Many were optimistic when the United Nations Sustainable Development Goals were launched in 2015 that the private sector — and domestic resource mobilization — would fund much of the investment needed to achieve these goals — especially as public aid flows stagnate. As 2018 begins, we would do well to reassess these optimistic projections for private finance for development, and ask are the “billions to trillions” materializing?
The data and trends to date are far from encouraging. Global cross-border private capital flows remain depressed — 6 percent of global gross domestic product in 2016 compared to 22 percent in 2007. Low income countries continue to receive a minimal share — 1.7 percent in 2016 — of total private capital flows to developing countries. World Bank data show that the volume of infrastructure investment with private participation in developing countries is down sharply from over $210 billion in 2012 to $76 billion in 2016. And the poorest International Development Association countries capture very little of these flows: Less than 4 percent from 2011-2015.
For the private sector windows, or PSWs, of the multilateral development banks, these limited private flows are both a test and an opportunity. They, and bilateral development finance institutions, were conceived as the original impact investors, helping to unlock private investment with both commercial returns and development impact.
Yet, based on their business volume, MDBs can fairly be regarded as marginal actors. Their annual commitments to both the public and private sectors totaled $118 billion in 2016, compared to estimated annual finance gaps of $2-2.5 trillion for SDG investments, and $1-1.5 trillion for infrastructure investments in developing countries.
Even if shareholders approve capital increases, the MDBs cannot themselves fill these gaps. PSWs, in particular, must evolve from lenders to mobilizers of private finance for development.
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That new role has dramatic implications for the business models of PSWs, which currently are charged by shareholders to seek risk-adjusted market returns, price on market terms, meet profit objectives, and avoid distortive subsidies. If they are to become enablers of high-impact investment rather than bankers for their own account — where they sometimes compete with the private sector — business as usual won’t work.
Many changes will be necessary, but I would highlight two as fundamental: First, greater risk tolerance and lowered expectations for risk-adjusted returns, and second, a major cultural shift to encourage collaboration rather than competition among the MDBs.
Lower risk-adjusted returns need not mean unsustainable PSWs requiring frequent recapitalization. But difficult decisions have to be made on how to create a new sustainable financial model. This is the time to consider a broad array of options; here are just a few illustrative examples.
1. Off-balance sheet operations (special purpose vehicles) could systematically be deployed for the riskiest slices of high-impact projects in ways that better crowd in both the private sector and on-balance sheet MDB operations. The recently launched IDA Private Sector Window is a promising move in this direction. A small amount of off-balance sheet investment can be highly catalytic.
2. To fund such off-balance sheet activities, it would make sense to consolidate and rationalize the many balkanized trust funds aimed at mobilizing private investment in order to achieve greater scale and efficiency. Or small PSW capital increases could be used for the purpose of capitalizing such vehicles.
3. For some PSWs, there may be scope to increase leverage (debt/equity ratios) and credit exposure. It may even make sense for PSWs to move a notch below the AAA rating. The consequences in terms of funding costs and default probabilities may not be that significant relative to opportunities for engaging in higher impact activities.
4. Or PSWs could radically change their business models to specialize in high-risk activities such as greenfield infrastructure. PSWs could focus on early stage operations — project origination and construction — and sell projects at the brownfield stage. For sustainability of such a model, much would depend on risk assessments and potential pricing of these long-term assets.
None of these would be easy, but I believe PSW managers are open to change. Careful financial and impact analyses need to underpin decisions, and shareholders must strongly back whichever options they and management choose.
Limited MDB collaboration has a direct negative impact on private investor interest. MDBs do not, as a rule, work together to harmonize and pool products — debt and equity investments, guarantees, insurance products — to create large and standardized, yet diversified, asset offerings attractive to institutional investors. Their processes and standards are also not harmonized, boosting transaction costs for project developers and investors.
The MDBs’ own transaction costs are higher than necessary in the absence of systematic sharing and pooling of project pipelines. And the coherence and efficiency of MDB policy advice — critical to the enabling environment for private investment — would benefit from development of common MDB country strategies. MDB managers are showing a willingness to collaborate more, and are being urged to do so by diverse private and public stakeholders. But significant progress is unlikely without strong shareholder support and creation of formal cross-MDB management and governance systems.
These issues should be high on the agendas of the G-20 and other fora for shareholders. Working with MDB management, shareholders must lead change — most importantly by finding consensus about their priorities for use of their capital and the trade-offs they are prepared to make. They must also lead on cross-institutional governance that incentivizes MDB collective action and holds MDBs accountable.
Inaction should not be an option. Current data do not suggest that private investment of sufficient scale will emerge under the status quo, or that poor countries have a real chance to capture a larger share.
