Blended Finance Must Deliver for the Least Developed Countries

12 June, 2018

Original source: Development Finance

The 47 least developed countries (LDCs) in the world constitute a critical piece of the development puzzle, yet they received only 7 percent of the private finance mobilised from 2012 to 2015. The figure has increased steadily over the years but remains insufficient to ensure we leave no one behind in seeking to attain the Sustainable Development Goals(SDGs).

The strategic use of concessional finance for the mobilisation of additional finance from the private sector, otherwise known as blended finance, has been gaining visibility by those vested in such goals. Donors have been allocating more funds around engaging the private sector, and greater volumes of private capital are flowing in. An OECD survey shows that the total amount of private finance mobilised by official development finance was US$81.1 billion from 2012 until 2015. Yet this is still short of the needs of the SDGs.

So why are we not seeing more engagement by private investors in the LDCs?

Recent OECD analysis shows that, much like foreign direct investment (FDI), private finance mobilised by official development finance remains positively correlated to gross national income per capita. The richer the partner country, the more private investors are likely to engage in blended operations.

Blended finance is typically easier to deploy in countries and sectors where policy frameworks for investment are well established and where revenue streams are clear. Severe structural impediments to sustainable development often identified in LDCs increase the perception of risk. Many private sector participants are wary of investing in LDCs given their concerns about absorptive capacity, low returns and sustainability. This is even truer where additional factors of fragility may stack up, such as conflict, corruption or environmental vulnerability. Blended finance should therefore be carefully calibrated to minimise potential negative side effects in LDCs, such as crowding out private capital.

The lack of risk mitigation tools is another major obstacle to raising private investment in LDCs. Guarantees are a growing and important part of the development finance landscape, and they stand out as the instrument that have mobilised the most private capital, particularly in LDCs and in Africa more generally. The argument could be made that greater blending in middle-income countries should allow donors to concentrate their grants on heavier lifting in LDCs. Though grants remain critical to LDCs, the value added of blended finance as an additional delivery channel should not be overlooked. By mobilising untapped capital for development purposes, blending can bring know-how, innovation and support local actors, such as small and medium-sized enterprises (SMEs), which are vital parts of the economy and future firms and employers of tomorrow.

Personal remittances, private grants and capital flows, including FDI, represent over 90 percent of external flows to developing countries. Donors need to improve their use of scarce concessional resources by steering the excess capital available to places where it is most needed. Blending is an important tool that can help to achieve this. Development finance should be used to guide the private sector to sectors and economies that require skills and innovation to be developed locally, not just to provide financial resources.

Six countries, including Vanuatu, Angola, Bhutan, Kiribati, São Tomé and Principe, and the Solomon Islands, are expected to leave the ranks of the world’s poorest and most vulnerable nations over the next three years. As these countries face a gradual phasing-out of their former benefits, such as special support measures from bilateral donors and multilateral organisations, blended finance should become the way to help them transition out of aid dependency. This may occur by bringing in much-needed private finance and by deepening capital markets, thereby softening the blow of potentially reduced support from donors.

To make sure blended finance does deliver on its mandate, the OECD will pursue its mission to develop further the evidence, analyses and standards on development cooperation. The already established OECD DAC blended finance principles for unlocking commercial capital speaks to the need to target LDCs. Donor governments have agreed that their blending operations should be anchored to a development rationale (as laid out in the first principle) and aligned with local and national development priorities, including building local capital markets (found in principle 3).

Through our partnership with the United Nations Capital Development Fund (UNCDF), we continue to explore how blended finance can more effectively serve LDCs.

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