OHRLLS input for the UNTT working group on Financing for Sustainable Development

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1 OHRLLS input for the UNTT working group on Financing for Sustainable Development 1 Background Least developed countries (LDCs), landlocked developing countries (LLDCs) and small island developing states (SIDS) are the 92 most vulnerable member states of the United Nations. 1 On average they experienced relatively high GDP growth over the past decade rates and made some progress towards achieving the MDGs, though less than in other groups of countries. In addition, much of this growth was jobless and their economic structure has been mostly unchanged. Their production and export structures are still highly concentrated on primary commodities and in some cases on low value-added manufacturing and services. In addition, they are highly dependent on aid. Furthermore their marginalization in the global economy is exacerbated by their geographical handicaps, including small size, remoteness and prohibitive trade transaction costs, especially for LLDCs and SIDS. Thus they are disproportionally affected by the multiple crises, especially high and volatile food and energy prices and the effects of climate change to which they did not contribute. LDCs, LLDCs and SIDS and their special needs are all specifically mentioned in the Millennium Declaration. 2 For LDCs special focus is given to market access, debt relief and development assistance. For SIDS it urges the international community to take into account their special needs in the development of a vulnerability index, and for LLDCs increased financial and technical assistance to help them overcome the impediments of geography by improving their transit transport systems are highlighted. Consequently ODA to LDCs, LLDCs and SIDS as well as duty free market access for LDCs are included in MDG 8. This chapter also elaborates the fact that access to most types of finance including private and domestic resources is very limited for LDCs, LLDCs and SIDS as compared to most other developing countries. While they are striving to become less aid dependent this has implications for them meeting their financing needs. 2 Access to most types of finance is limited for LDCs, LLDCs and SIDS LDCs, LLDCs and SIDS face different conditions with respect to financing options as compared to other developing countries. Most LDCs, LLDCs and SIDS are still highly aid dependent with respect to the share of ODA in government expenditure and in terms of to the source of foreign exchange earnings. For LDCs the share of ODA in recipient country GNI was 7%, for LLDCs this share was 4% and for SIDS 5% in 2010 (UN, 2012a). Average ODA per capita in 2011 was $52 in LDCs, whereas for middle income countries it was only $10. As for several countries the level of debt has also increased recently, they will need access to ODA and debt relief for the foreseeable future (UN, 2013). 1 These 92 member states are 49 LDCs + 15 non LDC-LLDCs (out of 31 LLDCs) + 28 non LDC-SIDS (out of 38 SIDS). 2 A/RES/55/2, paragraphs 15, 17 and 18. 1

2 ODA, FDI and remittances ODA is also still the largest capital inflow for many of these countries, bigger than FDI and remittances. This has been acknowledged in the Monterrey Declaration, which states that ODA to LDCs, LLDCs and SIDS is critical to the achievement of the MDGs (A/CONF.198/11). This situation has not changed much over the past decade. For example, in 2011 ODA to LDCs stood at $44.6 billion, whereas FDI amounted to $21 billion and remittances to $27 billion. 3 All of these flows are also highly concentrated with large shares going to a small number of countries. Also, ODA per capita to LDCs differed widely ranging from $8 in Myanmar to $4332 in Tuvalu. The average ODA per capita to LDCs of $52 in 2011 is roughly equivalent to the estimated costs of achieving gender equality and women s empowerment in low-income countries. Despite their high dependency, LDCs were disproportionally affected by the decline in ODA in 2011 and 2012 (the year of the Istanbul Conference), with their share in total ODA declining from 34% in 2010 to 33% in In 2012 bilateral ODA to LDCs is estimated to have declined by 12.8% in real terms compared to a 4 per-cent decline for total bilateral aid. ODA as a percentage of donors' GNI fell to 0.10% in 2011, down from the record 0.11% posted in 2010, despite the 0.15 to 0.2% ODA targets that are reaffirmed in the Istanbul Plan of Action (IPoA) (OECD, 2012a and 2013). ODA to LLDCs also declined in real terms from $25.2 billion in 2009 to $25.1 billion and $24.3 billion in 2010 and 2011 respectively. With respect to aid allocation both needs and performance need to be taken into account. The 2012 DCF found that most aid orphans i.e. countries that are under-aided relative to others are LDCs (ECOSOC, 2012). Furthermore, providers of aid do not determine their aid allocations in a coordinated