2.2. Fund-reflow-seeking financial instruments as main products and services

2.2. Fund-reflow-seeking financial instrumentsas main products and services

PDBs and DFIs use fund-reflow-seeking financial instruments, not grants, as their main

mode of intervention. This qualification criterion can help to distinguish PDBs and DFIs from other public entities, such as central banks, whose main products and services do not involve providing financial instruments although they pursue public policy objectives. This qualification criterion helps to further distinguish PDBs and DFIs from grant-executing agencies. A PDB or DFI deploys financial instruments such as loans, equity investments, or guarantees to provide financial support for its customers, whose business model must permit some form of repayment, capital dividends, or risk premium, depending on the type of financing they have received. It should not simply offer outright grants only. The Green Climate Fund, for example, would not qualify as a PDB for that reason, even if it manages a specific private sector facility. However, this does not necessarily mean that repayments will have to cover all borrowing costs. Yet, such an emphasis on clients’ financial discipline does not prevent PDBs and DFIs from extending grants or soft loans with subsidized interest rates in their portfolios if they have governmental support to do so. When seeking to distinguish DFIs from aid agencies by focusing on financial products, the most challenging borderline consideration is how to deal with “concessional loans.” After examining the definition of concessional loans, we decided that concessional loans are more of a modality than an identity when defining PDBs and DFIs. See Box 4 for more information.

Box 4: Concessional Financing

The Development Assistance Committee (DAC) of the Organisation for Economic Cooperation and Development (OECD) has used the “grant element” to determine to what degree a loan is soft (or concessional) to make the judgment on whether a loan should be classified as official development assistance (ODA). The central question concerns how soft the loan is to be counted as ODA in the OECD-DAC aid reporting system (Scott 2017). The OECD-DAC sets 25% of the grant element as the threshold, whereas the OECD-Export Credit Group initially set the bar at 20% and later raised it to 35%, and the International Monetary Fund (IMF) and the World Bank use 35% in their debt sustainability surveillance framework. The seemingly technical definition of concessional loans was born out of political considerations. In the 1960s, the United States urged its allies to step up their aid efforts to counterbalance the Soviet influence in the Third World. The Export Credit Group attempted to make “tied aid” too expensive to be used as a disguised form of trade promotion (Xu and Carey 2015). That is why China’s rise as a development finance provider poses significant challenges to the existing ODA reporting system and export credit discipline; China was not at the negotiating table when the rules were made (Xu and Carey 2014). For the aforementioned reason, operationalizing the criterion of “concessionality” may be arbitrary when drawing the threshold and politically controversial.