The European Union (EU) is the fourth-largest donor globally with a total official development assistance (ODA) of US$16.4 billion in 2018. As more developing countries reach middle-income status, the European Commission is exploring the idea of adding “policy-based lending” (PBL) to its existing arsenal of development finance instruments. This raises some questions regarding the meaning of “policy-based lending”, the consequences of it and the added value the Commission would bring to the table. Several answers have been given by former or current EC employees.
What is policy-based lending and how does it differ from budget support?
“Policy-based lending is a financial instrument launched by the European Commission to provide financial support to middle-income countries which have a strong commitment to reform their systems. PBL offers greater flexibility criteria including less eligibility requirements during the initial phase and fewer monitoring and reporting obligations, while being much larger in size and shorter in terms compared to the current EU’s budget support. Budget support represents a means to finance partner countries by transferring funds directly to their national budgets, either in fixed or variable tranches, to be managed by national authorities, with the aim of promoting sound public financial policies as well as the development of sustainable national strategies”.
“PBL differs from budget support. EU budget support grants/agreements are subject to four admissibility criteria that are evaluated when a program is agreed and before each disbursement of financial resources. These include (1) appropriate and reliable public policies; (2) steady macroeconomic framework; (3) adequate public economic management, and (4) budget openness and surveillance. EU overall and sector budget support agreements have a duration of three to six years. According to the EU’s Budget Support Guidelines, program execution should ideally be measured using three to ten induced output or outcome indicators, although process indicators may be more suitable in certain contexts”.
What are the consequences of policy-based lending?
“Switching from budget support to policy-based lending will offer emerging countries two perspectives. Firstly, a positive opportunity to take higher responsibilities in borrowing money, cutting down addiction to funding, and, secondly, a negative risk of lending money for political purposes, corrupt management or inappropriate investments, transferring the burden of debt to future generations and/or political enemies. As such, the responsibility of the European Commission will dramatically increase in attributing loans to emerging countries that are still growing to a more stable position in times of chaotic world economy. Defining which countries are able to request policy-based lending will prove crucial, requiring, on top of analytical and statistical references, a deep assessment of political risks”.
“As an element of policy reform, it reflects a process of change and its outcomes are shaped by the complexity of policy issues and associated processes, people and institutions. On the other hand, PBLs are faster and cheaper to prepare and to implement and they generate more income. They allow the European development actors to have continued political influence on the most developed aid recipient countries fostering security in the cross-border frontlines. Nevertheless, the commitment is lower and shorter than that of other instruments and eligibility implies an assessment only when the contract is approved. Still, it has the benefit of an enhanced impact on the implementation of the reforms”.
What is the Commission’s value-add in policy-based lending?
“Apart from the political approach and geopolitical interest, policy-based lending, still being a new instrument, does not yet have the evidence that it adds value to the Union itself. However, the introduction of policy-based lending represents an initiative undertaken by the European Commission in order to spread its influence in developing countries and, by this, boosting its visibility in neighboring countries as a sustainable and supporting financial provider. On the other hand, due to the fact that the instrument focuses on developing countries, it poses the risk of shifting the attention from less developed countries whose need for financial support is way greater, a policy that one could easily contest and criticize”.
“Policy-based lending is a way of offering funding pliability and at scale, with fewer entitlement evaluations, reporting obligations and performance requirements than the EU’s existing budget support grants. It is already used by several important institutions. Presently, in Europe, Germany’s KfW and France’s Agence Francaise de Développement (AFD) are the main developers of Policy-Based Lending. The Asian Development Bank (ADB) is also using Policy-Based Lending. PBL is also used by the International Bank for Reconstruction and Development, the International Development Association (IBRD/IDA), the Inter-American Development Bank, the Inter-American Credit Corporation (IADB/IIC) as well as the African Development Bank (AfDB)”.
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