Exploring new trends in development finance through private capital
In recent years, there has been a growing trend of utilising the functions of Development Finance Institutions (DFIs) to link private investment in supporting the economic development of low-income and emerging economies. While government-to-government financing through these countries’ Official Development Assistance (ODA) programmes has conventionally played a key role, the governments of host countries are expanding the use of private entities for project development and implementation. The latter is done through public-private partnerships (PPPs).
In this context, countries like China, the United States (US), and those in Europe, are strengthening their DFI functions to improve the competitiveness of their own industries and strengthen their geo-economic influence. DFIs in these countries are enhancing the coordination of their efforts, and private sector financial institutions are making proactive use of DFIs in response to the global trend of channelling more investments on Economic, Social, and Corporate Governance (ESG) aspects. This brief examines global trends in the strengthening of DFIs. It focuses on the initiatives of private sector financial institutions amidst the manifold impacts of the Covid-19 pandemic, as well as the geo-economic shifts occurring in many parts of the world. The brief will outline recommendations for the potential utilisation of Indian DFI.
Traditional forms of ODA such as grants and concessional loans have played a crucial role in development financing. In more recent years, the role of financing support for the economic development of low-income and emerging economies through the mobilisation of private capital investment has been expanding. DFIs are playing a role in supporting development finance through private sector investment. A DFI’s financial support is expected to serve as a bridge between a grant or concessional loan, and market-based private-sector financing, and its presence in the private and public sectors is being greatly enhanced.
DFIs promote foreign direct investment through a wide range of financing tools—such as loans, guarantees, political risk insurance, and equity participation—extended to host governments, governmental institutions, local entities, or specific projects. These harness the potential of public-private partnerships (PPPs), encouraging economic development in low-income and emerging countries and sectors where various risks disincentivise private investment. Therefore, private developers and operators rely on DFIs to be a source of funds, as they have the capacity to appropriate risk allocation with the host governments. For their part, host governments that suffer fiscal constraints are appreciating the use of DFIs to promote economic development by promoting private investment.
DFIs are often established as independent institutions or as part of public financial institutions with the backing of national governments, as well as international organisations such as the World Bank Group and the Asian Development Bank, and other regional financial institutions. Large economies in Europe, as well as China and the US, are strengthening efforts to enhance the international competitiveness of their own industries and strengthen their geopolitical and economic influence globally, by evolving their own DFIs strategically. This becomes important in response to the expanding role of private investment, geopolitical instability such as the US-China strategic rivalry, and the ongoing Covid-19 pandemic. In the case of Japan, for example, policy-based institutions such as the Japan Bank for International Cooperation (JBIC) have also been providing financial support to developing countries with a focus on supporting Japanese companies to invest overseas.
(The study has been authored by Hiroyuki Suzuki)