www.ifc.org/thoughtleadership NOTE 60 • NOV 2018 Blended Concessional Finance: Scaling Up Private Investment in Lower-Income Countries Blending funds from private investors with concessional funds from donors and philanthropic sources has a strong potential to scale up investment in lower-income countries and thereby accelerate development. The use of blended concessional finance is already prevalent in lower-income countries representing over 70 percent of IFC’s commitments. Recent strategies from development finance institutions including the World Bank Group indicate that the relative share of lower-income countries in the global mix of blended concessional finance will increase further. Scaling up engagements in lower-income countries requires solutions tailored to local contexts, as well as the deployment of the whole spectrum of development finance tools, including advisory work, regulatory dialogue and reform, and a mix of blending instruments encompassing both pricing and risk mitigation features. Guided by the 2015 Addis Ababa Agenda for Action, the trained workers, and a pronounced infrastructure gap. global development community has initiated efforts to Comprehensive solutions and strong domestic leadership help countries maximize finance for development without are required to tackle these issues, and blended concessional driving up public sector debt to unsustainable levels. Doing finance can help by unlocking untapped investments for so requires the pursuit of private sector solutions that can sustainable development. help achieve development goals while reserving scarce Blended concessional finance is needed given the difficulties public finance for where it is needed most. inherent in financing private businesses in lower-income countries. As illustrated in Figure 1, only a fraction of Recognizing the Needs lower-income countries today has investment grade ratings. According to the United Nations, in developing countries Yet many private investors have a preference—or even a alone, the annual investment gap in sectors covered by the regulatory requirement—for investment-grade products in Sustainable Development Goals (SDGs) is an estimated $2.5 their core investment strategies. More than 80 percent of trillion per year. At current levels of finance from official lower-income market investments remain below investment development assistance as well as private investment, the grade, which significantly restricts the amount of private funding shortfall will be approximately $1.6 trillion. This funding available in these countries and underscores the need is an enormous gap for the public sector to fill.1 Given the for blended concessional finance to initiate transactions and current global economic environment, public funding of demonstrate their long-term commercial viability. this order is unlikely to materialize, so new approaches to The challenge for crowding in private investments in crowding in private investment are essential. lower-income countries is often to initiate first-of-its-kind In lower-income2 and fragile countries, access to private investments that can showcase commercial viability in financing is often scarce due to both real and perceived the longer run, and thereby attract subsequent private market risks, including regulatory constraints, poorly investments on commercial terms. To address common developed investment climate, inadequately educated and market failures in lower-income countries, the World Bank 1 This publication may be reused for noncommercial purposes if the source is cited as IFC, a member of the World Bank Group. 100% Applying these DFI Enhanced Principles becomes 91% 90% even more important in lower-income countries where 80% benchmarks for commercial terms are often less clear, 70% and where perceived market risks are often greater. 60% While concessional funds can be effective in opening 50% 48% private investments in high-risk areas, there are also potential pitfalls.5 Without a market test of commercial- 40% based funding, there is potential for misuse of below- 30% market-priced funds—that is, investing capital with more 20% 16% concessionality than needed or providing subsidies that are 10% 0% captured by the private sector and are beyond the returns 0% Low Lower Middle Upper Middle High required to make a project viable. Steering around these Income Income Income Income pitfalls by implementing the joint DFI Enhanced Principles can help to effectively scale up private sector engagements Percent of Countries with Investment FIGURE 1 Grade Ratings, 2015–17 in lower-income countries. Source: IFC calculations based on Fitch Sovereign Ratings. World Bank income classification is based on GNI per capita: Low-income countries Blended Concessional Finance Utilization in (LIC) $995 or less; lower-middle income countries (LMIC) $996 to Lower-Income Countries $3,895; upper-middle income countries (UMIC) $3,896 to $12,055; high-income countries (HIC) $12,056 or greater. Blended concessional finance by DFIs is already focused on lower-income countries, and the share is expected to Group has developed a Maximizing Finance for Development increase as fund availability and donor interest increases. (MFD) approach. This entails prioritizing private sector In lower-income