manner. The report suggests that aid allocation practices need to better take into account the vulnerabilities and special needs of LDCs and should be based on expected outcomes of development interventions. Likewise, the 2012 SG report on Trends and progress in international development cooperation (E/2012/78) states that Development cooperation must above all be needs-based, taking into account structural vulnerabilities and structural needs. The decision of the General Assembly (A/RES/67/221) to promote the consideration of least developed country indicators, GNIpc, HAI and EVI, as part of their criteria for allocating official development assistance is an important step in this context. LDCs and SIDS in particular are vulnerable to climate change. Given their limited contribution to global warming the UNFCC has determined that for such countries the focus should be on climate adaptation as opposed to mitigation. However, despite increased recognition amongst the international community of the importance of adaptation, the sums involved are not commensurate to cover estimated costs of damages, loss of livelihoods and long-term socio-economic impacts. Around 92% of approved climate finance has, as of 2012, been directed to middle income countries, and has primarily supported mitigation action to reduce greenhouse gas emissions. SIDS, which are most vulnerable to climate change have received very little finance so far; for example, Fiji, Kiribati, Marshall Islands, Samoa, Tonga, Tuvalu and Vanuatu have received just 2% of the total amount directed to Asia and the Pacific (ODI, 2012). The funds specifically set up to assist LDCs in their efforts to respond to the climate change challenge include the UNFCCC GEF-administered Least Developed Country Fund (LDCF). As of June 2012, $346 million have been approved for projects and enabling activities, related to the implementation of NAPAs and some $537 million had been pledged. The Green Climate Fund, which is expected to be operational in 2014, is expected to allocate minimum amounts to countries particularly vulnerable to climate change, like LDCs and SIDS. However, it is not clear whether the contributions to these funds are in addition to ODA. Furthermore, the allocation of fast start finance has been unbalanced in favor of mitigation. Based on information submitted in 2010, roughly 62% of fast start finance was allocated for mitigation, 25% for is the latest year for which all three figures are available. See also UNCTAD,

3 adaptation and 13% for Reducing Emissions from Deforestation and Degradation plus (REDD+) (ACPC, 2011). In recent years the debt service ratios of LDCs declined on average. However, being granted HIPC debt cancellation does not always eliminate the prospect of debt distress. Of the 9 LDCs that were at a high risk of debt distress, as of February 2013, six had already received debt relief through the Enhanced HIPC Initiative and the Multilateral Debt Relief Initiative (MDRI) 4 (UN, 2013). Long-term debt sustainability was eroded by negative exogenous shocks, to which these countries were very much exposed. FDI inflows to LDCs, LLDCs and SIDS declined slightly after 2008 as a consequence of the financial and economic crisis, but have resumed growth since Against a sharp decline in global FDI in 2012, FDI inflows to LDCs and SIDS increased by 20 and 10 per cent respectively, and leveled out in LLDCs after continuous grows in the years before. However, in all 3 groups FDI flows remain concentrated in a few countries. 5 Especially for some very small countries, like the Pacific SIDS the prospects for attracting FDI are very low, as domestic markets are negligible, transport costs are often prohibitive and very few possess vast reserves of mineral and hydrocarbon resources waiting to be tapped. In addition, much of the FDI has gone to natural resource extraction with limited forward and backward linkages to the rest of the economy, therefore failing to generate spillover effects in the form of employment, access to technology and knowhow. Moreover there are also potential negative effects of FDI including environmental damage. In general, when considering private financial resources for development one has to bear in mind that while the private sector has the potential to mobilise huge resources it will only do so if a financial return is generated and the risk is not too high. The general lack of creditworthiness and perceived political risk of LDCs thus limits their ability to attract private flows (Secretariat of the Sustainable Development Solutions Network, 2013). Remittance flows have increased significantly in recent years both in absolute and relative terms. The total amount of remittances in LDCs stood at $30 billion in 2011 (UN, 2013). The ratio of remittances to GDP is as high as 31% in Liberia, 29% in Lesotho, 22% in Nepal and 21% in Samoa. One of the hurdles that remitters are confronted with is the cost of such a