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Do Development Finance Institutions (DFIs) play a role in promoting private investment in sustainable infrastructure?

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The global community set ambitious objectives through key events such as the Addis Conference on Financing for Development in July 2015, the adoption of the 2030 Agenda and the Sustainable Development Goals (SDGs) in September, and the groundbreaking international agreement on climate action at COP21 in Paris in December. This newfound global agenda has garnered support not only from national leaders but also from mayors, business leaders, investors, civil society, and citizens. The immediate challenge now is to swiftly translate this momentum into actionable measures, implementing the Paris Agreement, achieving the SDGs, and rekindling global economic growth. Sustainable infrastructure plays a pivotal role in all three goals, with investments in it poised to support inclusive growth, improve access to basic services, reduce poverty, accelerate development, and foster environmental sustainability.

Hilen Meirovich, Head of Climate Change at IDB Invest, emphasized the role of Development Finance Institutions (DFIs) in fostering private investment in sustainable infrastructure. He echoed the sentiment shared during the discussion about the COP28 UAE leaders’ declaration, acknowledging the private sector as a crucial source of financial flows for climate action. The leaders highlighted the need for more instruments, cost reduction of capital in emerging markets, and addressing currency risk. Meirovich stressed the potential for collaboration among DFIs as a powerful tool to address these challenges through financial innovation, reduced capital costs, and currency risk mitigation.

Sustainable Infrastructures

Infrastructure encompasses human-built structures and facilities essential for supporting power and energy systems, transportation, telecommunications, water, and waste management. This extends to investments in systems enhancing resource efficiency and demand-side management, incorporating measures for energy and water efficiency.

Moreover, the term “infrastructure” is broadened to include “natural” infrastructure, involving land use, agriculture, and forestry management. Natural, ecosystem-based infrastructure is increasingly acknowledged as a valuable complement to traditional “hard” infrastructure, capable of absorbing emissions, attenuating flood impacts, and even serving as a substitute in certain cases, such as cost-effective water purification compared to constructing new treatment plants.

Sustainable infrastructure is characterized by three dimensions:

Social Sustainability: Inclusive by nature, socially sustainable infrastructure serves all, prioritizing enhanced livelihoods and social well-being. It may be explicitly designed to meet the needs of the poor, improving access to basic services like clean energy, water, and sanitation, supporting poverty reduction, and reducing vulnerability to climate change.

Economic Sustainability: Economically sustainable infrastructure avoids burdening governments with unmanageable debt or imposing exorbitant costs on users. It contributes to job creation, GDP growth, and offers opportunities for local capacity building, benefiting suppliers, developers, and livelihoods.

Environmental Sustainability: Environmentally sustainable infrastructure minimizes pollution during construction and operation, promoting the conservation and sustainable use of natural resources. It aligns with a low-carbon, resource-efficient economy, emphasizing energy and water efficiency. With resilience against climate risks, including sea-level rise and extreme weather events, environmental sustainability is particularly notable in natural infrastructure.

Considering national circumstances, the evaluation of sustainable infrastructure depends on what could have been built or developed instead. For instance, investing in combined-cycle natural gas power plants might facilitate a transition from coal power in the short term, but it could potentially “lock in” natural gas at the expense of renewable alternatives.

A crucial aspect of sustainable infrastructure is its contribution to resilience. Given the increasing need for infrastructure to withstand climate change impacts and extreme weather events, existing infrastructure must be “climate-proofed.” This involves factoring climate risks into the design, maintenance, and operation of both natural and built infrastructure. Addressing climate risks through these measures is vital for poverty reduction and the protection of the most vulnerable populations (Federation, 2016)

How Development Financial Institutions (DFIs) Can Foster Private Investment in Sustainable Infrastructure?

Development finance institutions (DFIs) function as intermediaries positioned between public aid and private investment, embodying the concept of “facilitating international capital flows,” as articulated by the Chief Executive of CDC, Britain’s DFI (formerly the Commonwealth Development Corporation). Distinguished from aid agencies by their emphasis on profitable investment within market parameters, DFIs share a collective commitment to fostering economic growth and sustainable development.

