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Engaging the Private Sector for Development

What Role for the EU Regional Blending Facilities?

October 2012

Rudischhauser, K. 2012. Engaging the Private Sector for Development: What Role for the EU Regional Blending Facilities? GREAT Insights, Volume 1, Issue 8. October 2012. Maastricht: ECDPM

In view of massive developmental challenges it is important to make the most effective use of EU development grants. In the last years the EU Regional Blending Facilities have demonstrated the capacity to leverage substantial amounts of additional public non-grant financing for important public investments in EU partner countries. By using grants strategically, the Blending Facilities are equipped to also unlock private investments for achieving EU development objectives. While the involvement of the private sector holds great potential, a cautious and selective approach is necessary to ensure that development objectives are paramount and market distortions are avoided.

By using grants strategically, the Blending Facilities are equipped to also unlock private investments for achieving EU development objectives. While the involvement of the private sector holds great potential, a cautious and selective approach is necessary to ensure that development objectives are paramount and market distortions are avoided.

The European Union (EU) has recently started using Blending as one of its instruments to deliver development aid to its partner countries (1) . Together with EU Member States, the European Commission has set up seven EU Regional Blending Facilities (“the Facilities”) that now cover almost all countries in the European Union’s area of external cooperation (2)  (see Box 1). The Facilities combine grants from the EU Budget, the European Development Fund (EDF) and additional contributions from Member States with additional non-grant resources. At the project level, grant and non-grant resources are blended to create the right financing-mix for that specific project. The basic idea is that the strategic use of a grant element can make investments with a high economic and social return financially viable. By enabling such investments the grant element achieves a leveraged development impact.

Currently the Facilities mainly support public investment projects. About 92% of all grants contributions approved since 2007 went to investments promoted by a public entity. Financing a public investment project via blending can address several issues:

1. The grant element can close financing gaps in the project that keep the investment from materialising. 
2. The grant element may serve to finance additional components of the investment that improve the developmental impact of the project. Support in the form of technical assistance can speed up processes and increase the project’s sustainability. 
3. The grant contribution may reduce the borrowing cost for the beneficiary to ease its exposure to external debt (3) .

The grant element therefore has a quantitative leverage by unlocking the financing of important investments that cannot be financed by public funds from the partner country or donors. The easing and enhancing effect of the grant contribution leads to a qualitative leverage. Furthermore, the Facilities encourage finance institutions to seek cooperation in the preparation and financing of investment projects to improve the financial package for the beneficiary and increase the effectiveness of EU development aid.

Despite the emphasis so far on public investments, the Facilities do provide the means to catalyse also private investments. The regulatory framework of the Facilities allows using grants as innovative financial tools such as risk capital and investment guarantees. So far grant support of this type has been used to support Micro, Small and Medium Enterprises (MSME), primarily to provide access to finance. One approach is to use the grant element as a first-loss tranche in a structured fund and thus leverage the amount of resources that is available to achieve developmental objectives. Such funds (4)  have been established in the Neighbourhood region and have already attracted additional financing and extended several thousand loans to local MSMEs. In addition, partial portfolio guarantees were provided via Public Finance Institutions to encourage local financial institutions to extend their lending to MSME. 

Risk capital and investment guarantees

The European Commission is currently working to extend the use of innovative financial tools such as risk capital and investment guarantees with a view of unlocking additional private investments in other sectors, such as infrastructure. Blending could address several factors that currently hold back private investment into projects with a strong developmental impact.

A central issue in many developing countries is the high level of perceived – mainly political – risk that prevents even profitable investment projects from materialising. By sharing the risk the grant element could turn the risk adjusted return of projects positive and enable investments with a substantial social and economic return for the partner country.

Pilot projects that use the EU grant to share the risk via a first-loss approach or the provision of guarantee products are under preparation. Similar approaches are also under consideration in the context of early-stage financing for infrastructure projects and the fostering of local currency financing.

A cautious approach to private sector for development

While there are many opportunities to use grant contributions to engage the private sector for development, decisions must be made very carefully. As in all EU grant operations, it must be assured that the development aspect is absolutely paramount; regardless of the grant size compared to the overall project financing. The motivation for increasing the role of the private sector in development is to make a contribution to poverty eradication and the achievement of sustainable development; not to help private firms make a profit. Grant support therefore fulfils an enabling role and it must not directly subsidise the private sector. Market inefficiencies are to be addressed and not reinforced by further distorting the market with direct subsidies. The grant shall serve to crowd-in foreign and local financing, assuring the additionally of the EU grant contribution.