transaction, which averages the equivalent of 12% of the total amount transferred to some LDCs and SIDS (World Bank, 2012b). In some of these countries, however, some mobile banking operators have started to offer international remittance services at relatively low costs. Again, operational and regulatory challenges limit the ability of expanding these initiatives on a much larger scale (UN, 2013). In recent years the economic relations of LDCs with emerging markets have changed considerably. In 2011 more than half of LDC s exports went to developing countries (UN, 2013). In LDCs and LLDCs, FDI from developing economies such as China, India, Malaysia and South Africa is on the rise in both relative and absolute terms. In addition, investments from the Gulf Cooperation Council countries in African LDCs have recently increased in sectors such as telecoms, tourism, finance, infrastructure, mining, oil and gas, and agriculture. It has to be kept in mind that South-South cooperation is a complement, rather than a substitute for, North-South cooperation, as reiterated for example in the IPoA. It is often proposed that aid could leverage other financial flows. For example, ODA used for reducing infrastructure bottlenecks could help to attract FDI and capacity building in tax authorities could enhance tax revenues. However, the empirical literature indicates that with a better policy environment, including an enabling environment for the private sector and government capacity, the effect of aid on FDI is 4 These countries are: Afghanistan, Burundi, DRC, the Gambia, Haiti and Sao Tome and Principe. 5 See: UNCTAD,

4 stronger. Thus for the most vulnerable countries, which have limited capacities for policy making, the possibilities for leveraging aid are limited. Domestic resource mobilization In addition to the limited access to external resources, the potential for raising domestic resources in LDCs, LLDCs and SIDS is limited - except for major natural resource extraction countries. Average gross domestic savings as a percentage of GDP hovered around 20%, although this mirrors to a large degree high savings rates, particularly government savings in commodity producing countries (UN, 2013). Government revenues in LDCs are very low and increased only slowly over the past decade from an average of 11.7% of GDP during the period to 14.9% in Again, behind this trend was the good performance of resource-rich LDCs, where revenues generated from natural resource extraction rose thanks to the commodity price boom. In some cases, however, revenues derived from other forms of taxation, including excise taxes, corporate income taxes on other industries, trade taxes and value added taxes (VAT), stagnated or increased marginally. A small number of taxes therefore accounted for a growing share of government revenues. Such increasing unbalanced tax mix together with a small formal sector contributed to further narrowing the tax base in most LDCs (UN, 2013). Capital flight including illicit financial flows-- evasion and avoidance along with the multiplication of tax exemptions and administrative capacity constraints further erode the tax revenue in many of these countries. UNDP estimates suggest that illicit financial flows from the LDCs have increased from $9.7 billion in 1990 to $26.3 billion in 2008, implying an inflation-adjusted rate of increase of 6.2% per annum. The top ten exporters of illicit capital account for 63% of total outflows from the LDCs while the top 20 account for nearly 83%. Trade mispricing accounts for the bulk (65-70%) of illicit outflows from the LDCs, and the propensity for mispricing has increased along with increasing external trade. The ratio of illicit outflows to Gross Domestic Product (GDP) averages about 4.8% but there is wide variation among LDCs. Of the top 10 countries with the highest illicit flows to GDP ratio, four are small island countries, two are landlocked, and four are neither. In several LDCs, losses through illicit capital flows outpace monies received in ODA. Although these figures are only indicative they illustrate the magnitude of the issue (UNDP, 2011). Despite the increased use of the Extractive Industries Transparency Initiative (EITI) to strengthen disclosure standards, African LDCs, LLDCs and SIDS continue loosing revenue through illicit financial outflows. For example between 2010 and 2012, the DRC lost at least $1.36 billion in revenues from the underpricing of mining assets that were sold to offshore companies, which is equivalent to almost double the combined annual budget for health and education in 2012 (Africa Progress Panel, 2013). However LDCs, LLDCs and SIDS have limited capacities to deal with international mining companies and offshore financing institutions. Thus stronger efforts to reduce illicit flows and to repatriate stolen assets could play a significant role in bridging the financing gap, at least in a number of vulnerable countries. In the