Key points about DFIs include:

Financial Services: DFIs extend a diverse array of financial services in developing countries, encompassing loans or guarantees to investors and entrepreneurs, equity participation in firms or investment funds, and funding for public infrastructure projects.

State Guarantees: DFIs have the ability to leverage state guarantees and operate without the short-term limitations often faced by private investors. This capacity allows them to make long-term investments at attractive rates in markets considered too risky by the private sector.

Partnerships and Focus: Bilateral DFIs typically form partnerships with the private sector in developing countries, while regional development banks, like the Asian Development Bank and the European Bank for Reconstruction and Development (EBRD), engage in various activities. The EBRD, for instance, provides direct investment on commercial terms for both public and private sector projects, including support for infrastructure plans and significant commercial ventures within its specialized region (Eastern Europe through to Central Asia).

Risk Mitigation: DFIs play a crucial role in mitigating risk by acting as a public guarantee in countries and sectors deemed too risky for private sector engagement. Their public status allows for longer maturity loans at favorable interest rates, advantageous guarantees, and participation in high-risk equity investments. Additionally, DFIs may contribute to reducing the cost of capital for firms through partial credit risk guarantees.

Role of the Private Sector in Development

The involvement of the private sector is widely acknowledged as pivotal to economic development, contributing significantly to income generation, job creation, and the provision of goods and services that elevate living standards and alleviate poverty. Multilateral development banks and bilateral development finance institutions play a crucial role in supporting the private sector within developing countries. These institutions offer essential capital, knowledge, and partnerships, actively manage risks, and catalyze broader participation. By endorsing entrepreneurial initiatives, they contribute to sustainable economic growth in developing nations.

International financial institutions (IFIs) strive to bridge gaps in

finance, knowledge, and standards for the private sector, aiming to establish impactful and sustainable development projects and programs. The private sector in developing countries grapples with various challenges, including financial limitations, inadequate infrastructure, workforce skills, and challenges in the investment climate. IFIs dedicated to private sector development address these constraints effectively by focusing on high-impact sectors and projects, ensuring sound business practices, fostering partnerships, and concentrating efforts where their assistance is most needed, delivering significant added value to projects beyond what private financial institutions can offer.

Key Development Themes for IFIs:

Improving People’s Lives: IFIs are committed to enhancing overall growth and productivity, creating more job opportunities, increasing incomes, reducing poverty, and improving the availability of essential goods and services like housing, infrastructure, health, and education.

Inclusive Growth: Inclusive growth, a core concept for IFIs, emphasizes broad-based economic growth across sectors that includes the majority of the country’s labor force, addressing the welfare of both the poor and the middle class.

Poverty Reduction: Many IFIs consider poverty reduction as a fundamental mission, entailing not only elevating incomes but also providing greater job opportunities and access to essential services for the poor.

Food Security: Acknowledging the end of the era of cheap food, IFIs recognize the challenge of a potential food price crisis, aiming to address this by increasing food production to meet the demands of a growing global population.

Climate Change: IFIs acknowledges the potential impact of climate change on crucial development goals and focus on mitigating these impacts, particularly in middle-income countries where significant opportunities for energy efficiency lie.

Market Development: Some IFIs actively contribute to transitioning countries toward well-functioning markets with competitive and innovative businesses, fostering rising productivity and incomes while addressing environmental and social needs.

Global and Regional Integration: Emphasizing the importance of global and regional integration, certain IFIs work towards boosting productivity and growth by facilitating improved trade, promoting regional infrastructure networks, and creating integrated production chains.

In essence, IFIs play a multifaceted role in promoting sustainable development, addressing various challenges and fostering a conducive environment for inclusive and resilient growth.

The market for sustainable investments in developing countries.

The market for sustainable investments in developing countries represents a convergence of financial returns with intentional positive impacts on social, economic, and environmental aspects, aligning with the objectives of the Sustainable Development Goals (SDGs). A crucial aspect of such investments is the need for tangible evidence of their SDG impacts, necessitating rigorous impact measurement. Impact measurement, while essential, must be complemented by robust impact management, involving the integration of impact considerations into internal systems and processes for actionable insights. This ensures that data informs strategies, policies, investment decisions, and operational practices.

