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In my last blog post on the IDA Private Sector Window, I noted the strong principles on subsidies to the private sector that were agreed by the heads of the multilateral development banks (MDBs) in 2012 as part of the Multilateral Development Bank Principles to Support Sustainable Private Sector Operations:

  • In cases where MDB private sector operation financing is used alongside concessional resources, ensuring that a net subsidy to the project or enterprise is justified, e.g. by a clear market or institutional failure or public policy goal that is best addressed through a subsidy;

  • Ensuring that subsidies are transparent and targeted, and structured to ensure the potential for market distortion is assessed and the subsidy is phased out once it is no longer justified;

  • Avoiding the introduction of rent-seeking opportunities;

  • Supporting ‘level playing fields’ by providing an equal opportunity for funding to qualified companies on a non-discriminatory basis…

Those principles can be summarized as “start with the public policy problem, use open offers or competitive approaches, maximize transparency.”

It is interesting to compare the MDB principles to the principles which later emerged from the DFI Working Group on Blended Concessional Finance for Private Sector Projects. This involved a very similar group of multilateral organizations, but was led by people in the private sector arms of the development banks. The topic is the same: how to use concessional finance to subsidize the private sector. But as recast by the DFI working group, the principles appear to have been watered down to a homeopathic degree.

Principle One of the DFI Working Group, Additionality/Rationale for Using Blended Concessional Finance, reads in part:

DFI support of the private sector should make a contribution that is beyond what is available, or that is otherwise absent from the market, and should not crowd out the private sector.... An assessment should be made as to whether or not a reasonable investor would proceed with a particular project without the presence of concessional finance.” A guideline underneath adds “use of blended concessional finance should, if possible, be prioritized for projects with high developmental impacts.

So, from “start with the public policy problem” in the MDB principles, we go to “think about development impact if you can” from the DFI Working Group.

Principle Two from the DFI Working Group report is Crowding-in and Minimum Concessionality:

DFI support to the private sector should, to the extent possible, contribute to catalysing market development and the mobilization of private sector resources.... The concessionality embedded in a financing package should not be greater than necessary to induce the intended investment” A guideline adds: “Apply explicit processes in project analysis to determine minimum concessionality.

Here, we go from “use competitive, open processes” to “think about lowering concessionality during project analysis.”

And Principle Five from the DFIs is Promoting High Standards:

When confidentiality and other internal DFI considerations permit, DFIs should aim to report on their concessional programs and the results of these programs, including, if appropriate, on incremental impact of concessional finance.

In another watering down from the MDB principles we go from “ensure transparency” to “transparency is nice if your processes allow.”

You can see why development finance institution staff were keen to roll out weaker principles—the original MDB principles would require a different model to deliver projects than the standard DFI client firm-led approach. But that explanation is by no means a good justification.

Should we put up with the lower standards of the DFI Working Group? I don’t think so. As I’ve said before, the World Bank Group has issued considerable and sensible guidance over time on how government-backed subsidy of the private sector should work. That guidance highlights the importance of level playing fields, competitive approaches, and high levels of transparency including publication of the entire contracts involved. It is based on considerable experience of what can go wrong when we don’t follow that guidance.

The DFI Working Group recommendations suggest the best that can be achieved when DFIs use their current approach to project finance and try to add subsidies. That isn’t enough. If development finance institutions including the IFC are going to divert significant aid resources to the private sector, they need to redesign the way they operate so that they can follow best practices on subsidy allocation and reporting.

Disclaimer

CGD blog posts reflect the views of the authors drawing on prior research and experience in their areas of expertise. CGD does not take institutional positions.