“We need to rethink catchup development finance and how best to mobilize funding”

Annina Kaltenbrunner is a Post-Keynesian macro development economist studying how global finance structurally subordinates developing countries through currency hierarchies expressed for example through volatile capital flows and foreign currency debt, all of which limit their policy space to develop. Her work helps reframe development challenges as systemic financial constraints, specifically highlighting risks in current practices by multilateral development banks (MDBs). Kaltenbrunner is Professor of Global Economics at Leeds University Business School, UK. She has published widely and in December 2025 was awarded the Kurt Rothschild Prize, honoring her contributions to the public debate on economics. 

OPEC Fund Quarterly: You are one of the leading proponents of the concept of international financial subordination, or how developing and emerging economies remain structurally disadvantaged. Can you briefly explain this concept? 

Annina Kaltenbrunner: The concept of international financial subordination emerged from observing structural asymmetries in the international economy that disadvantage and penalize developing countries more than developed ones. These phenomena are common across many developing countries in monetary and financial terms: structurally higher interest rates, greater dependence on financial flows and the fact that these flows are often determined by conditions in international monetary and financial markets. When financial conditions change, developing countries are affected most and suffer the quickest withdrawal of capital, which then causes exchange rate volatility. 

The concept tries to conceptualize and partly theorize these empirical phenomena, which, from our perspective, are fundamental constraints on catch-up development. If the macroeconomy is unstable, with volatile exchange rates, high interest rates and prohibitively expensive domestic financing, then these are binding constraints. All the micro factors can be right, but if the macro is not in order, it is just not going to happen. 

It also highlights that these patterns are linked to the structure of the international monetary and financial system. In a system dominated by one key currency (the US dollar), risks are created as soon as finance crosses borders. If countries industrialize late and finance themselves in a strong foreign currency, these risks are structural. So, while domestic policy matters, improving development outcomes requires addressing these structural features. That is where international development finance institutions and multilateral development banks come in. 

OFQ: If these constraints are structural, where do MDBs fit in? Are they part of the problem or the solution? 

AK: Currently, these structures are perpetuated because most capital going into developing countries is denominated in US dollars or euros, which shifts the currency risk to the borrower – i.e. back to the developing country. So as soon as the local currency depreciates, the debt burden increases. 

MDBs are therefore extremely important because they are among the few institutions that can work against these structures, thanks to their countercyclical mandate. They can provide long-term lending and have the balance sheets to make a difference, while accessing relatively cheap funding. So, yes, they are part of the problem, but also part of the solution. 

We are working on how to shift international lending from US dollar and euro-denominated lending to local currency lending, where exchange rate risk is at least partly borne by international lenders. Only then can we begin to break these structural cycles. If we keep rolling over the risk to borrowers, we reproduce the same vulnerabilities, including exchange rate volatility and the lack of trust in local currencies. 

OFQ: Local currency lending does not eliminate currency risk. It simply shifts it elsewhere. 

AK: That is a good point. One idea is to create intermediaries that provide temporary risk-taking capital to create space and time for domestic capital markets to develop. The international development community could provide short- to medium-term support, allowing domestic financial institutions to develop this critical lending capacity and for interest rates to come down because of lower risk. 

We are also exploring risk-sharing mechanisms. For example, working with the Uganda Development Bank we are designing a scheme that spreads risk across different tranches and thresholds. 

Another important issue is how exchange rate risk is priced into interest rates. Our modeling suggests that a substantial premium is added based on expectations of depreciation rather than realized movements. There is some room for catalytic risk capital to help break existing structures and reduce interest rates, but the ultimate aim is for domestic financial institutions and development banks to provide lending themselves. 

OFQ: Would that not reduce profitability for development banks? 

AK: We are aware of the constraints. MDBs need to maintain their ratings and cannot take on unlimited foreign exchange risk within their frameworks. 

However, for highly impactful projects in low-income countries, where foreign exchange risk can determine whether lending happens at all, MDBs should consider taking on some of that currency risk. It is also not clear that local currency lending necessarily reduces profitability. While it introduces currency risk, it may reduce credit risk. If borrowers are not exposed to foreign exchange fluctuations, project sustainability improves and default risk may decline. 

There is evidence from philanthropic capital that when currency risk is absorbed by the lender, credit risk falls and there are fewer defaults. If that is correct, the assumption of lower profitability does not necessarily hold. It may even allow the financing of projects that are otherwise profitable but constrained by macro risks. 

OFQ: Turning to climate finance, how can developing countries manage the energy transition given all these constraints? 

AK: This is a fundamentally difficult question to answer. In some cases, the climate transition may create opportunities for catch-up development, for example in renewables or electrification, where latecomers can enter new industries. Larger economies may lead, but other countries could also integrate into these value chains – China is a massive example, but we also have Mexico and Brazil faring well. Even smaller economies like Uganda are now developing electric buses and scooters. 

