Mobilizing Financing for Inclusive Development
By FP Analytics, the independent research division of Foreign Policy magazine
The world’s least developed countries (LDCs) face a severe financing gap that hinders their ability to build critical infrastructure, develop competitive industries, grow their economic base, and achieve the United Nations (UN) Sustainable Development Goals (SDGs). Official development assistance currently covers only 6 percent of the existing $2.5 trillion investment gap in developing countries overall. In LDCs, accessing capital is particularly difficult due to underdeveloped financial industries and capital markets, relatively weak tax-collection abilities, and the prevalence of firms operating outside the formal economy.
The COVID-19 pandemic has caused further setbacks. Sub-Saharan Africa, where over three-quarters of LDCs are located, suffered $115 billion in output losses and an expected 3.3 percent GDP contraction since the pandemic began. The most heavily impacted LDCs, such as Somalia, Sudan, and Haiti, are not expected to recover to pre-COVID gross domestic product (GDP) levels for at least five years. The impact of this fallout has been especially severe for women living in LDCs. UN data estimates that across developing countries, the pandemic has pushed an additional 47 million women and girls below the poverty line and widened the existing gender disparity—globally, working-age women are 22 percent more likely to live in extreme poverty than men. Addressing this gap will play a key role in LDCs’ overall economic recovery across a range of sectors. For example, the UN’s Food and Agriculture Organization (FAO) found that if women in developing countries had access to the same farming resources as men, it would raise annual agricultural output by up to 4 percent across developing countries. Despite existing needs, virtually none of the private financing currently mobilized toward LDCs explicitly targets gender equality. Due to the economic fallout, combined with an existing funding scarcity, finding solutions for financing projects in the world’s most underdeveloped economies is becoming increasingly urgent.
While important, official development aid and donor funds are insufficient to address existing financing and funding gaps and stimulate local economies. The shortfall illustrates the need and role for private capital to achieve the UN sustainable development goals, but to date, perceptions of risk and challenges to scale have deterred private investors and lenders from committing to LDCs. However, innovative models for attracting private capital to LDCs are emerging and beginning to have success. Blended finance—investment models that mix development, donor, and private capital into the same investments—is helping to mitigate private investors’ concerns over downside risk and the lack of suitable investment opportunities. These models are enabling investors to play a key role in LDCs, including in promising emerging industries such as clean energy, agriculture, sustainable tourism, and digital infrastructure. Scaling blended finance investments will be crucial to facilitating LDCs’ post-pandemic recovery and charting a path toward long-term sustainable development. The amount of capital deployed annually has increased to over $10 billion in 2020, a more than $3 billion increase from 2010. However, blended finance transactions are still responsible for less than 20 percent of overall capital deployed to LDCs through public and private sources. Significant barriers to scaling these investments remain, demanding increased efforts and collaboration from key stakeholders, including development institutions, governments, donors, and private investors to identify, refine, and scale success models in order to fill the gap.
Developing Countries Around the World
There are 82 countries globally defined as low- to lower-middle income, and 46 officially classified as LDCs.
Note: Tuvalu is considered an LDC despite being categorized as "upper middle income" due to its limited potential for further economic development and its high risk of being impacted by natural disasters.
Major Financing Gaps in LDCs are Constraining Development
LDCs receive a comparatively small share of both public and private financing allocated toward developing countries.
*Note: Data is USD millions, dates included are from 2012-2019; Source: OECD
Why the Gap?
High-Risk Perception and Unclear Regulatory Environments Are Deterring Investors from LDCs
Since 2000, global wealth and net worth have tripled, according to McKinsey, but the world’s least developed countries have largely been left behind. In 2020, 377 million people in LDCs were living in extreme poverty, and a lack of investment in these economies has left many individuals unable to benefit from modern innovations such as the internet or mobile phones, or to even access basic needs such as clean water and healthcare. Due in large part to underdeveloped domestic lending and investment markets, LDCs are disproportionately reliant on investment from outside sources, and to date, inflows have not materialized. Issues such as exchange rate fluctuations, unclear regulatory environments, and political instability feed financiers’ perception that LDCs are too risky and continue to deter investment from both public and private sources. In 2019, LDCs received only 30 percent of official development assistance allocated towards developing countries, and attracting private financing is even harder. From 2012 through 2019, LDCs received just 7.6 percent of private funds mobilized by development finance institutions. Lack of investment creates major constraints to development across LDCs, and economic setbacks from the pandemic threaten to exacerbate this already pressing issue.
