Chapter 3. Innovations and good practices for a new way to respond to the complexity of development co-operation in small island developing states

Small island developing states (SIDS) face a set of specific development challenges and vulnerabilities that make achieving sustainable development particularly difficult. To help SIDS tackle those challenges and embark on a path of sustainable development, development co-operation needs to work better for SIDS. To this end, this chapter presents a set of recommendations that build on examples of innovative solutions and good practices of development co-operation with SIDS in relation to: (i) enhancing access, modalities and partnerships; (ii) using concessional resources innovatively to leverage more resources for development, including through support to unlock greater domestic resources, to create more fiscal space and to incentivise private investments; (iii) channelling resources to priority areas that could foster growth and development and move, at least some SIDS, closer to self-sufficiency: low-carbon investments and climate resilience, the blue economy, and stronger private and trade sectors.

As discussed in Chapter 2, concessional finance remains a vital source of financing for many SIDS but it is strongly concentrated on a few providers and few recipients, scattered across small projects, and insufficiently used to address some of the major vulnerabilities that hinder further development in SIDS, such as climate vulnerabilities, lack of fiscal space, and limited private sector development. In addition, while SIDS could see increases in climate-related finance in the near future (mainly because of resources from the Green Climate Fund), additional increases in concessional finance remain more uncertain, including because of the current absorption capacity constraints. Therefore, to maximise the effectiveness of these resources it will be essential to: (i) enhance access, modalities and partnerships; (ii) use concessional resources innovatively to leverage more resources for development, including through support to unlock greater domestic resources, to create more fiscal space and to incentivise private investments; (iii) channel resources to priority areas that could foster growth and development and move, at least some SIDS, closer to self-sufficiency: low-carbon investments and climate resilience, the blue economy, and stronger private and trade sectors.

By focusing on these three areas, this chapter recalls some of the key challenges identified in Chapters 1 and 2 and illustrates positive examples of actions and initiatives undertaken by the international community to tackle them. While these measures are often country specific and their applicability may be more challenging in some SIDS than in others, there is a need to invest more to replicate and scale them up. Building on these positive examples, the chapter provides a matrix of recommendations to the international communities for a more tailored and more effective approach to development co-operation in SIDS, to break a negative cycle of low growth and high vulnerability and to chart the course to prosperity for their people and their environments (Figure 3.1).

3.1. Enhancing access, modalities and partnerships for concessional finance

Providers can do much to improve the ways and modalities in which they extend concessional finance so as to maximise impact. Here three specific areas were selected where good practices and innovative approaches were found that could be replicated or further expanded: (i) building capacity and increasing absorptive capacity, (ii) using modalities that foster mutual learning and crowd-in additional resources, such as triangular co-operation; and (iii) fostering a reflection on the global architecture of concessional finance for SIDS.

For SIDS it will be essential to release capacity constraints and enhance the ability to mobilise, manage and spend financial resources from a wider array of sources to decrease dependence on a single provider. This could be done through long-term approaches to capacity development, innovative uses of technology, and a careful assessment of which functions could be performed at a regional level, which will need to remain at the national level, and which could be outsourced privately. Using pooled mechanisms to reduce transaction costs and modalities could also help to strengthen national capacities.

Partnerships with a larger set of stakeholders will bring a wider set of perspectives and approaches to the complexity of development in SIDS and could provide an alternative source of financing as SIDS move to higher levels of national per capita income. Collaboration between “traditional” and “emerging” donors could also be instrumental to in reducing transaction costs and enhancing policy dialogue in SIDS. Positive examples of multi-donor trust funds used to channel resources, such as the one established in Nauru with contributions from Australia and Chinese Taipei, could be replicated in other SIDS.

While several SIDS have flagged the negative consequences of losing access to concessional finance after graduating from bilateral or multilateral financing, no exhaustive analysis has been conducted on the real impacts of losing access to these sources. More evidence and policy dialogue needs to be fostered to understand the impacts of different graduation processes on financing landscapes and growth opportunities in order to maintain development gains as countries transition through different income levels and development phases, i.e. the “development continuum”.

3.1.1. Building capacity and increasing absorptive capacity

Recommendations - Finding long-term solutions to critical capacity constraints:

Managing external resources more effectively and tapping into a larger array of resources will require investing in strengthening internal capacities and releasing absorption-capacity constraints. A more systematic approach to national capacities – including through assessing which functions could be performed at a regional level which could be outsourced privately, and which will need to remain at the national level – could be beneficial. Innovative approaches and technologies could help tailor more sustainable capacity building approaches to the specific context of SIDS.
Because of the acute capacity constraints in SIDS, using pooled mechanisms to reduce transaction costs and modalities to strengthen national capacities is even more urgent than in other developing countries. The revival of budget support in some SIDS, especially in the Pacific, is welcome and could be further expanded to other countries – especially in other SIDS where the use of budget support is currently limited. Attention should be paid to the new ‘conditionalities’ attached to budget support, to ensure that SIDS governments preserve ownership.

Domestic capacity is inherently limited in SIDS, affecting all areas and the full spectrum of institutional needs. Low numbers of qualified staff working in key capacities – especially procurement, financial management and project management – particularly constrain the ability of SIDS to access and manage different sources of concessional finance, and limit their absorption and implementation capacity. SIDS often record significant undisbursed balances and limited capacities also constrain access to the full range of available sources, including to some large global funds. Therefore, actions to effectively enhance SIDS’ ability to absorb currently available resources, as well as new flows, will be critical.

Concessional finance providers sometimes put in place temporary solutions to fill human resource gaps with a view to increasing the speed of delivery and achieving results in the short term. While in some of the smallest SIDS technical assistance could be expected in perpetuity, innovative, longer term solutions for supporting national capacities and expertise have also been tested and implemented. The section below presents three selected examples of development co-operation initiatives aimed at enhancing capacities in SIDS. They relate to: (i) improving public financial management (Box 3.1); (ii) facilitating direct access to finance from the Green Climate Fund; and (iii) strengthening statistical capacity through regional approaches.

Box 3.1. Lessons from New Zealand’s support for public financial management reform in the Pacific

The New Zealand Aid Programme has for many years worked closely with partner governments and other development partners to strengthen public financial management (PFM) systems in the Pacific. PFM systems in the Pacific function very differently from the comprehensive systems that larger developing countries use. For example, evidence suggests that limited human resource pools, driven by competition from employers outside the public service, create severe constraints for Pacific countries to achieve higher PEFA scores, which are an internationally established tool for assessing the status of public financial management1. These differences mean that an effective reform programme requires considerable discipline to:

Prioritise a few key reforms that can be effectively implemented and sustained in a capacity constrained environment.
Look beyond capacity building to substitute or regionally supplement key technical skills that are hard to recruit and retain in the region.
Accept that some reforms that could drive higher PEFA scores in the short-run are not sustainable or necessary in the Pacific context.

A recent study of PFM reform experiences in Kiribati and Tonga found that reforms that were well targeted, consistent with capacity, and enjoyed political support were more likely to achieve their objectives (Bontjer et al, 2016). Where reforms were not prioritised or contextualised, they were either not successfully achieved or were enacted and not implemented. A key recommendation in the study was to ensure that implementation approaches reflected Pacific realities. The study suggested the following approaches to working within the Pacific SIDS context:

Altering the technical assistance model to focus on implementation and outcomes (e.g. better public services) rather than the policy or legislative process.
Ensuring that technical assistance plans account for the longer implementation timeframes that are required in the Pacific.
Allowing consultants greater leeway to change approaches and outputs when contracted to support a particular reform.
Greater use of financing linked to direct service delivery outcomes as a way of complementing financing linked to regulatory and legislative policy reform.
Considering regional capacity sharing for certain PFM functions that are hard to maintain in an individual country context.

The challenges that the Pacific faces in reforming its public financial management systems are not uncommon to those of other SIDS. Greater discipline in tailoring global reform best practices to the context of SIDS could significantly increase the effectiveness of PFM reforms in delivering better public services and development outcomes in small island developing states.

Source: Adapted from Government of New Zealand data

Readiness support to enhance access to Green Climate Fund resources

The many existing global climate funds are likely to contribute to an increasing share of financing for SIDS. However, at present, these resources are not delivering at full scale, with only relatively small volumes reaching SIDS. Access to these resources is limited by the complex array of accreditation procedures, application processes and fiduciary requirements which generally exceed SIDS’ limited administrative and technical capacities.

The lack of domestic capacity to directly access these global funds leads to reliance on intermediary accredited agencies, including the World Bank, United Nations agencies and other multilateral development banks. These intermediary agencies are often the main channels through which SIDS can obtain financing from vertical funds, and generally also provide the technical and co-ordination support needed to implement the related projects. However, the large transaction costs involved in the small scale of SIDS project proposals can weaken prioritisation by multilateral intermediaries and thus result in fewer opportunities for funding. Because of the implementation charges applied, intermediation comes at a cost (up to 8% of the project value as a fee) reducing the overall resources reaching the beneficiary country.

Therefore, more than for other developing countries, a trade-off exists for SIDS between investing in national capacities to gain direct access versus relying on an intermediary agency. Direct access confers greater ownership of the activities, builds domestic capacity and systems, and ensures that the maximum amount flows to the beneficiary government. However, for SIDS with acute capacity constraints, the resources required to engage with the fund directly can be prohibitive and make partnering with an accredited entity faster and more cost effective.

To facilitate greater access to financing from these global funds, priority should be given to adopting streamlined application procedures that are proportionate to the domestic capacities of SIDS. At the same time, the international community could also do more to help SIDS meet the application standards. In this respect, the actions taken by the Green Climate Fund to scale up its funding for readiness programmes and support enhanced direct access modalities represent positive steps.

The Green Climate Fund is currently the largest existing global fund. It aims to constitute a major source of financing for SIDS and other developing countries, with a target to disburse at least 50% of its adaptation resources to least developed countries, SIDS and African countries. Technical capacity, fiduciary compliance and the resources required to become an accredited entity to the Green Climate Fund, however, are often beyond the scope of many developing countries, especially those with such small civil services and limited expertise as SIDS.

The Green Climate Fund provides “readiness support” to help countries engage with the fund and meet its requirements to access finance. These resources, provided as grants up to USD 300 000, aim to address specific gaps in National Designated Authority2 programming to comply with the application requirements to access the Green Climate Fund. To date, the Green Climate Fund has disbursed readiness finance totalling USD 10.3 million to 59 countries, of which two thirds was allocated to SIDS, least developed countries and African states. At present 14 SIDS have drawn on these resources; the experiences of Vanuatu and Antigua and Barbuda and described in Box 3.2.

Box 3.2. Lessons from Green Climate Fund readiness funding: the experience of Vanuatu and Antigua and Barbuda

The Government of Vanuatu is working with Secretariat of the Pacific Regional Environment Programme (SPREP) as an implementing entity to develop a project around Climate Information Services for Resilient Development. As part of this, the Green Climate Fund allocated USD 157 000 over nine months up until April 2017. The activity gathered data in order to better understand the island’s Climate Information Service needs and will now be used to inform the development of a proposal to the Green Climate Fund. This process included several workshops and consultations to hear from a range of national and sub-national stakeholders, government officials, planners and policy developers to better understand needs. This programme is now a leading example of a project that has gone through the entire project cycle. The subsequent project Climate Information Services for Resilient Development Planning in Vanuatu was approved at the fifteenth board meeting with a value of USD 27 million including a USD 23 million grant from the Green Climate Fund.

