Inquiry into the Abolition of the Development Import Finance Facility

Chapter 6

The Place of DIFF in Australia's Aid Program

The Role of Mixed Credit Schemes

6.1 As well as its direct impact on development, DIFF, like other mixed credit schemes, also had the following features:

• it required commitment of financial resources from the recipient country and therefore provided a strong incentive to choose projects of the highest priority in the country's development program;
• it enabled worthwhile development programs to be funded which were unlikely to have been funded in the context of a traditional grant aid program;
• it was a catalyst for involving the private sector in the Australian aid program, particularly in the capital goods sector; and
• it stretched the aid dollar because aid funds provided only 35 per cent of total project cost. [1]

6.2 AusAID's 1996 review of DIFF argued that while the scheme might have addressed different types of development problems from other elements of the aid program, it played a complementary role to those elements in contributing to social and economic advancement in developing countries. [2] Mr Leigh Purnell, Director of the MTIA, told the Committee that:

The DIFF scheme is a critically important vehicle for the delivery of eight per cent of our total aid budget. DIFF is the only element of the aid program directed to the provision of capital goods and equipment ... We must realise that many of the so called softer, humanitarian type aid projects are not viable without the hard-edged, capital equipment projects. [3]

6.3 It has been argued that greater development benefits might be generated by reallocating DIFF funds to programs targeted more directly at such areas as poverty alleviation and health. [4] The approach of previous governments has been based on the view that poverty alleviation requires a range of development interventions, including:

• promotion of sustainable economic growth;
• investment in human resources through education, health, capacity building and social sector development; and
• safety nets and poverty targeting, which includes emergency relief. [5]

6.4 Investment in public infrastructure has been viewed as a fundamental element of any poverty alleviation strategy based on balanced growth. Mr Michael Lamb, Managing Director of ERG Telecommunications, said that 'The sorts of projects I am talking about now - remote rural infrastructure - are very definitely poverty alleviation'. [6]

6.5 While often not commercially viable (from 1992 projects had to be non-commercial to be eligible for DIFF funding) the projects targeted by DIFF played critical roles in the economic and social development of the recipient countries. DIFF provided an appropriate mechanism for larger public sector projects which could not attract private investment funds. [7] Mr Alexander Gosman, Executive Director of the Australian Electrical and Electronic Manufacturers Association, said that:

We believe aid is most effective when applied to removing major constraints to development, that there is a need for capital intensive inputs to develop the basic economic infrastructure. [8]

6.6 Increasingly, since the inception of the Helsinki rules, recipient countries have nominated development priorities and Australian companies have had to compete with firms from other donor countries to win contracts for DIFF assisted projects. Mr Purnell of the MTIA said that:

Critics talk about DIFF as though this is a grant to Australian companies. This is simply not the case. DIFF funds go to the recipient country where the project is being carried out, in the form of concessional loans. The host country sets its own priorities for projects based on their own developmental needs and the DIFF funding element represents one-third of the project value to make a highly concessional loan package which still must be repaid. [9]

6.7 Mr Kevin Pontifex, Executive Director of Energy Equipment Pty Ltd, told the Committee that:

Priorities for these projects have clearly been set by the target countries. We have not been instrumental in selecting the projects. They have been selected by the regional authorities in the target countries. They have been vetted by central government agencies. In particular, we have been subject to great price scrutiny in China. [10]

6.8 One of the major reasons for the introduction of DIFF was to match the concessional financing of other OECD countries in order to give Australian companies the opportunity to compete for infrastructure projects in developing countries. It was a recurring theme of submissions and evidence to the Committee that without DIFF, companies simply could not compete: 'there is no chance of a small company competing in a market like China without some form of government support'. [11]

6.9 Mr John Dougall, Managing Director of AWA Ltd, said of one project that:

Had we not got DIFF financing, we clearly would not have beaten the Japanese. They underbid us on the price but our solution was better. Let me assure you that our product is world class. We are not an inefficient manufacturer relying on DIFF funding to do business in Asia. The opposite is the case. [12]

6.10 Mr Robert Kerr, Acting Head of the Productivity Commission, told the Committee that:

From the viewpoint of the Australian economy as a whole, it would be better if Australian companies pursued contracts in markets where subsidies from Australian taxpayers are not required to enable them to compete.