“The Missing Middle”
Small Businesses Are Critical to Economic Growth but Are Unable to Attract Significant Investment Across LDCs
In addition to these macro risks, individual firms face compounding challenges. Both domestic and international financiers seek companies with experienced founders who can provide data-backed growth and profitability models, but underdeveloped internet infrastructure can prevent companies from building websites, offering digital services, or keeping digital records—all factors precluding them from appearing competitive to capital providers. A lack of international investment and lending options from domestic banks often forces companies in LDCs to rely on informal lenders that tend to charge higher interest rates, and qualification may be based on personal connections instead of business viability. Even for companies with formal business plans, investors tend to seek larger projects with greater prospects for generating returns. This issue is especially acute in LDCs, where most firms are either state-owned companies or small and medium-sized enterprises (SMEs) with few employees. Attracting investment to these smaller firms is critical for growth, but they tend to be the casualties of numerous factors underlying financiers’ overall hesitancy to invest in LDCs.
SMEs operating in economic sectors with significant growth potential, such as digital infrastructure and tourism, are essential to achieving the SDGs. In LDCs, these firms make up nearly the entire private sector and can have an outsized impact on supporting overall economic development. The impact investment fund Small Enterprise Assistance Funds found that every dollar invested in an SME generated an additional twelve dollars in the local economy. Despite the potential for developing SMEs operating in high-growth sectors, attracting investment has been notoriously difficult as they lack access to domestic financial services (as this sector is often highly underdeveloped in LDCs) and are often too small for international investors. In LDCs, between 50 and 70 percent of all SMEs lack access to basic banking services. When they seek investment from international sources, they are too large to qualify for micro-financing programs but not large enough to attract capital from major banks and investment funds. This dynamic is referred to as the “missing middle.” Firms that fall into this gap are left unable to effectively compete, and they often fail.
Development Challenges for SMEs
Ninety percent of jobs in the formal economy and 70 percent of total jobs within low-income countries are created by SMEs.
SMEs in 70 percent of countries globally cite access to finance as their biggest obstacle and face an estimated $2.6 trillion global credit gap.
Nearly 92 percent of all employed women in low-income countries are in informal employment, compared with 87 percent of men.
Over 28 percent of SMEs in sub-Saharan Africa have no formal access to funding.
The pandemic has exacerbated the gap and increased the urgency to support SMEs. Across LDCs in 2020, 34 percent of SMEs were at risk of shutting down within three months. Significant losses to these firms would be devastating—SMEs provide 70 percent of employment in low-income countries and are responsible for the bulk of innovation in sectors such as agriculture, information communications technology (ICT), and healthcare. Funding the long-term growth of these firms supports emerging sectors while helping LDCs make progress toward the sustainable development goals by bringing businesses into the formal economy, which can reduce income inequality and increase financial inclusion. Changing investors’ perception and de-risking investment in LDCs is necessary to unlock a larger share of private financing. To address this, Blended finance investment models that mix public and private capital are emerging as a promising pathway for financing a range of SMEs and supporting post-pandemic economic recovery across LDCs.
The Blended Finance Solution
A Novel Approach to De-risking Investment, Engaging the Private Sector, and Addressing the “Missing Middle”
To help address SME funding challenges, blended finance investments are structured to include both development funding and private capital in the same deal. The public capital can be used to offset some of the initial risk of losses or to increase returns for private investors, making the overall investment more attractive. While the use of public capital can ease concerns about investing in LDCs, it is not a substitute for due diligence from both public and private investors. Each investment should undergo standard evaluation processes and risk assessments to help ensure the responsible use of public funds and minimize risks for all parties. Capital providers can further diminish risk by constructing investment portfolios that pool groups of small businesses instead of individual SMEs. They can also invest in smaller impact investment funds with existing diversified portfolios that channel capital into SMEs and finance the “missing middle.” Development institutions such as the World Bank, the United States Agency for International Development (USAID), the Organization for Economic Co-operation and Development (OECD), and the UN, have been exploring using blended finance as a funding solution, and approximately $152 billion in private capital has been mobilized to developing countries since 2015.
