Why Development Finance Falls Short—and How It Can Better Serve the Global South
By Zheng Zhai and Kevin P. Gallagher
Countries across the Global South need a stepwise increase in investment to improve the well-being of their population and foster low-carbon, equitable and resilient growth. Countries must promote growth while simultaneously avoiding the significant social and economic losses that could arise from climate change and social instability. Lower bound estimates put this investment at $3 trillion annually, with $1 trillion coming from external sources. However, the international financial architecture (IFA) is falling far short of such mobilization. In a new report for the Global South Research Center (GSRC), we outline five flaws in the IFA that have stalled progress and present practical solutions to support sustainable global economy growth.
First, the IFA fails to generate sufficient investment to meet global development needs. Although gross financing flows have increased in recent years, the Global South countries continue to face substantial funding gaps to achieve the Sustainable Development Goals (SDGs) and the Paris Agreement targets. As illustrated in Figure 1, net transfers of external public and publicly guaranteed (PPG) debt to low- and middle-income countries (LMICs) except China have been declining since 2014. In 2024, net transfers were only $8.97 billion, significantly lower than pre-COVID-19 pandemic levels. China’s net transfers to LMICs have also turned negative in recent years, partly because of the substantial debt relief it provided during the pandemic, which postponed borrowers’ debt service payments. The debt restructuring is not a reason for the decline of private lending, as private lenders do not participate in the restructuring process.
Figure 1: Net Transfers of External PPG Debt to LMICs Except China, 2000-2024
Second, during periods of economic downturn, development finance for the Global South has not expanded meaningfully when it is most needed. Although bilateral and multilateral external financing modestly increased during the pandemic, the scale of this rise was inadequate to compensate for the sharp decline in private capital flows (Figure 1). Moreover, the rise of public external finance has largely been driven by multilateral non-concessional finance from 2020 to 2022. Only in the past two years have we seen a significant increase of multilateral concessional finance. Meanwhile, the contribution of bilateral concessional finance has remained limited (Figure 2).
Figure 2: Net Transfers of External PPG Debt to LMICs Except China, by Concessional Levels, 2000-2024
Third, the cost of development finance has reached unprecedented levels. Since 2021, the weighted average interest rate on new external PPG debt for LMICs has risen sharply—reaching 5.3 percent for International Bank for Reconstruction and Development (IBRD) loans and 5.9 percent for private loans in 2024. Even the interest rate of International Development Association (IDA) loans increased significantly to 2.2 percent in 2024. In comparison, China’s loans (5.0 percent interest) are relatively cheaper than those of both the IBRD and private sector. Although LMIC economies have shown moderate recovery following the pandemic, financing costs have increased even more rapidly, outpacing the growth rate. Combined with elevated debt levels and local currency depreciation, these rising costs have significantly intensified the debt burden faced by developing countries. In 2024, total debt-service payments of all LMICs excluding China reached $940.5 billion, staying at a high level though slightly down from the peak of $971.1 billion in 2023.
Figure 3: Weighted Average Interest Rate on LMICs New External PPG Debt and LMICs’ Annual GDP Growth Rate, by Percent, 2000-2024
Fourth, Western development finance has fallen short in supporting structural transformation needed for sustained economic growth in developing countries. Investment in infrastructure and productive sectors—such as energy and transportation—that directly stimulate economic expansion has remained limited. As a result, numerous studies have highlighted the limited impact of both bilateral and multilateral finance from Western creditors on fostering economic growth in developing economies. For example, Lin and Wang (2017) argue that traditional Western development finance has largely failed to address the structural bottlenecks that constrain economic transformation, while Wang and Xu (2024) find that World Bank projects in Sub-Saharan Africa (SSA) have not significantly boosted regional economic activities.
Fifth, global development finance governance remains asymmetrical and increasingly fragmented. Despite the Global South’s growing contribution to the world economy, its representation in the Bretton Woods institutions continues to be limited. Efforts to advance more equitable and representative governance have been hindered by geopolitical dynamics, as Western powers increasingly align development finance with their strategic interests. Consequently, development finance has not only been shrinking but has also become more politicized.
Given the existing flaws of the IFA and the great uncertainty of the current global political and economic landscape, we strongly recommend the international community to take the following measures to promote South-South cooperation and North-South cooperation in development finance.
For South-South cooperation, in the context of a sharp decline in development finance from traditional creditors, China and other Global South lenders should aim to expand the scale of their development financing. Emphasis should be placed on long-term, counter-cyclical investment in sectors such as infrastructure and industrialization, which are crucial for sustained economic growth and structural transformation. Moreover, emerging development partners could consider increasing the use of RMB-denominated financing in development projects, leveraging China’s relatively low domestic interest rates to reduce borrowing costs. It is equally important for the Global South to continue prioritizing low-carbon, socially inclusive and resilient investments that support both growth and structural change. At the multilateral level, Southern-led institutions (such as Asian Infrastructure Investment Bank and New Development Bank) and initiatives (including Belt and Road and BRICS) should take a more active role in fostering dialogue, policy coordination and information sharing among Southern countries, helping them form coherent and united positions on global economic governance reforms. Additionally, members of Southern-led development finance institutions and Regional Financial Arrangements (RFAs) should strengthen the capacities and functions to advance sustainable development and enhance financial resilience in the Global South.
For North-South cooperation, creditors are encouraged to leverage their comparative advantages to create complementary approaches that better address the Global South’s development needs. North creditors can contribute by offering more concessional financing and advanced technical expertise, while South creditors, with deeper familiarity with local development challenges, can play a key role in designing context-specific and tailored solutions. Financial cooperation between North and South can even be strengthened through increased co-financing initiatives and triangular cooperation. Traditional multilateral development banks (MDBs) should also adopt policies that enhance partnerships with national development banks (NDBs) in developing countries to improve overall effectiveness.
Looking ahead, addressing global development challenges will require coordinated efforts from a wide range of development partners, including public and private actors, traditional Western players and emerging economies. In this context, global development finance forums—such as the Finance in Common Summit and the Financing for Development (FFD) conferences—provide venues for setting shared goals, coordinating policies and actions and mobilize financing. These platforms can support more coherent action and better alignment between development priorities and technical and financing resources.
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