The Government of Antigua and Barbuda accessed readiness support directly. This support totalled USD 300 000 and lasted 12 months. It was used to strengthen the NDA and develop a country programme in order to submit a full funding proposal. Specifically, the money funded two inter-ministerial consultations, a policy adviser, a financial expert, a consultant specialised in Knowledge Information Management System development, a web developer to establish an online knowledge portal and three internal policy guides on operations. The NDA is well advanced in preparations to submit an application and to co-ordinate with other countries in the eastern Caribbean on a project proposal for enhanced direct access.

In addition, the Commonwealth Secretariat has developed the Climate Finance Access Hub, a capacity building initiative to build long-term capacity within National Designated Authorities. Long-term technical advisers embedded within National Designated Authorities provide both strategic and hands-on support to address capacity gaps limiting access to climate finance. In many SIDS, this support focuses on drawing down readiness support, and addressing financial management and compliance gaps. The first technical adviser was deployed in Jamaica in April 2017. New Zealand is supporting Pacific island countries to access Green Climate Fund funding in several ways. In 2016, it initiated the Green Climate Fund “Technical Assistance for Pacific Access” programme which supports the development of successful Green Climate Fund proposals. New Zealand has also partnered with the Green Climate Fund Secretariat to deliver a series of national awareness raising workshops in Kiribati, Niue, Tonga, and Tuvalu; and is providing USD 1.1 million over three years to the Secretariat of the Pacific Regional Environment Programme to support it in its role as an accredited entity to the Green Climate Fund.

The value of regional approaches for statistical development in SIDS

For most SIDS maintaining a fully functional national statistical system can be challenging. Yet, such systems are crucial to delivering the data required to assess the effectiveness of government programmes and policies, and monitor progress against development goals. A number of initiatives have been launched in both the Caribbean and Pacific regions to foster both stronger regional statistics and the development of national statistical systems. These initiatives aim to address the key constraints inhibiting progress in developing better statistical capacities in SIDS, including:

Human resource shortfalls regarding professional and/or technical competence across key thematic statistical areas, insufficient numbers of statisticians in national statistics offices to work on a broad spectrum of statistics and lack of statistical staff in other government agencies
lack of sustainable investment by governments and donors in the continuous development of statistical systems
institutional weaknesses arising from outdated statistical legislation, weak statistical leadership, ineffective co-ordination across the system and absence of a strong statistical culture promoting the use of statistics in decision making
lack of political recognition and support for statistics as a tool for policy making, development management and governance.

Strong regional statistical co-operation is valuable for both regions and countries. It is helping diminish the cost of a comprehensive national statistical system, expand the range of regionally – and, to some extent, globally – comparable statistical measures, and improve the quality of the data generated by national statistical systems as countries adhere to regional statistical standards and methods. It has also facilitated access to technical assistance on a range and mix of skills essential in a national statistical system; made available predictable and sustained funding from development partners for major statistical operations (e.g. surveys and censuses); and provided opportunities for establishing relevant statistical infrastructures in countries with limited resources. Finally, it complements statistical operations in countries with limited capacity.

These achievements were possible through the following actions and steps:

Establishment of regional statistical centres and/or programmes in the respective regional bodies: the Caribbean Community (CARICOM) for the Caribbean and the Pacific Community for the Pacific provide technical support to countries, and facilitate pan-regional co-ordination of statistical programmes and activities. These centres and programmes have helped strengthen national statistical systems and contributed to the compilation and harmonisation of regional statistics. The CARICOM Secretariat has a Regional Statistics Programme, while the Pacific Community Secretariat has a Statistics Development Division, both provide statistical capacity building support to national statistical systems; an enabling environment for statistical development; and technical support on thematic concerns for their member states.
Adoption of strategic frameworks to improve statistics in the medium and long term: the CARICOM Action Plan on Statistics and the Ten Year Pacific Statistics Strategy 2011-2020 contain short and long-term programmes in key statistical areas, which governments and donors use as a basis for resource allocation. This strategic approach to region-wide statistical development promotes a co-ordinated and harmonised approach to statistical financing.
Institutionalisation of regional statistical governance and co-ordination mechanisms: regular convening of the Standing Committee of Caribbean Statisticians and the Pacific Statistics Steering Committee, comprising chief statisticians, provides statistical leadership, and sets direction and guidance on statistical development in the region.
Development of regional standards, classifications and common methodologies: in line with international recommendations, allowing for more harmonised and comparable statistics in the region (e.g. Pacific Household Income and Expenditure Survey Questionnaire; Caribbean Common Census Framework and Pacific core Population and Housing Census modules; Pacific core statistical indicators and Caricominfo; CARICOM Model Bill; Pacific statistical classifications and standards on industrial, occupational, individual consumption according to purpose; etc.).

Similar approaches could be replicated for the benefit of SIDS in the Africa, Indian Ocean, Mediterranean and South China Sea (AIMS) region, under the leadership of an individual SIDS or of a regional institution, such as the African Union. In addition, innovative approaches and the use of new technologies could help further tailor capacity building approaches to the specific context of SIDS. Support could also be provided to make greater use of open data networks and observatories, which can increase efficiency and overcome capacity constraints.

3.1.2. Using modalities that foster mutual learning and crowd-in additional resources – stepping up triangular co-operation

Recommendations - encouraging partnerships with a larger range of actors, including through triangular co-operation:

Triangular-co-operation initiatives can combine expertise and resources from a broad range of actors and encourage mutual learning. Partnerships with a larger set of stakeholders will bring a wider set of perspectives and approaches to the complexity of development in SIDS and could provide an alternative source of financing as SIDS transition through the development continuum. Collaboration between “traditional” and “emerging” donors could also be instrumental to reducing transaction costs and enhancing policy dialogue in SIDS. Positive examples of multi-donor trust funds used to channel resources, such as the one established in Nauru with contributions from Australia and Chinese Taipei, could be replicated in other SIDS contexts.
Triangular co-operation can also be a means to foster greater policy dialogue. As development finance from China, Chinese Taipei, Russia, Venezuela and other non-DAC providers exceeds that from “traditional” providers in several individual SIDS, policy dialogue will need to be inclusive and look beyond traditional boundaries. China, India and other countries own the largest shares of the public debt of several SIDS. Given the increasing risk of debt distress, an inclusive reflection on possible measures to alleviate debt burdens should underpin development co-operation with SIDS.

As illustrated in Chapter 2, a broader set of sovereign states are establishing co-operation and partnerships with SIDS. Strengthening mutual learning and collaboration among a larger set of stakeholders will be fundamental for SIDS going forward, especially as access concessional finance decreases in line with higher national income and “graduation” in SIDS.

Triangular co-operation brings together expertise and resources from a diverse range of actors, creating opportunities to explore new ways of working together (Box 3.3). It provides SIDS with a relevant modality to tackle their development challenges (OECD, 2017a), by bringing together SIDS governments, Development Assistance Committee (DAC) members, other providers, such as China, and other middle-income countries (such as Mexico and Malaysia) to address shared development objectives. Triangular co-operation features in the 2030 Agenda for Sustainable Development as a powerful means of implementation.

Box 3.3. What is triangular co-operation?

Triangular co-operation is a dynamic partnership modality involving:

a pivotal partner who shares its development solutions, knowledge, expertise, technology and other resources.
a beneficiary partner who is the target of a development intervention, in line with its national development priorities and needs.
a facilitating partner who helps connect countries and organisations in the form of a triangular partnership, and provides financial and/or technical support to the collaboration.
These roles can evolve over time or projects. In some cases involving SIDS, the same country can play different roles. For instance, the Dominican Republic benefits from the experience of Chile and the United States in youth employment with support from the private sector. At the same time, the Dominican Republic is a pivotal partner in training Haitian agriculture and forestry professionals together with Japan.

According to responses to the OECD-DAC Survey on Triangular Co-operation (OECD, 2017a), in 2012-15, 92 triangular co-operation projects were implemented in SIDS. This represents one fifth of the over 450 reported triangular co-operation projects implemented worldwide in the same period (Table 3.1).3

Table 3.1. Small island developing states involved in triangular co-operation
SIDS involved in triangular co-operation projects	No. of Projects
Dominican Republic	37
Haiti	18
Cuba	14
Timor-Leste	13
Belize	9
Guyana, Jamaica, Kiribati, Samoa, Suriname	7
Fiji	6
Guinea-Bissau	5
Cabo Verde, Papua New Guinea, Sao Tome and Principe, Solomon Islands, Tonga	4
Cook Islands, Federated States of Micronesia, Marshall Islands, Seychelles, Vanuatu	3
Nauru, Palau, Tuvalu	2
Antigua and Barbuda, Dominica, Grenada, Mauritius, Montserrat, Niue, Saint Lucia	1
Total	92
Source: Responses to the OECD Survey on Triangular Co-operation (OECD, 2017a), https://doi.org/10.1787/a8b14341-en.

The majority of the reported triangular co-operation projects with SIDS were implemented in the Caribbean (66%), followed by the Pacific (26%). Only 8% of the projects involved more than one region, unlike the prevailing global trends, where a larger share (18%) of reported triangular co-operation projects worldwide are implemented across different regions. Thus, there seems to be scope for a greater exchange of experiences between regions through triangular co-operation. Table 3.2 provides an example of a project between a country in Asia and one in the Caribbean.

Table 3.2. Triangular co-operation among Suriname, Malaysia and the Islamic Development Bank: joining forces to work on rice production
Project name:	Rice production
Countries/IOs:	Suriname, Malaysia, Islamic Development Bank
Objective:	To enable Suriname to achieve and maintain self-sufficiency in rice production and increase its high-quality rice exports.
Budget:	USD 6 million
Project period:	2016-19
Source: Responses to the OECD Survey on Triangular Co-operation (OECD, 2017a), https://doi.org/10.1787/a8b14341-en.

The sectoral focus of triangular co-operation in SIDS mirrors the overall allocation of concessional finance (see Chapter 2), with the largest share of finance supporting the government and civil society sector (29%). Among the other top sectors, triangular co-operation in SIDS has the strongest focus on health (17%, compared to 13% in other developing countries) and food security (11%, compared to 5% in other contexts), followed by agriculture (8%) and business (7%). Despite the strong vulnerabilities of SIDS to climate events and natural disasters, only small shares are directed towards climate change mitigation and adaptation (3%) or disaster risk management (2%) (Figure 3.2).

Respondents from SIDS reported engaging in triangular co-operation mainly through project-type interventions, such as the Te Mato Vai project between the Cook Islands, China and New Zealand4 or the triangular co-operation between Cuba, Mexico and Germany5 on renewable energies and energy efficiency. Governments or international organisations are the main actors involved in triangular co-operation with SIDS (73% of the reported projects). However, one quarter of the projects also involved academia, research institutions, civil society organisations, the private sector and other non-governmental organisations.

The most typical triangular co-operation project with SIDS (61% of the cases) involved two or more middle-income countries and one or more high-income countries or international organisations. The second most typical arrangement involved one or more high-income countries or international organisations, middle-income countries and least developed countries. In 16% of the projects involving SIDS, four types of actors were involved with high-income countries, international organisations jointly engaged in triangular co-operation projects with middle-income countries and least developed countries.

Recognising the growing prominence of this approach in the Pacific, as well as the importance of developing and sharing best practice, the Pacific Islands Forum Secretariat has established a trilateral peer review mechanism. Along with its development partners, Australia and New Zealand, the Secretariat will evaluate progress and identify bottlenecks in this type of development co-operation. The objective of the peer reviews is to assess: 1) the political directives and policies shaping co-operation among the Pacific Islands Forum members and their main development partners; 2) the alignment of development co-operation with national and sectoral development plans; 3) the monitoring and evaluation procedures, and the role of the Forum Island Compact in this process; and 4) sector-specific targets and indicators for the regular monitoring of behaviour changes in development partners.

