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By Nicholas Burnett
Managing Director of Global Education at Results for Development Institute. Nisma Elias is Program Associate at Results for Development Institute

Last year was an important one for developing countries, if only because the world was reminded of the true value of education there. Indeed, Malala Yousafzai, the young Pakistani girl who spoke up for children's right to go to school - even after surviving an assassination attempt by the Taliban - served poignant notice that not educating a child in the developing world is significantly more costly than doing so.

With education squarely in the spotlight, new trends are gaining momentum, many of them merging with "innovative finance" - a concept much beloved by development policymakers and practitioners in difficult economic times. In particular, the emergence of so-called loan buy-downs could encourage financing for education from reluctant donor countries.

A loan buy-down is a transaction in which a third party pays down part of a loan by softening its terms or reducing the principal outstanding, thereby releasing the borrowing country from all or some of its future repayment obligations. Because the buy-down is triggered by achievement of a pre-defined target, such transactions promote results-based financing, bringing about quantifiable reforms that otherwise might not have been realized.

Appropriately defined triggers thus address one of the main criticisms of international aid. They also encourage borrowers to invest in projects with long-run returns that may not be politically attractive, such as teacher training.

Unfortunately, the education sector still lags behind others in harnessing the potential of innovative development finance - and loan buy-downs are no exception. As a result, the few examples of buy-downs so far have mainly been for health initiatives.

The Partnership for Polio Eradication Project in Nigeria and Pakistan - launched in 2003 by the World Bank, the Bill and Melinda Gates Foundation, Rotary International, and the United Nations Foundation - is a prime example of how a buy-down program can concentrate global efforts on a single issue and yield benefits for all parties. The Bank provided upfront long-term zero-interest loans for the purchase of oral polio vaccines in Nigeria and Pakistan, while the other three organizations covered all service and commitment charges associated with the loans.

At the end of the project - that is, when an independent performance audit determines that the vaccines arrived on time for the campaign, and immunization coverage has reached at least 80% - the partnership will buy down the Bank's loans. The World Bank will then cancel the credit and release the recipients from any future liability.

Loan buy-downs could mitigate dwindling flows of official development assistance (ODA) for education in low-income countries, which declined by 10% from 2010 to 2011 - and by 5% for basic education. This reflects lower spending by seven of the 11 major bilateral donors. The Netherlands led the way, slashing its aid to basic education by 36%, outpacing even the 31% cut by crisis-ridden Spain. Japan, too, reduced its aid by 30%, while France and Canada cut their assistance by 25% and 21%, respectively. Elsewhere, the United States lowered its budget by 13%, and Norway by 4%.

Given that the Netherlands has long been a key supporter of basic education, its decision to phase out its education programs was particularly notable. But, beyond aid reductions, donors may also make it more difficult for borrowing countries to repay the aid funds they owe (this is not limited to loans for education). And some donors - such as France, Germany, and the European Investment Bank - are lobbying the OECD Development Assistance Committee to count unsubsidized loans as official development assistance to enable them to meet their ODA targets. This reverses the trend over the last few decades toward grant-based financing, especially for basic education.

But education, a crucial public good, should not be left behind in the pursuit of non-grant-based aid. Loan buy-downs can help keep the education sector "competitive," and could prove to be a mechanism to leverage extra resources for education, for which capital-strapped countries may not be willing to borrow otherwise.

Despite the potential benefits, the many unanswered questions about buy-downs limit their application. Which countries would be willing to participate, either as borrowers or lenders? What kinds of triggers should be specified for mobilizing buy-down funds? How would it be decided whether these targets had been met?

With such questions in mind, Results for Development Institute has prepared a study for the Global Partnership for Education (GPE), analyzing the buy-down model's use in other sectors and considering ways to apply it to education. The report focuses on which countries have the right combination of basic education needs and borrowing potential. Moreover, it examines how the buy-down triggers could catalyze results, as well as the operational issues that might arise. As a next step, the report proposes a pilot program and consultations with borrowers, lenders, and funders to resolve enduring questions about their application.

That is a sensible approach. Buy-downs may prove to be the solution needed to ensure adequate and stable assistance to education in developing countries. It is time to find out.

Copyright: Project Syndicate