UN General Assembly Panel Discussion on Scaling Up Aid October 20, 2006 Macroeconomic Issues and Challenges of Scaling Up Aid Presentation by Elliott Harris, Advisor, Policy Development and Review Department, IMF EDMS: 3092403v1

Introduction and Overview Scaling up to meet the MDGs Resources, policies, and institutions Aid and the MDGs Issues/Challenges Absorbing the aid Fiscal and debt sustainability Predictability and volatility of aid flows

Scaling Up to Meet the MDGs More conducive external environment More effective use of available resources Better policy planning and implementation Improved institutions More resources – external and domestic We all agree on the need for MORE: More conducive external environment – particularly trade liberalization and market access More effective use of available resources – countries need to formulate appropriate policies for poverty reduction and growth and implement them consistently. This requires building up human and institutional capacity; transparency and accountability, and improved governance. But even if there may some debate about the first two points, everyone agrees that the poor countries of the work need considerably more resources if they are to have any chance of reaching the MDGs More resources – both domestic and above all external. Given their needs for large and sustained increase in spending in context of poverty reduction strategies in social sectors, economic infrastructure and productive investments

Aid and the MDGs Recognition of need for : massive increase in external resources donors to increase ODA—Aid to Africa to double by 2010 changes in aid architecture aid effectiveness agenda budget support; funding recurrent costs improvements by recipients Good planning; strengthened systems Absorptive capacity Since Monterrey, there is a general recognition of the need for a massive increase in ODA. Gleneagles Commitment Debt relief initiatives Since Monterrey also, a clear push to improve the overall effectiveness of aid Paris Declaration and mutual commitments Changes in aid modalities – more budget support (general and sectoral; willingness to fund recurrent costs) Increased activities of the global programs and vertical funds The new environment does pose challenges for recipients Need for good poverty reduction programs that give a prospect of reaching the MDGs while allowing for proper and sustainable economic management Need to improve systems for delivering social services, implementing policy, tracking and analyzing results to enhance absorptive capacity

Issues and Challenges of Scaled up Aid Predictability and volatility of aid flows “Absorbing” the Aid Fiscal sustainability Debt management/sustainability All that has gone before is well known and well accepted. What is less well known and accepted is that there are some macroeconomic challenges to scaled up aid that have to be managed as well, if the additional resources are to have the desired lasting effect on poverty. We do not want additional aid inflows to : unduly complicate the planning and implementation of poverty reduction programs destabilize the macroeconomic situation, or lead to undesired outcomes give rise to additional spending that cannot be sustained over time, especially as the aid tapers off; and put countries back into a situation of excessive indebtedness. Let me take each of these points in turn...

Planning and Implementing-- Alternative Scenarios For Scaling Up Use of alternative scenarios What could be achieved with more resources Identify improvements in policies and institutions Scaled up macroeconomic frameworks : consistent with macroeconomic stability balance ambition and realism Donors are more likely to provide more aid if they know how it will be used, and what the likely results will be. So countries can’t wait until the aid is there to start planning how to use it. But, until the aid is there, countries need to continue to manage the economies within the available resource envelope We think that this tension can be resolved by using alternative scenarios  Show what could be achieved with additional resources—clear results-oriented framework  Spell out how policies and institutions would be strengthened to manage the additional resources effectively How one defines the alternative scenario can vary. Some support the need-based assessment approach. What is important is that the alternative scenario map out a realistic path for achieving the MDGs, and spells out also what is needed in addition to more money—capacity, human resources; monitoring and evaluation etc. Many countries will need outside support in preparing such scenarios, including defining costing the programs needed to reach the MDGs. It is important that there be one common approach and one country strategy for this longer term planning, not competing views.