... Other countries' aid policies affect the competitiveness of Australian firms in developing-country markets but in our view, Australia should not embrace subsidies solely on the basis that other countries do. [13]

6.11 However, in response to questions from the Committee Mr Kerr said that in examining DIFF from the point of view of micro-economic policy issues the Commission had looked at the program solely from the point of view of domestic industry efficiency and had not considered its role in the aid program or the impact of its termination on foreign relations:

I daresay that is certainly a relevant issue for the Committee's consideration but we made no comment on that and nor do we have any basis for any expertise to make any comment on that. [14]

6.12 The Committee believes that views of Australia's aid program that are premised on a theoretical economic model which does not take into account the realities of the nature of developing countries' needs and international approaches to meeting those needs, are not only not helpful but can, in fact, distort discussion of the aid program by giving spurious legitimacy to arguments against the value of schemes such as DIFF.

6.13 DIFF was not just a financing mechanism, economically efficient or otherwise. As a part of the Government's aid program it was an important embodiment of a continuity of relationship between Australia and the recipient government which was not simply commercially based. It demonstrated Australia's practical commitment, through the provision of grant and export credits, to the projects and to the enhancement of the social and economic conditions of the communities affected.

6.14 Mr Robert Trenberth, Deputy Secretary of the Department of Industry, Science and Tourism, stated that:

If you believe that an important element or a legitimate element of aid relates to the provision of substantial infrastructure projects into markets where one is competing with countries that provide these kinds of facilities to their own companies, my view would be that, to the extent that it is possible, we ought to do the same.

... it seems to me important that companies who do want to compete in these markets, who do have the skills and who are in a sense the vehicles of Australian aid into the region be given the opportunity to do so. [15]

6.15 Mr Brent Davis, Director of Trade and Policy Research for the Australian Chamber of Commerce and Industry said that his organisation believed that 'capital infrastructure programs are an essential element of any comprehensive aid program'. However, he also said that spoiled markets, where there is a high level of concessional finance from other donor countries, should be eradicated so that Australian firms could compete for contracts without the need for the DIFF program. [16]

6.16 The Committee believes that while a 'level playing field' may be a desirable end in general, as long as other countries offer mixed credits, the DIFF scheme has a place in Australia's aid program. Moreover, the Committee believes that the enormous need for major infrastructure projects in developing countries, and the limited ability of those countries to finance such projects, makes mixed credit schemes a useful, if not necessary, mechanism for the delivery of aid.

6.17 Dr Katherine Woodthorpe, Chief Executive Officer of the Technology Industries Exporters Group, referring to two projects undertaken by companies in her organisation, spoke of the need for concessional finance for certain projects:

The projects that DIFF financed in these cases are ones that, although the country believes very strongly in them, they could not have afforded to have put together. [17]

6.18 Many witnesses spoke of the importance of the fact that concessional loans have to be repaid, and therefore ensure that close attention is paid by the recipient government, which has to provide funds and resources. [18] However, DIFF has sometimes been the subject of criticism precisely because it diverts scarce aid resources to better off countries with access to commercial funding.

6.19 Restrictions introduced in 1992 under the Helsinki rules, including a per capita income ceiling on countries eligible for mixed credits, specifically address this question by encouraging donor countries to direct mixed credits towards projects and countries with little or no access to market financing. The restrictions do not apply to countries recognised as 'least developed' by the United Nations, so that mixed credits are more freely available to such recipients.

6.20 In addition, the largest DIFF recipients were Indonesia and China, which were also the largest recipients of bilateral aid in general, so that it cannot be argued that DIFF distorted the geographical focus of Australia's aid program. [19]

6.21 One of the roles of mixed credit schemes under the Helsinki rules is to help finance projects that are not commercially viable. Rural electrification programs for remote villages have an undeniable value for the communities concerned but it is unlikely that any company, operating on a purely commercial basis, would consider investing in such schemes. A similar argument would apply to remote area telecommunications:

The two projects I talked about in China with the cable industry are right out near Mongolia. It is going to be a long time before anyone makes a commercial return. When they sat down to look at the extension to the existing projects, it had to be on the basis of concessional finance. [20]

[Contents]

The Current Situation and the Future

6.22 The DIFF scheme has been terminated. On 8 May 1996 the Minister for Foreign Affairs, Mr Alexander Downer, decided that, with the exception of those seven projects holding Letters of Formal Offer, it would terminate from the beginning of 1996-97.

