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The focus of UK funded aid programmes should shift away from grants and towards a system of loans and other financial instruments, say MPs in the UK Parliament.

Over the next ten years, development aid in the form of grants should be replaced for lower middle income countries, say MPs on the International Development Committee of the House of Commons. DFID should also establish a financial instrument team, prepare a development finance strategy and publish a Development Finance White Paper during 2014. This strategy should include consideration of whether to establish a UK development bank.

Launching a report examining the role of Development Finance in the Future of UK Development Cooperation, Sir Malcolm Bruce, Chair of the International Development Committee said today:

“We believe the overwhelming drive in UK aid should continue to focus on lifting people out of poverty and meeting post-2015 development objectives. The UK should continue to fund the development and delivery of key services to the very poorest people in low income countries through a system of grants. We should also continue to channel 0.7 % of GNI into development cooperation. But, to support structural transformation in lower middle income countries we suggest that a significant proportion of future UK development finance should also be delivered via a system of concessional loans and other financial instruments.”

In its core recommendations the international development committee suggests: 

• Grants should continue to be used to finance rapid and widespread access to basic minimum needs such as health, education, sanitation and water in lower income countries, in emergency settings, in failed states and in major conflict areas.
• Grant finance should also be used to help provide a range of global public goods – such as knowledge, environment and governance – required to achieve the post 2015 development agenda.
• Within a few years, grant funding for lower middle income countries should be substantially replaced by a range of financial instruments including returnable capital, with grants used only where no other form of finance is possible. UK aid in general and grant aid in particular should remain focused on lower income countries.
• While care must be taken not to re-burden lower income countries with unmanageable debt, sustainable lending should also be considered for some investments in lower income countries, not least infrastructure.
• DFID should establish a financial instrument team to prepare a   strategy and publish a Development Finance White paper during 2014. This team should examine which instruments could be used most effectively and in which contexts. It should also coordinate various finance initiatives currently being tested, monitor and draw together different bilateral and multilateral approaches, design new instruments and drive future innovation.
• DFID should continue to channel some of its finance through multilaterals, making greater use of their specialist skills and expertise rather than replicating these within its own bilateral programmes.
• Over the longer term DFID must undertake the work required to establish if and when it will be advantageous to establish a UK Development Bank

Commenting further, Sir Malcolm added,

“Aid is important for promoting growth and for leveraging in other resources. In middle income countries there is considerable scope to use UK aid funding to support the private sector to deliver programmes that generate economic growth, create jobs, raise tax revenues and reap social benefits, although the presumption should be that such support is provided in the form of returnable capital wherever feasible.
“The UK should also consider the establishment of a UK Development Bank which could give the DFID bilateral programme much greater scope to increase the impact of its aid spending through providing a wider range of financial instruments, including concessional loans.”

The Committee believes these changes will ensure that DFID remains a leading and effective player in a rapidly changing international finance landscape. A future inquiry will focus on the role of policy coherence to achieve development objectives to complement  the current inquiry into finance.