Predictability And Volatility Early commitments for the longer term For effective planning and budgeting Non-volatile disbursements For good economic management Steady effective implementation of programs But a major concern is that aid flows be predictable and not volatile.  Donors should make their commitments of assistance early in the budget cycle of the recipient  Commitments should be for the medium-term or longer even if the outer years can only be indicative due to budgetary restrictions in donor countries. Countries know how much they can reasonably expect and plan accordingly Shortfalls can be identified and filled  Donors and recipients should do what is necessary to allow the aid to be disbursed as planned. Volatile disbursement complicate monetary and fiscal management Lead to interruptions/slowdowns in program implementation Undermine achievement of results

Managing Aid Inflows -“Absorbing” the Aid “Absorption” - Using aid to finance higher imports or reduce domestic resources used for producing exports real resource transfer from abroad, higher current account deficit (excluding the aid) “Spending” – A higher fiscal deficit (excluding aid) that accompanies the aid inflow “Right” mix depends on circumstances Let me turn now to a couple of other challenges The first is ensuring that the aid is effectively absorbed by the economy, that is making sure that the aid is used to finance higher imports or to reduce the domestic resources needed to produce exports. In economic terms, this is different from “spending the resources”. Most people would naturally expect that an increase in aid should lead to an increase in spending. What few realize is that this is only one half of the equation—aid really only benefits the recipient economy when it is absorbed. Most often, the best response to an increase in aid would be to absorb and to spend the whole amount. But there may be situations when another response is appropriate, based on the macroeconomic situation: For example, policy makers might consider it appropriate not to use the aid to increase government spending, but to allow it be absorbed by the local economy if inflation is too high or domestic debt is a problem, or if private investment is much more efficient than public investment. I won’t go into details of the various combinations of spending and absorbing here. What is important is that, in order to achieve the right mix, there has to be a close coordination between fiscal, monetary and exchange rate policies. “Neither absorb nor spend”—no increase in government spending or imports and aid goes into reserves: May be appropriate macroeconomic response where reserves are precariously low and economy is subject to exogenous shocks “absorb but not spend”—no increase in government spending and aid used to slow inflation or reduce the domestic debt May be appropriate “spend but not absorb” – higher government spending and deficit, but aid put into reserves – inflationary and requires similar monetary policy response to any deficitary fiscal expansion— often reflects lack of coordination between fiscal and monetary policy

Fiscal sustainability Current versus future fiscal space Future cost implications Future aid dependency Effective service delivery and resource management The next major challenge is a longer term one. Aid creates immediate fiscal space. Aid can be used to step up spending on critical programs immediately. But policy makers need to look at the longer term as well, and answer some hard questions as they make their spending decisions: What would be the future cost implications? If one expands health or education services now, using aid, will the government be able to maintain that level of spending in the future, when the aid flows begin to slow? Are the systems in place to manage a greater amount of resources effectively, to deliver the expected results? Higher spending now tends to lock itself in, limits flexibility—if aid-financed spending programs increase the share of the budget used for non-discretionary programs, governments have little budgetary flexibility going forward, especially if their own resource base is limited. Aid dependency - Maintaining and increasing domestic revenue effort

Debt sustainability Not all the additional aid will be grants Danger of renewed debt distress from new borrowing Debt sustainability analysis and for debt management systems Private capital flows and emerging donors The next set of issues concerns debt, Many countries have a much greater borrowing space now, because of debt relief, and will want to use this to accelerate their poverty reduction efforts. But no one would want these countries to accumulate again an excessive level of debt - future debt service constrains fiscal space So they must use the new borrowing space wisely, and for that, they will need to analyze the implications of all new borrowing for their medium-term debt situation. Return on investment considerations in new borrowing Contribution of debt financed spending on growth Particular concern: new non-concessional borrowing: The new borrowing space gives countries the ability to take up loans on terms less concessional than ODA, and from other sources, including private capital markets and new/emerging creditors. Often the lending decisions of these creditors are driven by commercial considerations, not the same degree of concern with development. Information about these flows is often patchy. Comprehensive debt management and debt sustainability analysis must take into account all forms of debt, including government domestic debt, private flows, non-concessional borrowing (ECAs) and emerging creditors, as well as borrowing from traditional sources. All creditors/donors should accept that there will be times when additional lending is not in the recipient country’s interest, and be prepared in such cases to increase the share of their aid provided as grants.

Key Messages Countries: prepare early to use scaled up aid PRSs with coherent and costed scaled up programs Linked to MTEFs and annual budgets Strengthened institutions, service delivery systems Alternative scenarios Donors: predictable and longer-term commitments and improved aid practices Both: Careful analysis of fiscal and debt sustainability

Thank you