6.23 Many witnesses who appeared before the Committee or made submissions to the inquiry emphasised the effect of the suddenness of the of termination of DIFF, which seriously affected their companies commercially and which had severe repercussions on relations with the recipient governments. Mr Julian Dinsdale, Chairman of Austenergy, said that his organisation's main concern was that the termination of DIFF was so dramatic: 'Things have just been shut off instantaneously instead of being phased down.' [21]

6.24 The effect of the abruptness of the termination of DIFF, rather than a phasing out of the program with projects holding Letters of Advice allowed to go through the rest of the DIFF process, has been considered earlier in this report.

6.25 The Government has said that it will consider the introduction of a reformed, more tightly focused mixed credit arrangement as early as 1997-98. [22] On 17 July, however, the Minister decided that while the DIFF scheme is abolished, it might be possible to support some high priority projects using mixed credits with funding from AusAID's bilateral program allocation for 1996-97. Accordingly, he wrote to the four governments most affected by the cessation of DIFF, raising the possibility of funding some of those governments' highest priority projects. [23]

6.26 The Minister's decision reflects the strength of the adverse reaction by recipient governments and in the Australian business community to the original decision to terminate DIFF, and suggests a lack of understanding of what that reaction would be. Given the impact of the original decision to terminate DIFF, on Australian companies and on bilateral relations with countries in the region, and given the Minister's later decision to restore some DIFF projects, the original decision strikes the Committee as precipitate, ill considered and unwise.

6.27 According to Dr Woodthorpe of TIEG, the decision to restore some DIFF projects only:

compounds the idiocy of the whole thing. We will look foolish and naive. If we say, 'It's finished. Well maybe it's not quite finished. Well maybe some of you can get it and we might do it again in a year's time,' what do we look like? [24]

6.28 Mr Andrew Johnson, Chief Executive of Transfield Defence Systems, told the Committee that the Philippines authorities believed that all of the DIFF projects with Letters of Advice had:

passed the test of being worthy of aid and now suddenly they have been asked to rank the approved projects in some sort of order ... I suppose they believe that is not the way two friendly governments should deal with each other. That is the point they have made to us. [25]

6.29 On 20 August, in conjunction with the Federal Budget, the Minister announced funding for Australia's aid program in 1996-97. This included funds 'which may be used for high priority DIFF projects with Letters of Advice', the priority projects restored following the original termination of DIFF. [26] The funds allocated are shown below with the yearly average of DIFF funding over the last three years of the scheme and the value of the DIFF component of outstanding Letters of Advice shown alongside:

6.30 During the Foreign Affairs, Defence and Trade Legislation Committee's estimates hearings held in September 1996 the Minister representing the Minister for Foreign Affairs in the Senate, Senator Robert Hill, stated that 'It is expected that similar amounts would be applied in 1997-98'. [27] In addition, AusAID Director General, Mr Trevor Kanaley, and Deputy Director General, Dr Peter McCawley, made it clear during the estimates hearings that the additional funds are not necessarily to be used for DIFF projects affected by the cancellation of the scheme. Recipient governments might bring forward projects formerly holding DIFF Letters of Advice or might choose to bring forward other, full grant aid projects. Conversely, governments might choose to use funds nominally allocated as grant funds to add to the additional funds for former DIFF projects. [28]

6.31 However, the Committee reiterates the point made throughout this report, that the nature of the DIFF scheme, and of the understandings reached between Australia and recipient governments, makes anything less than allowing all applicants who hold Letters of Advice to go through the rest of the DIFF process a breach of faith on the part of the Australian Government. In February 1996 the Coalition had estimated total DIFF funding of $382.9 million for 1996-97, 1997-98 and 1998-99. [29] Alongside that figure, and the $384.4 million of outstanding Letters of Advice, the $32 million allocated to the possible funding of former DIFF projects in 1996-97 and the similar amount expected in 1997-98 hardly answer the criticisms made of the original decision to terminate DIFF and in fact may only serve to complicate matters by causing further difficulties when some projects are funded and others are not.

