Abstract
This policy brief highlights the crucial role of local currency lending by Multilateral
Development Banks (MDBs) in achieving the Sustainable Development Goals (SDGs),
particularly in low- and middle-income countries (LMICs). While current policy
discussions emphasise the need to increase MDBs’ lending capacity, this alone may not
ensure sustainable lending practices. It is vital to provide financing that aligns with
recipients’ absorptive capacity and minimises macroeconomic vulnerabilities.
A key aspect of this discussion is the currency denomination of financing
arrangements, which has gained attention in policy agendas such as the Bridgetown
Initiative. This framework stresses the need to avoid currency mismatches that could
exacerbate debt crises in LMICs. Despite growing consensus on the need to increase local
currency lending by MDBs, there remains a significant gap in systematic analysis and
understanding of these practices.
This brief aims to bridge the gap by discussing the advantages of borrowing in local
currency and analysing the reasons for MDBs’ reluctance to lend in these terms. The
central argument is that the risks associated with local currency lending are often
overestimated, resulting in insufficient financing. This overestimation stems from
perceived risks in LMICs, which drive up the costs of risk management, particularly for
exchange rate risk. Moreover, local currency lending could unlock untapped opportunities
and benefits for MDBs.
We offer several policy recommendations to the G20 to enhance MDBs’ capacity to
lend in local currency. These include scaling up and improving methods for hedging
currency risks, facilitating local currency funding in onshore markets, and reforming risk
management frameworks. Additionally, we advocate for integrating local currency
lending into the core of the developmental mandate of MDBs and strengthening the
technical assistance provided by these institutions to support these efforts.
Development Banks (MDBs) in achieving the Sustainable Development Goals (SDGs),
particularly in low- and middle-income countries (LMICs). While current policy
discussions emphasise the need to increase MDBs’ lending capacity, this alone may not
ensure sustainable lending practices. It is vital to provide financing that aligns with
recipients’ absorptive capacity and minimises macroeconomic vulnerabilities.
A key aspect of this discussion is the currency denomination of financing
arrangements, which has gained attention in policy agendas such as the Bridgetown
Initiative. This framework stresses the need to avoid currency mismatches that could
exacerbate debt crises in LMICs. Despite growing consensus on the need to increase local
currency lending by MDBs, there remains a significant gap in systematic analysis and
understanding of these practices.
This brief aims to bridge the gap by discussing the advantages of borrowing in local
currency and analysing the reasons for MDBs’ reluctance to lend in these terms. The
central argument is that the risks associated with local currency lending are often
overestimated, resulting in insufficient financing. This overestimation stems from
perceived risks in LMICs, which drive up the costs of risk management, particularly for
exchange rate risk. Moreover, local currency lending could unlock untapped opportunities
and benefits for MDBs.
We offer several policy recommendations to the G20 to enhance MDBs’ capacity to
lend in local currency. These include scaling up and improving methods for hedging
currency risks, facilitating local currency funding in onshore markets, and reforming risk
management frameworks. Additionally, we advocate for integrating local currency
lending into the core of the developmental mandate of MDBs and strengthening the
technical assistance provided by these institutions to support these efforts.
| Original language | English |
|---|---|
| Publisher | T20 Brazil |
| Number of pages | 17 |
| Publication status | Published - 30 Aug 2024 |