All SIDS respondents to the Survey (OECD, 2017a) replied that receiving support to carry out South-South co-operation was their main motivation for engaging in triangular co-operation, followed by building capacity to engage and manage development co-operation, and learn and share experience with partners in South-South co-operation. Samoa also stated that Pacific countries are eager to learn from their peers through triangular co-operation.

Survey respondents reported that triangular co-operation allows them to combine different assets – e.g. specific expertise, and technology and cultural proximity – to maximise the benefits for all actors, especially developing countries facing similar challenges. For instance, “by combining the comparative advantages in terms of financing, technical expertise and local knowledge, China and other development partners could assist Pacific Island Countries in strengthening their capacities to minimize the negative impact of climate change” (UNDP China, 2017). Respondents also called for a more strategic use of triangular co-operation by pooling different actors’ expertise and resources. In the long run, this evolution can lead to greater ownership by the actors involved, as well as involvement by other actors, and the scaling and joint implementation of activities designed to achieve both the Sustainable Development Goals and the actions agreed at the Third International Conference on Small Island Developing States, held in Samoa in 20146.

3.1.3. Better understanding the global architecture of concessional finance for SIDS

Recommendations - expanding the evidence base and policy dialogue around the complexity of development in SIDS

Development partners could foster policy dialogue with SIDS at different steps of the income ladder to help identify development solutions that respond to the specific circumstances of SIDS.
Some SIDS – especially microstates, which face more limited economic prospects – may present a structural need for sustained support from the international community. Some will soon see their free association status with larger economies terminated (as with the Marshall Islands and the Federated States of Micronesia [“Micronesia”] in 2023), and due consideration will need to be given to maintaining the development gains after this transition.
SIDS that have recently graduated from least developed country status, such as Cabo Verde and Samoa, have quickly moved from a moderate to a high risk of debt distress. While several SIDS have flagged the negative consequences of losing access to concessional finance after graduating from bilateral or multilateral financing, no exhaustive analysis has been conducted on the real impacts of losing access to these sources. More evidence is needed to understand the impacts of different graduation processes on financing landscapes and growth opportunities in order to maintain development gains and ensure that co-operation instruments and approaches meet countries’ needs as they transition through the “development continuum”.

SIDS are confronted with a complex web of classifications and eligibilities

Globally, a wide array of sources of concessional finance exists, comprising OECD DAC members, non-DAC sovereign states and a multitude of multilateral sources. Especially for climate finance, which SIDS are highly in need of to build resilience to their high exposure to climate risks, a myriad funds exist, some more recent and some decades old, including the Adaptation Fund, the Green Climate Fund, the Global Environment Facility, the Least Developed Countries Fund, the Special Climate Change Fund and the Climate Investment Funds.

However, SIDS are confronted with an intricate web of eligibilities and requirements to access concessional finance, limiting their actual ability to tap into these resources. In fact, while in aggregate, SIDS received concessional finance from 72 providers in 2012-15 (see Chapter 2), the financing landscape for individual SIDS can be fairly different. Eligibility for concessional finance from most sources is primarily linked to the World Bank’s income classifications, which identify low, middle or high-income countries based on gross national income (GNI) thresholds. However, actual eligibility rules vary depending on the institution, with different providers applying different income thresholds and exceptions, resulting in different financing landscapes for different SIDS and sometimes inconsistent treatment across SIDS (Table 3.3).

Table 3.3. The landscape of concessional financing to SIDS: a complex system of eligibilities

Source: Authors

Low-income status – i.e. per capita income below USD 1 025 as of July 2016 – is the main eligibility criterion for financing from the International Development Association (IDA, the soft window of the World Bank Group), and four SIDS are eligible for IDA financing based on this criterion. However, recognising the limitations of income classifications, the World Bank has introduced a number of “exceptions” that allow countries exceeding the low income threshold to remain eligible for IDA financing. In total, 17 SIDS7 are eligible for IDA financing through its Small Economy Exception or IDA blend terms. However, some SIDS – e.g. Nauru and Palau – do fall in some sort of “limbo”, being assessed as too rich for accessing IDA financing and yet lacking the creditworthiness necessary for accessing the International Bank for Reconstruction and Development. Low-income status is also the main eligibility criterion to access concessional finance from most other international institutions; but these organisations also apply additional criteria or exceptions. The Asian Development Bank, for example, considers Nauru as fragile/vulnerable owing to its weak institutional and economic capacity, and thus eligible for its concessional financing.

Eligibility for ODA can play a role in determining bilateral donors’ allocations to SIDS, but is not binding: some bilateral providers continue to allocate concessional finance to SIDS that have graduated from ODA.8 Besides low-income countries, all middle-income countries (i.e. countries with a per capita GNI up to USD 12 745 in 2016) are eligible to receive ODA.9 Only high-income countries are excluded.10 However, the DAC List of ODA Recipients (OECD DAC, 2014) rules out exceptions, and one in four SIDS is expected to graduate out of ODA by 2025.

Several SIDS have lost access to multilateral concessional funding because they exceeded income thresholds, and some have moved in and out of eligibility over time. Among all developing countries, 44 have transitioned from low to middle-income states, and out of eligibility for concessional finance, since the 1960s. Several countries have transitioned in and out of the same income class, and 11 countries transitioned back from middle-income to low-income status. Many of these countries had graduated to middle-income status in the 1980s and then reverted to low-income status because of trends in global commodity prices or political instability. Fifteen countries also reverted from high-income to middle-income status between 1990 and 2015, three of them transitioning in and out at least twice. The SIDS in this group include: Antigua and Barbuda, Aruba, Barbados, American Samoa and Guam. Some oil-rich economies and other countries that experienced large external shocks also fall in this group (e.g. Bahrain, Equatorial Guinea, Saudi Arabia, Venezuela, Hungary, Korea and the Russian Federation).

The examples of “reverse graduation” illustrate that development is not linear, and that setbacks and shocks are often part of the process. More importantly for SIDS, their exposure to economic and climate vulnerabilities linked to some of their geophysical features do not diminish, even as per capita GNI levels rise. In SIDS where national income per capita chiefly increased because of growth in a tourism sector largely owned by foreign investors or due to financial services, with little positive impact on the living standards of large swaths of the population, governments will need to implement more inclusive growth policies. Yet the global systems of international financial regulations, international taxation and multinational corporate governance also need to be geared to supporting more inclusive growth policies in these countries. Moreover, most SIDS are in a different position than larger countries when it comes to finding alternative drivers for the economy, and many may continue to remain structurally dependent on transfers from other countries and the international community.

The assumption underlying the current global system of concessional finance that higher per capita income levels allow countries to mobilise domestic and international capital may hold for larger economies, but does not generally apply to SIDS (World Bank, 2017a). Strong vulnerabilities, stemming from their geophysical and economic features (see Chapter 1), often lead to narrow tax bases, limited cash surpluses, low levels of international reserves, inadequate capital formation and insufficient levels of domestic credit. Combined, these factors constrain the ability of SIDS to mobilise greater public and private domestic resources, and international private finance.

Opportunities and challenges of including vulnerability criteria to expand eligibility

Because of their special development case and their challenges in accessing concessional financing owing to their relatively high national income levels, SIDS have voiced on countless occasions – and at the highest levels of representation – the need for a co-ordinated effort by development partners to review the rules governing access to concessional finance and include vulnerability aspects in the criteria for eligibility to concessional funding. Already in 1994, through the Barbados Programme of Action (BPOA, 1994), SIDS had called for metrics integrating ecological fragility and economic vulnerability to supplement eligibility criteria and ensure access to additional resources. More recently, they renewed the call in the SIDS Accelerated Modalities of Action (SAMOA) Pathway (UN, 2014) adopted at the United Nations Third International Conference on Small Island Developing States in 2014, and again at the Small States Forum in 2015 and 2016.

Several technical and political challenges exist to supplementing eligibility criteria with a vulnerability metrics. Vulnerability is determined by a multitude of factors, including location, income, assets, access to resources, and institutional and legal systems. For several of these indicators, data pertaining to SIDS may be limited. Moreover, the choice of sub-indicators, as well as their weighting and aggregation, could yield different results, affecting country rankings and classifications. Several vulnerability indexes already exist; 11 whether they converge significantly is not clear. In addition, both DAC members and financing institutions have expressed concerns revising eligibility criteria could divert resources from the poorest countries. Any reforms of the eligibility criteria for concessional finance would need to be accompanied by a careful analysis of the incremental resources that would be reaching SIDS, as well as of the global winners and losers, and the potential need for additional accompanying measures. An important concern remains that revising eligibility criteria may result in insufficient resource allocations to SIDS, highlighting the need to explore other options to ensure that SIDS can access adequate levels of development finance. Ultimately, given a global context of limited concessional finance, it will be fundamental to focus on using existing resources more catalytically to attract additional flows from public and private sources. This is the focus of the next part of this chapter.

Box 3.4. Lessons from the World Bank-UNDP Inter-agency Task Force on the link between vulnerability and access to concessional finance

The OECD Development Co-operation Directorate is part of the Inter-Agency Task Force on the link between vulnerability and access to concessional finance established in 2016 by the World Bank’s Small States Forum Secretariat and the United Nations Development Programme and also comprising the United Nations Office of the High Representative for Least Developed Countries, the United Nations Department of Economic and Social Affairs, the Commonwealth Secretariat, International Monetary Fund, Asian Development Bank, and Caribbean Development Bank.

The Task Force aims to review existing vulnerability measures, exploring how they could be implemented and examining whether their adoption would result in sufficient levels of concessional finance for upper middle and middle-income small states that are currently excluded from IDA eligibility. The Task Force will also explore innovative financing instruments and mechanisms to help SIDS gain access to development finance, including through innovative financing instruments such as insurance schemes (e.g. similar to the Caribbean Catastrophe Risk Insurance Facility, and the Pacific Catastrophe Risk Assessment and Financing Initiative), debt reduction instruments and approaches to leveraging climate finance (e.g. from the Green Climate Fund and the Global Environment Facility). Given a global context of limited concessional finance, it will be fundamental to focus on using existing resources more catalytically to attract additional flows from public and private sources.

3.2. Using concessional finance innovatively to leverage additional resources

Innovative uses of concessional finance have been tested in recent years, which have the potential to unlock more domestic resources, creating fiscal space, and crowd-in private investments. This section describes some of these approaches and suggests how the international community could enhance them and bring them to scale.

Domestic resource mobilisation could be enhanced through diaspora investment schemes; internationally co-ordinated fiscal reforms to expand tax coverage (especially to include high revenue-generating segments of the economy); and policies to reduce “leakages” from key sectors – especially tourism – and support linkages with other domestic sectors to effectively expand the taxable production base.

Debt relief opportunities, such as debt for nature swaps, and innovative countercyclical instruments, such as loans that automatically postpone debt servicing in the event of a major shock (e.g. through “hurricane” clauses) could help address debt sustainability and free resources for sustainable development including for the blue and green economy.

Innovative financial instruments, such as green and blue bonds, and blending arrangements to bring climate finance to scale, are promising sources of development finance for SIDS. However, none of these have been rolled out at scale in a SIDS context. Development partners can do much to support the design and implementation of these instruments, and back these new products with guarantees and co-financing schemes to encourage economic diversification and invest in building long-term resilience.

