Channelling only a tiny part — one per cent — of the $3.5 trillion of foreign exchange reserves held by developing countries in their sovereign wealth funds to least developed countries (LDCs) can lead to a significant increase in development finance for these countries, claims the Least Developed Countries Report 2011 (LDC 2011), a leading UNCTAD publication.
The report, released today is subtitled 'The Potential Role of South-South Cooperation for Inclusive and Sustainable Development'.
The new proposal for increased South-South financial cooperation builds on the fact that using surplus financial resources from dynamic, emerging developing countries to fund development-oriented investment in LDCs can serve to build productive capacities, facilitate trade and support sustainable development. In addition to increasing access to financing for LDCs, such investments would provide sovereign wealth funds with an opportunity to further diversify their portfolios.
Given the declining prospects for increases in official development assistance from industrial countries facing fiscal austerity and possible limits for private flows due to the crisis, access to new forms of development finance is especially critical for building inclusive development paths in LDCs.
A very fragile global recovery and highly constrained international liquidity conditions call for the creation of major financial mechanisms that could enhance the lending capacity of institutions such as regional development banks. These banks can be significantly expanded to provide low interest loans to LDCs as an essential instrument to facilitate their development strategies.
In the context, UNCTAD is proposing that developing countries with sovereign wealth funds invest one per cent of their assets in regional development banks, for example in the form of increased paid-in capital. It should be done on a voluntary basis.
Generally, regional development banks have performed very well in providing effective development financing, but they require additional resources to fund crucial investments, and this approach could prove to be an optimal vehicle for channelling resources to LDCs. It could facilitate intensified regional infrastructure investment that can promote trade and provide finance for green technologies, it said, adding that the financial details must be drawn up on a regional basis. "Lenders and recipients should agree jointly on precise mechanisms and levels."
Regional development banks, like the Asian Development Bank (ADB), for example, are already playing a key role in facilitating regional economic integration. Greater involvement of the regional banks will enable a greater sense of regional ownership and control of development projects. Regional or subregional development banks often rely on informal peer pressure rather than imposing conditionality. It allows them to disburse resources in a more timely and flexible fashion.
They also tend to better reflect the experiences of successful developing countries, the report added.
Although LDCs have very limited power to negotiate with large global institutions, their voice can be amplified by regional or subregional development banks. Information asymmetries may be far smaller at the regional level. Therefore, regional public institutions may be well placed to provide regional public goods, especially those requiring large initial investments and regional coordination mechanisms.
Good examples include financing regional infrastructure and coordinating the financing of region-wide projects in areas such as technological innovation. Another important function of regional and subregional development banks is financing small and medium-sized enterprises. Financial sectors in most LDCs are mostly unable to fulfil these financing functions, as they remain shallow, underdeveloped and vulnerable to external shocks. In addition, the high level of indebtedness and dependence on foreign capital inflows means that LDCs are exceptionally exposed to external shocks.