At the same time, many of these countries will face substantial adaptation and mitigation costs because they are also the most climate-vulnerable. Relying on mobilizing large volumes of private capital – billions or even trillions – is unrealistic, because private capital seeks profits, while many climate investments simply do not generate them. That’s the bottom line. 

We therefore need to rethink catchup development finance and how best to mobilize that. Ultimately, domestic financial systems must play a central role. Banks can create credit, so the issue is not purely one of funding availability. Strengthening domestic financial institutions, including public development banks, is critical. 

In the short to medium term, however, countries still face balance-of-payments constraints. They need foreign capital to finance imports required for industrialization and climate action. That capital does not have to be in US dollars, but it must be available. This is where international lenders remain essential: providing financing and helping reduce currency risk, which in turn supports domestic financial development. 

Take Uganda, for example. The central bank’s policy rate is about 10 percent, but borrowing costs are much higher because rates must remain attractive to foreign capital. This supports demand for the domestic currency and helps guard against financial outflows. As a result, exchange rate risk and the foreign currency composition of sovereign debt keep upward pressure on interest rates. Here the macro environment feeds directly into the micro: systemic risk translates into high borrowing costs across the economy. The outcome is lending rates over 22 percent, which are simply not sustainable for development finance. 

OFQ: You emphasize domestic financial systems, but many are small. Does regional integration offer a solution? 

AK: Yes, absolutely. Regional integration is likely necessary in the medium to long term as many countries are too small to support the use of their currencies and build deep financial systems on their own. There are already promising initiatives, particularly in Africa and Asia, such as regional local-currency payment systems and proposals for reserve funds. 

But these efforts need to be supported by mechanisms that provide financing, ideally in local currencies. Regional development banks are therefore crucial. That said, they face challenges, especially concentration risk. Unlike global institutions, they cannot diversify across as many currencies and markets, which makes taking on foreign exchange risk more difficult. 

OFQ: Are we seeing the end of globalization or more of a transformation? 

AK: It depends on how we define globalization. What we are likely seeing is fragmentation rather than an end per se. The rise of China and its growing trade and financial ties with many developing countries are reshaping the system. A recent Bank for International Settlements report shows that renminbi internationalization is happening through banking networks rather than trade networks. 

So, we may move toward a more dual structure, with the USA remaining important, but with China continuing to rise. There are also increasing regional initiatives, although their success varies. For international financial subordination, this may not change much. Whether finance is denominated in US dollars or renminbi does not fundamentally alter the structural challenges for many developing countries. Unless regional blocs become significantly stronger, structural subordination is likely to persist. 

Will that change the playing field for MDBs? Not really. New institutions and alternative sources of finance, such as the New Development Bank and Asian Infrastructure Investment Bank, have made their mark in the last few years. But given the scale of global financing needs, especially for climate and development, these are unlikely to replace existing MDBs. There is room for multiple actors. 

I see the system evolving into two layers. The US dollar will remain dominant in a market‑based global system, largely driven by asset managers, global banks and capital markets. Alongside that, a more China‑centered system is emerging via bank‑based, relational and quite closed lending, especially across the Global South. 

Many developing countries are already becoming more integrated into the latter system, reflected in the expansion of Chinese banking networks. In countries like Brazil, for example, we are seeing growing use of renminbi settlement and increased participation in Chinese payment systems. 

OFQ: Finally, what concerns you most today? 

AK: Inequality is what upsets me the most. We live in a system where a small number of people have enormous wealth while many have very little. If we could change that, we could probably solve many of the world’s biggest problems. 

Objection, your honor! 

By Angus Downie, Principal Economist, OPEC Fund 

From a mainstream liberal perspective, Kaltenbrunner’s analysis may overstate structural constraints and underplay the benefits of developing countries’ integration into global markets. Economic liberalism – from Adam Smith’s emphasis on market self-regulation to modern neoclassical theory – argues that open capital markets, trade and price signals (including exchange rates) allocate resources efficiently and promote growth. Excessive focus on “subordination” risks neglecting domestic policy weaknesses (such as fiscal mismanagement, weak institutions and poor-quality policies) that many economists see as key drivers of instability and inequality. 

Centrist, more orthodox economists, typically support pragmatic economic openness. While acknowledging volatility, they stress that foreign capital and currency competition can discipline domestic policy and deepen local financial markets, thereby helping to support development. Policies such as capital controls or heavily interventionist MDB strategies may reduce efficiency, deter investment and create moral hazard. 

From this view, MDBs should focus less on reshaping the global financial system and more on improving governance, transparency, and market‑friendly reforms – leveraging, rather than constraining, global finance to support long‑term growth.