Don’t Merge DFC and MCC: Here’s a Better Idea

The temptation to merge aid agencies in the hopes of creating cost efficiencies is understandable. But smashing two mismatched gears together doesn’t make them mesh. Instead of the plan being floated to merge the US International Development Finance Corporation (DFC) and the Millennium Challenge Corporation (MCC), it would be much better to create a strong link between DFC and MCC where there are potential synergies and make changes to MCC’s finance model that create returns to the US Treasury.

MCC, conceived and launched under the George W. Bush administration, is one of the world’s most innovative aid agencies. For more than 20 years it has successfully funded large public infrastructure projects in the poorest countries. Its strong prudential controls have protected its programs from fraud and abuse. MCC targets infrastructure projects that must be funded by governments because they do not yield commercial market returns, which for some kinds of infrastructure is often the case. It offers large-scale grants for investments carefully chosen for their growth-promoting potential to countries that are objectively pursuing good governance (i.e., pass MCC’s scorecard) and willing to meet MCC procurement and other project management standards. The deal offered to poor countries is: you help yourself by putting in place policies conducive to growth, and we’ll give you grants to fund the most productive infrastructure in ways that do not create unsustainable public debt. The difference from what China offers is obvious.

DFC, launched under the first Trump Administration, is a rapidly growing development finance institution that helps finance private infrastructure and other investments through loans, risk insurance, and equity, not grants. It is now one of the largest bilateral DFIs in the world. DFC finances commercially viable investments with market returns for its private sector partners. It has a global mandate in low-income and middle-income countries and is not restricted to countries with per capita income below a certain level as MCC is (though Congress has recently increased MCC’s income ceiling). Its financial returns go back to the Treasury. As stressed by CGD colleagues, a focus on development, as for MCC, is at the core of its founding bipartisan legislation, the Build Act.

So the core differences between the two models are:

• MCC mostly funds governments while DFC funds the private sector;
• MCC offers grants, while DFC offers financial instruments with returns;
• MCC targets poor countries with good governance; DFC can finance transactions in all developing countries;
• MCC’s annual programs equal about $1 billion, while annual commitments from the much-larger DFC have reached over $12 billion;
• MCC works with governments to select projects that have the maximum growth promoting potential, based on deep dives into country growth constraints and root causes; DFC project selection is private-sector-demand driven.

These are fundamental differences: whole different approaches to project selection and country partners, and very different staff skill sets. Forcing both approaches into one agency with one mission will at best mean that one of the models will disappear, and at worst that both models will suffer from conflicting priorities.

Most fundamentally, these agencies serve two distinct, but complementary purposes, both of which are powerful pillars of the US foreign policy architecture. MCC gives the US a way to support like-minded countries at the systemic level, boosting and sustaining growth in countries that can be key markets and allies as the global economy changes. Even today, Africa, the continent with the majority of MCC compacts, has 12 of the top 20 fastest growing economies in the world. And the recent expansion in the country pool enables MCC to work more in other regions.

Notably for cost efficiency, MCC compact finance is not the only driver of growth-promoting policies and investments. Countries’ desire to pass MCC’s scorecard incentivizes major reforms before MCC spends a dime in the country.

DFC, on the other hand, is our best means of working at the transaction level to catalyze private investment with commercial and strategic returns, including for US businesses. DFC has maintained its development focus, but has also pursued strategic investments that help secure critical supply chains for the US. Having nearly doubled its portfolio since 2019, it has demonstrated the scalability of its model. And its broad suite of finance instruments, including equity and political risk insurance, gives it an advantage over many development finance institutions (DFIs) that don’t have this range of tools. If the budget treatment of equity is fixed and if its maximum portfolio cap is greatly increased in reauthorization legislation this year, it will finally have the financial firepower to compete seriously with China.

But that doesn’t mean we should not consider changes that increase the value of both models for advancing US interests. There are obvious areas of overlap and potential synergies. To maximize growth gains, MCC compacts should promote private as well as public investment, and DFC would benefit from MCC help in making more projects bankable.

