British MPs have called for the UK to give more of its aid money as loans, which developing countries would have to pay back.
In a wide-ranging report on the future of UK aid, published on Thursday, the international development select committee says the focus of UK aid programmes to many developing countries should shift from grants to loans and other financial instruments by 2030.
"It is getting increasingly difficult to make the case for giving aid in the form of grants to MICs [middle-income countries]," says the report, adding that loans to poorer countries could also be appropriate in certain cases.
But critics say a shift to lending could overburden developing countries with debt. Meanwhile, the international rules on how donors can count loans as aid have come under attack in recent years for allowing countries to lend at high interest rates.
Last year, Richard Manning, former chairman of the Organisation for Economic Co-operation and Development's development assistance committee, said the current rules were encouraging finance ministries to "get away with murder". In January, the European Network on Debt and Development accused rich countries of profiting from their aid budgets. It said developing countries already faced interest payments of almost €600m (£500m) a year on aid loans from European donors.
Oxfam's head of UK campaigns, Sally Copley, warned that giving loans instead of aid "risks leaving the poor behind and exacerbating inequality".
"The UK should not replace traditional aid with loans, firstly because there is a lack of evidence that this has any real impact in helping the poorest and secondly because it risks increasing countries' debt," she added. "We are also concerned that channelling aid through financial intermediaries – such as banks, hedge funds or private-equity funds – lacks transparency about where the money actually reaches the people it is supposed to be helping, and meets the environmental and social standards."
The UK Department for International Development (DfID) has for decades dealt almost exclusively in grants, although it is starting to experiment with loans and equity in its support for private companies in developing countries.
"If these businesses are successful and make a profit, the money will be returned and redeployed, multiplying the development impact," the development secretary, Justine Greening, said in a speech at the London Stock Exchange in January. "This is smart aid, and I want this to be a major part of how DfID works in the future."
The select committee's report acknowledges that there are risks involved in a move to loans. It says: "There are, sadly, many examples of poor use of aid in past years on private investments and large public sector infrastructure projects, which failed to deliver long-term development benefits commensurate with their cost, but nevertheless left the countries concerned with high levels of development debt, which in the case of many least developed countries was eventually written off by donors."
Witnesses contributing to the committee's inquiry warned that tracking the development impact of loans can be particularly difficult. The UK Aid Network and Bond, which represents NGOs in Britain, argued that any increase in loans must be judged against risks, including "lack of transparency, lack of evidence of impact or very long evidence chains".
The report says DfID will need to develop a more explicit strategy on how best to spend its money and consider what new expertise it would need to start giving loans. It suggests the government should consider setting up a separate development bank.
The committee says grants should continue to be used to fund health, education and other basic needs in low-income countries, in cases of emergency relief, and in conflict areas. But grants to middle-income countries should be used only where no other form of finance is possible.
Diana Noble, chief executive officer of the CDC, which lends to private companies in developing countries, cautioned against any rapid change in the DfID's focus. "It really takes time to scale up teams and strategies," she told the committee.
"The history of CDC shows that the biggest disasters happened when CDC rushed into a market too quickly, without really understanding what worked at small scale and before accelerating investment over time. One of the big challenges will be to resist the temptation to give a new team a big pot of money and incentivise them to spend it quickly."
The committee's 200-page report on the future of UK development co-operation also looks at lending to the private sector and funding via multilateral institutions such as the UN and World Bank. It says the DfID should do more to help developing countries share knowledge and skills, and calls on the department to set out what steps it will take to help reduce global inequality.
The committee plans to hold a separate inquiry into the future of climate finance and proposes an investigation into the DfID's work with the private sector.
A DfID spokesman welcomed the report. "We are already using returnable loans and equity to help create jobs in developing countries. This is a totally new way of using our development budget because, unlike traditional aid grants, we expect our investment to be returned so that we can reinvest it," he said.
"Economic development is now a core priority right across the department, as creating jobs and growth is absolutely the only way of ending poverty. We are looking at a wide range of new ways to boost economic development and work with the private sector."
In 2005, EU member states pledged to increase Official Development Assistance (ODA) to 0.7% of Gross National Income (GNI) by 2015 and included an interim target of 0.56% ODA/GNI by 2010.
These were based on individual targets of 0.7% ODA/GNI for the EU 15 and 0.33% GNI for the 12 Member States which joined the EU in 2004 and 2007, according to the European Commission.
EU countries that were already at or above 0.7% ODA/ GNI pledged to sustain their efforts. The EU heads of state and government reaffirmed their commitment to reach the 0.7% target by 2015 at the European Council on 7/8 February 2013.
A Eurobarometer survey from October 2012, said that 85% of polled EU citizens believed that Europe should continue donating aid to developing countries.
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