Promoting private sector development by development partners
Development partners are increasingly promoting private sector development, especially by supporting the private sector directly. In doing so, it is necessary to ensure that financing private companies delivers the development outcomes expected.
Development partners are increasingly promoting private sector development (PSD) in their development co-operation programmes. They recognise the importance of the private sector in contributing to income generation, production of goods and services – including for the poor – and tax revenues that could be spent by the government for the provision of social services such as health and education. Here, PSD can be defined “as development co-operation that addresses policies and institutions, market functioning and enterprise resources in order to improve the investment climate and the productivity capacity of the local private sector—particularly of Small and Medium-sized Enterprises (SMEs)—in developing countries”. In practice, development partners promote PSD in the following ways:
The multisectoral nature of PSD and the wide variety of approaches that development partners adopt make it difficult to grasp the scope of PSD and financial resources allocated to this area. For this reason, comprehensive quantitative analyses of Official Development Finance (ODF) to PSD have been scarce (where ODF consists of Official Development Assistance, which is concessional, and developmental Other Official Flows, which are non-concessional). To overcome this issue, OECD has recently developed an analytical framework to measure development co-operation for PSD around three main components: investment climate, physical infrastructure and productive capacity. Physical infrastructure is captured on its own because of its significant total funding and as projects can contribute to both the investment climate and productive capacity. In fact, productive capacity is impaired without adequate infrastructure as companies need power, water, transport and communications to produce goods and services, receive inputs, distribute outputs and communicate with suppliers and clients. Furthermore, in such an investment climate, companies are not willing and/or able to invest in new or current business activities. Based on this analytical framework, ODF to areas related to PSD amounted to US$105 billion in 2013, of which 57% was concessional financing and 43% was non-concessional. In terms of distribution among the three PSD components, similar shares of ODF were spent on the investment climate, physical infrastructure and productive capacity. Comparing multilaterals and bilaterals, the former allocated proportionally more to physical infrastructure, while the latter allocated significantly more to enterprise resources, including agricultural and industrial development and vocational training. Within the investment climate, policy-based lending and technical co-operation for macro-economic stability and public governance received the largest amounts of ODF, as illustrated in Figure 1. As for productive capacity, support for financial services, particularly to commercial banks that on-lend to SMEs and investments in equity funds, were relatively high, as shown in Figure 2. Figure 1. Sectoral distribution of ODF for investment climate, 2013 Figure 2. Sectoral distribution of ODF for the productive capacity, 2013 Source: OECD Creditor Reporting System. From a demand-side perspective, the top 15 recipients of ODF related to PSD were mostly large middle income emerging economies, such as Turkey, India, Vietnam, Egypt and China, and a few low income countries such as Myanmar, Tanzania, Kenya and Afghanistan. Many of these countries received significant amounts of support to physical infrastructure as well as financial services within productive capacity. To note, the share of support to financial services increases with the income level of the recipient country, possibly due to more developed financial markets and financial institutions in higher income groups. Conversely, the share of support to agriculture decreases with the income level, possibly due to the lower dependency on agriculture in higher income groups. Another finding is that high levels of budget support for macro-economic stability are provided to the lower income groups, particularly in Africa, possibly due to their poorer macroeconomic environment and quality of governance.
