Blended Finance: A 'honey-trap' for development?

Private finances can not achieve what public finances can, especially in the area of social development and environmental protection. Public finance acts more predictably and plays an important role in protecting and providing public goods. Caution is needed as the development community needs to fully understand the pros and cons of using public money or ODA in 'leveraging' private finance, writes Anis Chowdhury

The donor countries, having failed to fulfil the aid commitment of 0.7 per cent of their Gross National Income (GNI), made more than four decades ago, have now floated a new idea, called Blended Finance (BF). The Organisation for Economic Cooperation and Development (OECD) and the World Economic Forum (WEF) define BF as "the strategic use of development finance and philanthropic funds to mobilise private capital flows to emerging and frontier markets". The OECD and WEF launched ReDesigning Development Finance Initiative (RDFI) in 2013 to "translate the desire for public-private cooperation for sustainable development into concrete results". In the wake of the adoption of the Agenda 2030 for Sustainable Development Goals (SDGs), they claimed that BF "represents an opportunity to drive significant new capital flows into high-impact sectors, while effectively leveraging private sector expertise in identifying and executing development investment strategies".

THE FAD: RDFI presented the concept of BF at the Third International Conference on Financing for Development in July 2015. At the lunching event, one of the pioneers of BF, Charlotte Petri-Gornitzka (former head of SIDA), said that BF is a complement to traditional overseas development assistance (ODA) such as grants, and has proven to be effective in targeted development interventions.

The European Council was first to endorse the concept of blending as a tool of development cooperation in 2014. Other donors followed suit. The multilateral development banks have also enthusiastically embraced the novel idea and produced a document, entitled, "From Billions to Trillions: Transforming Development Finance". It claims that BF is "the best possible use of each grant dollar". Canada's former minister of international development, Christian Paradis, echoed the sentiment and titled his piece "Turning billions into trillions: The power of blended finance" in DEVEX, a media platform of donor agencies, philanthropic foundations and businesses.

The OECD claims that blended finance is emerging as one solution with significant potential to help bridge the estimated US$2.5 trillion per year annual investment gap for delivering the SDGs in developing countries. The European Union (EU), the single largest contributor to BF facilities, has made the European Fund for Sustainable Development a key pillar of its External Investment Plan (EIP) to address investment gaps in the European Neighbourhood and Africa, with a budget of €2.6 billion and a guarantee of €1.5 billion.

HOW MUCH HAS BEEN MOBILISED? A 2016 OECD survey found that between 2012-2015, US$81.1 billion was mobilised from the private sector by five instruments surveyed (guarantees, syndicated loans, credit lines, direct investments in companies, and shares in collective investment vehicles), with the amounts mobilised increasing over the period. According to the recently released 2018 Report of the Inter-Agency Task Force (IATF) on Financing for Development, 17 of 23 OECD's Development Assistance Committee (DAC) members are engaging in BF, often through intermediaries such as development finance institutions and development banks. It also noted that between 2000 and 2016, 167 new blended finance facilities, with approximately US$31 billion in combined commitments, and 189 blended finance funds were launched.

WHAT IS THE CATCH? The first and foremost issue is the lack of a universally agreed definition of BF as pointed out in the 2018 IATF Report. A 2017 OXFAM-EURODAD Report by Javier Pereira listed six different definitions. They all accept the use of ODA (e.g., grants), either explicitly or implicitly, but other non-ODA types of finance (e.g., export credit) are also accepted. It also noted confusions as terms such as 'leveraging', 'mobilising' and 'catalysing', with no standard definition, are often used interchangeably, even though their meanings can change depending on the context.

This poses difficulties in monitoring BF's magnitude and development impacts. Thus, as noted by a EURODAD report, the activities of blending facilities lack transparency and accountability, and insufficient information is made available to the public. According to Sarah Vaes & Huib Huyse, current blending practices struggle to prove additionality effect of private finance - the extent to which public money is used to achieve development outcomes that otherwise would not have happened. The 2018 IATF Report observed that development of additionality, in particular, was a source of concern in existing projects, due to limited availability of reliable evidence on the sustainable development impact of blending. Many blending projects have not monitored development impacts, and evaluations are not routinely made publicly available.

