While there has been massive growth in commercial capital flows to developing countries in recent years, they remain concentrated in just a few countries - mainly those with large markets, good infrastructure and skilled labour. The World Bank and IMF are examining ways in which they can help other developing countries to attract more commercial flows, through the policy reforms attached to their adjustment loans, and through new instruments such as IDA guarantees to reduce risks to investors.
However, the poorest developing countries are likely to remain unattractive to commercial financing and unable to afford it, and will therefore be critically dependent on official financing for many years to come. Even those developing countries which can attract commercial flows still need finance from official sources. Commercial capital is expensive; it is only likely to finance projects with a high rate of return relative to risk; and the benefits tend to be skewed towards urban areas and better-off households. This means that governments concerned with reducing poverty or ensuring a fair distribution of resources will themselves need to finance less commercial projects, such as rural water and power distribution, schools and health services; and this is likely to require official financing.
Increasingly, official capital flows are being channelled through multilateral institutions, the most important of which are the World Bank and the IMF24. In contrast with commercial flows, official finance is:
intended to support economic and social development in order to eradicate poverty; and
not motivated by profit but made available on subsidised terms, and therefore, in principle, affordable to countries for which commercial finance is too costly.25 The questions are then:
are official capital flows sufficiently concessional for the poorest countries?
are the repayment terms of official flows to both low and middle income countries appropriate given that they are likely to be invested in projects whose financial returns may well be small, indirect and slow to materialise? and
will enough official financing be available to meet development needs?
The Bank26 and Fund27 do not have an unlimited supply of resources (particularly concessional resources); and they therefore argue that the interest rates and repayment periods on their loans are constrained by the need for a continuing supply of resources to lend to other clients. This is a reasonable concern. However, if the Bank and Fund’s programmes and projects perform as intended, then the need for new financing should diminish over time, as developing countries become less dependent on official financing and better able to access and afford finance from commercial sources. Thus the Bank the Fund should be able to reduce their lending volume over the long term.