countries there is often a need to offer solutions when possible, to promote judicious use of scarce products that go beyond senior debt, and it is important to public resources. Where markets are not conducive to private use multiple instruments in a coherent approach that may, investment, the World Bank Group focuses on reforms that in some instances, involve higher levels of concessionality. address market failures and constraints to private sector 252.4 70.2 solutions at the country and sector level. Where risks remain Upper Middle High Income Income 6% high, the priority will be to apply de-risking instruments 243.2 such as guarantees and risk-sharing instruments. In these 22% Low Income situations, blending concessional funds from public or 21% philanthropic sources with funds on commercial terms SUM OF from private sector sponsors, banks, Development Finance LOW AND Institutions (DFIs), and other participants has significant LOWER MIDDLE potential as part of a comprehensive solution.3 51% INCOME: 592.5 Lower Middle USD 836mn The Rules of the Game Income 72% Blended concessional finance can often make private investments happen that would otherwise not materialize. FIGURE 2DFI Concessional New Commitments by Income Level, 2017 (USD Millions) However, efficiency requires adherence to agreed rules Source: IFC calculations based on DFI self-reporting data across DFIs, including minimizing the risk of crowding out commercial capital and ensuring transparency. In 2017, 23 Figures 2 and 3 show data from the 2017 survey of DFI’s DFIs with a focus on private sector activities adopted a set use of blended concessional finance undertaken by the DFI of Enhanced Principles on the use of blended concessional Working Group on Blended Concessional Finance in Private finance.4 These DFI Enhanced Principles ensure, among Sector Projects.6 Figure 4 shows the concessional amounts other things, that concessionality is used to the minimum by income level specifically from IFC. As illustrated, extent needed, and it supports the crowding in of other blended concessional finance is particularly prevalent in investors as much as possible. lower-middle-income countries and in Sub-Saharan Africa. 2 This publication may be reused for noncommercial purposes if the source is cited as IFC, a member of the World Bank Group. USD USD Millions Millions 350 $4,000 326.0 FCS/Low Income 300 (IDA PSW) $2,000 250 200 223.0 $2,000 $248 $166 $166 $198 $198 $198 150 $367 133.4 $367 $367 $367 $367 $367 100 117.5 $1,218 $62 $62 $801 $801 $801 $801 $801 $801 90.8 50 $0 61.9 10.0 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 0 SUB SAHARAN EUROPE & NORTH LATIN AMERICA SOUTH EAST ASIA MIDDLE Climate Agribusiness & Food Security AFRICA CENTRAL ASIA AFRICA & THE CARIBBEAN ASIA & PACIFIC EAST SME & Gender Finance FCS/Low Income (IDA PSW) FIGURE 3 DFI Concessional Amounts by Region, 2017 IFC Blending Concessional Funds Under FIGURE 5 Source: IFC data Management FY2010–18 Recent DFI strategies and new concessional resources indicate Source: IFC data that the relative importance of lower-income countries in Instruments and Concessionality the blended concessional finance mix is likely to increase in The blended finance instruments used by DFIs in lower- the future. As an example, IFC has established a target to income countries have several differences from those used increase its share of new commitments in IDA countries— in higher-income countries (Figure 6).9 Lower-income largely low- and lower-middle-income countries—from about countries tend to have a greater variety of instruments 24 percent today to 40 percent by 2030 and increase its share beyond senior debt, with a combination of cost and risk in low-income and fragile countries from about 7 percent to bearing through pricing, incentives, subordination, or use 15 to 20 percent over the same period.7 of equity or guarantees. 14 346 Advisory services are also used more extensively in lower- High Income Low Income income countries to help create the capacity and conditions 2% 37% for effective private sector operations. This reflects the combination of constraints often found in lower-income 253 Upper countries that are related to risk parameters, costs, capacity, 27% SUM OF Middle and regulatory issues. Income LOW AND LOWER 100% MIDDLE 90% 34% INCOME: 80% 315 USD 661mn 70% Lower Middle Income 71% 60% 50% FIGURE 4IFC Concessional Amount by Income Level, 40% FY2010–18 (USD Millions) 30% Source: IFC data 20% 10% New blending facilities such as the IDA-IFC Private Sector 0% Low Lower Middle Upper Middle Window (IDA PSW) are specifically targeted toward Income Income Income lower-income countries and are becoming an important SENIOR DEBT LOCAL CURRENCY GUARANTEE SUB DEBT INCENTIVE EQUITY component of IFC resources available for blended concessional finance.8 Figure 5 illustrates the significance FIGURE 6 IFC Blended Concessional Finance of IDA PSW for allocations to lower-income countries. IFC Commitments by Concessional Instrument, by also is increasing advisory services in these countries via its Project Count, FY2010–18 new Creating Markets Advisory Window. Source: IFC data 3 This publication may be reused for noncommercial purposes if the source is cited as IFC, a member of the World Bank