3.2.1. Mobilising greater domestic resources through stronger systems and tax reforms

Recommendations - Generating more domestic revenues for development:

Enhanced tax collection systems can yield greater domestic revenues. To this end, providers could consider channelling greater support towards international initiatives, such as the Addis Tax Initiative and Tax Inspectors without Borders12.
Development partners could support fiscal reforms in SIDS aimed at expanding tax coverage, especially to include high revenue-generating segments of the economy and favour progressive taxation systems. Support could also be provided to assess the consequences of changes in the mix of tax policies, such as increases in already low corporate taxes or the removal of tax exemptions. Crucially, these country-specific interventions will need to be part of a wider global reform and co-ordinated across SIDS to avoid any race to the bottom.
Tangible opportunities exist in many SIDS to expand the mobilisation of domestic resources through enhanced management of key sectors, including fisheries, tourism and natural resource extraction. Policies to reduce “leakages” from key sectors – especially tourism – and support linkages with other domestic sectors (e.g. food and agriculture, consumer goods and construction) could effectively expand the taxable production base. Support from the international community could also target curbing illicit, unreported and unregulated fishing, as a way to enhance domestic resources available for development.

As discussed in Chapter 1 and 2, SIDS tend to have small and erratic domestic revenues and the challenges associated with domestic resource mobilisation in developing countries are compounded in SIDS. SIDS with only a few major economic sectors have a narrower tax base; consequently, their revenue can be more vulnerable to external shocks, such as changes in international commodity prices or natural disasters. SIDS with a large informal sector also have more difficulty raising internal revenue. For instance, the agricultural sector is often more difficult to tax, owing to the large number of small businesses and prevailing informality in the sector.

Improving the efficiency of revenue collection and enlarging the tax base are essential efforts needed to increase the resources required to sustain progress towards the United Nations’ Sustainable Development Goals. International providers allocated USD 19 million to this end in 2014-15,13 reaching 16 SIDS. This support built the capacity of tax authorities, with a view to increasing domestic revenues. In 2015, the United States provided USD 3 million to the Treasury of Haiti to build the tax function. Similarly, New Zealand provided USD 4 million in 2014-15 to strengthen the Inland Revenue Department of the Solomon Islands, with a specific focus on compliance. These amounts represent only 0.19% of the total official development assistance to SIDS in this period, hinting at room for expanding investments in this area. Providers might increasingly look to support initiatives like the OECD-United Nations Development Programme’s “Tax Inspectors without Borders”, launched at the Financing for Development summit Conference in Addis Ababa in 2015, which provides tax audit support and builds capacity to help mobilise resources. Successful pilots have been carried out in larger developing countries, such as Colombia, which saw an increase in tax revenues from USD 3.3 million in 2011 to USD 33.2 million in 2014. While outreach has been carried out to several SIDS, to date, Jamaica is the only SIDS to have benefitted from this programme. Further support in this area might help more SIDS pass the 20% of GDP target for tax collection, which could grow revenues and fiscal space.

Some providers have been particularly active in supporting SIDS in the area of domestic resource mobilisation. For instance, Australia has provided technical assistance to the Kiribati Taxation Office to support the implementation of the value added tax (VAT) and automated tax system. Australia also helped the Vanuatu government identify potential new sources of revenue and improve its revenue administration. This support led to an estimated AUD 12.5 million increase in VAT receipts in 2014 and to improvements in the customs administration. In the Solomon Islands, Australia has provided support for revenue forecasts, as well as assistance to the national Customs and Excise Division to increase revenue and create a level playing field for the private sector, including through the introduction of an automated customs system.14

In addition, much can be done by the international community to enhance the management of industries that are key for revenue generation in SIDS. For instance, improving the management of fisheries, and curbing illicit, unreported and unregulated (IUU) fishing activities, could significantly enhance domestic revenues in many SIDS. With their vast economic exclusion zones (EEZs), considerable revenues accrue to SIDS both through direct fishing and, often more importantly, fishing licences. Therefore, IUU fishing activities not only negatively impact biodiversity and natural resource sustainability in SIDS, but also reduce domestic revenues, and challenge economic and social sustainability. At the same time, the cost of enhancing the monitoring, control and surveillance of the vast coastal and sea areas of SIDS EEZs can far exceed the capacities and resources of SIDS. The OECD is currently working to expand its database on policy frameworks and initiatives to combat IUU fishing and the related economic crimes, as a contribution to the follow-up and implementation of Sustainable Development Goal 14.4.15 The aim is to provide policy makers with a better understanding of the remaining policy gaps and regulatory loopholes and help identify the tools that some countries could strengthen or introduce to bridge these gaps. Although, there is no "one size fits all” solution to IUU fishing, promoting greater transparency on existing procedures and legal systems as well as awareness of the tools at hand should help governments adopt better approaches. Improving the management of natural resources and mining resources would also help SIDS augment their domestic revenues. In this regards, a positive example is offered by Australia and other donors supporting the introduction of a mining tax framework in the Solomon Islands to improve tax generation.

In general, SIDS face important choices in developing an appropriate tax policy that can generate adequate government revenues and promote greater equity in the population’s living standards, while at the same time entice investment, support competitive markets and economic growth. Several SIDS, recently adhered to the OECD-led tax information exchange system, recognising that a better way to attract foreign direct investment is to improve infrastructure, education, and health standards. Some SIDS do not collect income taxes, and the largest share of their tax revenues often accrues from non-progressive tax instruments, such as VAT. Corporate taxes are fairly low in many SIDS, and in some cases existing tax caps prevent governments from raising them. For example, the Cook Islands has a 25% tax-to-GDP cap imposed by the Manila Agreement, which set conditions for the debt restructuring undergone by the country in 1998.16 Vanuatu’s 2016 Revenue Reform and Modernisation Review, which builds on co-operation with Australia, provides a recent example of an attempt to address some of these trade-offs (Box 3.5).

Box 3.5. Lessons from the Vanuatu Revenue Reform and Modernisation Review

Vanuatu’s 2016 Revenue Reform and Modernisation Review (Government of Vanuatu, 2017) highlighted that insufficient tax revenue is generated from VAT and import duties, and that the government misses out on a large source of potential revenue through low collection of, and compliance with, business taxes and fees. The review also noted that allocating tax revenues to public services, such as health and education, would stimulate economic growth and, in turn, help attract foreign direct investments. The review concluded by suggesting that Vanuatu raise corporate tax to 17% and introduce a personal income tax in a bid to move away from taxing consumption, which overly burdens the poor. While the approach presents potential challenges in terms of short-term slowdowns in economic activity, the reforms are a progressive attempt to address the domestic resource gap and donors could support similar projects.

3.2.2. Improving debt sustainability in SIDS, including through upstream actions

Recommendations - Implementing upstream and downstream measures to improve debt sustainability

Counter-cyclical products include loans that automatically postpone debt servicing in the event of a major shock, as well as loans featuring “hurricane” clauses. They can help SIDS manage the risks of exogenous shocks and can limit their impacts on debt sustainability and economic health. Development partners could do more to further test and roll out these products, which can make SIDS’ borrowing more climate-resilient and sustainable.
Debt-for-nature swaps and other buy-back instruments could help alleviate severe debt burdens but their application remains limited to only one SIDS (Seychelles). Development partners can do much to support the use of these instruments, including by absorbing design and implementation costs.

As discussed in Chapter 2, debt remains a critical issue for many SIDS, compounded by their structural and environmental vulnerabilities, which can trigger crises. While debt-to-GNI ratios considerably decreased for the five SIDS that benefitted from the Heavily Indebted Poor Countries Initiative, many SIDS have seen their debt levels increase. This has been the case especially for upper middle-income SIDS, but also for SIDS that recently from least developed country status, such as Cabo Verde and Samoa. In 2012-15, the total ODA allocated to action relating to debt was USD 856 million – although nearly 97% of this went to just three SIDS, including 78% to Cuba.

Given the acute nature of the debt issues facing SIDS, and the fact that concessional finance only sporadically addresses them, alternatives approaches are required. Providers have little appetite for debt forgiveness to SIDS – especially those with higher incomes – in part because this does not address the underlying drivers of debt distress (Haque T. et al., 2016) and might create perverse incentives and induce moral hazard. However, providers have proactively sought to address debt sustainability with innovative financing instruments, including climate-related debt swaps. The international community should prioritise making greater use of these instruments and developing additional tools to address the drivers of debt distress. Development co-operation that does not address debt sustainability will not break the cycle of low growth and high vulnerability. Debt relief innovations, including Seychelles debt for nature swap, are presented in Box 3.6.

Box 3.6. Lessons from the debt for nature swap adopted by the Government of Seychelles and other debt swaps proposals

The debt for nature swap adopted in 2015 by the Government of Seychelles and its Paris Club17 creditors could be replicated in other SIDS. This was the first debt-swap aimed specifically at ocean conservation and climate adaptation. As such, it allowed the Government of Seychelles to reduce immediate debt burdens while also increasing resources targeted toward climate action. Under this mechanism, providers used concessional finance to gradually write down the debt stock of Seychelles under the condition that funds otherwise used for debt service payments would be used for climate investments.

Several variations of debt swaps are presently under discussion, including through the joint Commonwealth Secretariat-World Bank “Multilateral Debt Swap for Climate Action” World Bank. (Commonwealth Secretariat, 2015). In this case, bilateral climate finance pledges would be used to buy back multilateral debt and to redirect debt payments to fund climate adaptation and mitigation. A pilot was initially planned in Jamaica, where high levels of external debt (103% of GDP) and debt-servicing costs (equating to 94% of the value of exports) combined with strict fiscal austerity measures imposed by the International Monetary Fund, effectively rule out any new borrowing, placing a major strain on public services. Given that less than half of Jamaica’s public debt is multilateral privately owned, additional measures to those envisaged to write off multilateral debt could be required to effectively address debt sustainability. The Economic Commission for Latin America and the Caribbean also proposed a similar model, where resources from the Green Climate Fund would be used (ECLAC, 2017).

In the aftermath of major exogenous shocks SIDS often struggle to meet debt servicing costs. State-contingent debt instruments can help governments at a time like this. The main idea behind these instruments is to help sovereign states preserve policy space and mitigate the negative impact of shocks by indexing a product with a state variable like GDP – which is a proxy for a country’s capacity to pay out or repay the product. State-contingent debt instruments can reduce the likelihood of debt distress and limit the impact of a shock on its capacity to finance public spending.

Counter-cyclical loans are also an ex ante instrument that can help SIDS in the aftermath of a disaster, by delaying repayments. As part of a broader risk management approach, counter-cyclical loans featuring a moratorium period following the triggering of an index linked to a disaster can provide a far more valuable injection of liquidity than ex post contributions. Well-designed products providing enhanced capacity to weather shocks will also help raise the creditworthiness of SIDS and foster investor confidence.

3.2.3. Making remittances work for development

Recommendations - Making remittances work for development:

The international community could co-ordinate measures to reduce the cost of remittances, including through appropriate regulations and a development-focused forum where regulators could come together to share the perspectives of sending and receiving countries.
Labour mobility programmes in the Pacific led to an increase in remittance flows, developed new skills for migrant workers and met a capacity gap for companies in the country. Providers could explore the scope for further expanding such schemes in the Pacific as well as in other SIDS regions.
Diaspora investment schemes could be promising sources of development finance for SIDS, and yet have been rolled out at scale in a SIDS context. Development partners can do much to support the design and implementation of these instruments, and back these new products with guarantees and co-financing schemes.

As discussed in Chapter 2, remittances represented the largest flow of external finance to SIDS in 2012-15 (54%). While they are relatively stable – especially compared to the volatility of foreign direct investment – donors can do more to facilitate their flow as well as create more opportunities for migrant labour. The anti-money laundering and counter-terrorist financing (AML-CFT) regulations implemented in 2009 seek to strengthen the health of the global economy, but the ensuing loss of correspondent banking relationships has resulted in higher transaction costs for transferring remittances. There is a need for greater policy coherence in this area if the international community is to increase the flow of remittances and maximise their benefits to development.

