2011 Report On Financial Resource Flows - OECD

GROWTH IN FRAGILE STATES DECLINING SINCE 2008Although fragile states are largely isolated from international financial markets and were thus insulated from the initial stages of the 2008financial crisis, the subsequent economic downturn led to a sharp fall in growth after 2008, with fuel exporters particularly hard-hit (see graphbelow).Looking ahead, growth in fragile states may rebound. Growth projections for fragile states are at 6.9% in 2012. These projections are morepositive than those for the overall world economy (3.3%) and the collective projection for emerging and developing countries (5.4%) (IMF, 2012).Most notably, Niger is expected to grow by 12.5% in 2012 and Angola by 10.8%. Not all fast-growing fragile states are fuel or mineral exporters:Ethiopia is expected to achieve a 5.5% growth rate in 2012, and almost 10% between 2013 and 2015. As for commodity exports, prices areexpected to fall from their 2010-11 levels, but the risk of further price volatility still remains high (OECD-FAO, 2011).At the same time, there is a risk of new or aggravated situations of fragility. The societal pressures for change that brought about the ArabSpring, the possibility of prolonged financial turmoil, continued commodity price volatility, rapid urbanisation, youth unemployment, demographic pressures and environmental degradation are all factors that will challenge state stability and resilience. Between the projected negativegrowth in the Eurozone for 2012 (IMF 2012) and continued pushes for fiscal austerity, aid budgets are under pressure. Fragile states maytherefore face not only more challenges to stability but also less international development support.30%25%25%20%20%15%15%10%10%5%5%0%0%growth (% CHANGE IN gdp; IN constant usd)30%2001-10%2003200420052006200720082009-5% FUEL-EXPORTING FRAGILE STATES200120022003% OF TOTAL EXPORTS NON-FUEL MINERAL EXPORTERS200420052006% OF TOTAL EXPORTSOTHER FRAGILE STATES200720082009Angola98.6DR eshNigerChad90.8Sierra Leone54.3BurundiKorea, DPRNigeria90.5Papua New Guinea54.0ComorosPakistanYemen90.1Burkina Faso40.7EritreaSao Tome & PrincipeSudan88.5Central African Rep.35.8EthiopiaSolomon IslandsCongo81.3Georgia33.7Guinea BissauSri andaCôte d’Ivoire32.6LebanonUzbekistanLiberiaWest Bank & GazaData: UNCTAD / World Bank (2011)-5%2002Data: World Bank (2011).35%MalawiDAC INTERNATIONAL NETWORK ON CONFLICT AND FRAGILITY (INCAF) 5

