​Yesterday the OECD’s Development Assistance Committee (DAC) agreed new arrangements for reporting and classifying the aid element of loans provided by its members. Under the new rules, only the concessional element in loans will now count as 'aid'. Mark Lowcock, Permanent Secretary of the UK’s Department for International Development, chairs the group leading on these new arrangements. Here he blogs about yesterday's breakthrough.

The DAC reached agreement on the new rules yesterday. You can see the detail in the communique (pdf). There is also a very well presented description of what we have agreed, by David Roodman, one of the most thoughtful commentators on the topic.

This is quite a complicated technical set of issues, and it is not always easy to understand what is really going on. The purpose of this short note is to set out why the issue matters and why, in my opinion, the new arrangements are a major improvement on what they replace.

Why does it matter? Most of the world’s richer countries have committed themselves to provide 0.7% of their national income as official development assistance (ODA). That is a lot of money. Of the $130 billion currently provided each year as ODA, some $30 billion is in the form of concessional (i.e. cheap) loans. The DAC sets the rules for ODA, including for loans. A professional team in the OECD is responsible for ensuring that all members follow the rules, and for providing statistical and other reports on who is doing what, where.

When the rules were first set, over 40 years ago, it was agreed that in order to score as ODA, a loan must have a grant element of at least 25%, calculated at a discount rate of 10%.

At the time, that discount rate seemed reasonable in relation to prevailing global interest rates, and the cost of borrowing faced by DAC members. Over the last decade and more, however, interest rates in OECD countries have been much lower. And lending from some DAC members has significantly increased. As one person familiar with the situation put it to me privately:

'Some DAC members are borrowing at 1% or less, lending at 3-4%, making a profit, and getting the same credit in the ODA system as those giving away the same amount of money in the form of grants. Moreover, the incentives encourage lending to better off countries, not to the poorest countries where most of the problems the DAC is supposed to be trying to help solve are most concentrated.'

Various efforts were made over the last ten years to modernise the system. None were successful. The more time passed, the more the system – and the DAC itself – started to fall into disrepute. Standard setting bodies are only valuable if they are respected. 

How is the new system better than what it replaces? In six important ways:

1. It incentivises (i.e. rewards, in terms of the amount of ODA recognised) the provision of aid in the form of grants rather than loans, and within the lending components, it incentivises cheaper loans over more expensive ones.

2. It incentivises lending to least developed and other low income countries (where most of the problems the DAC is concerned with tend to be concentrated) over lending to middle income countries.

3. It provides additional safeguards to rule out ODA loans to countries where the IMF and/or World Bank think there is a risk of excessive debt being built up.

4. It retains scope to associate ODA lending with other development finance.

5. It is more transparent: full details of all ODA lending will be made public, and figures will be published showing how the new system compares with what would have been reported under the old one.

6. It provides for regular review and updating as the wider world (eg global interest rates) changes.

Commentators have made various interesting suggestions for how the system could be better still. It is not really for me to comment on that. One thing I think everyone agrees is that the new system is better than the old one. I am very grateful to my American, Belgian, French, German, Japanese, Swedish and European Commission colleagues on the group, and to the professional staff of the DAC Secretariat, for their help in achieving that.