The BUILD Act Has Passed: What’s Next?
On October 5, 2018, the U.S. Senate joined the U.S. House of Representatives in passing the Better Utilization of Investment Leading to Development (or BUILD Act), a bipartisan bill creating a new U.S. development agency—the U.S. International Development Finance Corporation (USIDFC). This is the most important piece of U.S. soft power legislation in more than a decade. The success of the BUILD Act is something to celebrate. The next step will be to operationalize the new USIDFC, a process that may take up to a year.
The new U.S. development finance institution (DFI) will help developing countries prosper while advancing U.S. foreign policy goals and enhancing U.S. national security interests. Now that the BUILD Act is law, it is time to revisit why the legislation matters and what it implies for agencies such as the Overseas Private Investment Corporation (OPIC) and the United States Agency for International Development (USAID).
Q1: What is the BUILD Act?
A1: The BUILD Act of 2018 was simultaneously introduced in the Senate and House at the end of February 2018 with broad bipartisan support. The BUILD Act creates a full-fledged DFI called the USIDFC. The new USIDFC will seek to “crowd-in” vitally needed private sector investment in low and lower-middle income countries. The new agency is not prohibited from working in upper-middle income countries, and it can do so on two grounds: 1) for national security reasons or 2) for developmental reasons, that is, to work in an underdeveloped part of the country in question.
By crowding-in private investment, the USIDFC will help support developing countries through the transitory stage from non-market to market economies with an emphasis toward U.S. assistance and foreign policy objectives. The USIDFC is authorized by Congress to make loans or loan guarantees (including in local currency) and acquire equity or financial interests in entities as a minority investor. It also will provide insurance or reinsurance to private sector entities and qualifying sovereign entities. Moreover, the USIDFC will provide technical assistance, administer special projects, establish enterprise funds, issue obligations, and charge and collect service fees. Through these market-based fees, the USIDFC will operate at no net cost to taxpayers.
Q2: What is DFI?
A2: DFIs are government or quasi-government backed institutions that invest in private sector projects in low and middle-income countries. DFIs are structured as either multilateral or bilateral organizations that seek to invest in commercially sustainable projects in conjunction with private investors. These institutions are not new, but they have grown in importance over the last 15 years. The first DFI was the UK’s Commonwealth Development Corporation (CDC) set up in 1948; the United States’ existing DFI, OPIC was created in 1971. New financial commitments for the DFI sector have increased from $10 billion in 2002 to $70 billion in 2014. DFIs have variations in terms of their governance structures (e.g., either fully government-owned or co-owned by government and the private sector), sectors (e.g., financial services, infrastructure, renewable energy) and regions (e.g., sub-Saharan Africa and South Asia) they invest in, and the tools they use to crowd in private capital (e.g., equity investments, loans, loan guarantees).
Q3: Why does the BUILD Act matter?
A3: The BUILD Act adds new tools for the United States to utilize its foreign aid allocations. Moreover, the newly formed USIDFC will help solidify the work of different U.S. agencies that assist in fostering the private sector abroad. The private sector is the driver of an economy and is responsible for 90 percent of the jobs in developing countries. Official aid donors should use their financial resources strategically to catalyze flows of private capital towards development challenges and build a robust private sector in developing countries. For example, there are trillions of infrastructure funding needs where the private sector could become a significant investor. Globally, there are 1.1 billion people without electricity, close to 3 billion without clean cooking facilities, 1 billion without access to safe water, and 2.3 billion have no access to improved sanitation. Through the BUILD Act, these infrastructure challenges can be viewed as opportunities for the United States.
The USIDFC will also help the United States work better on development challenges with its allies such as Canada, Japan, the United Kingdom, the Netherlands and other partners with enhanced capabilities. The new USIDFC can help with a series of national security and foreign policy challenges better than the current set of development finance instruments that the United States has at its disposal. By generating economic opportunities for citizens in developing countries, challenges such as refugees, drug-financed gangs, terrorist organizations, and human trafficking can all be addressed more effectively.
Q4: What will be different in the new USIDFC vs. OPIC?
A4: OPIC is a very influential development finance agency, but it operates using old methods and outdated authorities. OPIC needs a remodeling to allow it to fully compete in today’s global economy. Our allies, Japan and the UK, have DFIs and want to work with OPIC, but OPIC has a limited toolkit and these limitations make it difficult to collaborate. The BUILD Act makes vital improvements with regards to its limitations, allowing the new USIDFC to:
- make equity investments;
- provide technical assistance;
- increase the ability to take smart risks using local currency loans, first loss guarantees, and the provision of small grants;
- raise the spending cap of the USIDFC’s investments to $60 billion, more than doubling OPIC’s current $29 billion funding cap;
- provide a 7-year authorization; and
- create a “preference” for U.S. investors, rather than a requirement.
These expanded parameters can improve the limited investment levels in nations like Afghanistan and others that have traditionally come with security concerns. The new USIDFC has been directed by Congress to focus its efforts on building up lower-income and lower-middle income countries.
Q5: Why do we need DFIs if there are global banks and investors?
A5: DFIs combine development impact with financial sustainability, but they also face criticisms on the projects they support. One such question is: Why do we need DFIs when there are private banks and big investors that can provide financing to emerging markets? Oftentimes, due to regulatory issues or local conditions on the ground, private financiers will not invest in certain markets. DFIs make investments, operate on market principles, and in theory, invest in sectors or countries that would otherwise be unable to attract capital. Generally, DFIs have a dual mandate: they need to maximize profit and development impact, providing “additionality,” or unique value. Additionality can be explained through four characteristics:
- Demonstration additionality is when a DFI generates revenue in an emerging sector or market, motivating the private sector and private capital to invest as well.
