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“It’s very straightforward,” says Diana Noble, head of CDC, the UK’s development finance institution (DFI). “If you provide wise financing with responsible investment practices to growing businesses, financial institutions and infrastructure projects in countries where this is needed, what results is economic growth, jobs and more taxes are paid.”
In a new joint CGD podcast, her US counterpart, Elizabeth Littlefield, the CEO of the US Overseas Private Investment Corporation (OPIC), agrees. “The DFIs’ business model is fully self-sustaining,” she says. “[It] supports businesses, creates development impact, and transforms our business leaders into some of the best ambassadors we can have that are investing in the very things people want most out of their own governments.”
OPIC and CDC are among the largest bilateral DFIs, in a group that includes most of the major donor countries. They are designed to use their funds to attract more private capital into developing markets through, for example, lending or insuring projects against political risk. In 2015 OPIC made new investments of $4bn bringing its total portfolio to $20bn, while in the same year CDC invested the equivalent of around $1bn for a total portfolio of around $5bn. Both institutions are profitable, returning money on their investments to their national treasuries.
Littlefield and Noble were both guests at CGD a few months ago, along with the heads of other major DFIs from Norway and Germany, at an event entitled $50 Billion in One Room. CGD senior fellow Todd Moss wrote that his takeaway from the event was that "development finance is the future."
In the podcast, Noble argues CDC’s own finances show the model is a “proven theory of change”, pointing out that “until , when the UK government decided to give CDC more capital to grow, the UK taxpayer had invested net GBP144m in CDC since 1948 and yet we [have] a balance sheet of $5 billion.”
Click below to see Noble and Littlefield explain what they think their institutions need in order to do more—and it’s not just the obvious: additional capital.
One major difference between OPIC and CDC is that while CDC is allowed by the UK government to take ownership stakes in companies it invests in—equity—Congress does not permit OPIC to do so. Littlefield sees this as a major constraint.
“Frankly [we need] a twenty first century tool kit,” she says. “Our tools were designed many, many years ago and right now they are not adequately designed for the way business is done today. I’m speaking particularly to the point about equity, in fact.”
Littlefield, who as a presidential appointee will soon step down from her position, also wants greater ability for OPIC to reinvest more of its earnings through an increase in the Congressionally-mandated cap of $29 billion on its portfolio. This echoes CGD work which lays out how an 'unleashed OPIC' could make a much bigger difference to development with no added cost to the US taxpayer.
For Noble of CDC, a much smaller institution, capital is not the main issue. “The limiting factor is much more deal flow and people, than capital,” she says. “Deal flow in terms of investable opportunities—that and the human capital bottleneck - skilled commercial investors who want to do this kind of work. Both are greater bottlenecks than availability of capital.”
When US Treasury Under Secretary David Malpass appeared before Congress just five months ago, he indicated that the World Bank “currently has the resources it needs to fulfill its mission” and went on to characterize the bank and other multilateral institutions as inefficient, “often corrupt in their lending practices,” and ultimately only benefitting their own employees who “fly in on first-class airplane tickets to give advice to government officials.”
From that standpoint, it would be hard to imagine US support for a significant injection of new capital into the World Bank’s main lending arm, the IBRD, as well as the bank’s private sector lender, the IFC.
And yet, that’s exactly the surprising outcome just announced at the World Bank’s spring meeting of governors. Not only is the Trump administration supporting a $7.5 billion capital increase for the IBRD (and at that, one that is 50 percent larger than the capital increase supported by the Obama administration in 2010), it has also signed on to a policy framework for the new money that makes a good deal of sense.
Here are the highlights:
The capital increase package will better enable the institution to deliver on its commitment to be a leader on climate finance and more broadly in support of global public goods, aligning with key recommendations from CGD’s 2016 High Level Panel on the Future of Multilateral Development Banking. Under the agreement, the climate-related share of the IBRD’s portfolio will rise from the current 21 percent to 30 percent. The IFC’s share will rise even higher to 35 percent. New ambition on the climate agenda also includes commitments to screen all bank projects for climate risks and incorporate a carbon shadow price into the economic analysis of projects in emissions-producing sectors. For global public goods more generally, the agreement newly commits a (very modest) share of IBRD annual income to global public goods.
The package introduces the principle of price differentiation based on country income status, with higher income countries paying more than the bank’s other borrowers. This proposal, which was also put forward by CGD’s High Level Panel in 2016, will generate additional revenues for the bank and asks more of countries that have less financing need. While the introduction of the principle marks an important step forward, the actual price differentiation is extremely modest—at most, the spread between high income borrowers will be just 45 basis points on IBRD lending rates of about 4 percent.
The package assigns new guidelines for the IBRD’s overall lending portfolio to channel 70 percent of the bank’s resources to countries with per capita incomes below $6,895 and 30 percent to countries above this so-called “graduation threshold.” These targets would not be binding when it comes to crisis lending. In practice, these new guidelines seem to align with the existing pattern of IBRD lending, as indicated in the figure. In this sense, the idea that these guidelines amount to cutting China's access to World Bank loans appears exaggerated, though over time, as more countries join the higher income category, the 30 percent share will be allocated across more borrowers.
The package also attempts to identify a new financial framework that requires greater discipline when it comes to tradeoffs between lending volumes, loan pricing, and the bank’s administrative budget. This framework, which reportedly was a priority for the US government, may not ensure that this will be the last ever capital increase for the World Bank (as an unnamed US official promises), but it does appear to introduce a greater level of coherence around financial/budgetary decisions that have historically proceeded in a disjointed fashion within the institution.