Given the high financing needs of developing countries to achieve the Sustainable Development Goals (SDGs), estimated at US$2.5 trillion per year, and the relatively small scale of ODF’s contribution to it, development partners are increasingly trying to use ODF to leverage private investment by supporting international and local firms. This is done through advisory services and provision of financial instruments such as equity, debt, and guarantees to crowd in the private sector in countries with commercial and political risks that would not have happened without the support of development partners. For instance, Multilateral Development Banks state that for every US$1 that they extend directly to the private sector, US$2-5 of additional private sector investment is mobilised (AfDB et al. 2015:2). In addition, development partners provide financial assistance to governments and national development banks to on-lend to private companies, which can also mobilise considerable resources. For example, a study shows that US$1.4 billion financing from the Clean Technology Fund to the public sector has mobilised about US$5 billion of private co-finance (CTF 2013). Other approaches include project preparation facilities to design well-structured bankable projects and project facilitation platforms to match the interest of public and private financiers in supporting joint projects. Furthermore, foreign and local companies can also contribute to development beyond providing financial resources through: (i) a demonstration effect on the viability of business models with positive environmental and social impact; (ii) creating direct, indirect and induced jobs; (iii) triggering knowledge and technological spill over effects; and (iv) fostering backward and forward linkages in value chains and clusters. Therefore, by collaborating with the private sector, development partners are hoping to increase the efficiency and impact of development co-operation. This aspect has been acknowledged in the Bilateral Development Partners' Statement in Support of Private Sector Partnerships for Development in 2010, where development partners committed to enter into partnerships with companies of various sizes that would focus not only on profits, but also on social and environmental impact. The importance of partnerships has been stressed more recently in the SDGs, which called for enhancing “multi-stakeholder partnerships that mobilise and share knowledge, expertise, technology and financial resources to support the achievement of SDGs” (see SDG 17.16).
While direct support to companies and financial institutions has the potential to contribute to sustainable development, there are several issues that need to be addressed. First, as directly financing or subsidising private companies holds the risk of market distortion if carried out on a massive scale, efforts should be made to provide resources to companies that are able to offer value for money. Second, as private companies aim for profit, it will be important to select projects that demonstrate financial feasibility while maximising contributions to economic, environmental and social progress. This means that careful project selection needs to be ensured. As Kindornay and Reilly-King (2013:31) pointed out, donors need to set funding criteria that are beyond years incorporated and audited financial statements to include corporate track records in terms of positive social, development, economic and environmental impacts. Furthermore, attention is needed to increase accountability of the supported private companies by monitoring results to ensure that project outcomes have been achieved and other social, environmental and development dimensions have not been compromised. In addition, it is necessary to strengthen ex-post evaluation of project impact and sustainability and learn from experience on how to improve provision of financial support to companies. Overall, challenges in project selection and monitoring point to wider transparency issues related to private sector projects. In fact, supporting the private sector and their commercial activities quite often entails levels of confidentiality that reduce the information flow related to the projects, although some development finance institutions (DFIs) are more transparent than others. Issues of transparency can be even more challenging as an increasingly common practice of certain DFIs is to support financial intermediaries, such as commercial banks and private equity funds, in turn investing in other projects (Geary, 2015). While this practice has the advantage of directing financing to investment vehicles with robust experience and to reduce market distortion, obtaining information on the impact of the project is even harder as the chain of intermediation is extended (Miyamoto and Chiofalo, 2015). Finally, many bilateral development partners state in PSD strategies or related policy documents that PSD should benefit both companies in developing countries and their own domestic companies. This includes supporting companies from development partner countries both directly with grants, loans, equity and guarantees and indirectly through tied aid. For this reason, it is important to ensure that PSD strategies of bilateral development partners prioritise development objectives over trade promotion of domestic companies. In particular, general principles of aid effectiveness agreed in Paris and Busan, notably to respect the ownership and priorities of the partner countries, should be adequately considered.
