On May 28 the report “How predictable is Swedish aid? A study of exchange rate volatility” was launched at a seminar at Medelhavsmuseet in Stockholm.
The report, which is written by Númi Östlund, shows that exchange rate volatility has a large effect on the predictability of Swedish aid and that this in turn has negative implications for aid effectiveness. This is an issue that is as yet not handled well by the Swedish aid apparatus. The aim of the seminar was thus to foster a broader discussion of how donor countries (with Sweden in focus) can work further to manage exchange risks and increase the predictability of aid.
Swedish multilateral aid (usually about a third of the total aid budget) is normally provided in USD. This means that risks associated with exchange rate volatility are born by Sweden -something that we have started to insure against to some extent. Swedish bilateral aid is however given in SEK, which means that the exchange rate risk is born by the recipients. It is these bilateral risks that are the focus of Östlund’s report.
Bilateral aid is channelled through three major channels: Multilaterals, which help manage bilateral aid (Multi-bi), International NGOs, and local organisations (e.g. recipient governments). Multilaterals essentially do their activities in USD, international NGOs use both USA and local currencies, and local organisations work in local currency. The exchange risk thus varies by channel.
In his report, Östlund has done an extensive and pioneering work to estimate how the risk exposure varies. He finds that, over the period 2006-2016, there was an average value change in commitments made in SEK by 7 %. Fluctuations in some instances were of course much larger than that.
Östlund’s study also investigates how volatility is managed in practice – specifically in the cases of Rwanda and Zambia. It is noted that recipients often have to handle complex risk exposures when many donors fund the same project or programme. Sida does not have much of prepared procedures to handle these problems. It is normally done on a case by case basis. When there are exchange rate swings, the recipient discusses with Sida and adjusts the implementation of the programme. When there are more funds available in local currency than planned for one can extend activities and vice versa. Either way this leads to an increase in administrative costs.
One common procedure when drawing up plans is to plan for less than the actual budget allocation, say 80 %, to be on the safe side if the exchange rate fluctuates. This means that around 20 % of the allocated money is tied up as “reserves” or buffers, which means that implementation is held back. This means that aid resources are not used as affectively as they could have been. There are no formal incentives from Sida to budget more of the aid. Recipients manage by implementing enough of the programme to get the next disbursement.
In the contract negotiations, it is not uncommon that the parties agree to use a “depreciated” SEK to allow for the risk of deprecation. This means that the contracted amount in SEK is inflated. The contract value thus does not represent the value (at the day of contracting) of services covered. This does not necessarily mean that Sida pays more for contracted services, since money should either be paid back or used for extensions in case the currency does not depreciate. Still, this means that aid money is locked up and that there are handling cots.
The issue of exchange rate risk is thus currently not part of Sida’s regular operations. Moreover, even if Sida is not exposed to the financial risk, it is certainly exposed to the risk of failing to get the intended development results due to exchange rate fluctuations. The existing uncertainty complicates budgeting and leads to extra administrative costs. This is certainly something that Sida should deal with! It is a rather straightforward way of getting more value for the aid money.
The fact that Sida does not work on these issues is maybe not surprising, since other traditional donors do not do it either. Still, Sida at least does require a discussion with their partner as to how one should handle large swings in the budget. There is one organisation set up by a group of international finance institutions – the TCX Fund – that provides managements services for them. Here one can get help in managing exchange risks.
Östlund argues that the Swedish government has the capacity and competence to manage exchange rate risks. For the major currencies there are many options available, such as forward contracts. These can be handled by the National Debt Office, which helps the Swedish government in such matters. Using this option, Sida could offer predictable funding to many of their partners at low costs.
It is more complicated to deal with the smaller currencies, where there are no market options available. In his report, Östlund suggests that a possible solution could be for Sida to use its guarantee instrument to back an institution that could provide risk management. The TCX fund could be used even if the underlying contract is not a loan but a funding pledge.
In the panel discussion following the presentation of the report, EBA had invited Georg Andrén, secretary general of Diakonia and chairman of CONCORD Sweden; Catharina Cappelin, deputy director at the Department for International Development Cooperation, Ministry for Foreign Affairs; and Alan Whiteside, professor emeritus at the University of KwaZulu-Natal, South Africa. The discussion showed quite a lot of convergence in views as all discussants agreed on the importance of the issue and the value of the proposed solutions.
Georg Andrén started by describing how Sida’s current system of dealing (or rather not dealing) with exchange rate fluctuations pushes the problem onto the end user. In practice, this means that the recipient bears the risks if there is a loss in value due to exchange rate fluctuations, whereas Sida reaps the rewards in the case of gains. Andrén therefore strongly propagated for the need to move risks “upstream” to safeguard against the weakest and most vulnerable organisations in the system having to bear the burden of unpredictability caused by fluctuating exchange rates.
Alan Whiteside highlighted the importance of ensuring increased predictability with an example from the HIV/AIDS sector. In some countries, about 90 percent of treatment costs for HIV are born by international donors. Increasing predictability in foreign aid flows is, in this context, vitally important as minor fluctuations in currency exchange rates can be the difference between life and death for people living with HIV.
Catharina Cappelin from the Ministry for Foreign Affairs explained that there are several good examples from the multilateral sector in terms of dealing with financing issues but that there is a greater need for institutional learning.
Cappelin also announced that the Ministry for Foreign Affairs is already pursuing a dialogue with Sida on how to come to terms with the issue of exchange rate volatility. The message from the MFA was that they are already working with all the three solutions proposed in Östlund’s report. Whether or not we can expect any concrete action in the near future remains however to be seen. EBA will of course follow any progress on this issue closely and hope that we, through the launch of this report and the ensuing discussion, have encourage further reflection and greater awareness about the problem of exchange rate volatility in foreign aid.