Foreign direct investment (FDI) and remittances: These financial flows have continued to grow throughout the crisis in bothfuel-exporting and other fragile states. Remittances to fragile statesovertook ODA volumes in 2008.ODA: The percentage of bilateral ODA from DAC countries to fragilestates is shrinking: from 53% in 2005 to 35% in 2009. BilateralODA from DAC countries to fragile states fell by 35.6% during theperiod 2005-09 (constant prices). This decline is explained by thefact that ODA in 2005 and 2006 included exceptionally high debtrelief, particularly for Iraq and Nigeria (see Figure 12). When debtrelief is excluded from the equation, ODA to fragile states increasedslightly over the same period (12%). It is also worth noting that ODAhas been less affected by the 2008 financial crisis than other flows,such as domestic revenue and trade. Between 2008 and 2009,DAC donors cut their ODA to all countries by 1.6%. In fragile statesthis figure was 11.2%. The fragile states that lost the most ODAbetween 2008 and 2009 were Iraq (-72%), North Korea (-67%)and Liberia (-58%).Domestic revenues: There was a dramatic contraction of domesticrevenues between 2008 and 2009, threatening cuts in education,health and social protection programmes. In Kenya, for example, domestic revenues contracted by half in the two-year period. In Angola,the economy contracted by 10.3% in 2009, in response to which thegovernment indicated budgetary cuts of 40% (see Box 1).Trade: The overall trade deficit has worsened since 2005. In 2009,40 out of 45 fragile states faced a trade deficit — all of them witha trade deficit exceeding 6% of GDP (see Figure 4). No Africancountry exceeded USD 250 billion in merchandise trade in 2010.For Africa, fuels and mining products constitute the main exports,accounting 66% of their total merchandise exports in 2010 (WTOInternational Trade Statistics 2011).In addition, fragile states suffer from illicit outflows of capital,which are estimated at USD 1.3 trillion globally, in addition to legal forms of capital flight.2 Illicit flows from the 48 least developedcountries (LDCs), of which 43 are affected by a recent conflict,have increased from USD 9.7 billion in 1990 to USD 26.3 billion in2008, a nearly three-fold increase (UNDP, 2011). For example, anestimated USD 2 billion in illegal narcotics trade transits through2Illicit flows are defined as “flows of money associated with tax evasion, criminalactivity such as drug trafficking, and corruption and theft by government officials” (Task Force on Financial Integrity and Economic Development, 2011).West Africa every year (UNODC 2009). An estimated 90% of goldexports from the Democratic Republic of the Congo (DRC) go undeclared (Global Witness, 2009). These huge outflows fuel instability,exacerbate poverty and limit the domestic resources available tofinance development (See OECD, 2012).Peacekeeping expenditures: In 2011, ten fragile states hosteda UN peacekeeping mission, with a combined budget of nearly USD7 billion, of which nearly USD 1.7 billion for UNAMID (Darfur) andUSD 1.5 billion for MONUSCO (DRC). In DRC, UN peacekeepingexpenditures represented half of the country’s ODA in 2009.3Are fragile states raisingdomestic revenues?Raising domestic revenues is essential to build capable states, toencourage engaged societies and to strengthen domestic accountability. Raising taxes in order to reduce aid dependency is an explicit goal for several fragile states (e.g. Liberia). Many developingcountries, including DRC, Haiti, Mozambique, Nicaragua, Rwandaand Sierra Leone, have implemented far-reaching administrationreforms since the early 1990s. Where these reforms have enjoyedsuccess, a common factor has been sustained political commitment at the highest levels (IMF, 2011b).Between 2005 and 2009, domestic revenues alone representedhalf of the total resource flows in fragile states — over USD 230billion in 2009. All but four fragile states managed to mobilise government revenue representing more than 15% of GDP in 2009which is usually considered a reasonable target for developingcountries. But compared to 2008, when 12 fragile states mobilised35% or more of their GDP in tax revenue, only four fragile statescontinued to manage this level of mobilisation in 2009 (IMF 2011a)(see Table 2).3Peacekeeping includes developmental and non-developmental activities, and isgenerally not counted as ODA, except i) the net bilateral costs to donors of carrying out the following activities within UN-administered or UN-approved peaceoperations: human rights, election monitoring, rehabilitation of demobilisedsoldiers and of national infrastructure, monitoring and training of administrators,including customs and police officers, advice on economic stabilisation, repatriation and demobilisation of soldiers, weapons disposal and mine removal.(Net bilateral costs means the extra costs of assigning personnel to theseactivities, net of the costs of stationing them at home, and of any compensationreceived from the UN.); and ii) similar activities conducted for developmentalreasons outside UN peace operations.box 2.Central African Republic: oda offsets reductions in other resource flowsIn the Central African Republic (CAR), 2006 and early 2007 saw a worsening of the conflict between the Union of Democratic Forces for Unity-led rebels and government-led forces, before a peace agreement was signed in April 2007.Over this period, there was a significant drop in domestic revenue (27%) and FDI (32%). During the same period, ODAnearly doubled to USD 118 million. Though overall resource flows were lower in 2007 than in 2006, the rise in ODA helpedcompensate for the 2007 fall.Source: OECD-DAC (2011)6 FINANCIAL RESOURCES FLOWS IN FRAGILE AND CONFLICT-AFFECTED STATES: 2011 REPORT

TABLE 2. government revenue (2009); in % of gdp15-25%6.11 Uganda25-35%35-45%15.10 Yemen25.0015.40 Papua New Guinea27.45 GuineaUzbekistan 45%36.72Solomon Islands49.8041.00Iraq71.73Bangladesh10.50 SudanSri Lanka14.53Eritrea15.91 Georgia29.27Kiribati78.39Pakistan14.70Central African 9 Angola30.86Timor-Leste347.93Zimbabwe16.71São Tomé and roon18.38Togo18.47Niger19.11Burkina Faso19.36Côte d'Ivoire19.49Sierra ikistan23.41Kenya23.67Congo, Dem. Rep. of24.32Congo, Rep. of24.32Lebanon24.35Guinea-Bissau24.80Data: IMF (2011). Note: Data unavailable for DPR Korea, Somalia and West Bank & Gaza. 15%MyanmarFigure 4. TRADE IN FRAGILE STATES (2009) IN USD BILLIONS-14-14-12-12-10-10-8-8-6-6-4-2-200Cote d’IvoireMyanmarAngolaNigeriaCongo, Rep2 24Sao Tome & PrincipeSolomon IslandsComorosCentral African Rep.Sierra LeoneSomaliaBurundiGuineaZimbabwePapua New GuineaTogoKorea, Dem. Rep.MalawiCongo, Dem. Rep.LiberiaBurkina ri PakistanNote: 2009 trade data unavailable for Afghanistan, Eritrea, Guinea-Bissau, Iraq, Kiribati, Timor-Leste, Uzbekistan, and West Bank and Gaza. Source: UNCTAD (2011), Exports and Imports of Merchandise and Services (1980-2010).DAC INTERNATIONAL NETWORK ON CONFLICT AND FRAGILITY (INCAF) 7

