Collectively referred to as countries with special needs, least developed countries (LDCs), landlocked developing countries (LLDCs) and small island developing States (SIDS) are characterized by a combination of geographic remoteness, being burdened with high trade costs, and lacking scale economies and resilience to crises and shocks, all of which hinders the achievement of sustainable development.
Prior to the COVID-19 outbreak, countries with special needs in Asia and the Pacific were largely off-track to attain the Sustainable Development Goals (SDGs) by 2030. The COVID-19 pandemic has further dampened prospects for achieving the SDGs.
Estimates of the annual investment needs of Asia-Pacific LDCs and LLDCs to achieve the SDGs by 2030 before the pandemic amounted to approximately 19 and 8 per cent of their respective gross domestic products (GDPs). While data scarcity constrains any estimation for SIDS, the costs are compounded by vulnerabilities to climate change and their small, scattered population bases, which raise the fixed costs of investments.
Owing to a combination of declining government revenue and expanding fiscal and monetary stimulus measures deployed to counter the adverse impacts of the pandemic, the financing gaps in achieving the Goals has further widened. Most COVID-19 response measures taken so far have fallen short of the scope needed to facilitate a sustainable recovery. This is because they were mostly aimed at mitigating the adverse impacts of the pandemic on the population’s health and the economy and not designed, at least initially, to provide a basis for “building back better”. Moreover, initial policy responses to the pandemic did not promote green development; most of them supported carbon-intensive sectors by providing subsidies, waiving fees or reducing taxes for environmentally harmful activities, such as coal exploration. In addition to the triple threats of COVID-19, climate change and disasters, the evolving crisis in Ukraine has further exacerbated rising energy prices, food inflation, a looming debt crisis and temporary disruptions in global supply chains.
Mobilizing the necessary resources from traditionally dominant sources has presented challenges to countries with special needs.
While many countries with special needs have managed to raise tax revenue as a proportion of GDP, the levels attained are still inadequate to finance development needs. In the larger LDCs, such as Afghanistan, Bangladesh and Myanmar, less than 10 per cent of GDP is collected in tax revenue (a ratio of 15 percent is considered a minimum threshold to provide basic services, such as road infrastructure, health care and public safety). The pandemic is projected to have further reduced tax revenue by an average of 5 per cent in 2020.
As a result, many countries with special needs rely heavily on official development assistance (ODA). While it is evident that multilateral donors are stepping up their lending and grant support in the wake of the pandemic, the impact on bilateral ODA and its outlook is still unravelling.
To finance their increasing investment requirements, many countries with special needs are gradually turning to borrowing, especially from external sources. External debt stocks as a proportion of GDP and debt servicing ratios are still manageable in most LDCs and LLDCs, but the source and composition of external debt may be a cause for concern for some countries with special needs, as reliance on commercial and less concessional loans has increased. This trend has important implications related to debt servicing obligations, debt roll-over risk and costs of debt restructuring. Debt servicing is especially challenging for SIDS; eight of them are now being classified as facing high debt-distress as the pandemic has squeezed their already narrow revenue base.
Foreign direct investment (FDI), another important source of financing, has been unevenly distributed across countries and proven to be quite volatile over time. Moreover, it has been trending lower since 2017. Notably, in the countries that have attracted FDI, the extractive sectors and low-cost labour sectors have been the primary beneficiaries. Accordingly, relying on FDI as a vehicle to recover from COVID-19 is difficult and uncertain for most of the countries with special needs.
External remittances, on the other hand, have emerged as an important source of financing for many countries with special needs. In some of these countries, remittances account for more than 20 per cent of GDP annually. Despite some disruption caused by the COVID-19 pandemic, these flows have remained resilient, helping households mitigate the impacts of reduced earnings. However, unlike in earlier crises, such as the 2008 financial crisis, the road to recovery this time around is likely to be much more protracted given the widespread impact and continuing disruptions. Accordingly, the ability to sustain these flows are a concern.
Beyond financial resources, institutional shortcomings impede absorptive capacity and spending efficiency. This has become evident during the pandemic, as governments attempted to launch interventions and stimulus measures. Even though funding is available, the ability to spend resources impactfully in areas aligned with the SDGs often has been weak, thereby reducing the effectiveness of response measures.
Overall, these traditional sources will continue to dominate the financing landscape in the short to medium term in countries with special needs and, therefore, must be strengthened.
