One solution, championed by the World Bank Group’s International Finance Corporation (IFC), is to use blended finance at the portfolio level, not at the level of individual investments. According to the IFC, one advantage of this approach is that it allows the underlying investments to be made on a non-concessional basis. Civil society organisations often make the point that public support of private investment is providing a subsidy by definition, even if the IFC regards the underlying investments as non-concessional. The subsidy enables what the IFC classifies as non-concessional finance to be available where it would not otherwise be.
Still, applying subsidies at the portfolio level is less distorting. Selected individual enterprises within the portfolio are not recipients of largesse that others are denied. In addition, the incentives are kept in place at the project level for investors to get the best possible deal and for managers of the underlying asset to perform well. Because the ultimate effect of the subsidy is to make finance available at a combination of price and volume that would not otherwise be possible, the risk remains of crowding-out private finance provided at market rates. Thus, what’s important is investing these portfolios in places where finance is demonstrably lacking. If done right, no enterprise is given a competitive advantage over others, but they do receive financing they would not otherwise.
The IFC – and other actors in this field – argue that perceived excessive risks are often the binding constraint on private investment in frontier markets, and ODA can be most effective when used to absorb some of the risks in an investment portfolio. Because every subsidy can be reduced to its impact on expected risk-adjusted returns, it is not obvious why using ODA to mitigate risk is preferable. In principle, the same impact on risk-adjusted returns can be achieved by a grant, for which it is at least easier for ODA donors to budget. But targeting risk, rather than boosting returns by other means, raises the possibility that the value of the subsidy to the recipient is greater than the cost to the donor (so it is the sort of product that could be sold at a profit). This could happen if investors are risk averse whilst donors are risk neutral, or if private investors systematically overestimate risks.
Both of these ideas are controversial. It is not obvious that governments should be more accepting of risk with taxpayers’ money than private funds are with their investors’ money, and the claim that private investors are systematically wrong is a bold one. But without such arguments, a dollar spent mitigating risk is no more effective than a dollar spent subsidising returns. If donors are going to pour more ODA into attempts to leverage private investment, some rigorous research is needed into the question of whether some instruments offer more bang for the buck than others.