Labour mobility schemes in the Pacific have proven beneficial for SIDS and larger partner countries

New Zealand operates a successful labour-mobility programme in the Pacific that has led to an increase in remittance flows, developed new skills for migrant workers and met a capacity gap for companies in the country.18 The programme operates at a volume that makes a tangible contribution to receiving countries, but the success of the initiative depends upon adequate facilitation by the source country, and its efficacy decreases with distance from New Zealand. A recent analysis (Berkelmans and Pryke, 2016) concluded that expanding access to Australia’s labour market could deliver significant development gains for SIDS. More specifically, permitting 1% of the Pacific region’s population – an average intake of fewer than 3 000 people – to work permanently in Australia would result in greater benefit to the Pacific peoples by 2040 than Australia’s current aid programme.

Experimenting with diaspora bonds to pool and channel remittances to larger development projects

Remittances are mainly used to smooth consumption expenditure and contribute to poverty alleviation. However, diaspora bond products might channel migrant savings towards businesses and development projects in SIDS. Diaspora bonds are not new – examples of countries where they have been issued successfully include Israel and India – but they have often been unsuccessful. Hence, some lessons should be considered before applying them in a SIDS context. In the Caribbean, a relatively large, educated diaspora that generally left to seek employment should be predisposed to invest in diaspora bonds, which essentially draw on patriotic sentiment. However, Caribbean SIDS might struggle to issue diaspora bonds because of their low or non-existent credit ratings, and prevailing perceptions of corruption and weak government effectiveness. Diaspora bonds also require good marketing; they should be flexible, and designed with the customers in mind. Poor credit ratings and a poor track record with debt would likely be a barrier to many migrants buying such products in the Caribbean, but the product could first be tested in a high-income small state, such as the Bahamas, or Trinidad and Tobago, and then replicated if successful. Donors can support SIDS in this effort by helping them improve their credit ratings, by bearing some of the costs of developing such products, and by issuing guarantees.

3.2.4. Financial innovations and approaches to mobilise private financing

Recommendations - Increasing resources for development through blending arrangements and other financial innovations:

Official finance can be used more catalytically to de-risk investments or structure returns in a way to mobilise finance from the private sector through new and emerging blended finance arrangements.19 Grants, guarantees, syndicated loans and other instruments can crowd in the private sector, especially in sectors with potential for positive returns. Providers can also contribute technical assistance, can absorb the costs of project preparation and help with the identification of a pipeline of bankable projects. Care should be taken, however, to avoid over-subsidising individual private sector players and privatising gains. Adherence to the OECD DAC (2017) ‘Principles on Blended Finance’ will be important20 in this regard.
Under the leadership of the Government of Grenada, a “fund-of-funds” is currently being developed as a means to pool concessional finance, catalyse public and private finance sources, and create a pipeline of bankable projects aggregating smaller country projects. This initiative could sensibly reduce transaction costs, alleviate capacity constraints and help address the financing gap SIDS face with respect to their intended nationally determined contributions and the 2030 Agenda for Sustainable Development.
The country coverage of risk-transfer mechanisms, such as pooled insurance schemes, could be expanded to cover SIDS in all regions and innovative mechanisms could be developed to further reduce the cost of premiums and facilitate access to these products. Further use of contingency funds or contingent credit lines could also be encouraged.

Providers are increasingly using grants and other instruments, such as guarantees and syndicated loans, to deepen private sector involvement and leverage additional financing sources. The European Union has established specific blending mechanisms benefiting SIDS countries, such as the Caribbean Investment Facility and the Investment Facility for the Pacific. Through these facilities, grant finance from the European Development Fund envelope leveraged public and private resources, including from regional development banks and other organisations, contributing to several infrastructure projects in SIDS. A similar partnership exists in African SIDS, notably between the European Investment Bank and the African Development Bank. In the Pacific, the European Union supplemented blending through the Investment Facility for the Pacific for very small, debt-stressed SIDS that are unable to take investment loans. The Caribbean Investment Facility is open to 11 of the 13 Caribbean SIDS considered in this report,21 as well as to 4 high-income (non-ODA eligible) Caribbean island states. The instrument financed nine projects between 2012 and 2015, with a grant allocation of EUR 68.6 million and a total investment cost of EUR 541 million, thus leveraging finance at an estimated 1:8 ratio (Latin America Investment Facility, 2015). While EUR 40 million of this amount is a direct allocation from the Facility, Guyana was able to include EUR 30.2 million from the overall country allocation received from the European Union. Two of these projects were at the regional level; there were two projects each in the Dominican Republic and Guyana, and one project each in Belize, Dominica and Suriname.

A new OECD survey provides new evidence on private amounts mobilised through official interventions

Overall, based on data collected through the 2016 OECD-DAC Survey on Amounts Mobilised from the Private Sector, (Benn et al, 2017), official development finance interventions mobilised USD 701 million of private resources for SIDS (USD 175 million on average per year) in 2013-15. The main leveraging instruments used were guarantees (44%, or USD 306 million), followed by syndicated loans (40%, or USD 285 million). Private finance was mostly mobilised by the International Finance Corporation’s (IFC) interventions (43%), the United States (31%), and the Inter-American Development Bank (13%), followed by the European Union (6%), France (4%), the International Development Association (3%), Denmark (0.17%) and the African Development Bank (0.07%).

As illustrated in Figure 3.3, official development finance leveraged private resources in only nine SIDS in 2013-15. SIDS with relatively larger domestic markets and fairly good private sector potential, such as Jamaica and Guyana, were the main beneficiaries of these funds, accounting together for 51% (USD 358 million) of the total in 2013-15. Private finance mobilised in Jamaica mainly targeted the energy sector (42%) and tourism (31%), while in Guyana the entire amount targeted the industry, mining and construction sector. Overall, main sectors where official development finance was used to mobilise private financing were: the industry, mining and construction (38%), banking and private business (23%), energy (15%) and tourism (10%), with the social sector receiving fairly limited support (3%).

With the exception of Papua New Guinea, no SIDS in the Pacific region benefitted from the use of official development finance instruments to mobilise private financing. As expressed by the key providers in the region (OECD, 2016), this reflects the difficulty of mobilising the private sector in this region through credit guarantees and other instruments, unless other more structural impediments to private investing are addressed.

Box 3.7. Lessons from Grenada’s proposal on fast track fund-of-funds for small states

At the International Monetary Fund/World Bank Spring Meetings in April 2017, Grenada’s Prime Minister Mitchell set out his vision for Grenada’s chairing of the Small States Forum until October 2018 (the Forum includes all members of the World Bank with a population below 1.5 million). Prime Minister Mitchell highlighted Grenada’s plans to work with partners to enable ambitious and innovative finance solutions for small states. This includes opportunities to advance national-scale transformative climate action, both for adaptation and mitigation.

As part of this work, Prime Minister Mitchell has proposed the establishment of a Fast Track “Fund of Funds” for Small States. This would seek to use some public funds to mobilise far greater private sector investment, and to overcome the long-standing challenges posed by fiscal constraints; market invisibility; perceived absence of sufficient scale investment opportunities; and perceived uncertainty and risk.

The Fast Track Fund will target catalytic investments for countries that seek transformational climate action, rather than project-by-project incremental change. In doing so, it will collaborate with development partners, and seek to boost small states’ ability to harness existing financing channels, while at the same time opening up significant new financing opportunities.

With support from the World Bank’s Small State Secretariat and other development partners, work has already started to advance the identification and development of commercially viable, climate-friendly, at-scale public and private investments. This work was first discussed during the Annual Meetings of the International Monetary Fund/World Bank in October 2017. After the Annual Meetings, efforts will continue to build business cases, as well as to market and facilitate transformative investments in the private capital markets. Work will also continue with development partners to (i) identify and access affordable public finance channels such as new IDA resources for several small states; (ii) identify, and where possible expand, existing international fiscal space initiatives to develop more ambitious climate action investment programmes; (iii) identify risk management and mitigation opportunities, in conjunction with development partners, through the use of insurance products.

The work builds from Grenada and other small states’ participation in other collaborative efforts to advance ambitious climate action and broader sustainable development. Notably, in the run-up to COP22, Grenada participated in a high-level meeting with other development partners hosted at the OECD DAC in Paris to contribute to the efforts led by HE Mary Robinson, then the United Nations Secretary-General’s Special Envoy on Climate Change and Mr Erik Solheim, then the Chair of the OECD DAC. These efforts enabled a dialogue on international climate finance between senior officials from OECD DAC members, least developed countries, SIDS and the V20 group of vulnerable countries. A report summarising issues raised by least developed countries, SIDS and the V20 – entitled “Escaping the Triple Trap” identified how least developed countries and SIDS might escape the “triple trap” of climate change, fossil fuel dependence and fiscal constraints through innovative financing. Importantly, the report identified specific finance building blocks to advance climate action. Grenada has pointed out that these building blocks have the potential to fast-forward many of the measures set out in the Small States Strategic Roadmap, and advance the Prime Minister’s priorities before October 2018.

Source: Interview with the Government of Grenada.

Devising and adopting adequate risk transfer mechanisms

Risk transfer mechanisms are risk-management tools that involve the transfer of financial responsibility for some or all of the risk and any costs associated with the materialisation of that risk (OECD, 2017b). These mechanisms include insurance and reinsurance contracts, catastrophe bonds, contingent credit facilities and reserve funds as part of risk transfer from governments to financial markets.

The use of such market-based financing mechanisms is increasing globally. SIDS, however, struggle to access these because of their high-risk profiles (which drive up costs), and in some cases, their weak technical capacities to manage them. Despite these challenges, progress has been made in this area, and should continue through the development of risk transfer mechanisms and insurance markets that meet the needs and circumstances of SIDS.

Through regional sovereign insurance facilities, such as the Caribbean Catastrophe Risk Insurance Facility (CCRIF) and the Pacific Catastrophe Risk Assessment and Financing Initiative (PCRAFI), some SIDS created regional risk pools, resulting in reduced premiums for individual member countries. These initiatives also include a donor-subsidisation component. The PCRAFI provided Vanuatu with USD 1.9 million following Cyclone Pam in 2015 and extended about USD 1.2 million to Tonga following Tropical Cyclone Ian in 2014. So far, five Pacific SIDS22 have received a combined USD 43 million in insurance payments against tropical cyclones, earthquakes and tsunamis.

Building on the CCRIF, the World Bank, the U.S. Department of State, the Food and Agriculture Organization, the Nature Conservancy are currently developing the Caribbean Oceans and Aquaculture Sustainability Facility, a climate-risk insurance product for vulnerable fishing communities in the Caribbean. This project aims to establish a platform for innovative insurance financing that could support SIDS governments in addressing the intertwined set of challenges relating to food insecurity, climate resilience and livelihoods. Through the Caribbean Oceans and Aquaculture Sustainability Facility, countries that incorporate measures to foster climate resilience and marine protection would benefit from lower, co-financed insurance premiums. So far, Belize, Grenada and Jamaica have expressed interest in participating in the Facility, and the World Bank is also considering its global application.23

To explore how to deploy climate risk insurances more broadly, providers could also leverage efforts under InsuResilience, a Group of Seven (G7) Initiative on Climate Risk Insurance established under Germany’s G7 presidency in 2017. InsuResilience aims to increase access to direct or indirect insurance coverage against the impacts of climate change for up to 400 million of the most vulnerable people in developing countries by 2020.

Box 3.8. Lessons on enhancing access to finance from international capital markets

Compared to larger developing countries with similar per capita incomes, SIDS struggle to access international financial markets. Most Pacific SIDS are not sufficiently creditworthy to raise funds in capital markets; only Fiji, Papua New Guinea and the Solomon Islands have a sovereign credit rating from one or more of the main international credit rating agencies. As for Caribbean SIDS, they have seen a rapid deterioration in international capital-market ratings by key credit-rating agencies, with a consequent rise in risk premiums. Obstacles to accessing private international capital market are connected to issues relating to challenges in government budgets planning and control, public financial management and, sometimes, critical debt situations. International support for fiscal reforms, public sector management and public sector investments are thus critical to help SIDS enhance their capacity to mobilise international private capital.