On the domestic revenue front, additional tax revenue ranging from 1.7 to 12.5 per cent of GDP can be raised in countries with special needs. While enhancing the collection of tax revenue is the most enduring form of financing, the current context makes increases in tax rates politically unfeasible, just as expanding the tax base remains challenging due to the largely informal nature of the economies. A feasible avenue in the short to medium term would, therefore, be to improve tax administration systems, particularly by increasing collection efficiency from existing taxpayers and minimizing leakages.
Electronic tax registration, filing, payment and dispute resolution, for instance, can help to reduce the risk of officials abusing their discretion and provide citizens clarity regarding the tax-paying process.
Official development assistance will continue to serve as an important financing source given that it can be leveraged and scaled up relatively quickly. Nevertheless, there is much room for improving the efficient and equitable use of ODA and to better channel it towards efforts to achieve the SDGs. The use of recipient national systems to deliver ODA has been identified as an efficient modality for small jurisdictions, such as SIDS, and could thus be pursued further. Given their limited public financial resources, countries must strive for allocative and operational efficiency through approaches, such as SDG budgeting and tagging, and project cycle management.
Debt and risk management is emerging as a key focus area because of the high number of countries with special needs that have been classified as suffering from high debt-distress. This is also important as countries take on debt that is less concessional and more commercial. From this perspective, the development of domestic sovereign bond markets could enable countries to lay the foundational elements for capital markets, while also harnessing idle domestic resources, which does not entail the type of exchange rate risks associated with external borrowing. However, this may not be an option for all countries. In cases in which the individual economy is too small, collective debt securitization can be explored with a multilateral development agency serving as guarantor.
To complement public flows, private external flows, such as FDI, must be sought with a renewed focus on the digital sector and investments need to be aligned with the implementation of the 2030 Agenda for Sustainable Development. Regarding remittances, in addition to investing in the skills of migrating workers and assisting them to secure better paying jobs abroad, governments can expand the digitization of financial transactions to reduce their costs and facilitate increased flows of remittances.
Traditional sources need to be complemented by innovative sources
In addition to mobilizing resources through traditional channels, there is a need to explore and leverage new and innovative sources and instruments. Thematic bonds, such as green bonds, blue bonds, social impact bonds and sustainable bonds, are possible options that can be used to address specific themes, such as climate change, marine protection or social inclusion. Risk-transfer instruments, such as catastrophe bonds, could also be explored. Debt-for-climate swaps constitute another innovative source of development finance, which can simultaneously reduce debt exposure and increase investments in climate mitigation or adaptation.
To effectively tap these sources, however, legal and regulatory frameworks need to be developed to accommodate policies for a sustainable recovery along with risk disclosure reporting practices that are either domestically oriented or aligned with recognized global standards. As such, countries with special needs could benefit by developing effective monitoring, reporting and verification frameworks, or building on existing global taxonomies and standards to ensure that collected funds are funnelled to related climate mitigation and adaptation projects.
Finally, there is an urgent need for strengthened multilateralism as well as regional cooperation and solidarity to mobilize the required resources to attain a sustainable recovery
Emerging transboundary challenges on taxation, including the rise of the digital economy, illicit financial flows and profit shifting by multinational firms, require stronger global and regional cooperation. Most existing cooperation platforms are fragmented at the subregional level, while global initiatives are marked by complex rules and standards, which may discourage countries with special needs from acceding to them. Accordingly, scaling up technical assistance to these countries in developing legal, institutional, and administrative capacity to benefit fully from these platforms is necessary.
As many countries with special needs are experiencing debt distress or showing early signs of such distress because of the pandemic, the international community can extend support beyond the current debt initiatives and programmes. More comprehensive debt relief programmes that are suitable for countries with special needs must be designed to ensure long-term sustainability.
The climate crisis has provided further impetus to international and regional cooperation, particularly in climate finance, to support the efforts of developing countries in dealing with this crisis. While commitments on climate actions have some promising features, including additional funding targets, there remains an urgent need to strengthen commitments and scale up the flow of climate finance to countries with special needs, particularly as grants and for climate adaption. Additionally, the international community can provide legal, administrative and technical support to countries with special needs to develop climate finance instruments. International and regional actions should also foster the engagement of the private sector and other stakeholders to make climate finance mechanisms more effective, broad-based and self-sustaining.
Despite the rapid adoption of the digital technology in finance within countries, cross-border opportunities largely remain untapped, thereby highlighting the need for regional and international cooperation. The international community can promote regional interoperability and the harmonization of laws, regulations and standards in digital finance, which will facilitate easier, quicker and cheaper cross-border remittance transfers. International and regional cooperation could lead to the development of a platform for knowledge exchange, experience-sharing and technology transfer to facilitate the diffusion of technological capabilities and applications in countries with special needs.