This is not the whole story: In all countries, the size of thetax base matters just as much as the overall volume of taxesassessed. When governments depend on a large number oftaxpayers for revenue, rather than only a few (e.g. multinational oil and gas companies), they have incentives to promotebroad prosperity and to be responsive to their citizens. Therise of a middle class in many fragile states presents an opportunity to enlarge this tax base, for example by introducinga value-added tax (VAT). In Africa, an estimated 60 millionhouseholds earn over USD 3,000 annually, and this numberis set to reach 100 million households — the current size ofthe Indian middle class — by 2015 (The Economist, 2012).Burundi introduced a national value-added tax (VAT) in 2009,and Sierra Leone and Liberia did the same in 2010.What about trade and fragile states?Trade, both formal and informal, provides thousands of jobs,including for women and youth. Informal trade alone providesan estimated 20-75% of total employment in most Africancountries (UNECA, 2005). In macroeconomic terms, however, fragile states’ total trade deficit has worsened alarminglysince 2005. The total trade deficit in fragile states reachedUSD 66 billion in 2009. Among the five fragile states thatregistered a trade surplus, three are fuel exporters. At theextreme, Haiti has a trade deficit of 26% of GDP.In addition, most fragile states’ exports remain poorly diversified in terms of sectors. Twenty out of 45 fragile states arenatural resource-dependent (i.e. fuel or minerals representmore than 25% of exports), which makes them dependenton boom-and-bust cycles (see Boxes 1 and 3). Both fuel andnon-fuel primary commodity prices peaked in 2008 beforehitting a five-year low in early 2009.Most fragile states’ exports are also poorly diversified interms of destination markets. Although exports to emerging markets accounted for 19% of African exports in 2009,growing from 8% ten years earlier (OECD-UNECA, 2011),exports from African fragile states (57% of all fragile states)remain oriented towards OECD markets, for which projections are sluggish.Are fragile states attracting FDI?Foreign direct investment (FDI) represents a major portionof gross capital formation (total spending on investments) infragile states.FDI is a source of economic development and modernisation,growth and employment. But the benefits of FDI do not accrueautomatically and evenly across countries, sectors and localcommunities. Despite the fact that fragile states rank at thebottom of international business climate and corruption indexes(see Table 3), FDI to fragile states grew almost fourfold from2000 to 2009, to USD 214 billion in 2009. However, the majority of this FDI (57%) went to the 11 fuel-exporting fragile states(see list on page 5 and Figure 5), as well as to Lebanon (mostlyin real estate) and Pakistan (communications and finance).8 table 3. E ASE OF DOING BUSINESS AND CORRUPTION:FRAGILE STATES RANK AT THE BOTTOM (2009)DOING BUSINESS RANKINGS(2009)CORRUPTION PERCEPTIONSINDEX (2009)181Congo, Dem. Rep.180Somalia180Central African 8Congo, Rep.176Sudan177Burundi176Iraq176São Tomé and inea168Guinea170Timor-Leste168Equatorial uatorial Guinea162Kyrgyzstan166Mali162Guinea-Bissau165Lao PDR162Congo, Dem. Rep.164Cameroon162Congo, Côte d’Ivoire158Lao PDR160Mauritania158Central African n157Liberia154Paraguay156Sierra Leone154Papua New Guinea155Comoros154Côte 152Iraq146Timor-Leste151Gabon146Sierra Leone150Bolivia146Russian Federation149Senegal146Kenya148Burkina 3Cape anon131West Bank and Gaza130Honduras130Gambia, The126Tanzania FRAGILE STATESSource: World Bank (2011), Transparency International (2011).FINANCIAL RESOURCES FLOWS IN FRAGILE AND CONFLICT-AFFECTED STATES: 2011 REPORT

