Development Lending: Big Loans, Big Groans and Volatility

In an era of geopolitical rivalry, development aid attracts attention. Talk of a ‘Non-Aligned’ movement has spluttered onto the news wires, to join the recent revival of 1970s hairstyles and anxiety about inflation. But the accompanying push for more official development assistance is an expensive distraction.

Back in the heady days before COVID19, the West looked anxiously at the growing encroachment of Chinese Belt and Road Initiative (BRI). It was feared the initiative would corrupt local officials, distort trade patterns, compete (unfairly) with existing financial arrangements, and divert development investment away from Western companies. In short, the BRI was a serious threat to the ‘rules-based’ international order. BRI was a ‘bad thing’.

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As an antidote, the Western official sector leaned on its official lending to developing countries. That was a lesson wrongly learned. The West should not be tempted to out-bribe geopolitical rivals, however good the intentions. Instead, greater long-term gains are to be made from volatile private sector lending. And while private flows were down in 2020, they ain’t out, even with higher interest rates and a queue of EM restructurings.

Source: Photo by Austrian National Library on Unsplash & author’s graffiti overlaid

Still the official sector seems to think private flows too are a ‘bad thing’, like the BRI. World Bank staff recently complained: “market failures, demand-side weaknesses, institutional capacity, policy shortcomings and inadequate risk-sharing mechanisms compound this challenge (of private lending). The result: private capital flows remain woefully short of what they could be.” Bah, humbug! Private sector lending may soon eclipse the official sector, as it did from 2009 till 2015. They would already if the official sector had not ramped up so much.

Plus, the Belt and Road may have begun life with subversion in mind. But in some cases, it has undermined China’s efforts to extend its influence. Good riddance. Now so alternatives are needed. In fact, the BRI never challenged Western lenders/aid in total, either official or private. BRI lending was compared, confusingly, to lending from the World Bank. The following chart from Boston University’s Chinese Overseas Development Finance (CODF) project is typical of comparisons made during the peak of BRI concern.

Source: Boston University Global Development Policy Center, 2023

The World Bank only ever accounted for a fraction of total Overseas Development Assistance provided by the West. Considering official preferential loans, grants and aid, the OECD collectively outstripped the BRI in the provision of development money in almost every region. And that doesn’t count private sector lending from the West. OECD official assistance has accelerated in recent years, whereas BRI (as measured by loans from CDB and CHEXIM) has tailed off to almost nothing.

If, instead Overseas Development Assistance is measured by the full range of Western official agencies, the picture looks very different. The next three charts plot the annual known lending/aid by OECD agencies & governments compared to China’s BRI known lending (by CBD and CHEXIM) in Asia, Africa, and Latin America/Caribbean.

Only in Latin America was BRI lending ever higher than aid/lending from OECD ODA programmes.

There are caveats to attach to these comparisons. The Chinese data does not capture all the lending/aid from China. The category of projects funded are often different, health, education, development in the case of OECD ODA, infrastructure, and commodity development in the case of BRI.

Among the concerns of ODA lenders, are a co-ordination problem at both ends of delivery. From the donors’ perspective, the combined delivery of OECD ODA is impressive, but the sources and the safeguards are fragmented. From the recipients’ perspective, the delivery often dissipates its effect due to asymmetry in community power and leads to concerns about paternalism. There are a lot of projects, many of which may make a difference, but may upset local sensibilities, and national power elites.

Chinese BRI lending suffered no such problems. Their answer was some version of ‘find out who has the power and pay them. When it doesn’t work out, just stop lending.’ That is terrible for developing countries in many ways.

Even so, the West’s official lending suffers from lack of sufficient or timely accountability. This is partially offset with a huge amount of Western private sector lending. This lending should be used to build, through negotiation of both loans and restructuring, a more sustainable financial arrangement with recipient countries. This is so even though recent restructurings suggests the best use of these benefits are not being made.

What are the advantages of private sector lending?

Size, efficiency, and speed: Private lending processes can be faster and more efficient than official programmes. The faster process also allows more funds to be allocated. This can allow funds to reach projects and people more quickly. Results can also be measured fast, and strategies adjusted.

Focus on financial sustainability: Private investors require financially sustainable projects with clear returns, which should ensure more efficient use of resources compared to some ODA projects, which suffer from the usual ‘off-switch’ problem of official investment.

Private sector expertise: Private lenders bring their own expertise in areas like financial analysis, project management, and risk assessment.

The flip side to these advantages are, well, the same. Speed of exit, unwillingness to maintain a long-term commitment and competition from more attractive recipients. But both advantages and disadvantages determine the price of development. We can’t just pretend progress in a neat application of good intentions. Whether it is the BRI, ODA or private sector, big loans mean loud groans.

Adjustment is the solution, not increased largesse or total curtailment. Private flows to developing countries, as reported by the OECD, are many times more volatile than official development assistance or BRI, because they adjust. Official sector lenders’ view that as a disadvantage. But volatility is a good thing, not a bad thing.

For volatility is a measure of information and is a requirement of learning, whether that is in liquid capital markets or development finance. The greater the volatility the greater the learning for those involved. Some in developing countries have learned a great deal since 2009. The restructurings are far from over, but the learning won’t be forgotten.

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