The OECD Development Assistance Committee (DAC) has become increasingly active in refining data and carrying out analysis and dialogue on development co-operation for PSD. This includes ongoing activities such as: the modernisation of the statistical reporting system to measure the amounts of development partners provided to and mobilised from the private sector; improving transparency and reporting on additionality; better capture of resource flows to developing countries beyond aid, such as foreign direct investment (FDI), export credits, remittances and so on; peer learning on private sector engagement; and research on blended finance, social impact investment, and investments in fragile states. Furthermore, the DAC and the OECD Investment Committee are jointly working on understanding the synergies between development co-operation and PSD within the Advisory Group for Investment and Development (AGID). Currently, the discussions within AGID include understanding the role of development partners in using the Policy Framework for Investment – a checklist for investment climate reforms – as a reference for development co-operation. Proposals for future work include delivering granular analysis on support to informal businesses, SMEs, responsible business models, corporate social responsibility (CSR), gender issues, and Small Island Developing States (SIDS), as well as addressing issues such as additionality, market distortion, and untying aid. Moreover, there is strong interest in generating lessons, recommendations, or key principles of PSD support in a user-friendly format in order to enhance their contribution to the 2030 Agenda. This article draws on the draft OECD paper Development co-operation for private sector development: Analytical Framework and Measuring Official Development Finance, 25 August 2016, which is expected to be finalised and published towards the end of 2016. References AfDB, ADB, EIB, IDB, IMF, and WBG. 2015. From Billions to Trillions: MDB Contributions to Financing for Development. Climate Investment Funds. 2013. Private Funding in Public-led Programs of the CTF: Early Experience. Geary, K. 2015. The Suffering of Others. OXFAM, Kindornay, S. and F. Reilly-King. 2013. Investing in the Business of Development: Bilateral Development partner Approaches to Engaging the Private Sector. The North-South Institute and Canadian Council for International Co-operation, Ottawa. Miyamoto, K. and E. Chiofalo. 2015. Official Development Finance for Infrastructure: Support by Multilateral and Bilateral Development Partners. OECD, Development Co-operation Directorate, Working Papers No. 25. October 2015.
About the authors: Kaori Miyamoto, Senior Policy Analyst, and Emilio Chiofalo, Policy Analyst, work in the Statistics and Development Finance Division of the Development Co-operation Directorate at the Organisation for Economic Co-operation and Development (OECD).
This article was published in GREAT Insights Volume 5, Issue 5 (October/November 2016).
Approaches to private sector development
Development partners are increasingly promoting private sector development (PSD) in their development co-operation programmes. They recognise the importance of the private sector in contributing to income generation, production of goods and services – including for the poor – and tax revenues that could be spent by the government for the provision of social services such as health and education. Here, PSD can be defined “as development co-operation that addresses policies and institutions, market functioning and enterprise resources in order to improve the investment climate and the productivity capacity of the local private sector—particularly of Small and Medium-sized Enterprises (SMEs)—in developing countries”. In practice, development partners promote PSD in the following ways:
- Improving public policy and institutions through technical assistance and capacity building for policy-making or institutional reforms in order to upgrade the investment climate and industrial and agricultural policies.
- Strengthening market functioning by ensuring the provision of market services for local companies: i.e. expanding access to finance through financial intermediaries; engaging business support organisations, developing appropriate economic infrastructure; and reinforcing commercial linkages.
- Bolstering enterprise resources, predominantly SMEs by reinforcing their productive and managerial capacity, including by providing vocational training and direct financial assistance for agricultural and industrial development.