How Blended Finance Works
Blended finance is being used to effectively mix public, private, and donor capital to increase investment in LDCs and to boost private-sector contributions. Since 2015, blended finance transactions have averaged approximately $9 billion per year, and they are primarily directed toward low-income countries. Ultimately, blended finance is meant to serve as a tool to help LDCs move toward the long-term goals of developing strong domestic capital markets that can attract international investment and move away from reliance on public capital contributions.
The different blended finance models are aimed at addressing the key barriers to investment in LDCs, but they work best when combined with additional measures for de-risking investments since. Concessional capital and first-loss guarantees can offset investors’ fears of political instability affecting investments at a macro level and concerns that companies will underperform at a firm level. To address the “missing middle” dynamic, blended finance investments generally take a portfolio approach—money is targeted toward a group of firms or multiple investment funds instead of an individual company. However, this is not exclusively the case as investments can also target individual SMEs directly or invest in SME financiers such as local banks and fintech companies. Working with local financiers can help effectively deploy large investments across multiple sectors or businesses, and technical assistance funds can help ensure that firms are investment-ready. Combining additional measures with blended finance can significantly de-risk investments, but hurdles such as unclear regulatory environments and poor physical and digital infrastructure across LDCs continue to pose barriers to investment. Addressing these high-level barriers will help make blended finance a more effective tool for closing the funding gap across LDCs.
Blended Finance Case Studies
Replicable Success Stories from Sustainable Investment Projects in LDCs
Blended finance is proving to be an effective tool for increasing the share of private investment allocated toward LDCs and providing funding for small businesses that previously lacked options. Targeting blended finance investment toward industries and projects that contribute toward economic development and long-term sustainability can provide a powerful tool to help LDCs reach the UN Sustainable Development Goals. Although blended finance is a relatively new phenomenon, compelling case studies of its impact accelerating sustainable growth in key economic sectors are already emerging. While blended finance models have still not attracted the necessary capital to fill existing financing gaps, effectively scaling them holds significant potential to address major financing struggles that LDCs have faced to date.
The following case studies highlight sectors in LDCs where there is opportunity to scale blended finance and examples of successful initiatives generating significant impacts. However, in order to fulfill the full promise of blended finance, additional efforts to effectively channel capital into these sectors are still needed. They also highlight how blended finance has served as an effective tool for engaging stakeholders across multiple realms and point to areas where improvements can be made to further boost the success of existing efforts. The real-world application of blended finance illustrates vast opportunities to scale public and private investment in LDCs and how this model can be effectively tied to the sustainable development goals.
Jump to Sector
Using Digital Connectivity and Mobile Banking to Enhance Financial Inclusion
Zambia is successfully leveraging partnerships among companies, development organizations, and local entrepreneurs to increase financial access and inclusion. Despite over 60 percent of the population still lacking access to electricity, Zambia has managed to increase the reach of financial services above Sub-Saharan Africa’s regional average. Since 2015, the Zambian government has placed mobile money—payment and savings services accessible via mobile phone—at the center of its financial inclusion strategy. The proliferation of digital banking services provided through mobile phones is increasing financial inclusion across the country. At the end of 2018, the number of Zambians with a mobile money account reached 4.3 million, up from 2.3 million in 2017. Combining national-level initiatives, local public-private partnerships, and blended finance has spurred this growth. Zambia’s major telecom companies partner with local entrepreneurs and financial institutions to handle customer transactions. For example, Barclays bank and the MTN telecom company partnered to create a bank-to-wallet service that lets Barclays’ customers move money seamlessly from their bank account to their MTN mobile wallet. To expand access to these types of services, local entrepreneurs are tapped to run kiosks and provide customer support and access to mobile services.
