De-risking is key to closing the global funding gap
By Rob Mosbacher Frist | June 2, 2022
The United States, its allies, and its partners are facing a choice. They can either continue to give lip service to closing the funding gap with lower-income countries but do nothing substantially different about it, or they can take advantage of the extraordinary unity that has emerged from the Russian invasion of Ukraine to turn the current risk paradigm into an opportunity to combine resources at an unprecedented level and use them to creatively “de-risk” projects throughout low- and middle-income countries.
When you look at the economic damage done by the COVID-19 pandemic and add to that the impact of inflationary pressures spreading around the world, it is no wonder that the progress in reducing poverty has stalled. Growth rates have fallen and fiscal deficits have ballooned, leading to higher debt levels at the very time that governments must address education remediation and health care readiness needs, among other concerns.
Aid agencies and multilateral financial institutions such as the World Bank and the International Monetary Fund, as well as the regional and multilateral development banks, are all working to help restore growth in countries hit hard by this confluence of challenges. However, much more can and must be done.
In 2015, members of the United Nations General Assembly committed to support 17 Sustainable Development Goals aimed at ending extreme poverty and converting billions in official development assistance to trillions in total financing. It was well understood that the only way to generate the kind of investment and economic growth required to permanently reduce poverty was by mobilizing private sector capital on a level never seen before.
Yet since then, while enormous progress has been made in a number of poverty measurements, the goal of enlisting private sector capital on a massive and transformational scale in lower-income countries has been largely a failure.
A study by the Overseas Development Institute found that for every dollar of public sector commitment to projects in countries classed as low-income by the World Bank, only 0.37 cents was mobilized in private sector capital.
A study by the Center for Global Development concluded that by using a combination of debt, equity, and guarantees from development finance institutions or MDBs, $1 of public sector resources should generate over $5 of private capital investment. Yet that is far from the current pattern. The reason, very simply, is risk.
Private sector investors and lenders consider most projects in low-income and lower-middle-income countries, particularly infrastructure, too risky and the returns too small to be attractive investments. As a consequence, projects that are essential for economic growth in these nations will never get done, unless China decides to finance them.
De-risking: How to
The objectives of de-risking projects are to make them more financeable by both public and private sector lenders and to attract investors that can earn an acceptable “risk-adjusted” return. In doing so, there is the real potential to gain access to trillions of dollars from institutional investors such as pension funds and insurance companies.
This also represents a critical opportunity to project and embrace a set of rules by which project procurement and implementation take place. The more transparency that host governments can bring to those processes, the more comfortable and secure that lenders and investors will be in their support of those projects.
There are a number of means for de-risking projects, including “first loss” grants, guarantees, blended finance, subordinated debt, and much more transparency and disclosure by DFIs and MDBs about past experiences with investments in challenging markets. The common thread in most of these options is that the public sector players must agree to take on more risk in the short term to attract more private capital for the medium-to-long term.
The best way to do that is by launching a collaborative and creative financing platform that uses the strengths of the international financial institutions to unleash trillions of dollars of investment and innovation from the private sector.
Historically, the U.S. has been the one country that can provide the leadership necessary to undertake new initiatives, such as the 1944 Bretton Woods Agreement for managing the international monetary system. If the U.S. government, through the U.S. International Development Finance Corporation, will take the lead on such an initiative, others will follow.
In this time of heightened competition among superpowers over political systems and economic models, it is essential that the U.S., its allies, and its partners put down a clear and unequivocal marker in support of the free-market, rule-of-law approach to economic growth and opportunity.