Here are three suggestions for making more efficient use of aid dollars and helping the two agencies join forces where their missions align.

1. Add concessional infrastructure loans to MCC’s product offerings.

Good infrastructure projects promote growth. Growth boosts government revenue and creates capacity to service debt incurred by the infrastructure investment. So there is nothing conceptually necessary about providing all MCC finance in the form of grants.

The original idea had merit: the rationale for offering well-governed poor countries scarce grant funding was that it would be spent more efficiently and effectively in better policy environments. But we are now in a very different US fiscal environment. Many view aid that is paid back, with some—even small—return, as a much more compelling proposition. Offering loans would help MCC pursue larger, more transformational compacts. At the same time, loans can be made so concessional that they add little to poor countries’ debt service for many years. Currently, the regular concessional loans of IDA (the World Bank’s window for the poorest countries), for example, have tenors of 38 years, 6-year grace periods, principal repayments of 3.125 percent for years 7–38, and fixed interest rates of 1.37 percent.

MCC could continue to offer grants to the poorest, most indebted countries, just as IDA does. But less concessional terms could be offered to countries at the other end of the per-capita income spectrum. Offering loans in fact would give Congress a rationale for further raising the per-capita income ceiling to allow MCC to operate in even more countries, with lending terms calibrated to country income levels and repayment capacity.

Another virtue of the MCC model is that finance is nearly always either delivered within the five-year compact period or returned to the Treasury if it cannot be productively spent in that time frame. This deadline would remain in place to maintain discipline over compact performance and avoid open-ended finance commitments extending over unlimited time periods. The difference would be that the loans would be repaid over a longer period than five years. For fiscal purposes, loans could be scored using the same methodology as other US government sovereign lending. Such scoring should incorporate evidence from IDA concessional loans to poor countries—very few of which have gone into arrears. Recent evidence from Moody’s Analytics for infrastructure lending in Africa shows default rates of 2.6 percent, the second lowest of any developing region. The probability of repayment, though not 100 percent, would give loans a much more favorable scoring than grants.

2. Establish a common board of directors for MCC and DFC.

The MCC Board is comprised of the Secretary of State, the Secretary of the Treasury, the US Trade Representative, the Administrator of USAID, the CEO of MCC and four private sector members appointed by the President of the United States with the advice and consent of the US Senate. The DFC Board includes the Secretary of State, the Secretary of the Treasury, the Secretary of Commerce, the Administrator of USAID, the CEO of DFC, and three private sector members. The substantial overlap in board composition would make it relatively straightforward to combine the two, though it would require Congressional action. Having one board oversee both agencies would help ensure their collaboration in countries and activities where both are active and that opportunities for synergies are seized. The two agencies would also be required to produce a joint annual report to the board detailing the scale, scope, and impact of their joint activities.

3. Establish a joint public-private investment group with staff from both agencies, reporting to senior management of both agencies.

Its mission (turbocharging collaboration begun on a small scale in the American Catalyst Facility) would be to consistently find and support opportunities for private investment in all MCC compacts, including opportunities for DFC-financed transactions. The MCC can play a powerful role in generating bankable projects for DFC when MCC concessional funding is used to share risk, or fund the public side of public-private partnerships, or support policy reforms that clear away investment obstacles. Top-down direction from a common Board will help, but it is equally important to have a working-level group that is accountable for driving and reporting on joint activities. It would define success metrics working with the leadership of both agencies. And it would produce the joint annual report to the Board that tracks performance on those metrics.

The aim of these proposals is to preserve what is most valuable in both models (both launched under Republican administrations), while adjusting to today’s fiscal realities and politics, driving collaboration where it can produce the most gains, and avoiding a mash-up that will weaken both agencies. Reauthorization of DFC this year offers an opportunity to institute these linkages. And changes in MCC legislation needed would be relatively limited. We hope that the administration’s ultimate goal is not just to cut for trivial fiscal savings, but rather to extract greater returns in America’s interest from what are already high-performing assets.