Finally, even as the agreement seeks greater differentiation among countries, it reaffirms the World Bank’s commitments to stay engaged with all its client countries, including China. In fact, given US rhetoric, it’s surprising that the agreement does not stake out any new ground on the subject of country graduation. In fact, it seems to go out of its way to reassure all current bank borrowers that they are still welcome and that the decision to graduate from assistance is theirs to make. In the end, as much as ending China’s borrowing from the bank would have been a political prize for the Trump administration, US officials appear to have taken a sensible policy path that favors good incentives over polarizing fiats.
At a recent CGD event, World Bank President Jim Yong Kim argued that the World Bank Group (which includes the IFC) is doing more in middle income countries (MICs) because “most poor people are in middle income countries.”
President Kim went on to say:
The first question that I asked as well, for our board, is we committed to ending extreme poverty in the world so… what percentage of people living in extreme poverty live in middle income countries? And now it’s probably 65 percent.
That matches what IFC Spokesman Frederick Jones said in response to our work on the IFC portfolio. And it sounds completely reasonable—indeed, based on our calculations, World Bank statistics suggest 24 percent of the world’s extreme poor live in low income countries, 58 percent in lower-middle income, and 18 percent in upper-middle income countries. So moving beyond low income countries (LICs) makes sense for an institution focused on ending extreme poverty. But does the IFC follow through by focusing on the countries that are home to the extreme poor? Not really.
It is true that the IFC (absolutely) invests more in countries that are home to greater numbers of poor people. Figure 1 plots absolute IFC commitments over 2011-16 against the number of people living at or below $1.90 per day (note the log scale). It shows that the average absolute IFC investment in middle and low income countries with more than 10m poor people is $641 million compared to average absolute IFC investment of $405 million in countries with less than 10 million poor people living at or below the $1.90 threshold.
Figure 1: Poverty and IFC investments
Figure 2 looks at the proportion of extreme poor in a country and IFC's investments as a percentage of recipient GDP. The average 2011-16 IFC investment as a percentage of 2010 GDP in countries with more than 20 percent poor people ($1.90) is 0.35 percent compared to average IFC investment as a percentage of GDP in countries with less than 20 percent poor people ($1.90) of 0.19 percent.
Figure 2: IFC investment in developing countries
However, a focus on poverty in middle income countries does not really explain IFC’s investments in Turkey, the largest recipient of IFC funding at $4.9 billion, home to 0.2 million poor people at the $1.90 threshold. Nigeria, which is home to 424 times the number of poor people at the same threshold, only got $1.5 billion in IFC financing over the same period.
And it is worth illustrating how poorly IFC investments are targeted if the aim is to focus on countries home to the world’s extreme poor. Figure 3 lines up countries along the x-axis according to their absolute number of extreme poor (countries with no people living under $1.90 a day come first). The y-axis reports cumulative IFC investments in those countries (note some countries are excluded for lack of recent poverty data).
The first thing to note is that the IFC has invested $4.5 billion over the 2011-16 period on countries home to no extremely poor people. And it has invested over $18 billion in countries collectively home to fewer than nine million extreme poor. More than half of the total value of IFC investments 2011-16 are in countries collectively home to just 45 million poor people—leaving countries home to 724 million extreme poor people to share the remainder. Put another way, countries home to those 45 million poor people get 18 times the IFC investment per extreme poor person than do the rest of IFC’s client base.
Figure 3: Cumulative IFC investment in developing countries
The defense that IFC is targeting where the extreme poor live nowadays is only partially vindicated. But President Kim did provide a possible explanation:
Now in terms of IFC risk… what the IFC representatives will say when I ask the question, is that, look, go back to the founding principles of the institution. You have to balance your portfolio with the risky investments and the not-so risky investments, and you know, to say to IFC, you have to put all your money into fragile and conflict-affected states or IDA states, if they did that they’d have to close down fairly soon. And right now we’re in a capital discussion. And so it’s just, you know, if you’re going to go into the low income countries, you need more capital, not less
That leaves another defense from the institution: that the IFC is focusing within countries on investments that better target poverty than the country-level statistics suggest. Once again we'd welcome the IFC publishing the necessary data to test that idea, but still question if a choice to invest more in richer countries focusing on a small share of poor people is the most powerful approach for an institution supposedly so focused on ending extreme poverty.
You can download the Stata code and raw data we used to produce these figures here.
Yet many of the world’s poorest countries in sub-Saharan Africa have shown they can reform and improve governance. The Heavily Indebted Poor Countries Initiative and Multilateral Debt Relief Initiative supported by the world’s major donors in the early 2000s took $75 billion in debt off the benefiting countries’ balance sheets—see the March 2016 World Bank-IMF update—and motivated wide-ranging macroeconomic and structural reforms that reduced poverty. Along with rapid growth in China and the commodity price boom, the result was a decade of high growth across the region.
But the momentum is fizzling out. In a new round of tough reforms, African leaders will need to do the heavy lifting. Africa is still poor, and not yet able to finance the investments critical to a new round of growth and poverty reduction. Here’s what donors could do:
Help jump-start a big push on regional infrastructure to knit together many small economies and create economies of scale for local producers. That requires attracting Foreign Direct Investment (FDI) since even the best-managed countries in sub-Saharan Africa (consider Rwanda, Côte d’Ivoire, or Senegal) cannot rely on market financing because maturities are too short and interest rates too high.
To find the money, securitize a small portion of the over $40 billion in annual aid flows that sub-Saharan Africa now receives, as outlined in a recent Project Syndicate article, to finance the public portion of public-private “blended” investments in major cross-border power and transport (the Lagos-to- Dakar highway is a good example)—with benefiting countries servicing these loans, which will be superior to market alternatives on cost and maturity.
Africa needs a new round of success stories. Success requires a big push not just on infrastructure but also on sustained policy and institutional reform. African leaders must take the lead. Donors can help.