(An earlier version of this note was published on the OECD Development Matters blog)
Welcome to 2020 -- the “Decade of Delivery” for the 2030 Sustainable Development Goals (SDGs). While the international development community remains hard at work on solutions, success over the next decade will require addressing an “SDG financing gap” of $5-7 trillion per year, with emerging markets making up $2.5-3 trillion of that. This offers notable opportunities for the private sector across the spectrum of investment vehicles—including foreign direct investment (FDI), listed and unlisted equity and private equity, in addition to debt instruments. Indeed, given the massive buildup of debt over the past two decades—to over 320% of global GDP, from around 230% in 1999—a shift towards more non-debt financing could be a more sustainable approach to closing the gap.
With fewer than 10 years left to achieve the SDGs, many low-income countries (LICs) remain far off-target. At slightly above 50, the LIC median on the composite SDG index—measuring country-level performance in achieving the SDGs—remains well below either mature or emerging markets (though with considerable variation among LICs).
Low-income countries face more acute challenges in funding sustainable development goals
Source: UN 2019 SDG index, IIF
For low-income countries, scaling up SDG investment presents an acute funding challenge. Available estimates suggest that meeting development objectives for education, health, roads, electricity, and water and sanitation in these countries would entail additional annual spending of 15% of GDP. Considering the investment spending already being undertaken to support rapid population growth and urbanization, the average annual cost of achieving the SDGs in low-income countries is expected to exceed 50% of GDP over the coming decade, with financing needs for education, infrastructure and health alone accounting for some 40% of GDP annually. Given the scale of the challenge, real progress on SDG implementation will require effective mobilization of domestic and international capital, both public and private.
For low-income countries, average annual SDG financing needs exceed 50% of GDP
Source: Sustainable Development Solutions Network, IIF
With the public sector still the main source of social and economic infrastructure in LICs, the challenge of meeting high SDG financing needs will add to concerns about debt sustainability.
Financing the SDGs in low income countries could put upward pressure on debt-to-GDP ratios
Source: UN SDG index, IMF, IIF ; SDG index score could be interpreted as the percentage of achievement.
Given persistent budget deficits in many low-income countries—in part reflecting structural problems in tax collection as well as narrow tax bases—general government debt has risen rapidly in recent years, increasing from around 35% of GDP in 2011 to over 50% in 2018. Although mature economies saw a much bigger rise in government debt, and emerging market economies also built up higher debt levels, over 45% of LICs eligible for concessional financing under the IMF’s Poverty Reduction and Growth Trust Program are either already in or at high risk of debt distress. This is in part a reflection of inefficiencies in public investment—nearly 40% of public investment in LICs does not turn into public capital stock. One potential remedy is greater use of public-private partnerships (PPPs), which along with better governance, more predictable tax, legal and regulatory frameworks could improve the allocation and efficient use of public funds. This in turn would reduce pressure on fiscal budgets. However, establishing an effective framework for monitoring PPPs and associated contingent liabilities will be vital to managing key fiscal risks and encouraging private sector SDG financing.
Given that domestic government spending will be insufficient to address SDG gaps for LICs, greater access to external resources must be part of the solution. But adding more external debt financing also poses risks: since 2011, external debt in LICs has increased by some 10 percentage points to over 35% of GDP and is projected to rise further for many given the sustained current account deficits expected over the medium term.
Financing the SDGs could require more external debt—already high in many low-income countries
Source: UN SDG index, World Bank, IIF; SDG index score could be interpreted as the percentage of achievement.
Countries with sizable external financing needs could end up with still larger current account deficits if they are unable to mobilize more domestic resources (e.g., via comprehensive tax reform and policies promoting domestic savings) to finance the incremental costs associated with the SDGs.
Many low-income countries already run high current account deficits that need external funding— making SDG financing still more challenging
Source: UN SDG index, IMF, IIF; SDG index score could be interpreted as the percentage of achievement.; A negative (positive) reading on y-axis indicates current account deficit (surplus)
Another problem for many LICs is lack of transparency about the full extent and nature of their debt obligations—in some cases associated with “hidden debt” and/or poorly understood contingent liabilities, as well as weak governance. The resulting uncertainty can increase the risk of debt distress, constrain market access and/or result in higher borrowing costs—all adding to the challenge of securing SDG financing.
Given the tremendous amount of capital needed to reach sustainable development goals in LICs, over-reliance on traditional debt financing can ultimately prove counterproductive, creating more challenges for the already-vulnerable populations the SDGs are meant to serve. Incentivizing funding alternatives and partnerships that promote non-debt-creating capital flows—particularly FDI and equity finance—can help.
The U.S. is the single most important source of portfolio equity financing for low-income countries; the EU provides more portfolio debt financing
Source: IMF, IIF
However, significant acceleration in such flows would be needed to attain the SDG targets by 2030.
China now has the largest stock of foreign direct investment in low-income countries
Although some LICs have enjoyed a notable rise in FDI over the past decade, non-residential private FDI inflows (excluding debt instruments and reinvested earnings) to LICs make up on average less than 2% of GDP—and have been broadly stagnant in recent years. In contrast, non-residential private debt inflows amounted to some 0.5% of GDP annually between 2014 and 2018—a slight rise from less than 0.2% of GDP between 2009 and 2013.
Official development assistance to LICs has been on a downward trend; private FDI is not picking up the slack
Source: OECD, IMF, IIF
Official development assistance (government aid to promote economic development and welfare in developing countries) could play a greater role in promoting FDI in low-income countries, while fostering social and economic infrastructure development in fragile and less-developed countries. In particular, the strategic use of ODA financing and enhanced risk mitigation could help scale up private non-debt finance—for example, through blended finance, de-risking and public-private partnerships. This in turn could help mobilize much-needed international private capital for SDG-related long-term infrastructure projects. However, despite their vital role in financing the SDGs, ODA inflows to LICs as a percentage of GDP have been on a downward trend since 2003 (Chart 8). While contributions from the 30 members of the OECD’s Development Assistance Committee account for 60% of total ODA flows into LICs, they remain well below donor countries’ 2015 pledges. The international financial institutions can play a more active role in scaling up ODA financing to deliver the SDG agenda, e.g. through poverty reduction strategy processes.
The path forward on SDG financing will obviously vary across countries, but the overall success of the SDG agenda requires global collaboration across a broad range of stakeholders, including international and regional development partners, national governments, and increasingly, the private sector. To make the 2020s a true “decade of delivery” for the SDGs—without also adding decades of debt—facilitating a more targeted, more efficient global allocation of private capital is a vital step.