Measuring Official Development Finance for PSD
The multisectoral nature of PSD and the wide variety of approaches that development partners adopt make it difficult to grasp the scope of PSD and financial resources allocated to this area. For this reason, comprehensive quantitative analyses of Official Development Finance (ODF) to PSD have been scarce (where ODF consists of Official Development Assistance, which is concessional, and developmental Other Official Flows, which are non-concessional). To overcome this issue, OECD has recently developed an analytical framework to measure development co-operation for PSD around three main components: investment climate, physical infrastructure and productive capacity. Physical infrastructure is captured on its own because of its significant total funding and as projects can contribute to both the investment climate and productive capacity. In fact, productive capacity is impaired without adequate infrastructure as companies need power, water, transport and communications to produce goods and services, receive inputs, distribute outputs and communicate with suppliers and clients. Furthermore, in such an investment climate, companies are not willing and/or able to invest in new or current business activities. Based on this analytical framework, ODF to areas related to PSD amounted to US$105 billion in 2013, of which 57% was concessional financing and 43% was non-concessional. In terms of distribution among the three PSD components, similar shares of ODF were spent on the investment climate, physical infrastructure and productive capacity. Comparing multilaterals and bilaterals, the former allocated proportionally more to physical infrastructure, while the latter allocated significantly more to enterprise resources, including agricultural and industrial development and vocational training. Within the investment climate, policy-based lending and technical co-operation for macro-economic stability and public governance received the largest amounts of ODF, as illustrated in Figure 1. As for productive capacity, support for financial services, particularly to commercial banks that on-lend to SMEs and investments in equity funds, were relatively high, as shown in Figure 2. Figure 1. Sectoral distribution of ODF for investment climate, 2013 Figure 2. Sectoral distribution of ODF for the productive capacity, 2013 Source: OECD Creditor Reporting System. From a demand-side perspective, the top 15 recipients of ODF related to PSD were mostly large middle income emerging economies, such as Turkey, India, Vietnam, Egypt and China, and a few low income countries such as Myanmar, Tanzania, Kenya and Afghanistan. Many of these countries received significant amounts of support to physical infrastructure as well as financial services within productive capacity. To note, the share of support to financial services increases with the income level of the recipient country, possibly due to more developed financial markets and financial institutions in higher income groups. Conversely, the share of support to agriculture decreases with the income level, possibly due to the lower dependency on agriculture in higher income groups. Another finding is that high levels of budget support for macro-economic stability are provided to the lower income groups, particularly in Africa, possibly due to their poorer macroeconomic environment and quality of governance.
Rationale for direct support to the private sector
Given the high financing needs of developing countries to achieve the Sustainable Development Goals (SDGs), estimated at US$2.5 trillion per year, and the relatively small scale of ODF’s contribution to it, development partners are increasingly trying to use ODF to leverage private investment by supporting international and local firms. This is done through advisory services and provision of financial instruments such as equity, debt, and guarantees to crowd in the private sector in countries with commercial and political risks that would not have happened without the support of development partners. For instance, Multilateral Development Banks state that for every US$1 that they extend directly to the private sector, US$2-5 of additional private sector investment is mobilised (AfDB et al. 2015:2). In addition, development partners provide financial assistance to governments and national development banks to on-lend to private companies, which can also mobilise considerable resources. For example, a study shows that US$1.4 billion financing from the Clean Technology Fund to the public sector has mobilised about US$5 billion of private co-finance (CTF 2013). Other approaches include project preparation facilities to design well-structured bankable projects and project facilitation platforms to match the interest of public and private financiers in supporting joint projects. Furthermore, foreign and local companies can also contribute to development beyond providing financial resources through: (i) a demonstration effect on the viability of business models with positive environmental and social impact; (ii) creating direct, indirect and induced jobs; (iii) triggering knowledge and technological spill over effects; and (iv) fostering backward and forward linkages in value chains and clusters. Therefore, by collaborating with the private sector, development partners are hoping to increase the efficiency and impact of development co-operation. This aspect has been acknowledged in the Bilateral Development Partners' Statement in Support of Private Sector Partnerships for Development in 2010, where development partners committed to enter into partnerships with companies of various sizes that would focus not only on profits, but also on social and environmental impact. The importance of partnerships has been stressed more recently in the SDGs, which called for enhancing “multi-stakeholder partnerships that mobilise and share knowledge, expertise, technology and financial resources to support the achievement of SDGs” (see SDG 17.16).
