Financial Economic Analysis of the International Financing Facility Randall Dodd

1. Financial Economic Analysis of the International Financing Facility Randall Dodd Financial Policy Forum John Ruthrauff Interaction January 26, 2005 www.financialpolicy.org

2. I. Summary of IFF Proposal In order to better meet the MDGs by delivering greater amounts of aid in the next ten years, the IFF will borrow against future aid flows by issuing bonds in international capital markets. The IFF will issue bonds that will be collateralized by commitments and pledges of aid from donor governments. The delivery of greater amounts of aid in the near term will greatly facilitate the achievement of MDGs – which in all likelihood will not otherwise be accomplished – by delivering key amounts of development finance. The IFF is designed as a neutral financing mechanism to facilitate the delivery of aid by donor countries. http://www.hm-treasury.gov.uk/documents/international_issues/int_gnd_intfinance.cfm

3. II. Background Even new, higher aid commitments are not high enough to achieve MDGs. Without additional aid, it is almost certain that we will fail to hit MDGs. One reason is that aid is stretched out over many years while MDG targeted are 10 years away. Poor countries will likely fail to achieve sustainable growth because they cannot achieve and sustain sufficient levels of balanced investment. Investment needs to be balanced between health, education, public infrastructure and plant and equipment. Current insufficient amounts of investment mean that an increase in investment can raise the return on investment. Too little new investment leaves overall investment unbalanced and therefore less efficient. Lower returns on investment will harm prospects for sustainable growth.

4. II. Background -- UNBALANCED INVESTMENT Capital High Output Low Output Labor

5. II. Background – INSUFFICIENT LEVELS Growth rate Developing Economy Developed Economy Investment/Output

6. III. Financial Analysis • The IFF provides a solution to the financing shortfall, and to the resulting unbalanced investment. • It does so by raising large amounts of new funds over the next 10 years. • Interest cost of borrowing must be offset by gains from higher returns on “balanced” investment. • Implication: if social-economic returns are not higher than market rate of interest, then front-loading is not justified. • Prospect of “failed” investment requires a back-up plan.

7. Financial Analysis • IFF functions much like a familiar home mortgage Payments Mortgage principal Principal payments Interest payments Time 0 1 30

8. III. Financial Analysis • Costs and Problems • It is a risk or gamble that the front-loaded funds will be used efficiently so that they generate higher returns that justify the future borrowing costs. • Imperfect commitment levels by donor governments. • Capital markets are likely to discount the imperfect commitments by donor governments and thereby raise borrowing costs. • This will be foreign currency exposure by the IFF because the currency denomination of the bonds will be different than that of donations. Alternatively, hedging costs of shifting risk will add cost to borrowing. • The political problem of how to control the leveraged funds and their allocation.

9. IV. Conclusions • It is a risk, but we almost certain to fail to reach MDG if something special more is not done. • It assumes high level of commitment performance, but if commitments are truly forthcoming then likelihood of achieving MDGs is also more likely. In other word, the IFF is less needed. • --

10. FINI