Document de Travail n° 2016/01 - Concessional finance and ODA reporting of long term financial instruments

This working paper is the sole responsibility of the author. It is circulated in order to stimulate debate and to encourage comments and criticism.

The rather unclear DAC definition of concessionality has created intense debate among DAC members and beyond. The 10% discount rate is not grounded on a sound definition, and the concessionality in character criterion, namely that interest rates on loans should be “below the prevailing market rate”, is also unclear. We advocate here for assessing concessionality through risk-adjusted discount rates. Such rates could easily be computed through risk and cost-of-funding proxies. For the sake of simplicity and clarity, as well as practicability considerations, we propose here to set only three distinct discount rates, relying on market and academic data on risk spreads. With such discount rates, one would be able to assess the concessionality of long-term financial instruments such as loans and guarantees. Every instrument found to be priced below private sector terms, proxied by risk-adjusted discount rates, should be considered as concessional. The corresponding grant element would then reflect the donor effort. In doing so, the DAC would restore incentives to operate more with least developed countries (LDCs) and other lower income countries (LICs), and contribute to address the massive long-term capital shortfalls these economies are facing. Based on empirical data, we found that only 10% of committed long-term concessional finance since 2006 was in favor of LDCs and LICs, while upper middle-income countries (UMICs) received nearly 30% of total committed amount. However, loans towards LDCs and LICs are found to be highly-concessional, with an average grant element of nearly 80%, interest rate of less than 1% for average maturities beyond 30 years. Risk-adjusted discount rates and appropriate safeguards (IMF/WB debt sustainability framework as well as concessionality thresholds) would change donor incentives, while better reflecting the operational framework and cost incurred to a greater exposure to LDCs and LICs (use of public money for provisioning uncovered risks, unhedged exposures, regulatory requirements and more broadly “advisory work” to secure enabling conditions for development results).