Challenges in direct support to the private sector
While direct support to companies and financial institutions has the potential to contribute to sustainable development, there are several issues that need to be addressed. First, as directly financing or subsidising private companies holds the risk of market distortion if carried out on a massive scale, efforts should be made to provide resources to companies that are able to offer value for money. Second, as private companies aim for profit, it will be important to select projects that demonstrate financial feasibility while maximising contributions to economic, environmental and social progress. This means that careful project selection needs to be ensured. As Kindornay and Reilly-King (2013:31) pointed out, donors need to set funding criteria that are beyond years incorporated and audited financial statements to include corporate track records in terms of positive social, development, economic and environmental impacts. Furthermore, attention is needed to increase accountability of the supported private companies by monitoring results to ensure that project outcomes have been achieved and other social, environmental and development dimensions have not been compromised. In addition, it is necessary to strengthen ex-post evaluation of project impact and sustainability and learn from experience on how to improve provision of financial support to companies. Overall, challenges in project selection and monitoring point to wider transparency issues related to private sector projects. In fact, supporting the private sector and their commercial activities quite often entails levels of confidentiality that reduce the information flow related to the projects, although some development finance institutions (DFIs) are more transparent than others. Issues of transparency can be even more challenging as an increasingly common practice of certain DFIs is to support financial intermediaries, such as commercial banks and private equity funds, in turn investing in other projects (Geary, 2015). While this practice has the advantage of directing financing to investment vehicles with robust experience and to reduce market distortion, obtaining information on the impact of the project is even harder as the chain of intermediation is extended (Miyamoto and Chiofalo, 2015). Finally, many bilateral development partners state in PSD strategies or related policy documents that PSD should benefit both companies in developing countries and their own domestic companies. This includes supporting companies from development partner countries both directly with grants, loans, equity and guarantees and indirectly through tied aid. For this reason, it is important to ensure that PSD strategies of bilateral development partners prioritise development objectives over trade promotion of domestic companies. In particular, general principles of aid effectiveness agreed in Paris and Busan, notably to respect the ownership and priorities of the partner countries, should be adequately considered.
The work of OECD DAC on PSD
The OECD Development Assistance Committee (DAC) has become increasingly active in refining data and carrying out analysis and dialogue on development co-operation for PSD. This includes ongoing activities such as: the modernisation of the statistical reporting system to measure the amounts of development partners provided to and mobilised from the private sector; improving transparency and reporting on additionality; better capture of resource flows to developing countries beyond aid, such as foreign direct investment (FDI), export credits, remittances and so on; peer learning on private sector engagement; and research on blended finance, social impact investment, and investments in fragile states. Furthermore, the DAC and the OECD Investment Committee are jointly working on understanding the synergies between development co-operation and PSD within the Advisory Group for Investment and Development (AGID). Currently, the discussions within AGID include understanding the role of development partners in using the Policy Framework for Investment – a checklist for investment climate reforms – as a reference for development co-operation. Proposals for future work include delivering granular analysis on support to informal businesses, SMEs, responsible business models, corporate social responsibility (CSR), gender issues, and Small Island Developing States (SIDS), as well as addressing issues such as additionality, market distortion, and untying aid. Moreover, there is strong interest in generating lessons, recommendations, or key principles of PSD support in a user-friendly format in order to enhance their contribution to the 2030 Agenda. This article draws on the draft OECD paper Development co-operation for private sector development: Analytical Framework and Measuring Official Development Finance, 25 August 2016, which is expected to be finalised and published towards the end of 2016. References AfDB, ADB, EIB, IDB, IMF, and WBG. 2015. From Billions to Trillions: MDB Contributions to Financing for Development. Climate Investment Funds. 2013. Private Funding in Public-led Programs of the CTF: Early Experience. Geary, K. 2015. The Suffering of Others. OXFAM, Kindornay, S. and F. Reilly-King. 2013. Investing in the Business of Development: Bilateral Development partner Approaches to Engaging the Private Sector. The North-South Institute and Canadian Council for International Co-operation, Ottawa. Miyamoto, K. and E. Chiofalo. 2015. Official Development Finance for Infrastructure: Support by Multilateral and Bilateral Development Partners. OECD, Development Co-operation Directorate, Working Papers No. 25. October 2015.
About the authors: Kaori Miyamoto, Senior Policy Analyst, and Emilio Chiofalo, Policy Analyst, work in the Statistics and Development Finance Division of the Development Co-operation Directorate at the Organisation for Economic Co-operation and Development (OECD).
This article was published in GREAT Insights Volume 5, Issue 5 (October/November 2016).
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