short-term, increasing government resources will be achieved mostly through deepening the current tax base, in particular reforming existing exemption regimes and addressing transfer pricing abuses by multinational enterprises and improving the taxation on extractive industries. Looking forward, only if structural transformation and private sector development leads to sustainable and equitable growth will it be possible to significantly increase government revenue in the most vulnerable countries. Another dimension of the relatively low savings rates is the weak private resource mobilisation. Not only are private savings low but so are financial savings. In a number of LDCs financial markets and institutions lag behind those of other developing countries according to the new Global Financial Development Database of the World Bank. The percentage of people holding bank accounts stands at merely 2% in Burundi and 6% in Tanzania. By the same token, the share of private credit as percentage of 4

5 GDP and the number of bank accounts per 1000 people are much lower in LDCs than in other developing countries. Furthermore many LDCs, LLDCs and SIDS do not have stock markets or have shallow capital markets. New Sources of Financing There have been some innovations to address limited access to long-term financing by governments and the private sector. Several LDCs have for instance tried new approaches to tap into remittance flows. For example Nepal and Ethiopia tried to establish Diaspora Funds to raise resources for public investment. However, the subscription to these bonds was below expectations (AfDB, 2012). While innovative sources of finance have been widely debated, their actual volume is rather limited. Some global health funds like UNITAID, GAVI and the Global Fund to fight Malaria, Tuberculosis and Malaria have focused on the poorest, most vulnerable countries in line with those countries high disease burdens. Other financing options like international taxes, such as a levy on air travel, have been used mainly for other purposes or have not been additional to ODA (UN, 2012b). New resources are also mobilized through the issuance of foreign- currency denominated debt on international markets. Zambia (an LDC and LLDC) has for instance sold a $750 million Eurobond in 2012 with a relatively low 5.625% yield, which was oversubscribed. Zambia has an annual infrastructure funding gap of $500 million according to World Bank estimates, thus it plans to invest over $1 billion in infrastructure projects, especially roads and rural power. However, it is the first African LDC to do so and the effects on debt sustainability remain to be seen. Nevertheless, Angola, Rwanda and Tanzania also have expressed interest in raising international bonds in the near term. Around 10 LDCs also have obtained international sovereign credit ratings, which should increase their access to international capital markets. (WB, 2013) Sectoral aspects Access to finance also varies by sector. While the MDGs were successful in focusing attention on the poor and have contributed to a greater focus on results, there are also challenges related to allocation of a large proportion of ODA towards social sectors at the expense of productive capacity, including in agriculture. Figure 1 below show the sectoral allocation of total programmable ODA for LDCs, LLDCs and SIDS over the last decade. For all three groups, ODA allocated to government and civil society accounts for the largest share. The share of ODA for economic infrastructure and production sectors started to increase somewhat since 2006, coinciding with the establishment of Aid for Trade (AfT). 6 AfT is crucial for the building of productive capacity in LDCs, LLDCs and SIDS, which would in turn allow them to benefit from their integration in the world economy and reduce their exposure to commodity price fluctuation. The IPoA calls for enhancing the share of assistance to least developed countries for Aid for Trade (IPoA paragraph 66, 3. (e)). However, the share of AfT going to LDCs has stagnated around 30%. As AfT can play a role in helping LDC companies entering global value chains it can make a substantial contribution to the development of productive capacity. 6 The AfT Initiative provides a platform for developing countries, particularly least-developed countries to build the supply side capacity and trade related infrastructure that they need to assist them to implement and benefit from World Trade Organization (WTO) agreements and more broadly to expand their trade. 5

6 Figure 1: Gross disbursements of ODA by sector in LDCs, LLDCs and SIDS from 2002 to 2011 Source: OECD DAC Statistical Database, accessed April Note: * ODA total from all donors 6

