By Harald Hirschhofer and Ugo Panizza 

At COP29 in November, negotiators agreed to triple annual financing for developing countries from USD 100 billion to USD 300 billion by 2035. The challenge is that even if this ambitious target is met— a big “if” given the declining political commitment to official development assistance (ODA)—it will still fall short of the resources needed to scale up climate and SDG financing while ensuring debt sustainability. 

All of this is made even more difficult amid the escalating frequency of shocks ranging from extreme weather events to pandemics and geopolitical tensions, which further hinder efforts to mobilise private financing.  

Public funds will be insufficient to bridge the SDG financing gap, so ODA’s effectiveness in catalysing private investment must take centre stage. That means attention must also be paid to how the ODA framework addresses—or fails to address—currency risk. 

What is currency risk?

Currency risk, or exchange-rate risk, refers to the risk that an investor will lose money on an international trade due to currency fluctuations. It is common when foreign savings fund domestic investments in developing countries. Ideally, if currency risk were correctly priced, borrowers and lenders would be indifferent to whether loans were made in domestic or foreign currencies. In practice, however, foreign currency lending dominates both commercial and official channels, leading to significant currency mismatches on borrowers’ balance sheets. 

These mismatches often stem from flawed risk models, with concessional finance providers such as multilateral development banks and institutions like the Green Climate Fund failing to adequately consider how loan currency impacts default probabilities. Short-term incentives exacerbate the issue: borrowers frequently opt for low-interest foreign currency loans despite their long-term risks, constrained by budgetary pressures and short political cycles. 

This systemic blind spot hampers the ability of concessional finance providers to appropriately manage and price currency risk. The burden is shifted onto borrowers, who are often ill-equipped to bear it. At the same time, lack of risk transparency distorts incentives for stakeholders, increases financial risk for lenders and obstructs the development of risk markets necessary to attract private capital. In a world increasingly defined by polycrises, this is untenable. 

But with great challenges come great opportunities. Improved risk management and higher-quality sovereign financing can reduce the likelihood of destabilising debt crises and foster private capital flows. Addressing currency risk can also help distinguish between project-specific and macroeconomic risks. To this end, subsidising local currency lending is essential during the transition to a more sophisticated risk management framework. Institutions better equipped to absorb and manage currency risk must take on this role. 

This approach aligns both with commitments made at COP29 and Brazil’s G20 roadmap, which emphasise strengthening risk management capacities and developing currency risk-sharing platforms. Strategic reforms can build resilience into development finance systems, fostering private investment while mitigating debt crises. 

What reforms can help make ODA fit for an uncertain future? 

1. The Development Assistance Committee (DAC) should redefine how ODA is deployed and measured, with lenders and borrowers considering the impact of debt composition on credit risks. ODA metrics should be strengthened to account for credit risk and currency risks to improve long-term debt sustainability. The IMF should provide reformed metrics to assist this process.

2. IDA, IFAD, the African Development Fund, the Green Climate Fund and other ODA lenders should help borrowers fully understand their currency risk and its impact on debt sustainability. They should systematically offer local currency loans with explicit pricing for currency risk. 

3. The IMF should review how local currency funding and risk management instruments are integrated into its Debt Sustainability Framework and Debt Limits Policy, ensuring borrowers are properly incentivised and prepared for currency shocks. 

4.The Paris Club should add currency conversions of existing debt to its toolkit, enhancing long-term debt sustainability. 

The path forward requires collaboration across the development finance community. Capacity-building efforts will be crucial, particularly in low-income countries where debt management offices are often under-resourced. Targeted training can enhance these offices’ ability to assess risks, paving the way for sustainable borrowing practices and greater private investment. The integration of risk-sharing mechanisms with robust training programs can significantly bolster the ability of nations to respond to external shocks. 

We cannot afford to fall back on outdated models. The time to act is now, before the next crisis strikes. With foresight, collaboration, and bold reforms, ODA can become a powerful tool for sustainable development in an increasingly uncertain world. 

Harald Hirschhofer is Non-Executive Director of the Ocean Finance Company and Senior Advisor of TCX, a global development finance initiative that protects borrowers in emerging markets from currency risk. He is writing in a private capacity and his views do not necessarily reflect those of TCX or OFC. 

Ugo Panizza is head of the Department of Economics and Pictet Chair in Finance and Development at the Geneva Graduate Institute.