Will blended finance lead to private sector growth in developing countries?

Donors are facing increasing pressure to scale up their investments in blended finance in order to mobilise additional commercial finance to plug the funding gap for the Sustainable Development Goals. Clear prominence is being given to the topic at this year’s UN Financing for Development Forum, and it will also feature during the World Bank and IMF Spring Meetings this week and next. However, there are five key elements that are at risk of being neglected in the current debate. These must be tackled if we want blended finance to be an effective addition to the development financing toolkit and to result in sustainable private sector growth in developing countries – without causing unintended diversion of scarce official development assistance (ODA) from interventions we know benefit the poorest and most vulnerable.

Long-term versus short-term solutions

To encourage private sector contributions to sustainable development as envisaged in the Addis Ababa Action Agenda, donors need to support initiatives that address underlying challenges to private sector development. These can range from unfavourable international trade and investment rules, to a weak judicial and regulatory environment at the domestic level, to a shortage of skilled and healthy workforce. Available evidence suggests that blending can offer a short-term fix by leveraging new partners into a new market via individual investment projects. Even then, without the right conditions, it isn’t always even a short-term solution. Ensuring the private sector fulfils its potential in relation to the SDGs requires longer term change at the national (and international) level to create the enabling environment within which the private sector can flourish.

Foreign vs local private sector

The private sector is not a homogenous entity; different types of private sector actors have different incentives and are likely to impact on poverty reduction and broader sustainable development objectives in different ways. When it comes to blending, international donors and the global and regional development finance institutions are mainly partnering with large foreign companies and investors. The risk of this is that local, job-creating private sector partners may, in many cases, end up being crowded out. For example, trade policies that enable the entry of foreign investors into the market may create additional challenges for domestic players. Donors must consider how blending can facilitate local private sector growth and development, as well as funding important projects alongside international commercial actors.

Middle income versus poorest/fragile contexts

Blending requires a supply of impactful and sustainable investment projects. Those that are at a ‘tipping point’ of being profitable in the long-run but that are not perceived as investable in the short run (usually due to factors such as deal size and not being part of recognised asset classes), are the projects that can create new markets and spur additional private investment down the line. However, they’re hard to find – especially in the poorest and most fragile settings. They also require a thorough knowledge of the local context in order to avoid distortion of local markets, and the crowding out of additional investment. Therefore, blending may not be the short-term solution which will bring new private partners into some of the poorest and most fragile countries.

Development effectiveness

In 2016, Development Initiatives published a blog titled The Busan principles and blended finance: time to bridge the divide. It remains important today. While calls to scale up blended finance have since intensified, the same is not true for the need to ensure that ODA used in blending adheres to the development effectiveness principles. Donors are increasingly sharing best practice on how to evaluate the development impact of blended finance projects but too little emphasis is placed on the need to ensure country ownership, transparency and accountability, a focus on results, and inclusive partnerships in blending.

Policy coherence

The world has changed and we cannot look at scaling up blending without also considering global trade regulations, international tax rules and financial markets. All these areas are connected and cannot be approached in isolation from the others. The aim must surely be to encourage the development of private sector at the domestic level and open up new financial flows to some of the poorest countries in the world. Blending alone cannot achieve this but used within a coherent approach to local private sector development, we could see a transformation in the impact of international public finance on this area.