Figure 5. FDI IN FRAGILE STATES (2009) IN USD cipePríncipeSão morosComorosKiribatiKiribatiWestAdm.Bank &AreasGazaPalestinian40.0 0.010.020.030.050.0FUEL-EXPORTING FRAGILE STATESNON-FUEL MINERAL EXPORTERSOTHER FRAGILE STATES40.050.0Source: UNCTAD / World Bank (2011)box 3.Aid, tax and responsible minerals in dr CongoThe Democratic Republic of Congo (DRC) is highly aid-dependent, with an ODA to GNI ratio of 22.6% in 2009(compared to an average of 3.9% across all fragile states). DRC also depends on the international community forsecurity, hosting the largest UN peacekeeping operation after that in Darfur, representing over 16,000 troops anda budget of USD 1.4 billion for 2011-12. However, there is potential for DRC’s aid dependency to subside over thecoming years: growth projections are optimistic, and there is a unique opportunity to reform the mining sector (e.g.recent legislation and measures in response to the US Dodd-Frank Act; initiatives for the transparency of paymentsmade by multinationals to government and for responsible sourcing of minerals).In 2010, the economy began to recover from the global financial crisis, with GDP growth estimated at 7% (up from2.8% in 2009). This growth was largely driven by mining, a sector boosted by increasing commodity prices and sizableinvestments in infrastructure. Minerals accounted for 73% of exports in 2000-06, and represent the largest source ofFDI in the country.If current efforts to sever the link between conflict and minerals (OECD 2011d) and to improve the business climate succeed, the mining sector is expected to remain an engine for growth. With improved domestic revenue mobilisation, the mining sector could contribute up to USD200 million annually (20-25% of GDP) by 2018. This would represent one-third of total tax receipts and thus contribute to improved welfarefor ordinary citizens. In 2005, receipts from the mining sector amounted to only USD 27 million.Source: ODI (2010), OECD (2011d, 2011e) and World Bank (2008, 2011).DAC INTERNATIONAL NETWORK ON CONFLICT AND FRAGILITY (INCAF) 9

When looking at either need or performance, 12 additionalcountries appear as potentially under-aided: BurkinaFaso, CAR, Chad, Comoros, DRC, Eritrea, Ethiopia, GuineaBissau, Myanmar, Togo, Uganda and Zimbabwe.The sources of FDI are shifting. In 2009, South-South FDI accounted for 14% of total FDI going to developing countries, from4% in 1998 (UNCTAD 2011). For example, outward FDI from Indiato Sudan is estimated at USD 730 million annually (2001-05 average), from China to Nigeria USD 131 million (2003-09) and fromBrazil to Angola USD 83 million (2001-07 average) (Mlachila andTakebe, 2011). Is aid going where it is needed most?Aid volumes continue to be very concentrated. Half of ODA to fragilestates goes to only eight countries (see Figure 7). This concentrationhas increased over the past decade, and aid projections (2009-12)confirm this trend. There is a growing risk that countries of lessergeopolitical importance and/or that are mired in chronic crisis willfall further behind. In 2009, nine of these countries received lowerODA levels compared to 2000 (in constant terms). A more optimalallocation of resources across countries, taking into account boththe need and the quality of a country’s policies and institutions, isin order.Fragile states receive more aid per capita than the average developing country, and this has been the case since at least 2000. In2009, the average amount of ODA per capita to fragile states wasUSD 39, whilst the average across all developing countries wasUSD 17. This is generally justified by the level of need (as measuredby low income and/or levels of poverty) which is higher in fragilestates than in non-fragile developing countries.However, most global resource allocation formulae are based notonly on need, but also on performance. While fragile states generally have higher needs, they also have weaker policies and institutions, which constrains their ability to absorb aid and use aidstrategically to deliver transformative results. Factoring in both needand performance, would some fragile states warrant more aid, andif so, which? A recent review of four resource allocation formulae showsthat four countries can be considered under-aided onthe basis of both need and performance (i.e. should receivemore ODA given high needs and ‘good enough’ governance):Bangladesh, Guinea, Nepal, and Niger (OECD 2012b).Half of aid to fragile statesgoes to only eight countriesTo which sectors does aid go?In fragile states, aid can play a particularly important counter-cyclical role, given that these countries are particularly vulnerable to theexternal shocks that frequently occur during times of financial turmoil. Since the onset of the financial crisis i

DAC INTERNATIONAL NETWORK ON CONFLICT AND FRAGILITY (INCAF) 3 LOW-INCOME FRAGILE STATES ( USD 1 005) LOWER MIDDLE-INCOME FRAGILE STATES (USD 1 006 TO USD 3 975) UPPER MIDDLE-INCOME FRAGILE STATES (USD 3 976 TO USD 12 275) The list of 45 countries in fragile situations used for this analysis (neither an official DAC list nor an official definition) is a compilation of two