7 Most LDCs, LLDCs and SIDS rely heavily on concessional funding for the development of infrastructure, which has increased in recent years. In Africa, investment in sustainable energy has increased from $300 million in 2004 to $3.6 billion in 2010, with much of that investment being channeled through development finance institutions (IEA, 2012). There has also been some private sector involvement in financing infrastructure in LDCs, but at a much lower rate than in other developing countries. In 2011, there were 21 infrastructure projects that reached financial or contractual closure in 9 LDCs: Bangladesh (6), Lao PDR (2), Malawi (1), Rwanda (1), Sierra Leone (1), South Sudan (5), Tanzania (3), Togo (1), Zambia (1). The total number of projects in lower and upper-middle income countries was 351. Most of the private sector projects in LDCs were in the energy sector (14). Next was the telecom sector with 6 projects. (WB, 2012a). Financing of infrastructure in many LDCs, LLDCs and SIDS is challenging because of a weak financial sector, weak risk management capacity and limited availability of long-term funding (OECD, 2012). Thus the bulk of infrastructure projects in LDCs is still financed by aid, including from non-traditional donors. Utilities like water and energy will only be able to attract more private investors if they are profitable. However, in LDCs there is a limit to tariffs for water and energy in order to make them affordable for the poor. Thus the gap between affordable tariffs and cost recovery needs to be covered by public funds, whether domestic or foreign. Furthermore effective regulation is required to avoid that PPP for public service delivery will increase inequality, e.g. by neglecting rural consumers. 3 Specific financing needs of LDCs, LLDCs and SIDS Due to the specific development challenges that LDCs, LLDCs and SIDS are facing, their financing needs to achieve economic, social and environmentally sustainable development are disproportionally large, at least as a share of their GDP. Rough OHRLLS estimates put the financing gap of LDCs at $75 billion a year if these countries are to grow--on average--by 7% over the next 10 years (UN-OHRLLS, 2011). There are no estimates of financing gaps to achieve the MDGs or sustainable development in a broader sense that directly apply to the three categories of countries with special needs. However, the estimates for regional or income groups with a large overlap with the LDCs, LLDCs and SIDS can serve as a proxy, thus some recent estimates are provided below. In any case estimates of financing gaps rather give an indication of the order of magnitude and are not comparable as different goals are covered. Financing gap estimates for low income countries (LICs) include $ per capita annually towards the end of the period before 2015 to meet the MDGs and that 10-20% of GDP would need to be provided in ODA (UN, 2012a). An OECD study estimates that $62 billion per year are needed to cover the financing gap to reach MDGs 1-6 in 20 LICs. At the same time they estimate the potential increase of tax revenue for these countries to be around $3 billion (Atisophon et al, 2011). 40 LDCs, LLDCs and SIDS are among the 47 sub-saharan African countries. Several estimates of financing gaps in that region for different sectors include the following: $31 billion per year for infrastructure, mainly power (Foster and Briceño-Garmendia, 2010) Achieving universal access to modern energy services by 2030 will require around $25 billion a year in investment (IEA 2012). The World Bank estimated that roughly $18 billion (in 2005 prices) would be needed per annum to adapt to climate change in Africa (World Bank, 2013). 7

8 Recent estimates of public investment needs to deliver a package of policies to promote inclusive and sustainable development in Asia Pacific countries show that the cost of the package is projected to exceed 10% of GDP by 2030 in Fiji (13%) and Bangladesh (22%). 7 By contrast the median value of required investments by 2030 is 8.2% of GDP. This suggests that domestic resources of economies with special needs, such as SIDS and LDCs will not be sufficient to finance such a comprehensive package (ESCAP 2013). The high vulnerability of LDCs, LLDCs and SIDS to economic shocks and climate change also causes additional expenditure for resilience building and disaster risk reduction. Risk mitigation schemes need to be developed with adequate financial means. This is especially relevant for small island economies, where the cost of damage caused by natural disasters can easily be higher than the annual GDP. The Caribbean Catastrophe Risk Insurance Facility (CCRIF) is one example. Countries buy coverage for a given year up to $100 million. Although the amount of financial resources provided is relatively small, it is disbursed fast and can be used according to government priorities. The pooling of risks among members lowers the cost of coverage by more than 50%. An extension of such a risk mitigation scheme in other regions would also need to be financed partly with external funds. To cover 16 Caribbean countries $76 million was provided by several donors over 4 years. 