As estimates of the financing gap in developing countries range from $350 to $635 billion, there are increasing efforts to find new sources and innovative ways to mobilize external financing. In the latest issue of Finance & Development, Suhas Ketkar and I contributed an article, “New Paths to Funding," which discusses diaspora bonds, performance-indexed bonds and securitization of future remittances and export earnings as possible means for restoring, or starting, access of poor country borrowers to international capital markets.
New sources of financing include potential savings from reducing remittance fees. The G8 Global Remittances Working Group has set a 5X5 target - reduce remittance fees by 5 percentage points within 5 years - which could raise more than $15 billion additional, annual resource flows to developing countries. This objective got welcome support from the G8 Development Ministers Meeting in Italy last week. The Leading Group - a group of 55 countries that have come together to explore innovative financing for development - also discussed remittances and diaspora bonds in a meeting two weeks ago in Paris.
If remittances are a way to tap into the income stream of migrants, diaspora bonds can be a way to tap the vast wealth of the diaspora. India and Israel have raised nearly $40 billion via diaspora bonds. Ethiopia and Sri Lanka announced diaspora bonds earlier this year. Many countries are eagerly watching. There is indeed huge potential to raise billions of dollars of new funding through diaspora bonds as the diaspora would be willing to invest back home even during crisis times when a typical foreign investor is likely to withdraw investments.
Securitization of future remittances has been going on for more than two decades. As remittances buck the trend and stay resilient in the face of falling private flows, developing countries can potentially tap into their large size and counter-cyclical nature and use them as collateral for borrowing abroad.
The article introduces a performance-indexed bond. It is a new and simple idea that would allow the debt burden to be automatically reduced when the economy (or the borrower) is not performing well because of unforeseen and unavoidable reasons. In the case of a government, performance-indexed bonds can be linked to GDP growth. In the case of a private or sub-sovereign borrower, they can be linked to profit or another well-defined quantitative indicator of performance. It would be key, however, to avoid moral hazard by making sure that the borrower is not knowingly and willingly underperforming to avoid repaying debt.
The usual fine print applies to what I said above that foreign debt, like fire, should be handled with prudence!
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