The original version of this blog appeared in top1000funds.
The investment requirements for global sustainable development are huge. State budgets are already stretched in most emerging markets and developing countries (EMDE), with tax bases weakened and public debt piling up.
Stagnating private finance in developing countries
The pandemic has exacerbated weaknesses also on the private sector side. External private finance tends to be highly volatile in EMDEs. Foreign direct investment has severely slowed down. Portfolio investments play an insignificant role in low-income countries, where capital markets are less developed. Even the controversial Chinese banks’ lending has retracted.
The World Bank’s Private Participation in Infrastructure (PPI) Database reports stagnating volumes of infrastructure projects with private participation in EMDEs at around $100 billion per year, or about 0.3 per cent of GDP. Furthermore, they are mainly concentrated in a small number of middle-income countries like China, India, Brazil, Vietnam or Russia. Low-income economies only see a small and even shrinking fraction, according to the G20’s Global Infrastructure Hub.
Mobilizing “blended finance”
, in addition to the traditional operations such as grants, loans and advisory services. The “mobilization” of private capital for development by MDBs has, so far, been small (about an annual 0.2% of GDP). Only a few billions reach the poorest countries, of which little goes into health, education and other social infrastructure. Loans and guarantees are the dominant instruments while fund vehicles and equity stakes appear under-used.
There is no shortage of opinions on what governments, DFIs and investors should do to improve the flow of money. One concept has become much talked about in recent years: “blended finance”—the use of public or philanthropic finance to increase private sector investment in development. Scope, metrics and definitions vary widely. Blended finance vehicles are often complex and not easy to scale up. Importantly, the involvement of asset owners is still meager.
Obstacles for institutional investors
Many investors are indeed keen to broaden the set of investment opportunities in growth markets. There are various hurdles and challenges, including:
- The (actual and perceived) political, regulatory and micro risks
- Regulations, fiduciary duty, and investor mandates
- Investor capacity and costs
- Specific constraints for less liquid investments like transport or water/sewage projects
How to match long-term investing with development needs? Our comprehensive report, Financing Development: Private Capital Mobilization and Institutional Investors, provides key analysis and recommendations for both policy makers and investors. In fact, institutional investors have moved into emerging markets since the 1990, mostly by buying securities of large, listed companies (such as financials, utilities or telecoms) or government bonds. More investors are now gaining exposure to EMDEs via private equity/debt or infrastructure funds. Some large asset owners are undertaking direct investments e.g., in renewable energy.
In short, investors can build on experience gained in middle income countries. There is scope for progress also in less developed economies when the conditions are right and opportunities arise. The main burden is with governments. More and better action is possible, with the DFIs here to help.
Creating long-term investment opportunities
- Investment environment:
The less developed a country, the more public institutions— domestic and international—must be up to the task.
- Investable assets:
Clarity on the underlying, long-term funding will facilitate financing and investing.
—for reasons of experience, risk mitigation, local knowledge and political clout.
- Co-investment vehicles: Equity co-investment vehicles for riskier countries and sectors are still underdeveloped. Both commercial and blended finance vehicles (e.g., with certain limited credit enhancements or insurances) targeting investors of different risk appetite could be expanded.
- Domestic investors:
- Sustainability and impact investing: Responsible investor boards are keen to raise their ESG and SDG profiles, opening a new door. Such demand could be increasingly satisfied in EMDEs. Green and social bonds will gain momentum also in developing countries. We see tentative steps towards investing in low-income countries via impact funds, e.g., in water, housing and other community projects.
Expectations need be realistic on the potential of institutional investors, particularly in less-developed countries. Policy makers, DFIs and investors should not just focus on a few headline policy vehicles. They need to better utilize the full spectrum of investment routes: impact, blended, and especially commercial. Even small re-allocations of capital can have a big impact on the ground.
Disclaimer: The content of this blog does not necessarily reflect the views of the World Bank Group, its Board of Executive Directors, staff or the governments it represents. The World Bank Group does not guarantee the accuracy of the data, findings, or analysis in this post.
Key green transitions & infrastructure finance: views from the World Bank Group/IMF Spring Meetings
How do we link private sector participation and climate resilient infrastructure right now? Some ideas from PPIAF
Private sector’s retreat jeopardizes recovery
The developing world is crying out for greater private investment in sustainable infrastructure
Climate finance: Creating the conditions we need to invest in emerging markets
2019 brought private investment in infrastructure to more countries: Is there a message for policymakers amid COVID-19?
This blog is managed by the Infrastructure Finance, PPPs & Guarantees Group of the World Bank. Learn more about our work here.