LDCs Should Direct External Aid toward National Development to Avoid Debt Trap: UN Report

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LDCs Should Direct External Aid toward National Development to Avoid Debt Trap: UN Report

November 20:  The world’s most impoverished nations should proactively ensure external finance from all sources is directed to national development priorities, according to the latest report of the United Nations on Least Developed Countries (LDCs). This approach is the best way to manage their aid dependency and eventually escape it, says United Nations Conference on Trade and Development (UNCTAD)’s Least Developed Countries Report 2019.

According to the report, LDCs account for 15 of the 20 most aid-dependent countries in the world due to persistent shortfalls in their domestic savings, among other factors.

“For LDCs to attain the Sustainable Development Goals and escape aid dependency, they need external finance that is targeted at the structural transformation of their economies,” UNCTAD Secretary-General Mukhisa Kituyi said.

To make this possible, LDCs should take ownership of their development agenda and manage the allocation of external development finance in alignment with their national development priorities. The international community also needs to step up its support towards this common goal, the report states.

It calls for an “Aid Effectiveness Agenda 2.0” to revitalize the aid efficiency agenda consolidated in the 2005 Paris Declaration on the quality of aid and its impact on development. LDCs should be equipped to adjust to a significantly changed aid and development finance landscape.

The developing world has access to a new aid architecture, with a wider array of external finance sources, but this situation has resulted in more complexity and opacity for the most impoverished nations, the report notes.

Moreover, this funding diversity has not translated into meaningful increase in development finance from all sources. Rather it has expanded the number of actors and instruments.

Official development assistance (ODA) disbursements to LDCs have increased by only 2% annually since the Istanbul Programme of Action of 2011 and remain far from internationally agreed targets, the report observes.

“Critically, the linkages between external development finance and national development priorities are weakening,” said Rolf Traeger, chief of UNCTAD’s LDC section.

The sectoral composition of ODA continues to be biased towards social sectors, which absorb 45% of total aid, compared to economic infrastructure and production sectors, which receive only 14% and 8% respectively.

Modern development finance is also characterized by a growing number of complex instruments and declining concessionality - a measure of the "softness" of a credit reflecting the benefit to the borrower compared to a loan at the market rate.

The net result is that LDCs have increasingly resorted to debt financing, more than doubling their external debt stock from US$146 billion to $313 billion between 2007 and 2017. Currently, one third of LDCs are in debt distress or at high risk of debt distress.

“This threatens debt sustainability and economic development potential. These developments are further weakening the limited state capacities of LDCs,” Traeger said.

To reverse the trend, the report urges LDCs to strengthen the management of their development finance. This could be achieved by establishing or reinforcing aid coordination mechanisms, as has been exemplified by some LDCs, such as Rwanda and Lao PDR.

In addition, the report recommends that LDCs clarify decision-making on the allocation of financial resources, project selection and the determination of priority areas and issues. They should devise mechanisms for the efficient disbursement, allocation and use of external finance to safeguard their fiscal space.

In addition, LDCs should carry out the policy reforms needed to expand the tax base and raise revenues, for instance by reviewing low tax rates in natural resources sectors (especially mining) and eliminating tax loopholes and unnecessary exemptions.

 

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