By Chris Clubb, Managing Director, New Products and Knowledge, Convergence
The facts are known. Official Development Assistance (ODA) from member countries of the OECD’s Development Assistance Committee (DAC) will not grow at the rate necessary to fully deliver on the Sustainable Development Goals (SDGs). Blended finance, defined as the strategic use of official (public) funds to mobilise private sector investment for emerging and frontier economies  , is recognised as an important tool within the development toolbox to mobilise new capital sources to achieve the SDGs. Through blended finance, public funds can target a risk that the private sector is unwilling or unable to take. It also can be used to improve the risk-return profile of an investment to an acceptable level for the private sector. What all this does is attract much-needed private sector investment and know-how to projects.
A recent survey on blended finance funds and facilities found that 74 blended finance funds and facilities accounted for USD 25.4 billion in assets and have a leverage effect ranging from less than 1 to over 20. While the survey does not represent the entire blended finance market, it does illustrate the leverage potential of blended finance mechanisms. Imagine applying this to ODA. In 2015, ODA reached a record high of USD 132 billion. Assuming blended finance mechanisms achieve on average 10 times leverage and that 10 percent of ODA could be allocated to blended finance instruments, blended finance would mobilise USD 119 billion in additional private sector investment annually. This private sector investment would represent 1.5 times the aggregate financing provided by all international financial institutions to ODA-eligible countries. If targeted, it would represent 1.8% of the GDP of low- and lower middle-income countries. These figures are even more impactful given that blended finance mechanisms are often self-sustaining and revolving. In other words, they don’t have to be recapitalised because project returns can be retained and recycled for future rounds of investment.
Nonetheless, the proof for blended finance will be in the growing evidence base of development impact and public sector leverage. While the potential for blended finance is great, a number of steps are critical to ensure effective implementation and scale.
First, sharing best practices for engaging the private sector is needed. To ensure that blended finance doesn’t simply subsidise the private sector, it is imperative to develop effective evaluation and risk frameworks. These frameworks should be shared lessons between established players and new entrants to the blended finance market.
Second, understanding when blended finance is appropriate is needed. The myriad blended finance mechanisms each boast varying benefits and costs. Each blended finance mechanism should be selected based not just on the development context but also on its potential to achieve the required scale. For example, public sector partial guarantees to investors as a way to leverage public funds have shown increased promise and could be more widely applied across regions and sectors. Statistics from a 2015 DAC survey showed robust growth in the use of guarantees — above and beyond the share typically used by development finance institutions. In fact, the total volume of bilateral guarantees rose from 25% to 40% from 2009 to 2014.
Third, building the capacity of development agencies to employ blended finance effectively is key. Blended finance will be measured on its early successes, which is why a pipeline of well-structured projects is critical. As a result, relevant agencies are ramping up their capability to implement blended finance. The majority of DAC members have taken unprecedented steps over the past decade to restructure organisational systems, establish an array of funding mechanisms and bodies, and deepen institutional capacity to work with private sector actors. Further developing these capabilities will be required to meet the financing needs of the SDGs.
And fourth, understanding the potential for blended finance specifically in lower-income countries and new sectors is helpful. Applying blended finance in low-income countries and sectors like education is still limited. In addition to targeting infrastructure projects in middle-income countries, blended finance should be deployed to address financing gaps in agriculture, health, education and other key development sectors in low-income countries. Only through innovative blended finance approaches to crowd in private sector investment and know-how will markets blossom where none existed before.
The development community is engaging across multiple new initiatives to ensure blended finance is effectively implemented and achieves scale. The OECD, for one, promotes blended finance to donors and practitioners as a development tool to narrow the SDG financing gap. It is undertaking research towards producing more data on blended finance to guide policy making and determine best practice. Similarly, born from the Addis Ababa Action Agenda and supported by the Government of Canada, the World Economic Forum, the Ford Foundation and the Citi Foundation, Convergence was established as a new institution to execute blended finance mechanisms to address the SDGs. Among Convergence’s activities is an active online platform where private, public and philanthropic investors can connect with blended finance deals in emerging and frontier markets.
To ensure the viability and credibility of blended finance, institutions need to understand the risks associated with it, where and when to invest, the most appropriate mechanisms to deploy and how to price them, and the most appropriate policy frameworks. This is where organisations like the OECD and Convergence can play important roles for facilitating the growth of blended finance. Done correctly, the opportunities created through blended finance are considerable and will go a long way to contributing significantly to delivering on the SDGs. That’s why during 2017, the OECD, Convergence and other blended finance partners will work with the development community and the private sector to co-organise conferences, workshops and trainings to increase the ability of blended finance to contribute to the SDGs.
Read more about this topic:
- What does the evidence on blended finance tell us about its potential to fill the SDG funding gap?
- Reaching the last mile: The role of innovative finance in meeting the SDGs
- Maximising bang for the buck: Risks, returns, and what it really means to use ODA to leverage private funds
3) ODA from 2016 OECD DCR and GDP/population from UNSDN report. GDP of low-income and lower middle income countries: USD 6.5 trillion (sheet D2, cell E51). Population of low-income and lower middle income countries: 1.5 billion (sheet B13, cells F16-17)