To boost Zambia’s mobile banking sector, the UN mobilized the Last Mile Finance Trust Fund, a blended finance vehicle sponsored by the Swedish International Development Cooperation Agency. In 2020, the fund distributed $180,000 in grant funding, in addition to providing technical support, to boost SMEs operating in the digital financial services space. This investment, in part, has helped to drive the growth of mobile money usage across Zambia while providing capital for companies that are seeking to build on top of the expanding mobile banking infrastructure. The growth in mobile money adoption has enabled previously unbanked Zambians to participate in the financial system, provided entrepreneurial opportunities for agent providers, and increased Zambians’ ability to access savings and loans. While mobile money usage is still largely concentrated among higher-income individuals in the capital city of Lusaka, there is significant opportunity to expand mobile banking services in Zambia. Other developing African countries, such as Uganda and Kenya, offer perspective on the potential to grow the scale of existing mobile money services. The breakthrough success of the M-PESA mobile banking service in Kenya offers a roadmap for the potentially robust market growth in Zambia. The success of M-PESA in Kenya has led to 72 percent of Kenyans now being able to access a formal bank account, which is higher than the global average for all countries. Further investment and continued among private, public, and development institutions can build on Zambia’s success and help push a similar transformation forward.
Mobile Money Provides Critical Opportunities for Financial Inclusion
Zambia illustrates how mobile money can play a key role in closing LDCs financial inclusion gap. Chart shows percent of population over age 15 with access to an account.
Source: Global Findex 2017
- Mobile banking presents a key opportunity to increase financial inclusion, and continued investment in the fintech sector will accelerate this opportunity.
- Expanding public and private initiatives could help to grow existing services and make technological tools available for widespread adoption.
- Engaging local entrepreneurs and small-scale businesses can provide on-the-ground support to rapidly expand new services, which in turn increases overall economic activity.
Innovative Financing for the Transition to Clean Energy
Access to energy is one of the most fundamental needs in LDCs and underpins countries’ ability to develop across many other critical sectors. Clean energy is the sector that has attracted the most blended finance capital to date, and roughly 70 percent of all blended finance funds allocated toward climate priorities has gone toward developing clean energy. Nevertheless, there is still a need to expand access significantly. Across LDCs, 60 percent of the population lacks reliable access to electricity, but promising efforts are emerging to address this shortfall. For example, the impact investment firm CrossBoundary is using blended finance to fund the development of solar-powered electric grids across Sub-Saharan Africa. In 2015, CrossBoundary partnered with the United States Agency for International Development (USAID) to offer a first-loss guarantee investment structure to attract additional investors for its Africa-focused energy fund. This structure has had initial success, helping the fund raise an additional $30 million from public and private institutions. To date, CrossBoundary has mobilized over $100 million in combined capital, and it is one Africa’s largest solar electricity providers.
Another example of a blended finance initiative that has been able to effectively mobilize both public and private capital is the BUILD fund. The BUILD fund is a collaboration between the United Nations Capital Development Fund and the impact investment firm Bamboo Capital. It divides investments into risk tranches, making donors and aid providers liable for the riskiest parts of a capital stake, therefore lowering the risk for private investors. The fund has invested in projects such as Mwezi Ltd, a Kenyan distributor of solar products that focuses on expanding energy access to rural areas. Another approach spearheaded by the UN and backed by EU governments is the Global Energy Efficiency and Renewable Energy Fund, which raises capital for private equity funds investing in clean energy in developing countries. Contributions have gone to private equity funds, such as Frontier Investment Management, that focus on investing in solar, hydro, and geothermal energy across Uganda, Rwanda, and Tanzania. Clean energy has been one of the most successful sectors at attracting private capital to date, but funding still needs to be significantly increased to meet the needs of LDCs. The UN estimates that the annual growth in electricity generation will need to increase by 350 percent for LDCs to reach the level of electricity access that the developed world currently has by 2030. These types of blended finance approaches represent promising strategies for achieving clean electrification goals.
