Western countries, through the OECD, have agreed new rules for themselves on when they are allowed to call loans ‘aid’. The new rules restrict the terms on which loans can be called aid, but still allow governments to make a profit from loans whilst including them in meeting aid targets.
The UK government has not given aid directly as loans in the last two decades, but it has a new policy of considering loans on a case-by-case basis. It does give aid money to institutions such as the World Bank which is then used as loans.
Under previous rules, loans could count as aid with an interest rate of up to 7%. All of a loan was counted as aid in the year it was given, with principal repayments counted as ‘negative aid’ when they were repaid. This system incentivised loans over grants as it allowed current governments to artificially increase the amount of aid they are seen to give, without them baring the consequences of ‘reduced’ aid in the future.
Under the new rules, just the ‘grant element’ of a loan will be counted as aid. The grant element does not mean any grant is given, but is a calculation which is supposed to reflect the cost to the lender of the loan, by comparing how much lower the interest rate is on the loan they are giving, compared to the interest rate they can borrow at themselves.
The old rules assumed the interest rate faced by loan givers was 10%; the new rules still do not use the actual interest rate faced by lenders, but have reduced this to 6%-9% depending whether the loan is to an upper middle income, lower middle income or low income country. The actual interest rate on UK government borrowing for 30 years at the moment is 2.5%.
One justification for this much higher rate (known as the ‘discount rate’) is the risk of not being repaid, which is seen to be higher the poorer a country is (which is not true; there are several upper middle income countries which are riskier to lend to at the moment than some low income countries). However, there is no corresponding commitment to cancel debts which cannot be repaid.
Under the old rules, the ‘grant element’ of a loan had to be at least 25% to count as aid. Under the new rules it has to be 45% for low income countries, 15% for lower middle income countries and 10% for upper middle income countries.
David Roodman has calculated what this means in practise. This is summarised for a 30 year loan below:
So whilst the new rules are more restrictive than the old, the UK and other governments such as Germany, Japan and the US could still give loans at a higher interest rate than they themselves have to pay, make a profit, but count a significant part of the loan as aid.