Noting the confusion surrounding BF, the 2017 OXFAM-EURODAD Report concluded that blending can be problematic: "it does not necessarily support pro-poor activities; often focuses on middle-income countries; and may give preferential treatment to donors' own private-sector firms, and hence incentivises tied aid".

DONOR COUNTRY BIAS: Margaret Callan & Robin Davies found evidence of BF's bias towards donor country corporations. The 2017 OXFAM-EUORAD report made a similar observation that by pooling public resources and using ODA, donors subsidise private companies most often owned and domiciled in OECD countries. When it relies on external private finance, BF may crowd out the domestic financial sector in the host country. Furthermore, projects may not align with country plans, and commonly fail to incorporate transparency, accountability and stakeholder participation.

In evaluating EU's BF-based EIP, Xavier Sol, et al found no reliable evidence to show that blending mechanisms were actually applied in line with and contributing to development objectives. Secondly, existing lending facilities had no appropriate mechanisms to involve developing countries' stakeholders, which risked undermining country ownership.

BY-PASSES POOR COUNTRIES: The 2018 IATF Report found that so far, BF has largely bypassed LDCs. In 2016, the MDBs directly mobilised US$49.9 billion in private co-financing; only 2.0 per cent of this co-financing, or US$1 billion went to low-income LDCs where infrastructure gaps are huge. According to the 2016 OECD survey, only 7.0 per cent of private finance was mobilised for projects in LDCs, and between 2012 and 2015, the majority of private financing mobilised through ODA was in middle-income countries (43 per cent in upper middle-income countries), with a minority being mobilised in least developed countries (LDCs).

MODEST IMPACTS ON POVERTY AND SDGS: The 2018 IATF Report observed that BF generally had a modest impact on poverty. It also noted that BF tended to target SDG investment areas where the business case was clearer-such as energy, growth, infrastructure and climate action, and, to a lesser extent, water and sanitation-as well as cross-cutting priorities such as poverty and gender. The OECD also made similar observations that the mobilisation of private capital was most pronounced in the finance and energy sectors, and BF played a much smaller role in areas such as ecosystems, reflecting the strong public good character of these investments, where public finance is often the most effective financing option. The 2017 OXFAM-EUORAD report found that BF diverted aid from public investments in social programmes and essential services.

PUBLIC FINANCE AND PUBLIC INTEREST: These observations show that private finance is not guided by the same interests and principles as public finance and consequently will not act the same way. Labelling BF as a 'honey-trap', The Economist highlights, "Private investors do not typically fund the construction of rural roads in Africa, say, or vaccination drives in villages, even though the returns on such investments are often enormous. That is because the returns are either hard to monetise, or the risks are too great for the private sector to tolerate."

Yet, as pointed out by Vaes & Huyse, the current blending mechanisms pay little attention to the question on how to ensure that public interest and development objectives are safeguarded when public funds are used, especially involving financing of ODA. They wondered how sound it is to channel public development funds through risky commercial financial services and products.

GOING FORWARD: ODA still remains crucial for LDCs and low-income countries. Private finances can not achieve what public finances can, especially in the area of social development and environmental protection. Public finance acts more predictably and plays an important role in protecting and providing public goods. Caution is needed as the development community needs to fully understand the pros and cons of using public money or ODA in 'leveraging' private finance. First steps would include agreeing on a universally acceptable definition of BF and a monitoring framework to be able to track additionality of various blending mechanisms - both input (finance) and output (development impacts). Additionally, BF mechanisms must be driven by the recipient country's development strategies.

This cautionary approach is in the spirit of the Addis Agenda which underlines the potential of blended finance instruments, while calling for careful consideration of their appropriate structure and use.

Anis Chowdhury is Adjunct Professor, Western Sydney University and the University of New South Wales (Australia); held senior United Nations positions in New York and Bangkok during 2008-2016. [email protected]