Development Finance 2.0: Improving Conditions for Local Currency Financing

By Harald Hirschhofer, Senior Advisor, TCX 1 

Development-Finance-shutterstock_524218915Achieving the UN Sustainable Development Goals (SDGs) will require very large investments measured in the trillions until 2030. To mobilise such amounts, policy makers try to crowd-in the private sector, its financial resources and its entrepreneurial creativity. But private sector engagement will not happen if risk-adjusted returns are perceived to be unattractive. While telecom and mobile banking have shown that achieving development goals also means good business, perceived risks in most other sectors and countries are still too high for expected economic returns.

That is why donors, recipients and development banks have been developing programs to lower and share risks, including policy and structural reform, technical assistance and information sharing, and providing financial de-risking instruments. Especially in situations where private investors perceive risks as higher than they actually are, such de-risking measures can be impactful in catalysing private investment flows. Accordingly, development finance institutions (DFIs) are expanding their focus from mere funding to blending risk tolerant donor funds with commercial capital to offer de-risking services and support for (perceived) high risk activities.

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Wanted: mechanism for additionality

By Paddy Carter, Research Fellow, Overseas Development Institute

development-financeAdditionality is the thorn in the side of Development Finance Institutions (DFIs). It means: making an investment happen that would not have otherwise. Of course, everybody in development wants to make things happen that would not otherwise, and the possibility that aid substitutes for domestic efforts is a concern in other contexts. But additionality torments DFIs because of the constant suspicion that they crowd out private financiers by investing in products that would have been viable without public support.

DFIs are regularly called upon to provide rigorous evidence that their investments are additional. Rigorous quantitative evidence, in the eyes of academics, requires some credible method of estimating the counterfactual (what would have happened otherwise). And that requires something like a randomised control trial or a natural experiment or a valid instrumental variable. Yet, none of these is feasible in the world of DFIs. And without that, we are unable to distinguish correlation from causation.
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Broadening financing options for infrastructure in Emerging Asia

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By Kensuke Tanaka, Head of Asia Desk, and Prasiwi Ibrahim, Economist at Asia Desk, OECD Development Centre 


Learn more about this timely topic at the upcoming
1st International Economic Forum on Asia
Register today to attend on 14 April 2017!


Kensuke-Prasiwi-AsiaForumAgreeing on the need for new infrastructure is one thing; finding a sustainable way to finance it is another. According to the ADB, an estimated USD 26 trillion (or USD 1.7 trillion per year) will need to be invested in infrastructure in its developing member countries1  between 2016 and 2030 if these economies are to maintain their growth momentum, eradicate poverty and respond to climate change2  .Given the scale of investment needed, countries in the region will not have sufficient funds to meet demand. Indeed, financing infrastructure investment has been a considerable challenge for the region. Political factors can further complicate financing when they lead to the inefficient allocation of public funds. How best to finance infrastructure is, therefore, a key concern for policy makers in the region.
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Unlocking the potential of SMEs for the SDGs

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By Lamia Kamal-Chaoui, Director, Centre for Entrepreneurship, SMEs and Local Development


Learn more about this timely topic at the upcoming
Global Forum on Development on 5 April 2017
Register today to attend


SMEs-Dev-MattersA universal definition of small – and medium-sized enterprises (SMEs) does not exist. What is generally undisputed, however, is the fact that the overwhelming majority of private-sector businesses in the world are SMEs and that SMEs account for a very large share of world economic activity in both developed and developing countries.

Look at the data. In the OECD countries where SME definitions are comparable, the contribution of SMEs to national employment ranges between 53% in the United Kingdom to 86% in Greece. The contribution of SMEs to national value-added 1 is between 38% in Mexico and 75% in Estonia. The SME share of economic activity is typically larger in OECD economies than in emerging-market economies, reflecting a mix of stronger SME productivity levels in the former and higher rates of economic informality in the latter. In emerging-market economies, SMEs are responsible for up to 45% of jobs and up to 33% of national GDP. These numbers are significantly higher when informal businesses, which are often more than half of the total enterprise population, are included in the count. Some estimates suggest that when the informal sector is included, SMEs in emerging-market economies account for 90% of total employment.
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Financing the SDGs in cities: Innovative new approaches

By Gail Hurley, Policy Specialist on Development Finance, Bureau for Programme and Policy Support, United Nations Development Programme

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Mumbai is among a growing number of cities exploring green bonds as an option for financing sustainable urban development.