Australia’s technical advice and support helped the Government of Solomon Islands to obtain a Moody’s credit rating (B3 in November 2015) in order to gain access to international credit markets. In March 2017, the Solomon Islands’ government signed for the first time a Domestic Development Bond Agreement worth USD 150 million with the Solomon Island National Provident Fund.

3.3. Channelling resources to priority areas

To break the cycle of low growth and vulnerability facing SIDS, public international finance will need to continually seek innovative ways to strengthen the role of the private sector and its contribution to sustainable development in these varied contexts. This will include the promotion of adequate policy and regulatory frameworks as well as support to increase the economic and financial viability of income-generating activities and to promote trade integration and global value chains participation.

Specific opportunities could arise from the development of the blue economy, which could boost economic growth and help address unemployment, poverty and food insecurity. In this area, the international community could provide advisory services and legal and regulatory support to address cross-border policy challenges relating to the development of the blue economy. Development partners should also support the development of appropriate financing instruments, including blue bonds.

Lastly, long-term development gains need to be “climate-proof” in SIDS. Development partners will need to maintain a focus on fostering climate-resilient economies in SIDS and on facilitating a transition to low-carbon economies. This will require helping SIDS integrate climate and disaster risks into national policies and planning, and project design; support them in accessing climate financing by using their influence to encourage the adoption of proportionate, streamlined approaches for accessing finance from the global funds; removing the barriers to investments for renewable energy sources would significantly reduce import costs for SIDS, improve debt sustainability and create more fiscal space for development investments.

3.3.1. Fostering private sector development and trade

Recommendations - Supporting private sector development and enhancing trade:

Opportunities for developing stronger domestic private sectors and enhancing international trade may differ significantly across SIDS. To break the cycle of low growth and vulnerability facing SIDS, public international finance will need to continually seek innovative ways to strengthen the role of the private sector and its contribution to sustainable development in these varied contexts, including through the promotion of policy and regulatory frameworks, support to increase the economic and financial viability of income-generating activities and trade integration.

Chapter 1 highlighted that domestic private sectors are often shallow, especially in the Pacific, while Chapter 2 pointed to the small contribution of private finance to the external financial flows reaching SIDS. Opportunities for developing stronger domestic private sectors and enhancing international trade may differ significantly across SIDS. The smallest and most remote SIDS face the greatest challenges to developing a competitive private sector and finding a niche in global markets.

For many SIDS, the main challenge remains the economic and financial viability of income-generating activities in the context of structural constraints such as a higher cost of inputs, higher transportation costs, and frequent extreme-weather events and natural disasters. In the case of English-speaking SIDS in the Caribbean, the proximity of the North American labour market makes it very hard to find highly qualified human resources to work in managerial positions on the islands. A lack of adequate policy and regulatory frameworks also prevents greater development of the private sector and of investments.

A large share of financing to SIDS aims to foster an enabling environment for private sector development

The good news is that concessional finance to support private sector development is increasing. According to the framework developed by the OECD to measure official finance for private sector development (Miyamoto and Chiofalo, 2017),24 the international community deployed an estimated USD 3.3 billion in 2012-15 to improve policies and regulations, as well as governance, for the private sector in SIDS – a little less than 20% of the total concessional finance provided over the period. An additional USD 3 billion was allocated by the international community to “support market functioning” in SIDS, including through activities – such as enhancing physical infrastructure through road extensions and electrical efficiency gains – aiming to reduce costs and barriers to economic activity. A smaller amount (USD 1 billion) was allocated to increasing enterprise resources across SIDS, including through activities aiming to heighten small farmers’ productivity, enhance community-based fisheries and aquaculture, and implement education programmes and scholarships.

Across geographical regions, support to private sector development mainly targeted SIDS in the Pacific (46%) and Caribbean (41%), followed by SIDS in the AIMS region. However, these regional trends hide important differences. The largest shares of support were directed to: Haiti, some natural resource-rich SIDS (e.g. Papua New Guinea, Solomon Islands and Timor-Leste) and the Dominican Republic. Support mainly targeted enhancing the policy environment and governance in least developed and fragile SIDS, in natural resource-rich SIDS and in some of the smallest SIDS in the Pacific, as the shallow domestic markets in these countries call for some important preconditions to be met, and structural barriers to be lifted, before more support can be given directly to private actors. SIDS with relatively larger and more developed private sectors received most of private sector development support as financing aimed to strengthen market functioning (Figure 3.4).

Several development partners are developing new approaches to private-sector development. The World Bank has developed the “Cascade” approach (Box 3.10.) aiming at crowding in private finance for infrastructure in developing countries. The World Bank sees this approach as potentially meeting shortages in development finance and infrastructure gaps in SIDS (World Bank, 2017a), but the approach will need to be adequately tailored to the context of SIDS. In addition, the World Bank Private Sector Window will use IDA18 concessional funds for market creation and private sector engagement in the riskiest of markets, with IFC as main implementer. It targets fragile and low-income states and SIDS account for 26% of eligible countries but represent a tiny portion if calculated in terms of market size/population. The Asian Development Bank has carried out a Private Sector Development Initiative, including in SIDS. The main achievements are briefly described below.

Box 3.9. The cascade principles for infrastructure finance

In its Forward Look: A vision for the World Bank Group in 2030 – progress and challenges (World Bank, 2017b), the World Bank Group presented its long-term vision and approach to crowding in private-sector investment and “creating markets”. By introducing “cascade” principles for infrastructure finance, this report attempts to operationalise the call to scale up private finance outlined by the World Bank, the IMF and five other multilateral development banks in the 2015 From Billions to Trillions (World Bank, 2015).

Forward Look explains that “to maximise the impact of scarce public resources, the cascade first seeks to mobilise commercial finance, enabled by upstream reforms where necessary to address market failures and other constraints to private sector investment at the country and sector level. Where risks remain high, the priority will be to apply guarantees and risk-sharing instruments. Only where market solutions are not possible through sector reform and risk mitigation would official and public resources be applied”. While currently focused on infrastructure, the document highlights that the cascade approach will be expanded to other areas, including finance, education, health and agribusiness.

The World Bank includes this approach in the “package” of initiatives and measures it makes available to small states (which include the SIDS eligible for concessional finance from the International Development Association) in Small States: A Roadmap for World Bank Group Engagement (World Bank, 2017a). The “judicious” use of scarce public finance, including of international concessional finance, and the need for upstream reforms and for addressing market failures suggested by the cascade approach, seem to be in line with providers’ approach to private sector development in SIDS. Extending this approach to the social sectors and private sector provision of social sectors, however, could raise concerns along the lines of those expressed by the civil society (Brettonwoods Observer, 2016), and may be more challenging to implement in a SIDS context.

Source: Adapted from World Bank (2017b) and World Bank (2015).

Enhancing access to international trade

In 2012-15, the international community also channelled USD 1.1 billion in concessional finance to activities supporting better integration in the international trading system (i.e. “aid for trade”). While this support targets enhancements along the same three dimensions as in the private sector development framework (i.e. policy and regulations, economic infrastructure and productive capacity), some overlap exists between support to private-sector development and aid for trade.25 In 2012-15, examples of aid for trade in SIDS in these three areas include: (i) support from the European Union under the 10th European Development Fund for the CARICOM Single Market and Economy and for the Economic Integration Programme; (ii) support from Japan to Kiribati to develop the Betio Port, including finance to improve berthing facilities as well as cargo-handling equipment; and (iii) funding by the Inter-American Development Bank for a market-access and agricultural diversification programme in Guyana. To promote greater regional trade linkages, much of aid for trade provided at the regional level (i.e. 20% to the Pacific and 28% to the Caribbean) supports policy and regulatory measures.

Box 3.10. Lessons from the Asian Development Bank’s Private Sector Development Initiative

According to the Asian Development Bank’s independent evaluation of private sector operations (ADB, 2016), Pacific countries showed varying degrees of success under regional private equity funds and trade finance programmes. Nevertheless, the Asian Development Bank’s Pacific Private Sector Development Initiative, now in its seventh year of operation, has demonstrated a strong track record of achievement in the private sector. Achievements include:

Improved access to finance in the Marshall Islands, Micronesia, Palau, Solomon Islands, Tonga and Vanuatu, through secured transaction reform: as a result of the new secured transaction laws and registries, financial institutions in these Pacific countries have extended approximately 28 000 new formal sector loans.
Assistance to microfinance institutions in Papua New Guinea, Timor-Leste and Vanuatu resulted in a significant growth in savings accounts, particularly in remote areas, with women being the major beneficiaries: over 50 000 new savings accounts have been opened since 2010. The Pacific Private Sector Development Initiative is also assisting financial institutions in improving rural outreach through branchless mobile phone banking systems.
In business-law reforms, the Pacific Private Sector Development Initiative has helped Samoa and the Solomon Islands establish online business registries, leveraging the digital revolution to make it easier to start a formal business. The Initiative facilitated a new business registry and an innovative Companies Act support local communities and women’s groups start businesses.
The Company House online registry installed by the Solomon Islands in 2010 reduced the necessary time to license a business from 45 days to 1.5 days, thereby doubling the rate of business formation. Similarly, the rate of business registrations doubled after Samoa launched its online company registry in 2013.
The Initiatives’ large, ongoing programme to help Pacific governments improve their outdated commercial laws is bringing more businesses into the formal sector, with corresponding improvements in productivity and wages.
The Initiative has also helped a number of countries improve the governance and efficiency of state-owned enterprises, and the state owners’ capacity to hold them accountable for commercial results. The Finding Balance series of publications highlights the very substantial drag on growth state-owned enterprises create throughout the region. The Initiative has assisted with a number of privatisations, with resulting efficiency improvements and job creations. It has also assisted Papua New Guinea and Timor-Leste in establishing policy and legal frameworks for public-private partnerships, as well as identifying opportunities for public-private partnerships in infrastructure, several of which are undergoing further development.

Finally, the Pacific Private Sector Development Initiative has initiated pilots to increase women’s private sector activity, e.g. by training them in technical and business development skills, facilitating their access to finance and markets, and mentoring them in entrepreneurship skills.

Source: ADB, 2016

3.3.2. Prioritising the climate and resilience

Recommendations - Supporting transitions to low-carbon, climate-resilient economies:

Development partners need to continue to help SIDS integrate climate and disaster risks into national policies and planning, and project design. This will include supporting the adoption of policies and regulations – such as building codes, incentives for efficient water use and prevention of new assets in exposed areas – that promote climate resilience by influencing the choices of private actors.
Complex application processes and fiduciary standards exceeding the capacities of SIDS constrain access to financing from the global climate funds. Development partners could use their influence to encourage the global climate funds to adopt proportionate, streamlined approaches promoting greater access and project implementation.
Providers need to do more to remove the barriers to investments for renewable energy sources. The status of renewable technologies and the large extra- resource allocation potentially available for climate action make this the perfect moment to increase the renewable capacity in SIDS. The international community should drive this agenda, which could also reduce import costs, improve debt sustainability and create more fiscal space.
Financial innovations will be central in mobilising climate finance at scale. Already, the Green Climate Fund is using grants to promote investments in adaptation activities; concessional loans to absorb high market rate costs of debt; and guarantees and equity to de-risk investments and increase the commercial viability of investments projects. This financing is likely to be used for higher return investment projects, and in SIDS could contribute, for example, to climate-resilient infrastructure, maritime-infrastructure investments and renewable energy projects.

