Channeling UK aid through finance institutions: views on CDC

30 November 2016
Articles and blogs

The UK’s development finance institution (DFI), called CDC, doesn’t usually receive much attention. That changed recently when the Secretary of State for International Development, Priti Patel MP, put forward a bill in the UK parliament to significantly increase the limit on how much UK aid can be allocated to its investment arm. MPs raised some concerns during the bill’s second reading in the House of Commons, but it has now progressed to committee stage.

Meanwhile the National Audit Office (NAO) has just published its review of CDC. Overall, the report was positive, acknowledging the reforms and changes that CDC has made since its critical 2011 report. These include tighter cost controls and strengthened governance. The report also highlights the positive impact CDC investments can have by creating jobs and supporting private sector investment in developing countries.

However, the NAO report also highlighted some serious shortcomings, most particularly CDC’s inability to prove its ‘actual development impact’. Media reports have also covered wider concerns about accountability and transparency.

Despite these concerns, the parliamentary bill would likely mean an increase in funding to CDC if it is enshrined in law, though this will not be automatic. It would pave the way for the Secretary of State to ‘top up’ the £735 million recapitalisation CDC received in July 2015.

Here, three ODI experts offer their thoughts on CDC and the role of DFIs more broadly, based on ODI’s research and analysis.

Joanna Rea, Head of Public Affairs

We need a more balanced assessment

Dirk Willem te Velde, Head of the International Economic Development Group

CDC needs to do better on a range of issues but, on balance, an increase in UK government aid to CDC would be:

  1. In line with global trends of increased funding for working with the private sector for inclusive growth;
  2. Long overdue, as CDC equivalents in countries like the Netherlands and Germany are still relatively bigger (compared to their aid budgets);
  3. Good for growth, productivity and – ultimately – poverty reduction.

A recent report showed that funding is increasingly channelled through DFIs, and we may see annual DFI investments surpass annual official development assistance within the next decade.

This reflects the fact that the global community has assigned specific roles to DFIs to reach the Sustainable Development Goals (SDGs), Paris climate agreement, and outcomes of the 2015 UN Financing for Development Conference.

As I’ve argued in the Financial Times and Guardian, DFI investments are now so significant that they are having an impact far beyond individual projects and can even affect economic growth.

ODI will soon publish statistical evidence suggesting that a £10 billion increase in exposure of DFIs in Africa would raise average incomes and labour productivity by 0.25%. Aid increases (pdf) a recipient country’s gross domestic product (GDP) in the long-term. Our evidence finds that DFI investments increase GDP just as much – if not more so.

It is good to see the NAO acknowledge that CDC has improved on a number of metrics since its last report. But there are three things CDC can still do better:

First, I agree with some critics that DFIs can be more transparent and provide more information about their operations (they have gone a long way – but more can be done).

Second, CDC’s impact measures are much improved and rank amongst the best used by DFIs and aid agencies. However, it can do better at demonstrating how it affects productivity and should conduct a few detailed impact assessments.

Third, the NAO report rightly emphasises the need to more closely examine its attribution of effects to its work. But cracking the attribution nut is not easy, as our evaluation of the Netherlands Development Finance Company (FMO) (pdf) shows.

Different tools for different jobs

Paddy Carter, Research Fellow

Trickle-down economics alone is not good enough at helping the poorest and most marginalised, which should be the priority of aid spending. It takes too long for the benefits of growing sectors of the economy to spread, especially given the 2030 deadline of the SDGs.

But the poor and marginalised also need the countries they live in to get richer, not least to generate government revenues to pay for decent public services and social protection. And that requires electricity and telecoms and factories and banks and all the other building blocks of a productive economy. 

To help the poorest and most marginalised, the ideal policy mix would be some combination of measures targeted at them directly and those aimed at accelerating economic transformation and the growth of the formal sector. Evidence suggests economic growth is driven by the formal sector and informal firms tend to disappear rather than formalise.

There is such a thing as the division of labour, and criticising CDC for lacking immediate impact on the poorest misses the point that the UK Department for International Development (DFID) needs different tools for different jobs. Other parts of the aid budget can (and should) be spent trying to raise the incomes of subsistence farmers or urban informal traders.

As the NAO report notes, CDC struggles to provide evidence of its development impact. Elsewhere I discuss some of the problems involved in generating evidence about the impact of CDC, and there is an extended version of this blog available.

CDC’s proof of impact is long overdue

Judith Tyson, Research Fellow

Only economic growth and job creation in poor countries can end poverty on a permanent basis. In this regard, CDC’s mission is spot on.

But there is a big problem. As the NAO report highlights, CDC is unable to prove that this is what it’s helping achieve or that private investors can’t do it better than it can. 

This is exemplified in the ‘slow’ progress on developing impact measures for employment, the unused £5 million budget for doing so, and the failure to appoint a senior evaluation specialist.

The NAO also report that CDC is unable to demonstrate that their financing is being applied in countries and sectors where private investors are absent.

If they can’t show this, they may be simply be wasting public funds on deals that would have been done anyway.

They have tried to tackle this through a new policy that limits investments to low-income countries, which is a good step. But the policy also determines ‘priority sectors’ for investment that, in reality, are awash with private equity money, such as telecommunications and financial services in Africa.

The obvious solution is more testing conditions for selecting countries and sectors to invest in. However, this solution is not an easy one due to a fundamental contradiction in CDC’s mission: its need to make investment returns of 3.5% as well as achieve development impact.

The reality is that this is only achievable if it makes low-impact, high-return investments to bolster its overall portfolio return. This has led, as the NAO reports, to almost a quarter of investments failing to meet even the current low bar for development impact goals.

This failure to demonstrate development impact appears to partially stem from what the NAO describes as DFID’s ‘confusion’ about oversight of investment decisions and ‘not hav(ing) officials with the depth of commercial investment experience’ to provide it.

As the NAO concludes, there is a ‘significant challenge’ for CDC in demonstrating it can, and is, meeting its mission.

For an organisation responsible for managing what will be more than £16 billion in public funds for development, this is inadequate.

Either DFID or CDC should provide more convincing evidence or the £16 billion should be used elsewhere.