Breaking the funding fence – building the EMDEs

Given that you are reading this article, it is ostensible that you are literate, have access to a stable internet connection and have access to some form of financial services. Yet on the other side of the fence, there are 1.7 billion people who are unbanked, i.e. no financial services to their avail. For 40% of the world, the Internet too remains a mirage. Fortunately though, the world has sustained an upward trend of literacy rates at over 86% today. The question that emanates from this picture is: How do we maximise development and actually become an egalitarian world? The United Nations also shares this sentiment, motivating the mission to eliminate this fence and achieve the Sustainable Development Goals (SDGs) by 2030. This is where our gaze is set on the Emerging Markets and Developing Economies (EMDE). What are these? 

Using the International Monetary Fund’s  definition we categorise economies into Advanced or EMDE based on:

  1. Per Capita Income
  2. Export Diversification – for instance having 70% of exports as oil excludes an economy from being advanced*
  3. Degree of integration into the global financial system

The consulting firm McKinsey&Co anticipates that global growth will be driven by EMDEs for at least the coming two decades. As the world reaches a level of  goods and services consumption worth $62 trillion by 2025, they will contribute a full 50% of it. Moreover, manufactured goods from these countries will be hitting 65%. These figures symbolise how quintessential it is to nourish these EMDEs. The problem is the fence – the barrier choking the flow of funding between them and advanced economies. 

In this first part of the series, we address the highlighted sources within the private sector beyond the horizon of reforms attracting ‘Foreign Direct Investment (FDI)’, so how does the picture look? Annually, over $1.5 trillion flows into EMDEs, largely through FDI, with a peak of $1.7 trillion in 2016. While substantial at first glance, just 10 countries receive the majority of the amount and only 1% reaches countries amid conflict or facing tremendous instability. 

Coming up with a numerical value required to encompass all areas of development as per SDGs is impossible as a result of how multidimensional the goals are. However for a contextual perspective, it is estimated that between $5-7 Trillion annually is required solely to develop global infrastructure, be it pipelines or entire cities. This is where even the aforementioned $1.7 Trillion is rather diminutive. Even the largest public source of funding, Official Development Assistance (ODA) topped $146.6 billion, despite being the fifth largest source of all financial flows to the EMDEs.

To tackle this scene, the Addis Ababa Action Agenda was established in 2015, the summit led to private and public entities to reform financing to realise the behemoth of SDGs. At the frontline were the IMF and many Multilateral Development Banks (MDBs) such as the World Bank Group (WBG) pledging to attract and leverage global financing to mobilise funds. It is crucial to consolidate the existing and emerging landscape of investment into one which is sustainable, not just for the marketing and branding, but for the priorities and disposition of younger investors towards the goal of the SDGs.

So how does WBG mobilise finance? 

Mahmoud Mohieldin, Senior Vice-President for the 2030 Development Agenda at the United Nations, expounds that in many EMDEs government revenue from taxation accounts for only a fraction of their GDP. Many reasons such as corruption and poor record-keeping, mean the state simply does not have enough money to spend on its people. What the World Bank does is, it assists nations in their policy-making to tap into whatever resources and methods available to facilitate development.

 When a project is presented the private sector has the priority to realise the project, and if there are any impediments then WBG coordinates with the government to resolve “red-tape” and improve the business environment, promoting public-private partnerships to avoid “crowding out” the private sector, i.e. avoiding the state hoarding money, which private cannot use to invest.

How do we achieve this? 

The “Maximising Financial for Development” approach strives to mitigate risk, aiming to welcome the private sector through reforms and policies on the basis of Hamburg principles laid out by the G20 in 2017. The emphasis of “country ownership” is such that countries are accountable for their own engagement with MDBs, in how they open themselves up to embrace new projects and investments. 

The approach conducts cost/benefit analyses of private vs public solutions with past success/failure stories in mind

Key areas that are weighed are:

    • Economic viability 
    • Fiscal and Commercial sustainability 
    • Transparency in the risk allocation 
    • Environment & social impact

In 2017, the World Bank was able to mobilise $28 billion in private capital, greater than 50% of all MDBs combined through risk mitigation instruments and its advisory. For example, the collaboration with ‘West African Economic and Monetary Union’ with smaller regional companies vastly expanded housing finance as 50000 businesses and households were able to attain new mortgage loans with 250000 housing sector jobs created alongside 200,000 having access to superior shelters. This occurred through the leverage whereby for each $1 invested by the World Bank, $5 was crowded in through the bond market. Such projects are a testament signifying that it is not the lack of money in the world, nor overambitious goals, rather the challenge of attracting and distributing funding in areas of priority.