Therefore identifying opportunities where the profit-seeking private sector can be encouraged to act towards achieving developmental objectives is a balancing act. To address this, blending with the engagement of the private sector must follow a project-by-project approach, in which attention is paid to the details and a number of checks are built-in. The EU Regional Blending Facilities can provide the basis for such an approach and contribute to further extending the instruments available to the EU for delivering its development aid effectively, tailored to the needs of our partner countries.

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Box 1: The EU Regional Blending Facilities – Facts and Figures

Since 2007 grant amounts of €910 million were approved in the Facilities. These grant contributions are part of investment projects with a total volume of approx. €30 billion, of which at least €10 billion are financed by loans from European Public Finance Institutions. The residual amount consists of grants from other donors, loans from Regional Development Banks, the beneficiary’s own resources and some private financing. The composition of financing differs from project to project, but always contains EU grant contributions and loans by European Public Finance Institutions. In the same way the grant to non-grant ratio varies: In large renewable energy projects that involve many actors, the ratio may be above 10:1, whereas in projects in the social sector it may be only 3:1.

 In principle the Facilities operate on a first-come first-served basis, which means that there is no ex-ante quota for certain sectors or countries. Nonetheless, priority sectors are defined on an annual basis by the European Commission, Member States and partner countries. Currently most of the supported projects have been in the transport (37%), energy (33%) and water (16%) sector. Smaller contributions went towards the support of MSME (8%), ICT (4%) and the social sector (3%).

 The Facilities are flexible entities that can provide several different types of grant support. Grants used as direct investment (33%) and interest rate subsidy (27%) decrease the investment cost for the beneficiary. Technical assistance (33%) can accelerate projects and improve the quality, efficiency as well as sustainability. Risk capital (5%) aims at crowding in additional private and public financing for development. Guarantee mechanisms and the financing of insurance premia (2%) aim at unlocking market financing for development that is held back by high risk-perception.

Blending is done in close cooperation with Public Finance Institutions. The main actors are European multi- and bilateral Public Finance Institutions. Regional Development Banks are also starting to play an important role.

Finance institutions identify projects in dialogue with the beneficiary and EU delegations. Projects are submitted by the Lead Finance Institution to the Technical Body, where proposals are subject to a peer review process among finance institutions to discuss, facilitated by the European Commission, technical aspects identify co-financing opportunities. Project proposals are then discussed in the Operational Body, which consists of Members States and is chaired by the European Commission. The Operational Body decides over the approval of the EU grant contribution. A screening process involving EU delegations, geographical and technical directorates of DG DEVCO as well as line DGs of the Commission informs the decision. The Commission ensures that economic, environmental and political aspects are taken into account as well as debt sustainability and that the additionally of the grant has been proven. The Strategic Body – with the European Commission, Member States and partner countries participating – convenes once a year and decides on the strategic orientation of the specific Regional Blending Facility.

 In 2012 the Commission lead an expert group to assess the costs and benefits of an EU platform for External Cooperation and Development with a view to optimising the functioning of blending mechanisms in the external regions. Such a platform would provide guidance to the Facilities regarding coherence of their operations, standards and technical expertise. The platform would not replace the Facilities and not decide on individual projects. A report with the results of the expert group will be submitted to the European Parliament and the Council in Autumn 2012.

 More information – including the specific projects – is available in the Facilities’ Annual Reports, which are accessible online via http://ec.europa.eu/europeaid

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Klaus Rudischhauser is Deputy Director-General at the European Commission, DG Development and Cooperation – EuropeAid.

Footnotes:
1. As laid out in the EC Communication Agenda for Change, the EU seeks to pursue a differentiated approach. The EU’s partner countries are at very different stages of development and grant support must be tailored to their specific needs. In principle, blending is mainly aimed at countries that have some basic capacity to access and manage non-grant funding. Nonetheless, in certain sectors it may be used even in least developed countries, supporting innovative approaches to poverty reduction. As one of many instruments used by the European Commission to deliver its aid, blending does not replace but complement purely grant financed operations addressing severe poverty. In fact, using grants more strategically in the context of blending allows allocating a greater proportion of funds to the least developed countries.
2. 2007 – EU-Africa Infrastructure Trust Fund (ITF)
2008 – Neighbourhood Investment Facility (NIF)
2010 – Latin American Investment Facility (LAIF) & Investment Facility for Central Asia (IFCA)
2012 – Asian Investment Facility (AIF), Caribbean Investment Facility (CIF), Investment Facility for the Pacific (IFP)
3. The approval process of the Facilities has a built-in check for concessionality requirements, based on IMF regulations. Usually this is already flagged in the identification phase of the project by the lead finance institution. 
4. Examples are the European Fund for South-East Europe (EFSE) and the SANAD MENA fund for MSME.

 

This article was published in Great Insights Volume 1, Issue 8 (October 2012)

 

 

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External authors

Klaus Rudischhauser