When should concessional loans be reported as ODA?

Members of the Development Assistance Committee of the Organization for Economic Cooperation and Development (DAC-OECD) met in Paris on 15-16 December 2014.  The main objectives of the meeting were to agree on how the measurement of official development assistance (ODA) could be revised to ensure greater transparency and comparability of data as well as to make the concept of ODA better adjusted and fit to today’s global context and the needs of the upcoming United Nations sustainable development agenda.  In particular, members agreed to revise how concessional loans should be reported as ODA.

Under the current system, concessional loans are reported as ODA only if they meet a grant element of at least 25 per cent calculated on the basis of a reference interest rate of 10 per cent. According to the OECD reporting directives, the grant element “measures the concessionality of a loan, expressed as the percentage by which the present value of the expected stream of repayments falls short of the repayments that would have been generated at a given reference rate of interest.” Loans need also to be “concessional in character” to be considered as ODA, though this concept lacked a clear definition and subject to different interpretations compromising data consistency across countries.

However, interest rates have been much lower than the 10 per cent reference rate for quite a while. This has implied that the grant element test could be easily met. Thus, official loans extended at market rates could easily qualify and be treated as ODA. The practice masks true donor’s effort and negatively affects data comparability as flows with different grant element (above 25 per cent) are equally fully treated as ODA. Furthermore, loans are reported on a cash flow basis. This means that ODA flows are boosted when loans are disbursed. Conversely, ODA flows contract when loans are repaid.

Under the new system, to be fully operational in 2018, loan concessionality will be assessed based on differentiated discount rates. These rates will consist of a base factor, the IMF discount rate (presently, 5 per cent), plus an adjustment factor which is an implicit measure of risk. The adjustment factor will be as follows:

  • 1 per cent for upper-middle income countries (UMICs)
  • 2 per cent for lower-middle income countries (LMICs)
  • 4 per cent for LDCs and other low-income countries (LICs)

Thus, the reference rate for LDCs is somewhat lower than the current reference rate, but the change is unlikely to affect the calculation of ODA flows to these countries as most flows are already in grant form (almost 99 per cent, on average, for the period 2012-2013).

Another agreed change is that the reporting of loans that qualify as ODA will be of a grant equivalent basis, that is to say, only the grant portion of the loan will be reported as ODA. Thus, if country A extends a concessional loan of $1,000 to country X with a, say, 65% grant equivalent, only the amount equivalent to that grant element, $650 in this case, will be reported as ODA.  Alongside reporting on grant-equivalent basis, ODA figures will also be reported on a cash flow system.

Additionally, the minimum grant element for concessional loans to be considered as ODA has been revised as follows:

  • At least 45 per cent for LDCs and other LICs;
  • At least 15 per cent for LMICs;
  • At least 10 per cent for UMICs.

As an illustration, and using the OECD grant equivalent calculator, let’s suppose country A lends $3.5 million to upper-middle income country Y. The terms of the loan include a repayment in 10 years, a grace period of 2 years and an annual interest rate of 4 per cent. Under the present system (reference interest rate of 10 per cent), the loan meets the minimum grant element of 25 per cent (25.0968 per cent), qualifies as ODA, and has a grant equivalent to $878,388 but is reported in its entirety as ODA. Under the new system, the reference rate falls to 6 per cent (5 per cent IMF reference rate + 1 per cent as adjustment factor).  The same loan now has a grant element of 9.5678 per cent, which is below the minimum required, and can no longer be considered as ODA. Country A would need to offer more favourable terms for this loan to meet the minimum grant requirement and be treated as ODA. For instance, lowering the lending rate to 3.75 per cent raises the loan’s grant element to 10.7638 per cent. The loan can be treated as ODA and generates a grant equivalent ofof $376,733.

Additional information: OECD-DAC