

592.7

646.0

Source: UNCTAD, World Investment Report 2017, unctadstat.unctad.org

Traditionally, and until the late 1990s, developing countries have rather hosted than homed FDI flows. While inward FDI have plateaued for many of the emerging economies in the 2010s, much of the dynamism is now taking place in outward FDI. Table 1 provides evidence on FDI outflows and inflows for the years 1990, 2000, 2008 and 2016. It shows that FDI flows have increasingly turned into a two-way street since the GFC. Up to the GFC, Latin American companies used to spearhead outward investment from emerging economies. Since then, China raised its percentage share in developing-country FDI outflows from 1% in 2000 to almost half by 2016. Chinese multinationals have increasingly taken the mergers and acquisitions (M&A) route for their overseas expansion, particularly after the global financial crisis of 2008-09.

Greenfield investment is an important mode of entry for Indian and Malaysian multinationals compared to mergers and acquisitions, behind China the only two other emerging countries listed among the top 15 countries for greenfield FDI in 2016. Emerging countries continue to primarily invest South-South in other emerging and developing economies, as most emerging economies' regional markets serve as the primary destination for their outward greenfield FDI flows. However, the share of the E20 group OFDI projects (in value) directed to the Asian-Pacific region has declined while the shares of Africa, Latin America and especially North America increased (Casanova and Miroux, 2017).

It is noteworthy that the poorest countries classified by UNCTAD as LDC group has started to participate at last in hosting considerable FDI inflows, as a proportion of their GDP. South-South FDI contributed to that new trend, with growing activity from many firms in China, Brazil, India and South Africa. Keep in mind that net FDI flows do not constitute net capital flows as they are often financed in the host country's domestic financial markets, as multinational companies try to keep currency and expropriation risk down.

In the 2000s, China became a global leader in official bank credit for infrastructure funding, benefitting Africa above all, by building roads, dams, bridges, railways, airports, seaports, and electricity grids. Meanwhile, China has established a number of bilateral and multilateral funds across the world, in addition to two policy banks, the China Development Bank (CDB) and the Export Import Bank of China (C-EXIM). Figure 22 suggests (for Africa) that in recent years bilateral official lending flows have been substituted for multilateral flows. Despite steady growth in private sector funding in the past decade, official development finance backs 80% of Africa's infrastructure funding, for example (ECN, 2015). China has also pioneered a host of bilateral and regional development funds in the wake of founding the Belt and Road Initiative (BRI) in 2013 (see next section). These funds add upwards of $100 billion in development finance; a major portion of these Chinese investments is in Asia, with the largest being the $40 billion Silk Road Fund established in 2014 (Kamal and Gallagher, 2016).

In 2015, two new multilateral financial institutions of consequential size and scope came into existence as legal entities: The Asian Infrastructure Investment Bank (AIIB), a Chinese led initiative, and the New Development Bank (NDB), an effort championed and owned by the BRICS nations (Brazil, Russia, India, China and South Africa) to strengthen cooperation among themselves and beyond. The advent of these new multilateral development banks is emblematic of a decentralization of power from the Bretton Woods system. It reflects a shift in terms of soft power distribution beyond the G-7. Their potential role and influence stems from: 1) the size of their lending activity, even relative to long-established institutions such as the World Bank and the Asian Development Bank (ADB); 2) their relatively high capitalization; and 3) their focus on infrastructure - a sector that is vital for growth and development. AIIB and NDB are expected to add significant financing capabilities with combined loan portfolios estimated at $230 billion (Reisen, 2015).

Staying outside the relatively transparent DAC framework, China does not disclose comprehensive or detailed information about its international development finance activities. Aid Data (Dreher et al., 2017) constructed a dataset with a new methodology for tracking underreported financial flows. According to these new data, the scale and scope of China's overseas infrastructure activities now rival or exceed that of other major donors and lenders. Between 2000 and 2014, the Chinese government committed more than $350 billion in official finance to 140 countries and territories in Africa, Asia and the Pacific, Latin America and the Caribbean, the Middle East, and Central and Eastern Europe. Transport and power generation are the two main sectors financed. Chinese cooperation also invests significantly in health, education, water and sanitation, agriculture, and other social and productive sectors.

Chinese official finance consists of Official Development Assistance (ODA), which is the strictest definition of aid used by OECD-DAC members, and Other Official Flows (OOF). China provides relatively little aid in the strictest sense of the term (development projects with a grant element of 25 percent or higher). A large proportion of the financial support that China provides to other countries comes in the form of export credits and market or close-to-market rate loans. Table 2 provides a calculation of the weighted average of China's development finance that was extended at concessional ODA terms: 24.5 percent for the period 2000-2014.

Table 2. Recipients of Chinese Official Finance, 2000-2014

World Region

Total, $bn

ODA Terms, %

No. of Projects

Africa

118.1

58

2345

Eastern Europe

56.7

3

171

Latin America

53.4

12

317

South Asia

48.8

10

423

Southeast Asia

39.2

7

507

Other Asia

28.5

6

183

Middle East

3.1

1

93

Pacific

2.8

3

265

Total/Average

350.6

24.5

4304

Source: Aid Data (2017); authors' calculation

Table 2 shows that Africa benefitted most from Chinese development finance during the period 2000-14 - in terms of amounts, degree of concessionality (percentage share at ODA terms) and number of projects. Zimbabwe, Angola, Sudan, Tanzania, Ghana, Kenya and Ethiopia headed the ranking of Africa's recipients in number of projects. Africa has received more Chinese ODA-like finance than all other developing regions in the world combined.

Infrastructure funding has risks for low-income countries with low debt tolerance, however, despite its transformative nature. Much of China's and other emerging creditors' new funding supply is through official bank credit outside the Paris Club framework. Concerns have become louder recently (notably in Washington, DC) that a new debt overhang might be building in the absence of a concerted mechanism for debt prevention and resolution. The expansion of available borrowing opportunities has provided more room to expand development-oriented spending and address infrastructure gaps. But long-term growth is enhanced only if borrowed funds are used productively, yielding a high economic rate of return that exceeds borrowing costs. The IMF (2018) has noted, however, that higher budgetary borrowing levels have been associated with a drop in public investment in many LIDCs.

The Fund is particularly worried by the rise since 2013 and by the composition of debt in several post-HIPC countries now judged by then IMF at high risk of or in debt distress. Those countries are all African: Cameroon, Chad, DR Congo, Ethiopia, Ghana, Mauritania, Mozambique and Zambia. Their rise in debt levels has been financed by a mix of emerging bilateral creditors, commercial external creditors, and the domestic financial system. By contrast, the contribution of traditional creditors (the multilateral development banks, Paris Club creditors) has been modest as they tend to limit their provision of loans to countries at high risk of/in debt distress, or are more likely to provide grant finance in such cases.

Washington, DC is also worried by prospective debt distress in connection with the BRI. A recent policy paper at CGD (Hurley, Morris and Portelance, 2018) cites media sources, according to which the BRI could span at least 68 countries with an announced investment as high as $8 trillion over the coming years and decades. The CGD paper identified a subset of 23 countries to be significantly or highly vulnerable to debt distress, of which ten are Asian and four African.

Are these concerns more than 'sour grapes'?