What are the risk-mitigating facilities that allow a great emanation of developing finance dollars?

When you walk into a car dealership looking for a second-hand car, only the dealership is aware of the history of the product, the most you can do is take a test-drive, even then many defects may be masked, unless that country has a rigorous legal framework for the car market. The same deterrence is faced by many institutions looking to invest in EMDEs, the challenge of due diligence and assurity of their sunk investment. This is where the Multilateral Investment Guarantee Agency (MIGA) comes in, one of the four entities of WBG aims to eliminate moral hazard and uncertainties faced by firms and individuals when looking at less developed foreign markets. The objective is to provide guarantees and risk-insurance products against:

  • (Creeping) Expropriation by the government
  • Inconvertibility of currency
  • Breach of Contract
  • War, terrorism and disturbance

In 1994, FDI exceeded ODA for the first time and by 2013 FDI peaked at six times the value of ODA. However, with rising vulnerability and global turbulence across geopolitical and economic tensions, and especially at present amidst a tumultuous pandemic, the value of risk has marched upwards which means MIGA’s role is even more instrumental today. In 2014, political risk insurance guarantee was given for “Adana Integrated Healthcare Campus Project” in Turkey, a 1550 bed hospital campus was Turkey’s first Public-Private partnership facilitated through long-term financing across global investors with a guarantee on macroeconomic risk and expropriation. This was a significant milestone not just by the structure of the project, but in advancing healthcare and sustaining a healthy human capital for the country.

The lifeline of development relies on such tremendous projects, showing why infrastructure finance is termed as the “Nexus of growth”. To overcome 940 million people’s lack of access to electricity, 663 million to potable water and 2.4 billion to adequate sanitation facilities in itself requires $50-$60 Trillion in the coming 15 years. We have demonstrated that there are institutions, frameworks and paradigms which show it is possible. While operating in fragile and undeveloped economies may have become easier, the fact remains that the positive externalities yielded are not accounted for when considering financial viability. It is indispensable to attract private finance by delivering the message that financial and social returns can co-exist and are in fact complementary. 

 Private investment has the power to overcome fiscal constraints and creates more room for financial innovation, which becomes even more paramount due to the “infrastructure paradox” as outlined by Jay Collins – Vice Chairman of Corporate and Investment Banking at Citibank. $3 Trillion per year is not sufficient to cover the excess demand of $6 trillion necessitated by the need to meet the 2030 SDGs; in a climate of sharp fiscal constraints intensified by Coronavirus, only $400 billion is privately financed. The tightening for banks in response to the 2008-09 recession means that financing such projects is difficult for banks. On the other hand, in capital markets despite many advances in fixed-income securities such as project bonds, their scale remains minute at $50 billion, and moreover there is a lack of expertise and risk knowledge. This makes segmenting risk essential for the institutions, paving a path for blended finance which culminates in the fusion of fiscal social returns and private financial returns – a win-win desire. Making a refreshing cocktail of ODA and private funding is the step, Mr Collins believes that the shift will come when we make our metric not about the amount of funding, but rather the “mobilised capital”; how much smaller risk capital such as “grant capital” can bring in multiples of private capital. 

A shining paragon of this mechanism is the “Rikweda Project” in Afghanistan which looks towards“Improving Yields and Incomes for Raisin Farmers Through Markets”. Less than 40 percent of Afghan raisins produced are exported due to lacking technical expertise and food safety standards. About 70 percent of exported raisins are traded with little or no processing, resulting in deep discounts relative to its neighboring countries. The business environment too is nestled amongst violence and instability. The International Financing corporation was able to commit $3.1 million through the “private sector window” catalysing private sector funding with the addition to risk-insurance provided by MIGA to rationalise the feasibility of the investment. The outcome will improve the lives of over 3000 small-scale farmers as well as double the production capacity of raisin production in Afghanistan, a significant boost economically and socially, with long-run ripening of fruits of financial profit. 

‘Raisin farming at work’⁣

This was the perspective of just one institution operating several projects globally, many successful stories are being written to empower the ideas and innovation for tomorrow. It is about leveraging, mobilising and breaking that fence stifling the flow of funding. Quintessentially the world can achieve the SDGs from a pragmatic point of view, however equally pragmatic needs to be the mindset of private institutions to embrace cooperation, long-termism and an open-mind.

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