Group. The amount of concessionality required in lower-income by expanding veterinary services, developing new road country projects also tends to be greater. This can be infrastructure, addressing agriculture value chain policy and inferred from DFI data in Figure 7 below, which compares governance issues, and building related technical capacity. total project cost and concessional financing amounts, and IFC is complementing these activities with support for a local indicates a relatively higher share of concessional finance agribusiness firm, BoViMa, which is developing the country’s for projects in lower-income countries than in upper- first modern feedlot and abattoir. With support from the middle-income countries. Global Agriculture and Food Security Program (GAFSP), IFC’s experience with blended concessional finance advisory services are provided to help BoViMa improve confirms that this observed level of concessionality—or animal husbandry and strengthen the company’s supply embedded subsidy as a percentage of total project cost— chain for both breeders and local farmers who produce tends to be higher in lower-income countries. animal feed. IFC and GAFSP are also providing a $7 million subordinated debt investment in the company to make the Total Leverage of Concessional Amount 16 14 project viable and crowd in other investors.10 The BoViMa 14.4× project will help support the livelihoods and operations of 12 more than 20,000 local herders and farmers. 10 10.5× This project illustrates how a comprehensive approach 8 involving advice to government and suppliers, development 6 institution financing, private sector sponsorship, and donor- 4 4.5× funded concessional co-investment can help create markets. 2 The project required extensive effort to develop but could 0 Low Lower Middle Upper Middle revive the country’s former export market for beef and goat Income Income Income meat. The project also illustrates the importance of higher risk-bearing instruments such as subordinated loans in FIGURE 7 DFI Total Leverage of Concessional Amount high-risk environments. Source: IFC calculations based on DFI self-reporting data (2017) Fruit Processing in Afghanistan The Importance of Blended Concessional Finance to Lower-Income Countries: Nearly 90 percent of Afghanistan’s poor live in rural areas Case Study Examples where agriculture is dominant. The country was once famous around the world for its raisins, but currently less Blended concessional finance has significant potential in than 40 percent of its annual produce is exported due to lower-income countries, especially when the blending is instability, poor quality, and food safety standards. The part of a comprehensive approach supporting local capacity World Bank-managed Afghanistan Reconstruction Trust development and policy change to create new markets. Fund is providing $190 million to enhance agricultural The four case studies below provide examples of some practices, introduce new technologies such as for raisin of the characteristics of blended concessional finance in drying and handling, and connect farmers with markets. lower-income countries and how they relate to advisory services and the prevalence of risk-bearing instruments. Within the World Bank Group, IFC and the Multilateral These examples also illustrate the Maximizing Finance for Investment Guarantee Agency (MIGA) are complementing Development approach of the World Bank Group. these efforts by working to catalyze private investments into the sector. IFC is providing $3 million in financing support, Helping Farmers and Agribusiness in Madagascar including the support of GAFSP, and MIGA is providing $7.8 Three-quarters of Madagascar’s population lives in million in political risk insurance coverage for a new raisin extreme poverty, and 80 percent of them are dependent on processing plant by the Rikweda Fruit Process Company. The agriculture. Although Madagascar has excellent conditions goal is to double production levels and improve the quality of for cattle and goat production, inadequate veterinary services processed raisins by introducing modern technology and food and infrastructure limit economic opportunities and exports. safety practices. IFC advisory services will also help provide The government of Madagascar, with World Bank support, guidance to small farmers on how to improve farming has been helping rural herders and farmers improve incomes practices. GAFSP is providing a first loss guarantee, and the 4 This publication may be reused for noncommercial purposes if the source is cited as IFC, a member of the World Bank Group. IFC-MIGA IDA Private Sector Window has allocated $3.1 financing instrument was also used—the PSW Local Currency million in support of MIGA guarantees.11 The project has the Facility provided risk guarantees that allowed IFC to obtain potential to improve livelihoods for some 3,000 smallholder the domestic currency funds and thereby fulfill its role in farmers in remote rural areas, strengthening their access to strengthening the emerging long-term housing finance market. market, and promoting roles for women in agriculture. Distributed Generation in the West Bank and Gaza This project illustrates the value of a comprehensive approach that brings together government