As discussed in Chapter 2, the sectoral focus of concessional finance in SIDS reflects in part the specialisation of providers and it may fail to adequately target sectors and areas that are critical for advancing development in this context. A clear example stems from providers’ investments in climate and disaster resilience, and more broadly for climate adaptation and mitigation. Globally, SIDS bear the brunt of climate change impacts. Rising sea levels and ocean acidification pose existential challenges to SIDS. While hurricanes and cyclones have been a feature of life on islands for centuries, the effects of climate change are exacerbating their intensity and making extreme weather events more likely to happen. These circumstances will increase the cost of achieving sustainable development in SIDS.

In addition, as discussed in Chapter 1, transitioning to a low-carbon economy will be an important step for SIDS to move towards more sustainable development, abating the costs of an economy that relies on expensive imported fossil fuels. While most SIDS have ideal situations to exploit renewable energy, many struggle to bear the large initial costs of investments for renewable energy sources, in part owing to limited borrowing capacity.

National policies as well as donor interventions in SIDS take into account the current and future impacts of climate change, in the interest of both the viability of the investment as well as SIDS’ debt sustainability. Development partners need to continue to support SIDS integrate climate and disaster risks into national policies and planning, and project design, including through policies and regulations – such as building codes, incentives for efficient water use and prevention of new assets in exposed areas – that can promote climate resilience by influencing the choices of private actors.

Climate finance will need to be scaled up. This will require the adoption, to the extent possible of streamlined application processes that are proportionate to SIDS constrained capacities. It will also require innovation from a broad range of actors and will provide an opportunity to trial new instruments. The Green Climate Fund will be an important source of financing and of innovation (Box 3.11). The Global Innovation Lab for Climate Finance - a multi-partner platform led by the United Kingdom, Germany, Denmark, France, Japan, United States, Netherlands and Norway - could also be an important actor in this regard. Along with private sector partners, it seeks to catalyse new approaches, by bringing together experience and expertise to identify, design and pilot the next generation of climate- finance instruments. These will provide concrete solutions to the financing challenges facing real projects, as well as build new markets, attract new investors and help to unlock resources for new climate-friendly investment in SIDS.

Box 3.11. Lessons from an innovative use of Green Climate Fund resources

The Green Climate Fund will be an important source of finance for SIDS, as well as a vehicle for innovation in development finance. Having received to date USD 10.3 billion in pledges, it is now the largest vertical fund operating at a global level; the first formal replenishment will be triggered once 60% of the initial resource mobilisation has been spent.26 The co-chairs commissioned further consultations at the 16th meeting of the Green Climate Fund board in April 2017, with a view to triggering the replenishment process in the near future. The Green Climate Fund has been operational since 2015 and now has 45 approved projects.27

To date, eight of the projects are in SIDS and two regional initiatives include SIDS as beneficiaries. Of the direct projects, six are in the Pacific and two in the AIMS region; three are least developed countries, one is a lower middle-income country and four are upper middle-income countries. Both regional initiatives are in the Caribbean. In SIDS, the Green Climate Fund is using both grant financing and more complex financing arrangements that blend sources with varying degrees of concessionality. These projects generally include government co-financing.

One of the first projects the Green Climate Fund approved in 2015 was a regional initiative comprising four countries, including two SIDS. The project will be piloted in Mexico and will then include Columbia, Dominican Republic and Jamaica. The project aims to enhance energy efficiency in Latin America and the Caribbean, and will aggregate resources to mobilise institutional funds to finance SMEs involved in servicing this sector.28 It is being implemented by the Inter-American Development Bank, with additional financing from the Clean Technology Fund and the private sector.

The project provides loans for energy efficiency projects. It will bundle multiple projects to underpin the issuance of partly guaranteed green bonds. The pilot in Mexico will cost USD 2 million in grants for programme development and a further USD 20 million in credit guarantees. For the following phase a further USD 195 million has been allocated. The programme targets a minimum emission reduction of 13.2 million carbon dioxide tons equivalents (tCO2e) (2.5 million tCO2e in Phase 1) and USD 780 million (150 million USD in Phase 1) of private sector bond issuances, with potential for further up-scaling and replication in other developing countries. This could provide a valuable financing modality: not only are concessional resources being used catalytically to leverage capital, but collaboration with larger developing countries will effectively leverage growth in the private sectors of SIDS. There is scope to apply such a model to the AIMS region, which is less well defined, and where most SIDS have strong ties with continental African states.

Source: Adapted from the Green Climate Fund website www.greenclimate.fund/home

3.3.3. Navigating new frontiers – supporting the development of the “blue economy”

Recommendations - Exploring new opportunities for growth, including through the “blue economy”:

The international community could provide advisory services and legal and regulatory support to address cross-border policy challenges relating to the development of the blue economy. Development partners should also support the development of appropriate financing instruments, including blue bonds.
Specific attention could be dedicated to developing instruments that finance the conservation of marine protected areas, linked to national blue economy strategies. Valuation of marine resources and ecosystems – and especially the full value of ocean resources – must inform policy.

As discussed in Chapter 1, SIDS’ economic vulnerabilities largely stem from their reliance on few economic sectors and trading partners, which exposes them to fluctuations in the global markets. If they fail to expand their narrow productive and export bases, SIDS will continue to experience precarious cycles of vulnerability.

Increasingly, the greatest scope for diversification and expansion lies within the vast oceans surrounding many SIDS. The sustainable development of marine resources (i.e. “blue economy”) could open new opportunities to develop new competitive sectors and diversify the economy. Maritime resources, which are already closely linked to key income generating sectors such as the tourism and fisheries, could lead to greater economic diversification and more rapid growth through innovative investments that integrate and develop a broader range of land-based, coastal and ocean-based sectors in a sustainable fashion. The development of the blue economy could boost food, energy, transport and other sectors, and foster sustainable and inclusive development in SIDS.

To effectively help SIDS develop the blue economy and make the best of it for their economies and their people, the international community will need to support SIDS in the development of adequate policies and regulations, expertise and technical capacities, as well as be responsive in helping them to have sufficient fiscal space and adequate resources to invest in this endeavour. Therefore, there is scope for the innovations and good practices described so far in this chapter to catalyse achievements for the blue economy. The remainder of this section explores current support for the blue economy and highlights how these efforts could be brought to scale going forward.

Current financing will need to be scaled up, and be part of an integrated and strategic approach

Of the USD 18.8 billion in concessional finance channelled to SIDS in 2012-15, approximately USD 1.15 billion (6.11%) went to sectors relating to the ocean economy.29 Bilateral and multilateral providers of concessional finance have steadily increased their support (from USD 264 million in 2012 to USD 329 million in 2015, an average increase of 8% per year). The bulk of this financing has targeted transport policy and administration management (41%), and water transport (30%). Over the same period, concessional finance for the ocean economy also targeted the fisheries (13%) and tourism (7%) sectors.

The SIDS that received the largest share of this investment are Papua New Guinea (23%), Haiti (17%) and Cabo Verde (7%). The biggest donors are: Australia (21%), the Inter-American Development Bank Special Fund (18%) and Japan (14%).

Examples of donor support to the ocean economy emerge from responses to a survey on DAC members’ development co-operation policies and practices vis-à-vis SIDS conducted for this report. These include:

Australia supported Timor-Leste in the tendering programme for the Tibar Bay Port construction, and provided an AUD 5 million (Australian dollars) grant to the Pacific Island Forum Fisheries Agency.
Italy supported SIDS in the Caribbean region to strengthen supply chains around key economic sectors, including tourism and agribusiness, and promotes public-private partnerships to this end.
Japan provided technical assistance and grants to SIDS in the Eastern Caribbean to develop the fisheries sector and promote sustainable development.
New Zealand supported the Pacific SIDS at a regional level to develop the fisheries sector, including through scientific, management, regulatory and technical support.
The United States has been working with Haiti to develop the Cap Haïtien Port, supporting the development of critical infrastructure and regulatory reform in order to modernise the facilities and grow trade. The United States has also supported the growth of aquaculture programmes in Guyana.

While these are positive examples to build on, achieving a sustainable ocean economy calls for an integrated and strategic approach to better align policies across multiple sectors. It entails integrating the value provided by ecosystems into our economic decision-making frameworks, scaling up finance in innovative ways, and investing these resources more efficiently and strategically. Consequently, fostering the blue economy will require a combination of enabling factors: a concerted national strategy supported by adequate international support; expertise from various fields to come together and establish synergies; partnerships between national and international actors, the private sector and civil society; and adequate financing approaches and instruments. An important component of the blue economy will be marine protected areas (Box 3.12).

Box 3.12. Italy’s leadership in promoting marine protected areas: the 10X20 Initiative

Oceans are facing unprecedented pressures from human activity. Protecting them is essential, not only to spearhead future economic growth, but to preserve the very existence of humankind. This is why promoting marine protected areas is a critical element of the global blue economy.

Together with the Ocean Sanctuary Alliance, the Government of Italy has launched the 10X20 Initiative, a plan of action to support the achievement of Target 5 of the U.N Sustainable Development Goal 14: conserving at least 10% of coastal and marine areas by 2020. This initiative aims to assist countries in achieving this globally agreed commitment through a scientifically based framework. It aims to create a co-ordinated global network of marine protected areas, to achieve the 10% target to conserve biodiversity. The network will foster an exchange of knowledge, information and best practices, and will pursue advocacy.

Investing in marine protected areas can help promote food and nutritional security, as well as economic security. It provides recreational value, and preserves cultural and spiritual values. It contributes to well-functioning ecosystems and helps regulate the earth’s climate. It is estimated that the economic benefits from establishing new marine protected areas can offset the costs in as few as five years (Sala et al., 2016). In Hawaii, a review of six marine managed areas showed that they generated cost-benefit ratios ranging from 3.8 to 41.5 (van Beukering and Cesar, 2004). In Vanuatu, a mean return on investment of 1.8 was achieved for five marine protected areas only five years after the initial investment (Pascal, 2011).

Marine protected areas require adequate financing for the transition period, as well as for enforcement and management. The international community can do much to support this by helping establish conservation funds, dedicated national budget allocations, user fees and fines.

Financial innovation will be needed to help boost the blue economy

Blue bonds, which have been implemented successfully in Indonesia, are a prospective source of revenue for SIDS. The Seychelles is a precursor among SIDS in this respect, issuing a USD 15 million, ten-year blue bond, including guarantees from the World Bank and grant finance from the Global Environment Facility. The new initiative was awarded the 2017 Ocean Innovation Challenge at the World Ocean Summit 2017 in Bali. The blue economy strategy in the Seychelles focuses on economic diversification, food security, and the protection and sustainable use of marine resources. The proceeds of the bond are aligned with this strategy: they will specifically finance fisheries management and planning activities, and will be loaned out to encourage public and private investment that adds value and job opportunities in areas that protect ocean resources. The funds will be disbursed by the Seychelles Conservation and Climate Adaptation Trust, and the Development Bank of Seychelles. These activities will proceed in tandem with the implementation of the Seychelles Marine Spatial Plan for its economic exclusion zone, which is one of the commitments included in the country’s debt swap for conservation and climate adaptation.

3.4. Conclusions and recommendations

Small island developing states stand at a critical juncture on their paths towards sustainable development. As discussed in Chapter 1, economic growth, human development and vulnerability indicators point to specific challenges facing SIDS, suggesting that new development solutions and approaches are needed to chart the course to prosperity for their people and their environments.

