DFIs lend and invest money – public money or publicly guaranteed money – to private sector companies operating in developing countries. The activity of DFIs has come under close scrutiny from several civil society organisations, including Eurodad, as well as think tanks and academics, investigating whether they are truly delivering development outcomes.
The challenges of estimating the ‘true cost’ of DFIs
Evaluating the cost of DFIs to the public sector is not easy and remains poorly understood and researched. Most DFIs, either multilateral or bilateral, are owned by governments and often benefit from public transfers and support when conducting their activities. These can be translated into financial benefits for private sector beneficiaries working with DFIs (companies and funds), either through direct subsidies or indirectly through the conditions under which DFIs operate - for example, tax exemptions or cheaper borrowing costs thanks to state guarantees. Governments’ support to DFIs involves a cost to the public purse (taxpayers) which can be real (if there is an actual transfer of resources from governments) or potential (for example if governments promise to bail them out if something goes wrong).
New research: first comprehensive framework to assess DFI operations
Over the past year, Eurodad has undertaken a research project to contribute to this debate by identifying methods that could potentially be used to quantify the cost of DFIs to the public purse. As part of this, we commissioned a discussion paper that proposes for the first time a comprehensive framework to assess the costs of DFI operations. We also organised an expert seminar to discuss the main implications of this work.
Our research explores and classifies the types of subsidies that are present in most DFIs operations. It points to a huge variety of methods, some obvious – for instance transfers of funds reported as Official Development Assistance (ODA) – and some you may not have thought of – for instance tax exemptions granted to multilateral DFIs, such as the World Bank’s International Finance Corporation (see the full list below). It also points out how huge the gap in knowledge is on the impacts of these subsidies, which refers to a familiar tale of how the benefits are being oversold without good evidence to substantiate them. As previous Eurodad research, A private affair
shows, DFIs face serious challenges when demonstrating the effect their investment have on poverty reduction in developing countries, including a reduction in inequality, impacts on women’s rights and those of marginalised groups.
Here is a list of subsidies in relation to DFIs:
a) Subsidies from taxpayers to DFIs
I. Cash transfers (ODA)
II. Subsidised loans
III. Equity stakes and paid in capital (with no expectation of dividends)
IV. Implicit or explicit sovereign guarantees
V. Exemptions from indirect taxes
VI. Exemptions from income and employment taxes
VII. Exemptions from corporate taxes
VIII. Intangible support (i.e. a ‘seal of approval’ from the host government, access to privileged host government information or diplomatic support from shareholder governments)
b) Subsidies direct from taxpayers to DFI clients
I. Grant co-financing (using ODA)
II. Intangibles (i.e. a ‘seal of approval’ from the host government, access to privileged host government information or diplomatic support from shareholder governments)
c) Subsidies from DFIs to their clients
I. Interest rate subsidies
II. Longer maturities on loans
III. Grace periods on loans
IV. Absorbing exchange rate risk
V. Expectation of lower returns on equity stakes
VI. Guarantees and risk insurance
VII. Lower / Fewer fees
VIII. Technical Assistance
The methodology that has been produced as part of this project estimates the value of each of these subsidies. For each type of subsidy, we considered the likely extent of subsidies, we reviewed potential methods for estimating the subsidy and we considered data requirements for these methods. Below is a summary table that shows that the situation is different for bilateral and multilateral institutions.
Finally, we explored the technical and practical challenges of implementing the methodology, for instance:
- the lack of an agreed typology of DFIs. Although the Development Assistance Committee of the OECD has increased its work on the area, this is still controversial;
- the best approach to choose: ‘social opportunity costs’ of government resources – i.e. the next best alternative use of that money by the government versus the value of the subsidies to private sector companies;
- different ways of estimating the costs of sovereign guarantees, approaches and challenges;
- potential double counting problems and solutions;
- how to value intangible support; and
- data availability, obstacles and the impact on the work that can be done.
Eurodad has repeatedly called for a full review of DFI operations from a developing country perspective. With the increased prominence of DFIs as players in the development finance arena, this review – including the full costs and benefits – and the debate that it can steer, becomes more relevant than ever.