programs; development Gaza’s only power plant suffers from a lack of fuel, aging institution investment, political risk mitigation, and advisory feeding lines, and damage caused by three wars. Outages services; private involvement; and donor support via first- range from 12 to 16 hours per day, with annual supply at less loss or parallel guarantees. Donor participation supported than 50 percent of average demand. The Palestinian Authority the project in a high-risk environment and utilized first-loss is working with the World Bank Group and international guarantees which directly targeted the risk issues. partners on an energy reform agenda, including reforms to enhance financial discipline, help public institutions improve Housing Finance in West Africa the efficiency of electricity distribution, and pilot new business Fewer than 7 percent of households in the countries of the models for solar energy in Gaza. West African Economic and Monetary Union (WAEMU) Contributing to this program, IFC, MIGA, and the World can afford to buy their own home, partly due to a lack of Bank, with donor support, are financing a $12 million, financing. The region’s mortgage market is quite limited, 7-megawatt rooftop solar project in Gaza—the first with short tenors that average less than eight years. Banks privately financed energy project in more than a decade. generally have short-term liabilities that limit their ability This will provide critical energy to 32 factories in Gaza’s to lend long-term, and they have difficulty obtaining only industrial park—the Gaza Industrial Estate—at a price external long-term funds in local currency because of poorly 10 percent cheaper than current grid-provided power and developed local capital markets. The World Bank and other up to 50 percent below the cost of diesel-based generation. DFIs are supporting a comprehensive housing development Project financing will include up to $4 million in loans each program in the region that includes the development of from IFC and the IFC-Canada Climate Change Program, effective regulations and government planning with respect a blended concessional finance program supported by the to the many areas that affect housing. Government of Canada. MIGA is providing critical political To support this overall program, IFC is providing financing risk insurance from two trust funds supported by government to CRRH, a mortgage finance company serving the eight contributions.12 Thanks to the reliable and cheaper electricity countries of WAEMU. IFC is helping to scale a market that will be available to factories inside the park, the project is in bonds supporting housing finance by purchasing local expected to create approximately 800 direct and indirect jobs. currency bonds issued by CRRH at longer maturities than Donor financing was important to achieve the financing the company been able to issue in recent years. This is structure. The project demonstrates the importance in starting with 12-year tenors, but eventually is expected to lower-income countries of anchoring blended concessional reach 20 years. The project is important to help pioneer these finance in in an overall sector development strategy. It also long maturity bonds and over time establish the viability of illustrates how the use of a combination of instruments— the long maturity housing bond market for the region. concessionality, risk guarantees, and grants—or “ultra- The IFC financial package used concessional funds from blending” may be necessary in lower-income countries. the IDA Private Sector Window (PSW) to assume risks associated with providing local currency financing. Over The Journey Ahead time the long-term bond market should become viable with Given limited public funds and the need to move funds coming from local investors, including institutional development finance contributions from billions to trillions investors. Greater access to long-tenor mortgages would of dollars, increasing attention is being devoted to ways of help increase the affordability and availability of housing as crowding in private investments to contribute to sustainable well as contribute to economic growth and job creation. development. Looking forward, blended concessional This project illustrates the importance of a holistic approach, finance has enormous potential to unlock private business with a combination of government regulatory reform, private in developing countries if it is implemented correctly. investment, FDI involvement, and donor support to help The data presented in this paper illustrates an increasing create long-term impact and new markets. An innovative focus on lower-income countries among development 5 This publication may be reused for noncommercial purposes if the source is cited as IFC, a member of the World Bank Group. finance institutions. This trend is likely to continue through The third lesson is the crucial importance of stronger innovative mechanisms with an explicit focus on lower- cooperation between development banks with respect to income and fragile countries such as that of the World Bank strategies and approaches to blended concessional finance in Group’s IDA Private Sector Window. lower-income country contexts. The latest data from the DFI Blended concessional finance