New global trends could open up promising opportunities for SIDS, giving them access to new markets, boosting economic growth and helping some of them achieve economic self-sufficiency. By developing old and new sectors linked to the abundant marine resources of SIDS, the blue economy could fuel economic growth and help address food insecurity, high unemployment and poverty. Innovations in technology and world digitalisation could lift connectivity barriers to global markets, provide opportunities for participating in “virtual” labour markets through remote access and the use of holograms, reduce brain drain and stir the development of new economic niches. Sun, wind and ocean waves – all abundant in SIDS – are potentially powerful and exploitable energy sources that could be used to help break dependence on fossil fuels and create fiscal space to address critical development needs. These needs include enhancing resilience to the severe climate events and devastating natural disasters to which SIDS are highly exposed.

The international community has a critical role to play in helping SIDS seize these opportunities and embark on sustainable development pathways. The international community can invest in generating innovative thinking and creative solutions to lay out new, effective development options and paradigms for SIDS. This chapter presented some innovative solutions that providers could make greater use of or further develop. It suggested priority areas where the international community could take action for making development co-operation work better for SIDS and thus support them more effectively in achieving sustainable development. Building on this information, the international community, including SIDS governments, can move forward to take urgent action to pave the way for new development paradigms and sustainable development in SIDS. The recommendations presented in this chapter are summarised below.

Enhancing access, modalities and partnerships for concessional finance:
- Building capacity and technical assistance: Providers can do more to improve the absorption capacity of SIDS, and the ability to mobilise, manage and spend financial resources from a wider array of sources to decrease dependence on a single provider: through long-term approaches to capacity development, innovative uses of technology, and a careful assessment of which functions could be performed at a regional level, which will need to remain at the national level, and which could be outsourced privately. Using pooled mechanisms to reduce transaction costs and modalities could also help to strengthen national capacities.
- Encouraging partnerships with a larger range of actors, including through triangular co-operation: Partnerships with a larger set of stakeholders will bring a wider set of perspectives and approaches to the complexity of development in SIDS and could provide an alternative source of financing as SIDS move to higher levels of national per capita income. Collaboration between “traditional” and “emerging” donors could also be instrumental to reducing transaction costs and enhancing policy dialogue in SIDS. Positive examples of multi-donor trust funds used to channel resources, such as the one established in Nauru with contributions from Australia and Chinese Taipei, could replicated in other SIDS contexts.
- Expanding the evidence base and policy dialogue around the complexity of development in SIDS: SIDS that have recently graduated from least developed country status, such as Cabo Verde and Samoa, have quickly moved from a moderate to a high risk of debt distress, signalling that development partners could do more to support and advise countries during transitions. While several SIDS have flagged the negative consequences of losing access to concessional finance after graduating from bilateral or multilateral financing, no exhaustive analysis has been conducted on the real impacts of losing access to these sources. More evidence and policy dialogue needs to be fostered to understand the impacts of different graduation processes on financing landscapes and growth opportunities in order to maintain development gains as countries transition through different income levels and development phases, i.e. the “development continuum”.
Using concessional finance innovatively to leverage additional resources:
- Access to new and existing financing, including climate finance and private sector investments: Innovative financial instruments, such as green and blue bonds, and blending arrangements to bring climate finance to scale, are promising sources of development finance for SIDS. However, none of these have been rolled out at scale in a SIDS context. Development partners can do much to support the design and implementation of these instruments, and back these new products with guarantees and co-financing schemes to encourage economic diversification and invest in building long term resilience.
- Domestic resource mobilisation: this could be enhanced through diaspora investment schemes; internationally co-ordinated fiscal reforms to expand tax coverage (especially to include high revenue-generating segments of the economy); and policies to reduce “leakages” from key sectors – especially tourism – and support linkages with other domestic sectors to effectively expand the taxable production base.
- Debt sustainability: There is a need to work with partners to address debt sustainability and free resources for sustainable development including for the blue and green economies. Debt relief opportunities, such as debt for nature swaps, and innovative counter-cyclical instruments, such as loans that automatically postpone debt servicing in the event of a major shock (e.g. through “hurricane” clauses) could be further explored and expanded.
Channelling resources to priority areas:
- Transitioning to low-carbon, climate-resilient economies: Providers could do more to help SIDS integrate climate and disaster risks into national policies and planning, and project design and support them in accessing climate financing by using their influence to encourage the adoption of proportionate, streamlined approaches for accessing finance from the global funds. Removing the barriers to investments for renewable energy sources would significantly reduce import costs for SIDS, improve debt sustainability and create more fiscal space for development investments.
- Fostering new growth opportunities such as the blue economy: The international community could provide advisory services and legal and regulatory support to address cross-border policy challenges relating to the development of the blue economy. Development partners should also support the development of appropriate financing instruments, including blue bonds. Specific attention could be dedicated to developing instruments that finance the conservation of marine protected areas, linked to national blue economy strategies.
- Supporting private sector development, enhancing trade and attracting private finance: Opportunities to develop stronger domestic private sectors and enhancing international trade may differ significantly across SIDS. To break the cycle of low growth and vulnerability facing SIDS, public international finance will need to continually seek innovative ways to strengthen the role of the private sector and its contribution to sustainable development in these varied contexts, including through the promotion of policy and regulatory frameworks and support to increase the economic and financial viability of income-generating activities.

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Notes

← 1. For further information please see https://pefa.org/.

← 2. To directly access funding, Green Climate Fund countries are required to designate national implementing agencies: i) national implementing entities are responsible for overseeing implementation of funded initiatives, and ensuring that finance received follows the Fund’s objectives and meets its fiduciary standards and social safeguards; ii) National Designated Authorities are responsible for overseeing all resources coming into the country from the Fund. The authority is the point of communication with the Green Climate Fund and undertakes a wide range of functions, including aligning activities with national sustainable development objectives and frameworks; and iii) executing entities are responsible for the actual implementation of initiatives. These can be members of other government agencies, civil society, community organisations and the private sector. See: www.wri.org/sites/default/files/22DIRECT_ACCESS_TO_CLIMATE_FINANCE_LESSONS_LEARNED_BY_NATIONAL_INSTITUTIONS.pdf.

← 3. This survey involved responses by 60 stakeholders, namely: Argentina, Armenia, Australia, Austria, Benin, Brazil, Burkina Faso, Cameroon, Canada, Chile, Colombia, Cook Islands, Costa Rica, Dominican Republic, Ecuador, Fiji, France, Germany, Guatemala, Honduras, Indonesia, Israel, Italy, Jamaica, Japan, Kiribati, Korea, Madagascar, Mexico, Mozambique, New Zealand, Norway, Paraguay, Peru, Portugal, Russian Federation, Samoa, South Africa, Spain, Sudan, Sweden, Switzerland, Timor Leste, Tuvalu, United Kingdom and Uruguay; the African, Caribbean and Pacific Group of States, Asian Development Bank, Food and Agriculture Organization, Inter American Development Bank, International Labour Organization, Organisation Internationale de la Francophonie, Pacific Islands Forum, Pan American Health Organisation, United Nations Children’s Fund (Mexico Office), United Nations Economic Commission for Europe, United Nations Volunteers, United Nations Industrial Development Organization, United Nations Office on South-South Co-operation and World Food Programme. The Islamic Development Bank and the United Nations Development Programme China contributed information on their triangular co-operation initiatives to the online project repository of the OECD..

← 4. This is a project over 2013-23 involving Cook Islands, China, New Zealand, and the World Health Organisation. This project, with a USD 42 million budget, aims at upgrading Rarotonga’s water supply infrastructure to deliver a high-quality and reliable water supply, which is critical for growing tourism and safeguarding public health. The project will increase resilience to drought for the majority of the Cook Islands population who live on Rarotonga.

← 5. This project involves Cuba, Mexico and Germany over 2017-19. With a USD 500 000 budget, this project aims to strengthen the institutional capacities to implement renewable energy and energy efficiency measures in Cuba.

← 6. See https://sustainabledevelopment.un.org/sids2014.

← 7. Cabo Verde, Sao Tome and Principe, Maldives, Dominica, Grenada, Saint Lucia, Saint Vincent and the Grenadines, Guyana, Kiribati, Marshall Islands, Micronesia, Papua New Guinea, Samoa, Timor-Leste, Tonga, Tuvalu and Vanuatu.

← 8. This is the case, for example, of Japan, as indicated in Japan’s response to a survey conducted to inform this report.

← 9. With the exception of G8 members and European Union members.

← 10. Countries above the high-income threshold for three consecutive years at the time of the review (which happens every three years) are removed from the List.

← 11. These include the United Nations Economic Commission for Latin America’s structural-gap approach, the adapted Economic Vulnerability Index used by the United Nations Office of the High Representative for Least Developed Countries and the vulnerability metrics developed by the Commonwealth Secretariat.

← 12. See https://www.addistaxinitiative.net/ and http://www.tiwb.org/.

← 13. Aid-for-tax data is only available only from 2014.

← 14. Self-reported information provided by Australia through its response to an unpublished OECD DAC survey questionnaire regarding OECD DAC members’ policies and practices supporting small island developing states conducted to inform this report.

← 15. SDG 14.4: by 2020, effectively regulate harvesting, and end overfishing, illegal, unreported and unregulated (IUU) fishing and destructive fishing practices and implement science-based management plans, to restore fish stocks in the shortest time feasible at least to levels that can produce maximum sustainable yield as determined by their biological characteristics.

← 16. The Manila Agreement was facilitated by the Asian Development Bank, and signed by the governments of Italy, Nauru and New Zealand.

← 17. The Paris Club is a group of officials from 22 major creditor countries which negotiate coordinated solutions to the payment difficulties experienced by debtor countries.

← 18. Responses to an unpublished OECD Survey on policies and practices in support of SIDS.

← 19. OECD definition of blended finance is “the strategic use of development finance (1) for the mobilisation of additional commercial (2) finance towards the SDGs in developing countries”.

← 20. The Principles are intended to assist providers of development finance - DAC member governments, non-DAC donors, development co-operation agencies, philanthropies and any other interested stakeholders - in the design and implementation of blended finance policies and approaches. They aim to ensure that blended finance is deployed so as to mobilise additional capital effectively in order to deliver development outcomes and impact.

← 21. Neither Cuba nor Montserrat are members of the Africa, Caribbean and Pacific Group of States, through which much of the EDF’s European Development Fund allocation to SIDS is channelled.

← 22. Cook Islands, Marshall Islands, Samoa, Tonga and Vanuatu.

← 23. For more information on the project, see World Bank (2016).

← 24. This framework comprises three main components: (i) polices and governance (ii) market functioning and (iii) enterprise resources. Budget support, which is included in original private sector development (PSD) framework, is excluded from the analysis presented here. The original framework includes budget support on the grounds that it contributes to macroeconomic stability, which is crucial for enabling investment. However, in a SIDS context where private markets are effectively very thin and budget support is often used to finance public services, counting general budget as a PSD component would likely over estimate its potential contribution to stimulating private investment.

← 25. This was estimated at USD 4.68 billion for SIDS in 2012-15.

← 26. www.greenclimate.fund/documents/20182/584114/GCF_B.16_Inf.11_-_Matters_related_to_the_replenishment_of_the_Green_Climate_Fund.pdf/4fba80f5-6c45-4134-85ea-26c8872fda28.

← 27. www.greenclimate.fund/projects/portfolio.

← 28. www.greenclimate.fund/documents/20182/87610/GCF_B.11_04_ADD.06_-_Funding_proposal_package_for_FP006.pdf/4be31e42-bda9-46a0-b200-bc2f78ed81d6.

← 29. The purpose codes considered to contribute to the blue economy are: water sector policy and administrative management; water resources conservation (including data collection); transport policy and administrative management; water transport, storage; marine energy; fishing policy and administrative management; fishery development; fishery education/training; fishery research; fishery services; transport equipment industry; tourism policy and administrative management; and flood prevention/control.