 “Cities are major drivers of the global economy. Today, cities occupy only 2% of total land but account for 70% of GDP.” (Habitat III, 2016)

Many of the investments needed to achieve the Sustainable Development Goals (SDGs) will take place at the sub-national level and be led by local authorities, especially in urban areas. Massive public and private investments will be needed to improve access to sustainable urban services and infrastructure, to improve cities’ resilience to climate change and shocks, and to prepare them to host 2.5 billion new residents over the next three decades, particularly in developing countries.  If city authorities can meet these challenges head-on, the sustainable development dividends could be immense. This reality underscores the need to recognise and strengthen the capacities of local authorities as major actors in promoting sustainable development.
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Unlocking Private Finance in Frontier Markets

By Dr. Nancy Lee, Deputy Chief Executive Officer, Millennium Challenge Corporation

The development landscape has changed fundamentally. Private actors and private finance increasingly drive development, and annual private financial flows to developing countries now amount to more than five times official aid flows. Potential sources of development funding — institutional investors, impact investors, foundations, diaspora communities, sovereign wealth funds — are not lacking.

The challenge is to harness more of these flows for poorer countries and for investments with more development impact — which is central to the conversation at this month’s World Economic Forum on Africa in Rwanda. Even motivated investors face two critical impediments: (1) weak and sometimes toxic policies and investment climates and (2) underinvestment in the supply of bankable projects. Continue reading

How will the world raise the $4 trillion needed to pay for the SDGs and can philanthropy help?

By Sam Parker, Director, Shell Foundation – an independent charity

If the global community doesn’t find a way of increasing available finance by a factor of ten, reaching the Sustainable Development Goals (SDGs) remains a pipedream. Philanthropy is well placed to make a critical contribution by helping to trigger the massive increase in private capital. This is more critical than ever, now that the world has made such a fanfare about achieving the SDGs by 2030.

Meeting the SDGs will cost $3-$4 trillion a year of public and private money over the next 15 years. That is roughly 15% of annual global savings, or 4% of world GDP. Western governments promise to provide 0.7% of GDP in aid, and in fact deliver a third of that. Current annual SDG-related investment is around $1.4 trillion, implying a shortfall of $1.6-$2.6 trillion. In power alone, annual investment is around $260 billion, compared to the $630-$960 billion needed. Discussing deployment of funds that do not exist is fantasy.

It is now recognised that the shortfall must come largely from the private sector. In 2015, I heard senior UN officials, presidents and leaders of monetary financial institutions all concede that government funds are clearly insufficient, and that private capital must be mobilised if we are to stand a chance of reaching the goals. This is a shift in thinking. At the Millennium Development Goals planning meetings in 2000, there was little mention of the private sector and virtually none of philanthropy.

For new enterprises, we are seeing the first signs of material scale. Shell Foundation – an independent charity – has several partners, for example, who are now exceeding $50 million in annual revenues. However, for start-up enterprises to make a difference to the SDGs, we need to learn how to facilitate the growth of multiple enterprises simultaneously, whilst catalysing demand growth. In other words, we need to learn the art of market building. No plane will take off without a clear runway; no business will grow without a supportive market environment. Few demonstrated approaches to market building exist, and this remains a key challenge for philanthropy today.

So how should the finance gap be filled? Whilst the system has a lot of money, it is generally not the right sort of finance for stimulating the private sector.

For start-up social enterprises, there is an acute lack of early stage patient capital. According to the 2014 Global Impact Investment Network survey, of the $10 billion of impact investment, a mere 9% was seed stage. The CEOs we support spend two-thirds of their time on fundraising, rather than on other aspects of their business, like marketing, staff development, systems, finance controls and governance. Building start-ups needs plenty of early-stage grant funding. It is curious why social enterprises are expected to become profitable so quickly without the grant-support that most new commercial businesses enjoy.

While building new enterprises will ensure the pace of innovation, larger companies have the ability to take proven models to scale quickly and therefore have an equally critical role to play. For large multi-national companies (MNCs), it is often difficult to secure support from public institutions that are nervous about being perceived as benefitting private interests. I believe the untapped opportunity is huge to better leverage the power of MNCs through public-private joint ventures to accelerate progress towards the SDGs.

Philanthropy has a key role to play in building the new generation of financial products that are needed. We have seen promising results already from our portfolio. An innovative tiered capital structure has allowed small – and medium – enterprises (SME) financier Grofin, a Shell Foundation partner, to include different funders with different risk return appetites in a single fund for African SMEs. We have used a range of grants, convertible debt, loans, first-loss guarantees and equity at different stages of growth with companies like d.light, M-KOPA, Intellegrow and Envirofit.

Increasing the availability of all categories of finance is needed. Financial institutions with a mandate to contribute towards the SDGs need to offer the full range – not just the lower risk end. We won’t reach the SDGs if big money only invests in de-risked opportunities. How many planes would take off if passengers were only willing to pay for the latter stages of the flight?

More early-stage grants for start-ups, more grants for building supportive market environments, more mezzanine debt for mid–sized companies with limited track records, consumer finance targeting low income customers, more use of public funds in joint ventures with large corporations, tax incentives for critical technology and components, and government guarantees to local banks offering commercial credit to local entrepreneurs are needed. This is the transformation that is needed.


 

This article should not be reported as representing the official views of the OECD, the OECD Development Centre or of their member countries. The opinions expressed and arguments employed are those of the author.

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