DFIs Drive the Development Agenda to Center Stage
The development finance landscape has changed dramatically in recent years. It is broadly accepted that the private sector plays a crucial role in development, and Development Finance Institutions (DFIs) are one of the best ways to enable private enterprise. DFIs are government- or quasi-government-backed institutions that provide equity, loans, and other financial support for private-sector projects in low- and middle-income countries. DFIs seek to invest in commercially sustainable projects, often in concert with private investors, that may struggle to attract commercial investors for a variety of reasons.
DFIs are not new. The United Kingdom created its DFI—the CDC Group (formerly the Commonwealth Development Corporation)—in 1948; the International Finance Corporation (IFC) was established in 1956; and the United States’ Overseas Private Investment Corporation (OPIC) was spun out of the U.S. Agency for International Development (USAID) in 1971. The Association of 15 European DFIs (EDFI) is celebrating its 25th anniversary this year, having been founded in 1992, at a time when DFIs were just beginning to gain recognition.
In the fall of 2016, the Center for Strategic and International Studies (CSIS), in partnership with the EDFI, released a report, titled Development Finance Institutions Come of Age. The report underscored the importance of DFIs for international development and stated that these institutions were going to grow at a very high rate and that official development assistance will remain relatively the same. About 18 months later, a number of events have taken place that largely corroborate our findings that DFIs are moving to center stage. DFIs are adjusting to a dynamic and changing economy and they are needed now more than ever.
The Growing Importance of DFIs in the Global Economy
The various international development agreements have concluded that while Official Development Assistance (ODA) has an important role (the term that is used is “catalytic”), ODA is not going to solve the challenges of the developing world. A variety of other sources of financing are going to be more central, including foreign direct investment, local private savings, and taxes collected by developing countries among others. The phrase describing this conclusion is moving from “billions” to “trillions.” In the words of the Financial Times’ chief economics commentator, Martin Wolf, “We have no hope in achieving the Sustainable Development Goals (SDGs) without high growth in poor countries.”
DFIs played a modest role in development policy at first, and few experts anticipated the growth of private investment in emerging and frontier markets over the past two decades. From 2000 to now, the total annual commitments by all DFIs (bilateral and multilateral) has grown from $10 billion to around $70 billion, an increase of 600 percent. ODA grew by roughly 50 percent over the same period.
DFIs’ new commitments for 2015 were around $71.2 billion, slightly lower than the projection in our report last fall of $76 billion. The drop in new commitments by the Japan Bank for International Cooperation (JBIC) and IFC, $4 billion and $7 billion respectively in 2015, can explain most of the difference. The amount of new commitments tends to fluctuate substantially from year and year, but the trend over the past 15 years still supports the theory that DFIs are growing at a higher rate than ODA.
Even though the level of new commitments by DFIs as a whole was slightly lower in 2015, OPIC and the CDC Group, two of the world’s leading DFIs, still experienced tremendous growth. OPIC’s new commitments grew from $3.0 billion to $4.4 billion, a 47 percent increase, and the CDC Group’s new commitments grew by 140 percent. EDFIs’ new investments in 2016 reached $8 billion, and their total portfolio has expanded to represent close to $50 billion. Most DFIs are taking on more investment activity, and it remains likely that DFIs’ investments will surpass ODA in the medium term.
DFIs are coming of age, but the shifts over the past year and a half present uncertainty—challenges as well as opportunities.
Political and Economic Shifts
The United States and United Kingdom have seen massive changes in policy over the past year with the election of President Donald Trump and Brexit. The “skinny budget” proposed by the Trump administration called for the elimination of OPIC, the zeroing out of the U.S. Trade and Development Agency, as well as a 30 percent cut to traditional U.S. foreign aid. Ultimately, the Trump administration named a strong leadership team to OPIC, and both the House and Senate foreign aid funding bills have included funding for the agency. Contrary to his original “skinny budget,” in his remarks at the Asia-Pacific Economic Cooperation (APEC) CEO Summit in Vietnam, President Trump announced his commitment to reforming the United States’ development finance institutions to better incentivize private-sector investments in Asia.
China has become a soft power competitor to the United States through the Belt and Road Initiative (formerly called “One Belt, One Road”) and the emergence of the Asian Infrastructure Investment Bank (AIIB) and the New Development Bank. The Belt and Road Initiative targets improving trade and connectivity between China and 65 countries.
The two multilateral development banks that China cofounded, the AIIB and New Development Bank, are up and running. The AIIB is already half the size of the World Bank and two-thirds the size of the Asian Development Bank (ADB). In 2016, the New Development Bank had initial authorized capital of $100 billion and approved seven infrastructure loan projects totaling over $1.5 billion. Two of China’s “policy banks”—the China Development Bank and the China Export-Import Bank—hold around the same total international assets as all of the Western multilateral development banks combined.
New Leadership in DFIs
There have been recent changes in leadership at many of the largest DFIs, including IFC, OPIC, CDC, the Netherlands Development Finance Company (FMO), and France’s Proparco. Elizabeth Littlefield stepped down as the head of OPIC after serving as president and CEO since 2009. Ray Washburne was confirmed as president and CEO of OPIC by the U.S. Senate in August 2017 and has already begun to expand their operations. OPIC recently announced an agreement with the Japan Bank for International Cooperation (JBIC) and the Nippon Export and Investment Insurance (NEXI) focused on strengthening key sectors like infrastructure and energy in emerging markets in Asia, the Middle East, and Africa.