Reliable Access to Electricity in LDCs is Lacking
Nearly half the people living in LDCs still do not have electricity, well below the global average
Source: World Bank
- Clean energy attracts a significant share of blended finance investments, but it is still insufficient to meet energy needs in LDCs.
- Developing the energy sector in LDCs is the first step in opening investment in many other sectors, such as telecom and digital services.
- There are already many funds operating in clean energy in LDCs, but they need increased access to capital to scale.
Leveraging Public-Private Partnerships to Develop Sustainable Tourism
The global tourism industry has suffered a major blow during the COVID-19 pandemic, but it remains a vital sector for LDCs that holds significant potential for future economic growth. Increasing tourism activity can help improve LDCs’ attractiveness for investment, create jobs, facilitate small business development, and help countries’ transitions and diversify their economies away from raw materials extraction and toward higher-value services. Developing the tourism industry can also help LDCs use their existing resources in more sustainable and economically efficient ways. For example, a study by the Australian Institute of Marine Science found that in Palau, sharks are often killed to make shark fin soup, fetching a price of $108 per shark. However, the same shark’s estimated value to Palau’s diving industry was over $179,000 per year—or $1.9 million over the shark’s lifetime. Preserving and managing access to natural resources such as coral reeds, local wildlife, and natural habitats can be sources of sustainable revenue. The Maldives, one of the most successful ex-LDCs at developing tourism (which accounts for 28 percent of its overall GDP), has had success integrating environmental conservation into its tourism sector. The local NGO Save the Beach Maldives works with tourism companies to educate tourists on conservation practices and leads expeditions to help sustain coral reef ecosystems. Additionally, the Maldives Ministry of Tourism works closely with local resorts to support sustainable practices such as increasing solar power generation and eliminating single-use plastics.
The potential for tourism to drive sustainable growth makes it an attractive sector to target for blended finance investments, but to date this sector has attracted a relatively low share of capital flows. Pre-pandemic, tourism in LDCs accounted for over $21 billion worth of exports but attracted less than 1 percent of official development assistance money. To address this shortfall, a number of LDCs are working with development institutions to grow their tourism sectors, alongside creating clearer regulatory rules for investors and developing comprehensive investment guides. For example, in the Solomon Islands, where tourism accounted for over 10 percent of pre-pandemic GDP, the World Tourism Organization is supporting eco-tourism initiatives that have resulted in the development of a national tourism strategy, launching websites for SMEs operating in the tourism sector, and training for hospitality workers. A number of blended finance investments have been targeted in the Solomon Islands to preserve natural ecosystems, including an International Finance Corporation (IFC) investment in the National Fisheries Development company to develop an environmental action plan. The IFC is also partnering with the Ministry of Culture and Tourism to create a shortlist of investment-ready land for developing tourism and coordinating with donors and the private sector to attract investment. These types of initiatives across LDCs are critical to increasing the share of private investment in the tourism sector, while offering an attractive market for potential private investors in a sector that has proven successful across other developing countries.
Tourism is a Major Source of Revenue for LDCs
Sustainability-focused tourism industries can help safeguard environments and boost economic activity.
Source: World Bank
- Tourism is a largely underfunded sector with a proven record of delivering economic benefits in LDCs.
- Eco-friendly tourism represents an opportunity to generate economic activity while preserving ecosystems and managing natural resources more sustainably.
Innovative Financing Solutions to Combat the Climate Crisis
LDCs are among the countries most likely to experience severe impacts from the climate crisis, despite being responsible for less than 1 percent of historical greenhouse gas emissions. Extreme weather events generated by climate change, such as floods, hurricanes, drought, and desertification, have an outsized impact on LDCs, where infrastructure to combat their fallout is lacking and economic reliance on natural resources is high. The World Bank estimates that nearly 2 percent of the global population is at risk of falling into extreme poverty due to the effects of climate change, with the worst economic impacts concentrated in Sub-Saharan Africa and South Asia. Preserving existing ecosystems is estimated to cost between $300 and $400 billion per year, significantly more than governments and development institutions can currently provide.