- Financial additionality refers to enhancing the structure of the investments, such as in the form of longer loan periods (for example, for financing infrastructure), which typically require longer time periods to complete.
- Design additionality refers to the global expertise that such DFI investments can bring.
- Policy additionality relates to reforms that DFIs may jumpstart as a result of their financing.
Moreover, as mentioned, DFIs are criticized because they need to prioritize profits and development outcomes, but at the same time, they face significant pressure to increase their investment volumes every year. So, extending a low-risk, high return project finance loan in a middle-income country will always be tempting.
Another criticism that DFIs face is when they make investments in fragile or low-income countries: Is the DFI rewarding corrupt governments or ineffective policy decisions implemented by developing country governments? One response to this challenge is to either wait for reforms to happen or to use the DFI investment as a springboard for the policy reform process with a constructive dialogue involving developing country policymakers. These criticisms reflect the pressures inherent within DFIs that are manageable but not “solvable.”
Q6: Is the BUILD Act part of a U.S. response to the challenge of China?
A6: Yes, absolutely. Two years ago, when the Trump administration took over, OPIC was one of 62 agencies slated for elimination. The need for bureaucratic government agencies was questioned heavily, sometimes even described as corporate welfare. However, something happened during President Trump’s time in office, and that “something” was the recognition that China was a major challenger in the global economy. The new USIDFC is in part a response to China’s rise. The new USIDFC has been referred to in key speeches by President Trump and Secretary of State Mike Pompeo and in the National Security Strategy. As Secretary Pompeo recently stated, “The Act provides opportunities for American companies to compete overseas and create jobs here at home, a critical component of the President’s national economic strategy. BUILD strengthens the U.S. government’s development finance capacity, offering a better alternative to state-directed investments and advancing our foreign policy goals.”
China is active in Latin America, Southeast Asia, and Africa by providing financing for large projects as part of its Belt and Road Initiative. China is filling the void created by a lack of funds from other bilateral and multilateral investors. China offers quick financing and “no questions asked” infrastructure projects in these places.
However, the USIDFC offers something different than China’s model of large state-to-state lending—it offers a private sector, market-based solution. Moreover, it fills a clear void that Chinese financing is not filling. China does not support lending to small and medium-sized enterprises (SMEs), and it rarely helps local companies in places like Africa or Afghanistan grow.
The BUILD Act is a useful addition to the United States in its competition with China, but it is not a sufficient response on its own. In addition to the BUILD Act, we will need a new international economic strategy and will need to reinvigorate our leadership in the multilateral development banks. In sum, we will need to enable a “better offer” than what China puts on the table. With this notion in mind, in the short run, we need a fully functioning U.S. Export-Import Bank (EXIM). EXIM experienced a “lapse in authority” beginning in 2015, facing a severe shortage of leadership and capacity ever since. EXIM protects against buyer nonpayment, provides financing and export credit insurance, among other functions. U.S. competitors including China and Japan benefit from the strong support of their Export-Import banks, which reinforces the notion that the United States must make use of all its tools to strengthen U.S. development finance. The BUILD Act has promised $60 billion in funding for the USIDFC, but it is still a far cry from China’s $60 billion pledged to Africa alone at the last Forum on China-Africa Cooperation in September 2018. We can have a better offer than China, and the new USIDFC is part of that better offer.
Q7: What does this mean for USAID and OPIC?
A7: The new USIDFC will merge OPIC with some key private capital functions of USAID. In an ideal world, these functions and offices would have remained at USAID, but for reasons of political expediency, they are being moved. These functions and competencies that USAID has to support private enterprise may very well be revisited down the road. One such tool that is slated to move is USAID’s very successful Development Credit Authority, which provides guarantees up to 50 percent of financing made by developing countries local banks or financial institutions to small companies that might be deemed too risky for bigger financial players. Another key tool that USAID currently manages which might relocate to the new USIDFC is the Office of Private Capital and Microenterprise within the Bureau for Economic Growth, Education and Environment, which helps liaise private investors to strategic development projects.
The administration now has to submit to Congress a transition plan for the new USIDFC within 120 days, and it will probably take a year for the agency to be operational. There are still operational details that need to be fleshed out, specifically:
- How will OPIC staff transition to the new agency?
- How will the new agency hire new staff?
- How many and how quickly can the new agency hire staff who have experience with equity investments?
- What will be the guidelines for equity investments?
- Under what circumstances will the new agency use of local currency instruments?
- How will USAID work together with the new USIDFC?
A key issue will be how the new USIDFC collaborates with USAID, since USAID has “boots on the ground” with a strong local presence in the form of 80 country offices, while the new USIDFC’s operations will be centralized in Washington, D.C. This can be an opportunity for both agencies to draw upon their strengths and complement each other through a pipeline of projects and technical assistance.
Daniel F. Runde is senior vice president, holds the William A. Schreyer Chair in Global Analysis, and directs the Project on Prosperity and Development at the Center for Strategic and International Studies (CSIS) in Washington, D.C. Romina Bandura is a senior fellow with the Project on Prosperity and Development and the Project on U.S. Leadership in Development at CSIS. Special thanks to CSIS Project on Prosperity and Development program coordinator Owen Murphy and CSIS interns Pearl Risberg and Austin Lucas for their contributions to this analysis.
Critical Questions is produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).
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