Key participants in the landscape of sustainable investment in developing countries include:

Donor governments: Comprising OECD countries, emerging donors, and organizations like USAID and SIDA, donor governments play a fundamental role in facilitating the flow of development resources.

Development Finance Institutions (DFIs): Specialized banks or subsidiaries supporting private sector development in developing countries, DFIs have diverse shareholder structures. National DFIs derive capital from national development funds, while multilateral DFIs like IFC and IADB source funding from international development funds and private market actors through mechanisms like bond issues.

Private investors: Encompassing a range of investors with varied risk-return-impact expectations, private investors include asset managers increasingly engaging in impact investing. Specialized impact investment funds operate in developing countries, often co-investing with DFIs through blended finance vehicles.

Partner governments: Referring to developing countries receiving development aid, these countries are categorized by the DAC based on factors like Least Developed Countries (LDCs), Low Income Countries, Lower Middle-Income Countries, and Upper Middle Income Countries.

Civil Society Organizations (CSOs): Representing a diverse array of non-profit, non-state, non-partisan organizations, CSOs include both formally registered entities and informal associations without legal status. They serve as implementing partners in developing countries, executing projects targeting the SDGs. Some CSOs express concerns about private sector subsidization and the potential misuse of official development assistance (ODA).

The collective involvement of these key actors forms a dynamic ecosystem aimed at advancing sustainable development objectives, promoting positive impacts, and addressing challenges related to impact measurement and management.

The pivotal role of Development Finance Institutions (DFIs) in advancing the Sustainable Development Goals (SDGs) for developing countries cannot be overstated. DFIs serve as catalysts for positive change by channeling crucial financial resources, expertise, and partnerships into key sectors that underpin sustainable development. Their impact is far-reaching, fostering economic growth, social well-being, and environmental sustainability. By addressing the unique challenges faced by these nations, DFIs contribute significantly to poverty reduction, inclusive growth, and the attainment of broader developmental objectives. As we navigate the complex landscape of global development, recognizing and supporting the instrumental role of DFIs emerges as a strategic imperative for steering these countries towards a more sustainable and prosperous future.

Bibliography

Dickinson, T. (2008). Development finance institutions: Profitability romotingdevelopment. Organisation for Economic Co-operation and Development (OECD)(Ed.), TurningAfrican Agriculture into a Business–A Reader. Paris, France: OECD

Eschalier, C., Cochran, I., & Deheza, M. (2015). Climate and development finance institutions: linking climate finance, development finance and the transition to low-carbon, climate-resilient economic models. Mainstreaming Low-Carbon Climate-Resilient Growth Pathways into Development Finance Institutions’ Activities, 1–30. http://www.i4ce.org/wp-core/wp-content/uploads/2015/10/I4CE-Mainstreaming-Climate-and-LCCR-by-DFIs-Paper-1_new1.pdf

Federation, C. S. (2016). THE SUSTAINABLE INFRASTRUCTURE IMPERATIVE – Financing for Better Growth and Development. 85–100.

Herenberger, L. (2022). Unleashing the Impact of Development Finance: A roadmap for the Impact Standards for Financing Sustainable Development. June, 1–26.

Meirovich, S. N. H. M. J. M. J. S. H. (2023). How Development Financial Institutions (DFIs) Can Foster Private Investment in Sustainable Infrastructure. https://live.worldbank.org/en/event/2023/cop28-how-development-finance-institutions-can-foster-private-investment-in-sustainable-infrastructure#transcript

OECD. (2000). Annual Report of Organizational for Economic Co-operation and Development (OECD).Ryrie, W. (2011). Development through the private sector. Finance and Development, 22(1), 80.

Saman Janaranjana Herath
Saman Janaranjana Herath
PhD (NRE). MBA (Fin). Associate Professor, University of Mount Olive, North Carolina, USA. Writer,

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