Investment requirements are huge in emerging markets and developing economies (EMDE), with development spending predominantly coming from the public budgets. The private sector is facing growing calls for a stronger engagement to alleviate investment gaps in particular for infrastructure, climate and other SDG-related investments. However, external finance to EMDEs was stagnating even before the coronavirus crisis 2020-2021. The little progress made over the years has been mostly concentrated in a dozen or so advanced middle-income countries.
Multilateral development banks (MDB) and development finance institutions (DFI) are stepping up their efforts to facilitate private investment. The “mobilization” of private capital in EMDEs has, so far, been small (about an annual 0.2% of GDP). Only a few billions reach low-income countries. In terms of instruments, loans and guarantees dominate while equity stakes and investment funds appear underused.
A comprehensive report on “Financing Development: Private Capital Mobilization and Institutional Investors“ by Georg Inderst, provides several key analyses and recommendations for both policy makers and investors. The report highlights various issues with MDBs’ private sector co-financing drive also known as “blended finance”.
The focus is in particular on institutional investors, often seen as reluctant to deploy at least a fraction of their $150 trillion of assets to crucial investments in EMDEs. Most investors are keen to broaden the set of investment opportunities in growth markets but expectations need to be realistic. There are various hurdles and challenges, including fiduciary duty, investor mandates and political, regulatory and micro risks. This even more so for riskier, less liquid assets like infrastructure.
How to match long-term investing with development needs? In fact, institutional investors have moved into emerging markets since the 1990, mostly by buying securities of large, listed companies or government bonds. More investors are now gaining exposure to EMDEs via private equity/debt, or infrastructure funds. Some large asset owners are undertaking direct investments e.g. in renewable energy. We also see tentative steps towards investing in lower-income countries via impact funds. Green bonds and social bonds will gain momentum also in developing countries.
Investors can build on experience gained in middle-income markets. There is scope for progress also in less developed countries when the business conditions are right for investable long-term projects. The main responsibility is with governments. They need to work out a pipeline of assets that are suitable for private sector investors. Good governance in a reasonably stable legal and political environment is paramount. Many international investors find co-investing alongside MDBs a good way of entry into “more difficult” countries and riskier, less liquid assets – for reasons of experience, risk mitigation, local knowledge and political clout.
The growing importance of sustainability, climate-change and SDG investing will generate new demand. EMDE domestic investors ought to get more involved in this, too. Policy makers, development finance institutions and investors should better coordinate to utilize the full spectrum of investment and co-investment vehicles – commercial, impact and blended finance. Even small re-allocations of capital can have a big impact on the ground.