6.32 Had the 50 projects holding Letters of Advice gone through the usual DIFF process, only 35 could have been expected to reach Formal Offer. [30] The cost of funding those projects would have been significantly outweighed by the damage caused to Australian business and to relations with recipient governments as a result of not allowing them to proceed.

6.33 In the light of the Minister's announcement that the Government would consider introducing a revised mixed credit scheme as early as 1997-98, and given that a number of DIFF projects will now proceed after all, the Committee is at a loss to understand why the existing mixed credit scheme could not have been allowed to continue to operate for those projects already at a stage which involved a degree of commitment on the part of the Australian Government, the recipient governments and the companies concerned.

6.34 On 28 May 1996 the Minister announced that Australia's overseas aid program would be the subject of a major independent review by a three person committee, chaired by Mr Paul Simons AM, former Executive Chairman of Woolworths. The review will report to the Minister on the overall priorities, objectives and focus of the aid program. Its principal objective will be to examine how the aid program can best contribute to lasting poverty reduction while also serving Australia's interests.

6.35 The Simons review will consider, among other things, what form any 'new, reformed and more focussed mixed credit arrangements' might take and how they might differ from the scheme that was abolished by the Minister. [31]

6.36 The Government has acknowledged the continuing need for concessional finance, citing World Bank estimates that developing countries of South East and East Asia will require $US 1.5 trillion of infrastructure investment during the next decade. According to AusAID and the Department of Foreign Affairs and Trade, 'there will continue to be important activities that are critical to development, that will not be funded except through concessional finance'. [32]

6.37 AusAID and the Department go on to say that among those sectors which might fail to attract sufficient public or private investment are environmental improvement and water sanitation: 'Both sectors have an immediate impact on growth and equity in developing countries, and both sectors have huge investment needs.' By the year 2000 developing countries in the region will require $US 8.5 billion investment each year for pollution and emission controls, and $US 7 billion a year for water and sanitation. [33]

6.38 Among those projects holding Letters of Advice at the time of the decision to terminate DIFF were water supply projects in China, Vietnam and Indonesia and environmental projects, including the emission control project of Smartgas cited in this report, in China, Vietnam, the Philippines and Indonesia. [34] AusAID suggested to the Committee that 'the Minister himself has said that he has been attracted to water, sewerage and sanitation type projects. That has a clear humanitarian focus. He has said that he thinks they are good.' [35]

6.39 The Committee finds it difficult to understand that the Government can acknowledge the need for concessional finance for such projects and cite figures such as those quoted above and yet can terminate a program involving the very projects which are contributing to the acknowledged need for such activities in developing countries in the region.

6.40 Witnesses who appeared before the Committee were willing to concede that despite the very significant improvements to DIFF brought about as a result of the Helsinki rules there might still be further improvements to be made. Dr Woodthorpe of TIEG conceded the questionable value of some earlier DIFF projects, as did many witnesses, but spoke of the need not to 'throw the baby out with the bathwater'. She said that it was preferable to:

look at the DIFF scheme, tighten it up, maybe add a few more guidelines about what sort of aid is appropriate under the DIFF scheme, than cancel it completely. That seems to me to be too cavalier and foolish. There is much that is good within it, even if there is much that is rightly and genuinely criticised. [36]

She added that:

It is a clean scheme that has a lot of decent things associated with it. If it needs to be tightened down, if you need to change some of the projects allowed under it, that is great. Do some work on it, modify it, but do not just chuck it out. [37]

6.41 The submission from AusAID and the Department suggests that any new concessional finance mechanism might include the following:

• Objective: A clear statement of the primacy of the development objective of the mechanism;
• Focus: A greater emphasis on projects which focus on humanitarian, poverty alleviation and environmentally targeted activities;
• Selection and appraisal of projects: A greater role for recipient governments and AusAID in nominating and appraising projects;
• Integration into AusAID's bilateral programs for individual countries; and
• Greater competition among Australian companies. [38]

6.42 It is the Committee's view that in the light of the evidence presented during the course of its inquiry, such an outline very largely describes DIFF, either as it was or as it was in the process of becoming under the Helsinki rules. The major difference in the outline suggested is the incorporation of concessional financing into bilateral programs. The Committee accepts the value of this suggestion but believes that given the very close parallels between DIFF as it was and the outline proposed by the Government's key agencies in the area, there was no need at all to terminate DIFF.