In 2017, Diana Noble stepped down as CEO of the CDC Group after six years at the helm. Nick O’Donohoe took office as CEO in June of this year, and his strategy is expected to continue to evolve. In October, the United Kingdom’s Department for International Development (DfID) announced a capital increase of up to £703 million per year to the CDC Group for the next five years, signaling its interest in becoming one of the largest DFIs in the world.
In early 2016, the IFC saw major changes in its leadership with Philippe Le Houérou becoming CEO and Joaquim Levy becoming managing director and World Bank CFO. Le Houérou’s selection and close ties to the development side of the World Bank represented a change in policy, as the IFC is typically led by bankers from the private sector. The IFC has been criticized in the past for focusing too heavily on financial returns and ignoring the “development” side of development finance.
In 2016 after 29 years at the FMO, Nanno Kleiterp stepped down as chief executive and became chairman of EDFI. He was replaced by Jürgen Rigterink who had served as a member of FMO’s management board since 2008. FMO remains one of the largest bilateral private-sector development banks in the world.
In 2016, Grégory Clemente became CEO of Proparco, which operates in 80 countries and whose investments total around $6.3 billion. He replaced Claude Periou who had served as CEO twice, totaling eight years in charge.
New Approaches and Instruments for Development Finance
“Blended finance” approaches have also become a key topic in development finance policy discussions. Blended finance refers to the use of development finance and philanthropic funds to mobilize private capital in emerging and frontier markets. Some DFIs worry that the excessive use of blended finance could distort markets. In addition to the World Bank, the Organization for Economic Cooperation and Development (OECD) has been exploring principles for how and when foreign aid donors can use money and grants to leverage private-sector investment.
In October 2017, more than 20 development finance institutions, including the European DFIs and the IFC, endorsed enhanced principles on the implementation of blended concessional finance for private-sector operations. The report produced by this working group focused on providing clear guidance on how to implement blended-finance transactions in different development contexts.
“Impact investing” is a new approach where investments are made not only to create financial returns but also to have a beneficial social or environmental impact. The IFC reports that nearly 90 percent of its clients support the environmental, social, and corporate governance (ESG) standards and see them as critical to their long-term business success. Impact investing is one way that the private sector can support efforts to achieve the SDGs.
Multilateral Development Banks (MDBs) have been called on to increase their reach in development via innovative approaches. One such call is by further leveraging their balance sheets to lend at higher volumes. In 2015, the Asian Development Bank merged its concessional and nonconcessional balance sheets. The merger of the Asian Development Fund (ADF) lending operations and ordinary capital resources (OCR) was a step toward improving operations and is expected to raise ADB annual loan and grant approvals by 50 percent. In November 2015, the Canadian-led MDB Action Plan to Optimize Balance Sheets was agreed to by G20 Leaders, and in July 2016, MDBs submitted their own report to G20 finance ministers.
Another innovation that impacts the DFI sector was the rollout in April 2017 of the World Bank Group’s “Cascade” approach, which helps create markets and leverage more private financing. The Cascade approach is currently focused on infrastructure projects but should be expanded to finance, education, health, and agribusiness. The Cascade uses policy reforms and institution building to mobilize private-sector investment for projects in the poorest and most fragile countries.
Moreover, the World Bank’s 18th replenishment of the International Development Association (IDA 18) allocated $2.5 billion to IFC and the Multilateral Investment Guarantee Agency (MIGA) for a new private-sector window to catalyze private-sector investment in the 75 poorest countries, especially those that are fragile and conflict affected. IDA 18 also included a blended-finance facility within the private-sector window to mitigate various financial risks by providing loans, equity, and guarantees to pioneering IFC investments across sectors with high development impact.
The new European external investment plan (EIP) released in September 2016 is based on three pillars: mobilizing investment through the new investment fund and its guarantee; technical assistance to develop economically viable projects; and cooperation programs and dialogue to improve economic governance and promote a better business environment. The European Fund for Sustainable Development (EFSD) supports the first pillar by mobilizing investments by public financial institutions and the private sector in Africa and the EU neighborhood in order to stem the migration crisis and contribute to the SDGs.
The private sector is now broadly acknowledged by the international development community to be the engine of economic growth and a major force for poverty alleviation. Private financing has a large role to play in funding the SDGs. DFIs are instrumental to catalyzing private investments for development and are using new approaches and tools to help tackle these challenges.
The increased scale of DFIs’ investment activities will raise their international profile as major players in development. The renewed focus on fragile states and some of the new blended-finance instruments generate real concerns for DFIs because their success has been built primarily on strong financial returns and a positive development impact. Shareholders are demanding DFIs take on new challenges that have a higher degree of risk or a lower financial return if viewed through a traditional DFI approach. DFIs should evolve and further develop their capabilities to meet the changing global demands. The challenge is to be responsive while not completely breaking the DFI business model that has led to so much success.
Daniel F. Runde 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. Christopher Metzger is the program coordinator for the CSIS Project on Prosperity and Development.
Commentary 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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