The need to attract private investment for climate priorities has given rise to “green finance,” the practice of increasing financial flows from the public, private, and non-profit sectors to sustainable projects. The primary financing mechanisms for green finance projects have been green bonds, which are specifically linked to sustainable development projects. The green bond market reached $1.2 trillion in 2021 but still accounts for less than 1 percent of the overall bond market. Blended finance initiatives offer an opportunity to augment this market and present another avenue for increasing financing for climate-mitigation efforts in LDCs.
Today, there are numerous blended finance funds working to combat climate change globally. One example is the Global Fund for Coral Reefs, a blended finance partnership among private donors, investment funds, development institutions, and governments. The fund has raised over $3 billion to date and will begin deploying capital in 2022. It will invest in a wide range of businesses and actors that interact with coral reefs, including eco-tourism, fisheries, clean energy, and waste management. These investment initiatives can help to mitigate the impact of climate change as well as preserve critical sources of food, protecting infrastructure from flooding, and lessening the impact of natural disasters.
Another example is the Mobilizing Finance for Forests fund, a blended finance investment vehicle that includes the British government, the Dutch development bank FMO, and the investment fund Andgreen (&Green). The fund focuses on investing in commercial agriculture projects to make them more sustainable and to protect and restore tropical forests. To date, the fund has mobilized more than $2 billion and has protected or restored five million hectares of tropical forest. Other similar funds are leveraging public-private partnerships to invest in combatting the effects of climate change and preserving critical ecosystems. These types of efforts highlight the ability of blended finance vehicles to mobilize capital toward critical global issues that have both sustainability and economic impacts.
LDCs Lack the Necessary Funding to Combat the Climate Crisis
LDCs will be among the countries most affected by climate change, but they still receive a relatively small share of climate financing.
Source: World Bank
- Mitigating the effects of climate change now is critical to the future growth of many LDCs.
- Blended finance presents a way to boost private-sector interest in climate investments.
Boosting Sustainable Agriculture and Enhancing Rural Opportunity Using ICT
Agriculture accounted for nearly 13 percent of Bangladesh’s overall GDP in 2020 and upward of 87 percent of households in rural areas there rely on it as a source of income. As a predominantly rural country, advances in agriculture in rural areas have been stunted by a lack of connectivity, driven by poor or non-existent internet infrastructure and low technological literacy among rural farmers. A multi-party effort has been made by the Bangladeshi government, NGOs, and the private sector to tackle this challenge, helping to establish Bangladesh as a leader among LDCs in agricultural innovation. Since 1996, the Bangladeshi government has crafted a series of comprehensive national strategies to encourage the adoption of technology in agriculture, including a national-level effort to create an agricultural database for planning and research. In 2006, the government of the southeastern district of Khulna launched the Agriculture Knowledge Management System (AKMS), a program that focused on educating young people in rural communities to act as local knowledge brokers. The local youth were trained to use the internet to access existing agricultural resources and databases containing information on climate change-adaptive farming techniques, methods for maximizing yields, updated market prices, and weather patterns. They would then disseminate this information throughout the community for a small fee, achieving a 20 percent profit margin on their services a year after the program’s launch.
Variations of the AKMS program and other models for overcoming literacy and information communication technology (ICT) access barriers have now been adopted and implemented across the country by companies, government agencies, and NGOs. Accessible online national databases containing agricultural information have been updated and expanded, and novel ICT services are using a mix of techniques to reach local entrepreneurs and rural farmers. These include Zero Cost and Krishi Jigyasha 7676, phone-based services that provide agricultural information through mobile phone lines and information centers and rely on local entrepreneurs to run their operations. These programs often bring together multiple stakeholders from the public and private sectors to succeed. For example, the e-Krishok initiative, which provided a wide-array for information to farmers via a mobile phone helpline, was a collaboration by the Bangladesh Institute of ICT in Development (BIID), the development initiative Katalyst, and the telecom company Grameenphone. Early recognition for the need of multi-stakeholder engagement at both the national and local level has helped to guide Bangladesh’s e-agriculture policies over the past decades and has contributed to its outsized success in implementing innovative ICT projects in the agricultural sector. With only 13 percent of the population online, and nearly 50 percent still lacking a mobile phone, there is significant room to build on these efforts. Strong public-sector guidance and active private-sector participation will be critical to this effort, and for Bangladesh to continue to serve as an example of using innovative methods to develop sustainable agriculture on a national scale.