can play a critical role in working group on blended concessional finance shows that mobilizing private investments and creating new commercial more than 70 percent of new commitments were to lower- markets to impact sustainable development. However, income countries.13 With increasing engagements and focus solutions for blended concessional finance must always on lower-income countries, it also follows that DFIs have the be adapted to the prevailing market context and based on opportunity to coordinate and share experiences to support comprehensive approaches to catalyze markets that will be sustainable development and new private markets. Continued self-sustaining in the long run without concessional finance. interactions among DFIs will further enhance the overall effectiveness and discipline of blended concessional finance. The cases presented in this paper illustrate three important lessons for the journey ahead on how to scale concessional ABOUT THE AUTHORS finance to lower-income countries: Kruskaia Sierra-Escalante, Manager, Blended Finance—New The first lesson is that DFIs must prioritize working in Business and Portfolio, Blended Finance, Economics and difficult environments—and be willing to take risks in doing Private Sector Development, IFC. (ksierraescalante@ifc.org) so. Multiple instruments will be required to tackle different Arthur Karlin, Consultant, Blended Finance—New Business market barriers and have sufficient risk absorption capacity in and Portfolio, Blended Finance, Economics and Private Sector lower-income markets. Innovative models are needed that can Development, IFC. (akarlin@ifc.org) be adjusted to local circumstances, as are exit strategies to Morten Lykke Lauridsen, Principal Economist, Thought avoid creating long-term dependence on concessional finance. Leadership, Economics and Private Sector Development, IFC. A second lesson is the importance of comprehensive (mlauridsen@ifc.org) approaches where the use of blended concessional finance should never be seen in isolation from other efforts. In ACKNOWLEDGMENTS lower-income countries it is important to view the use of The authors would like to thank the following colleagues for concessional finance as part of a transformative process their review and suggestions: Martin Spicer, Director, Blended that involves actions at many levels to maximize long-term Finance, Economics and Private Sector Development, IFC; development finance. Operatively, this approach implies a Gonzalo Gutierrez, Associate Operations Officer, Blended close link between blended concessional finance, advisory Finance, Economics and Private Sector Development, services, upstream efforts, sector plans, and regulatory IFC; and Thomas Rehermann, Senior Economist, Thought reforms in maximizing development finance. Leadership, Economics and Private Sector Development, IFC. 1 See UN (2018) concept note “Financing for SDGs—Breaking the Bottlenecks of Investment from Policy to Impact.” 2 In this note, lower-income countries refer to low-income countries and lower-middle-income countries. 3 For more information on the World Bank Group’s MFD approach refer to: www.worldbank.org/en/about/partners/maximizing-finance-for-development 4 IFC. “Blended Concessional Finance Principles for Private Sector Projects.” www.ifc.org/wps/wcm/connect/corp_ext_content/ifc_external_corporate_site/ solutions/products+and+services/blended-finance/blended-finance-principles 5 For a full overview of caveats and how blended concessional finance can contribute to creating markets see Kruskaia Sierra-Escalante and Morten Lykke Lauridsen. 2018. “Blended Finance – A Stepping Stone to Creating Markets.” IFC EM Compass Note 51. 6 DFI Working Group on Blended Concessional Finance for Private Sector Projects. 2018. https://www.ifc.org/wps/wcm/connect/9ae7c66a-d269-4707-9f4d- 0fb79947ede8/201810_DFI-Blended-Finance-Report.pdf?MOD=AJPERES 7 Development Committee of the World Bank and IMF. 2018. “Sustainable Financing for Sustainable Development.” World Bank Group, International Monetary Fund. 8 The IDA PSW is specifically targeted toward the category of IDA countries called “IDA-only” countries, which are the lower-income countries of IDA, not IDA Blend countries which are eligible for World Bank IBRD lending at higher rates. 9 This discussion and the next sections exclude DFI data in high-income countries because of the small sample. 10 See: https://disclosures.ifc.org/#/projectDetail/SII/38036 11 MIGA. 2017. “Afghanistan Rikweda Raisins – Project Description.” https://www.miga.org/node/1883; see also IFC. 2018. “IFC, MIGA Support Raisin Production in Afghanistan.” https://ifcextapps.ifc.org/IFCExt/Pressroom/IFCPressRoom.nsf/0/DC5864BACB50E935852582A20037972E; see also World Bank. 2018. “Afghanistan: Improving Yields and Incomes for Raisin Farmers Through Markets.” Brief, July 2, 2018. https://www.worldbank.org/en/about/ partners/brief/afghanistan-improving-yields-incomes-for-raisin-farmers-through-markets 12 MIGA. 2017. “PRICO Operations Rooftop Solar – Project Description.” https://www.miga.org/node/1874 13 IFC. “Blended Concessional Finance Principles for Private Sector Projects.” 6 This publication may be reused for noncommercial purposes if the source is cited as IFC, a member of the World Bank Group.