The recent passage of the Better Utilization of Investments Leading to Development Act — or the BUILD Act — promises to supercharge the Overseas Private Investment Corporation and equip the United States with more modern development finance tools and capabilities.
But even with this upgrade, can a U.S. development finance institution really have an edge in the increasingly crowded playing field of development investing? Yes, it can — but only if we do it right.
Earlier this month, the U.S. Senate approved the BUILD Act, a culmination of bipartisan efforts on Capitol Hill. The bill, backed by the Trump administration, will create a new U.S. development finance institution. Here's what's next.
The rest of the world continues to invest heavily in emerging markets. Consider this: OPIC’s current portfolio totals $23.3 billion across 90 countries; in 2017, China announced plans to invest $30 billion in Haiti alone. Even the BUILD Act’s proposed doubling of the current investment ceiling to $60 billion pales in comparison to other countries, especially China.
In 2013, China launched a $900 billion global infrastructure and connectivity project known as the Belt and Road Initiative, a resurrection of the ancient Silk Road that extended across Eurasia and made China one of the world’s foremost powers. Belt and Road is seen as China’s attempt to recapture that economic dominance and geopolitical influence. It aspires to cover 65 percent of the world’s population, approximately one-third of global gross domestic product, and one-quarter of all goods and services. And it could grow further: Some believe China could pledge more than $8 trillion to Belt and Road.
How does the U.S. compete with such an undertaking? The answer may lie in the new and improved development finance corporation, which is categorized internationally as a development finance institution. DFIs are specialized development banks designed to support public and increasingly private sector development in emerging markets and developing countries.
Given the limited availability of foreign aid and a funding gap of $2.5 trillion needed to meet the Sustainable Development Goals, DFIs are challenged to crowd in private capital, which is both more sustainable than aid and encourages partner countries toward economic self-reliance.
Unfortunately, OPIC — while great at deploying mostly debt funds to projects involving U.S.
businesses abroad — simply cannot compete with China and Europe in its current form. Currently, the United States’ fragmented development finance landscape is spread across multiple government agencies, causing confusion and inefficiency.
As we move toward transforming OPIC into a globally relevant DFI, there’s no need to reinvent the wheel, but the U.S. should learn from best practices to offer a compelling alternative to countries seeking growth. If America’s DFI is to have a competitive advantage, it will rest on having a cooperative and modern focus, improved standards and outcomes, the right range of instruments, and the ability to crowd in as much private capital as possible.
Development focus and culture
The BUILD Act as it unfolded:
The new DFI must have development at its core and focus on overall market impact rather than just transactions and high returns. Recent years have seen a shift in investment from low-income to middle-income countries. In fact, from the early 2000s to 2015, 90 percent of the $59.4 billion in long-term co-financing mobilized by DFIs and multilateral banks in low-income and middle-income countries went to the better-off middle-income countries such as Turkey and Brazil.
The DFI should prioritize projects with significant positive spillover effects across the economy. Instead of rigid targets by sector or countries, the DFI should look for market gaps and fill them — supporting small businesses, for example — and should also integrate gender into every project.
Organizationally, the new DFI should promote a culture of collaboration rather than competition, which will not only strengthen its partnerships but also facilitate the exchange of knowledge to create the most impact. As part of a more coordinated approach, we should bring together the currently fragmented parts of USAID, such as its “enterprise funds,” the Office of Private Capital and Microenterprise, and the Development Credit Authority. These agencies fit more naturally into a DFI than a government agency.
Improved standards and outcomes
DFIs have an increasingly important role in promoting environmental, social, and corporate governance standards. While China portrays itself as a “good neighbor” responsible for high-quality infrastructure projects, its neighbors remain skeptical of its influence in the region. Various factors underlie this distrust, the most notable being the negative perceptions of the nation’s standards in the form of cheap and inferior quality goods, the use of Chinese laborers and materials in aid projects, and the quality of its work, and project selection criteria.
While the U.S. cannot — and should not — match China’s investments dollar for dollar, it can do more to gain trust and improve the “social output” of projects by imposing strict ESG standards, as well as investing in sustainable projects. Many DFIs (particularly in Europe) already mandate sustainability standards.
DFIs should have the right range of tools to create the most impact in the form of employment generation, tax revenues, investment outcomes, and so forth. These tools range from grants or other subsidies (used judiciously) to loans and equity participation. Risk capital is desperately needed to get projects off the ground. Equity is imperative in providing risk capital for financing projects and engaging with entrepreneurs.
Databases such as Convergence help stimulate investments through blended finance mechanisms in developing economies, attracting private capital toward investments that support the SDGs. With around 300 members and $1.8 billion in total funding, Convergence provides investors with a range of resources, such as a global network of investors, data and intelligence, and a deal flow platform that help them make the most out of their investments.
Mobilization is perhaps the biggest challenge facing all DFIs today. On top of its investments, the new DFI must scale up and crowd in private capital as much as possible, both in local and international capital markets. This is already happening, but more can be done to build relationships with private investors who can participate in deals, as well as embrace innovative financing practices.
M-Kopa is an example of a company that has used more development-oriented capital to crowd in commercial investment, with funding rolling in from both venture capitalists and funds drawn to the sector’s social and environmental impact. Investors are enthusiastic about Africa’s off-grid players such as M-Kopa, which has raised more than $160 million and powered more than 600,000 homes in East Africa since 2011.
While other countries continue to make gains in developing countries, the U.S. has an opportunity to position itself as a champion of development finance. Equipped with the right tools, it has the potential to unlock the trillions needed to achieve our development goals.