4 Conclusions The financing needs of LDCs, LLDCs and SIDS are considerable, especially compared to their GDP. There is some scope for increasing government revenues but together with current ODA levels this will not at all be sufficient to cover the financing needs of the most vulnerable countries, especially for infrastructure. Another issue that needs to be addressed is the sustainability of funding support. To improve domestic resource mobilization, rationalizing exemption schemes, dealing with transfer pricing manipulations and designing fairer and more transparent taxation systems on natural resourcesbased industries will be some important steps towards deepening tax bases in LDCs, LLDCs and SIDS. Likewise reforms to expand the scope and the functioning of domestic financial and capital markets are also likely to increase financial savings and thus the potential for long-term investment capital. Climate financing for LDCs, LLDCs and SIDS needs to be extended in line with the promises made at recent international Conferences. Access to these funds needs to be fast and simple and additional resources need to be made available as adaptation to climate change presents an additional challenge to these countries. Furthermore, the imbalance in funding in favor of climate mitigation should be redressed to ensure adequate financing of climate adaptation programmes. There is growing consensus that ODA will have to be more focused on countries with limited access to other sources of financing, especially LDCs, LLDCs and SIDS. The current trend of disproportionally cutting ODA to LDCs needs to be reversed. ODA commitments need to be implemented and the quality of aid needs to be improved, especially with respect to predictability and use of country systems. The sectoral allocation of ODA in line with country priorities should be accelerated. In this context, the amount of AfT going to LDCs, LLDCs and SIDS should be increased. The leveraging of aid for other forms of financing cannot be assumed to be automatic in the most vulnerable countries. Dedicated support, for example in the form of home country incentives for FDI with positive spillover effects need to be carefully designed and implemented. To enhance the potential for 7 The package includes a job guarantee programme, a universal non-contributory pension, benefits for all persons with disabilities, increasing the share of public health expenditure of GDP to 5% by 2013 and three energy goals. 8

9 private financing of crucial infrastructure in LDCs the capacity of governments, especially of regulators needs to be strengthened. Besides ODA and domestic resource mobilization, the most vulnerable countries should also put strong emphasis on other means of implementation, such as trade, investment, technology transfer, innovative financing and South-South cooperation. References ACPC, (2011). Integrating renewable energy and climate change policies: Exploring policy options for Africa. United Nations Economic Commission for Africa, African Climate Policy Centre, Working Paper 10. AfDB, 2012: Diaspora Bonds: Some Lessons for African Countries Africa Progress Panel, 2013: Africa Progress Report Equity in Extractives, Stewarding Africa s natural resources for all Atisophon, Bueren, De Pape, Garroway and Stijns, 2011, Revisiting MDG cost estimates from a domestic resource mobilization perspective, OECD Development Center WP 306. ECOSOC, 2012: Report of the 2012 ECOSOC DEVELOPMENT CO-OPERATION FORUM, New York, 5 and 6 July 2012 ESCAP, 2013: Economic and social survey of Asia and the Pacific 2013 Forward-looking Macroeconomic Policies for inclusive and sustainable development Foster, Vivien and Cecilia Briceño-Garmendia, 2010: Africa s Infrastructure, The World Bank. IEA, 2012: World Energy Outlook ODI, 2012: Ten things to know about climate finance in 2012 ( OECD, 2012a: ODA Statistics from DAC website ( OECD, 2012b: Mobilising Investment in Low Carbon, Climate Resilient Infrastructure, OECD Environment WP No. 46. OECD, 2013: Aid to poor countries slips further as governments tighten budgets, Press Release 03/04/2013 Secretariat of the Sustainable Development Solutions Network, 2013: Financing for development and climate change post UN, 2012a: MDG Gap Task Force Report - The Global Partnership for Development: Making Rhetoric a Reality UN, 2012b: World Economic and Social Survey In Search of New Development Finance UN, 2013: Secretary-Generals Report on the Implementation of the IPoA. UNCTAD, 2013: World Investment Report 2013 Global Value Chains, Investment and Trade for Development. UNDP, 2011: Illicit Financial Flows from the Least Developed Countries UN-OHRLLS, 2011: Resource Requirements in LDCs based on OHRLLS staff Estimates, mimeo WB, 2012a: Private Participation in Infrastructure (PPI) Project Database WB, 2012b: Migration and Development Brief. Migration and Remittances Unit, Development Prospects Group. Washington, DC. WB, 2013: Africa s Pulse, April