6.43 The Committee believes that if such a scheme is to be introduced as early as 1997-98, in other words if concessional financing is to be suspended simply for one year as part of the Government's budget strategy, the enormous disruption caused to business and to bilateral relations by the one year suspension of such an important and valuable program simply does not justify the questionable need to save the 1996-97 DIFF allocation. Rather, the Government would have been better advised to maintain DIFF and work with agencies and recipient governments to continue to refine the scheme in order to achieve the best possible means of assisting developing countries with major infrastructure projects.

Michael Forshaw

Chairman

Footnotes

[1] AusAID, A Review of the Effectiveness of the Development Import Finance Facility, p. 41.

[2] AusAID, A Review of the Effectiveness of the Development Import Finance Facility, p. 42.

[3] Committee Hansard, pp 68-69.

[4] AID/WATCH, Australian Conservation Foundation, submission, p. 1.

[5] AusAID, A Review of the Effectiveness of the Development Import Finance Facility, p. 40.

[6] Committee Hansard, p. 109.

[7] AusAID, A Review of the Effectiveness of the Development Import Finance Facility, p. 40.

[8] Committee Hansard, p. 105.

[9] Committee Hansard, p. 69.

[10] Committee Hansard, p. 76.

[11] Mr Kevin Pontifex, Director, Energy Equipment Pty Ltd, Committee Hansard, p. 74.

[12] Committee Hansard, p. 71.

[13] Committee Hansard, pp 479-80.

[14] Committee Hansard, p. 488.

[15] Committee Hansard, pp 497-98.

[16] Committee Hansard, p. 189.

[17] Committee Hansard, p. 263.

[18] See, for example, Mr Peter Dawson, Director, LANDMARC, Committee Hansard, p. 416.

[19] Dr Ravi Tomar, A DIFFerence of Opinion: Cancellation of the Development Import Finance Facility, Parliamentary Research Service, Current Issues Brief No. 20 1995-96, p. 7.

[20] Mr Alexander Gosman, Executive Director of the Australian Electrical and Electronic Manufacturers Association, Committee Hansard, p. 109.

[21] Committee Hansard, p. 214.

[22] AusAID/DFAT, submission p. iv. Note, however, the Minister's 'intention' to introduce such a scheme: AusAID/DFAT, submission, p. 27.

[23] AusAID/DFAT, submission, p. iv. See also Chapter 3, above.

[24] Committee Hansard, p. 272.

[25] Committee Hansard, p. 407-408.

[26] Australia's Overseas Aid Program 1996-97, pp 32, 33, 35, 37.

[27] Senate Foreign Affairs, Defence and Trade Legislation Committee, Estimates Hansard, 23 September 1996, p. 200.

[28] Senate Foreign Affairs, Defence and Trade Legislation Committee, Estimates Hansard, 23 September 1996, pp 203, 206.

[29] This is the amount which Mr Costello announced would be saved in those three years by the termination of DIFF. Press release, 15 February 1996, AusAID/DFAT, submission, Appendix 3, Attachment A.

[30] 'Seventy per cent of those with a Letter of Advice proceed to ultimate fruition.' Mr Ian Anderson, Assistant Director General, AusAID, Committee Hansard, p. 161.

[31] AusAID/DFAT, submission, p. 27.

[32] AusAID/DFAT, submission, p. 27.

[33] AusAID/DFAT, submission, p. 27.

[34] AusAID/DFAT, submission, Appendix 3, Attachment G.

[35] Committee Hansard, p. 139.

[36] Committee Hansard, p. 267.

[37] Committee Hansard, p. 275.

[38] AusAID/DFAT, submission, pp 27-28.