How blended finance can reorient cautious private investors to infrastructure

After decades of private sector growth, private capital holds most available global finance. The rise of private wealth coincided with the decline of public wealth in developed countries, which now hold zero or even negative shares in total wealth due to significant public debt burdens, according to the 2022 World Inequality Lab Report. Moreover, the 2023 IMF Global Debt Monitor revealed that global public debt reached 90% of GDP in 2022, a dramatic increase from the 30% recorded in the early 1970s. 

Against that backdrop, private capital mobilization has taken center stage as a solution to bridge the infrastructure financing gap of around $3 trillion a year. 

Despite their ample resources, private financers often view infrastructure investments as high risk. These perceived risks are the result of a complex set of issues, such as large asset sizes, long project life cycles, complex structuring, large initial irrecoverable costs, political and regulatory changes, wariness of citizens to accept privately run services due to perception of higher prices, and the lack of tradability of infrastructure assets. 

This is where blended finance comes in—as a way to improve risk-adjusted returns and mobilize private capital to close infrastructure financing gaps.

Blended finance uses catalytic capital from public or philanthropic sources to reduce risk and costs, improve returns, and mobilize private capital. However, most blended finance currently used to mobilize private capital heavily relies on government financial support and collaboration between the public and private sectors.  

Blended finance can be used more effectively: blended finance infrastructure deals attracted 40 cents of private capital for every $1 worth of public or philanthropic money during 2013–2023, according to our Infrastructure Monitor 2023 report based on the Convergence database. Governments are seeking to take things even further, calling for innovative and scalable blended finance approaches, including de-risking instruments and solutions that most effectively use limited public funds to maximize private capital investments.

Encouragingly, some infrastructure deals are mobilizing large amounts of private capital using blended finance approaches and show pathways for increasing private investment. Around 10% of blended finance infrastructure deals mobilized more than $2 for every $1 worth of public or philanthropic money used to implement blended finance approaches. These deals are the ones that addressed the unique risks of infrastructure projects emanating from the high initial barriers to entry and market gaps, in a sustainable, optimal, and innovative manner.

Put another way, the infrastructure deals most successful in mobilizing private capital through public or philanthropic financing have some strategies in common. Specifically, they: 

• Mitigate the risk of large investment size, counterparty non-payment and lack of asset tradability, for example, a clear revenue stream based on affordable amounts paid by users that is institutionalized through a credible revenue channel like electricity or water bills to act as a collateral makes private investors willing to finance infrastructure projects.
• Support launch and commercialization of companies for the roll out of affordable decentralized solutions for infrastructure services like off-grid or mini grid solar panels, portable clean water products, e-mobility vehicles, or satellite-based internet solutions, at scale.
• Address the discouragement of initial irrecoverable investment through financial and technical support. This can include early-stage project studies, first-loss equity that provides a cushion to establish proof-of-concept, especially in new territories or asset types like solar power. This helps in infusing investor confidence and launching projects at scale.
• Reduce high perceived risk and complexity of project development that involves multiple stakeholders through involvement of a trusted expert entity such as the World Bank. It boosts investor confidence, participation, and investment value. Development banks play an indispensable role in enabling private investment in low-income countries where private investors perceive high levels of risk. 
• Use political risk guarantees that provide some immunity to investors to changes in governance, policy, and regulations during the long lives of critical infrastructure assets like a power generating plant or a national highway, which possess an implicit government guarantee by virtue of their criticality. Guarantees play an important role in mobilizing private capital for infrastructure projects in countries with weaker sovereign credit ratings where investors think governments will default on their commitments. 
• Create a diversified investment security option from existing infrastructure assets, for example a pool of investment-grade infrastructure loans with high credit ratings. This allows private investors to diversify their investment while investing reasonably small amounts from their total capital. Private investors cite diversification as a key reason for investing in infrastructure. Overall, this strategy releases capital invested in existing infrastructure assets that can then be used to create new infrastructure assets.  

Sustainable, optimal, and innovative strategies can increase private capital mobilized from limited public budgets. When combined with strategic use of government resources and technical support, blended finance can play an instrumental role in increasing private investments in infrastructure.

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