Low Internet Access in LDCs Limits Connectivity
As the world becomes more interconnected, many people in LDCs are missing out on the benefits of the internet age.
- Local entrepreneurs and community leaders are a key resource for stakeholders looking to expand services in rural areas.
- ICT services impacts a wide range of sectors and investing in internet and celllular infrastructure improvements can help spur economic growth in adjacent economic sectors.
- Cooperation with government agencies and clear national guidelines can help engage the private sector.
Increasing Multi-Stakeholder Collaboration to Effectively Scale Blended Finance Solutions
Blended finance is proving to be an effective tool for increasing private investment and filling funding gaps across LDCs. The initial success of this model needs to be scaled up significantly for LDCs to effectively recover from the pandemic, and increasing the share of private capital is key to that effort. Promising developments mobilizing private capital are underway. In 2018, private capital invested in LDCs rose to $3.8 billion, double the amount invested in 2017. Despite this trend, greater coordination among development institutions, non-governmental organizations, and governments is needed to increase the share of private funding. There is also a need for additional actors to help coordination and execution efforts. Organizations across the board must also begin increasing transparency and collecting data to inform investments and help to assuage private investors’ concerns. Financial intermediaries are also needed to help pool investments in SMEs and facilitate moving money from funding organizations to local business. To date, there is significant capital from donors and financiers that is ready to be invested in opportunities aligned with the sustainable development goals, but not enough financial intermediaries to effectively match and channel those funds into SMEs. Coordinated efforts to build an effective funding pipeline connecting blended finance vehicles to local SMEs are necessary to address the “missing middle” and unlock continued economic growth in LDCs. These bottlenecks are a primary reason why blended finance still has not expanded as significantly as needed and remains an area where an additional push from relevant stakeholders is needed.
Despite existing challenges, combining private capital and public funds through blended finance is helping many previously underserved SMEs access capital for the first time. As illustrated in the case studies above, there are many attractive sectors for investment in LDCs that remain underfunded. Developing these sectors relies on increasing engagement and coordination with local governments, domestic investment funds, and regional development banks. This collaboration has been lacking to date, but increasing communication between international financiers and local institutions is key to effectively scaling investment across LDCs. These institutions possess critical country knowledge and can lend in domestic currency, thus helping to offset investors’ fears that have served as significant barriers.
Actionable Steps for Financing Sustainable Development
Engaging all relevant stakeholders will be critical for achieving the long-term goals of developing domestic lending and capital markets and strengthening regulatory environments and legal standards. Reaching these goals begins with effective collaboration toward developing existing growth opportunities in LDCs. Prioritizing the following action-oriented steps can help stakeholders move in that direction:
- Increase multi-stakeholder coordination among development agencies, private investors, local governments, and local lenders.
- Develop clear channels of communication among international financial institutions, allowing them to build investment portfolios together and optimize risk/return ratios for each party.
- Push for increased local lending, capital market development, and clear regulatory standards that protect investor capital.
- Prioritize investment in critical infrastructure and growth sectors that can support the long-term development of key economic sectors and deliver higher investment returns.
- Take a forward-looking approach to development and investment that considers the coming challenges of climate change.
Steady progress is being made towards increasing private sector engagement and mobilizing private capital in LDCs. Increasing collaboration among key stakeholders, aligning investors interests with local needs, and pushing for sustainable investment in critical economic sectors are key to scaling existing solutions. Blended finance is providing a roadmap towards achieving these solutions, but the hard work needed to fulfill its promise is just beginning.
Illustrations by Allie Sullberg for FP Analytics
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