This year, donors will negotiate the 19th replenishment of IDA, the triennial fundraising exercise for the World Bank’s poorest clients. Among the major issues up for discussion will be the future of the private sector window (PSW), a $2.5 billion facility launched under IDA 18. We believe the PSW is a vital addition to the multilateral toolkit, but donors could help secure stronger performance with some significant modifications:
creating sectoral compacts that promote complementary public and private investment;
adding catalytic grant instruments;
expanding IDA country access to products from the Multilateral Investment Guarantee Agency (MIGA); and
allowing other multilateral development banks to access the IDA PSW.
The decision to stand up the PSW reflected growing donor pressure on the IFC to significantly expand its footprint in IDA countries, while at the same time safeguarding its AAA credit rating. Donors reasoned that by transferring risk to IDA, the IFC would finance investments in poor and fragile states with high development impact that would otherwise be rejected by their risk assessment team.
When initially conceived, donors were keen to ramp up support for SMEs given their potential contribution to job growth and economic diversification. Ultimately the PSW included four separate windows: a blended financing facility (BFF) using debt, equity, and guarantees to mobilize private finance for SMEs ($600 million); a local currency facility (LCF) to share currency risk ($400 million); a MIGA guarantee facility (MGF) to enable greater political risk coverage in IDA countries ($500 million); and a risk mitigation facility (RMF) providing project-based guarantees to crowd in private finance for infrastructure projects ($1 billion).
In approving this facility, IDA donors challenged the World Bank Group to embrace close IFC/MIGA/IDA collaboration in the project development process. Internally, this was not met with much enthusiasm; indeed, President Kim’s call for a “One World Bank Group” approach had already generated fierce internal resistance stemming from significant cultural differences and mutual distrust. Nevertheless, donors saw greater collaboration within the Bank Group as critical for capturing the essence of the unique comparative advantage of multilateral development banks—a wide array of tools to support both the public and private sectors.
Off to a slow start, but donors hanging in
The midterm PSW review, issued in late 2018, showed that only $185 million of the total had been committed, but projected that the blended finance and local currency facilities would be fully subscribed by the end of IDA 18. In contrast, it is unlikely that funding for the MIGA and infrastructure risk mitigation facilities will be fully tapped. Creating a pipeline under the RMF is proving especially tough, and to date no projects have been brought forward under this facility. MIGA is constrained by its policy of limiting coverage to countries rated BB- or above, which only a few IDA countries meet.
The PSW team has stressed that infrastructure projects require lengthy preparation in any context, but especially in PSW-eligible countries. Staff report that the projects under consideration include the public sector as a counterparty in the transaction, bringing an array of capacity, governance, policy, political, legal, and regulatory challenges. Surveys suggest that investors rank adverse regulatory action and breaches of contract as the leading risks. Deciding which risk-sharing tool is appropriate to cover different kinds of risks associated with government action and policy is not easy. Arguments for minimal concessionality suggest that the guarantees under the RMF are preferable since they are less concessional than the IDA Partial Risk Guarantee (PRG) available under IDA public finance operations. But, on the other hand, the PSW is not supposed to be used to bear risk that could be mitigated by appropriate and feasible government actions and policies. This reality just adds to the already obvious case for better intra-Group collaboration. The review honestly highlights this challenge—calling for better synchronization of policy dialogue and project pipelines.
In addition, the report is refreshingly candid in addressing the challenges of assessing the scope for additionality, highlighting the difficulties of determining whether the “halo effect” created by a first-mover investor in a new market or country justifies PSW support. Regarding development impact, there is reason to be cautiously optimistic, as projects scored well under the new IFC’s development assessment tool, on average 82 (out of 100) compared to the IFC non-blended transactions average of 57. For the first 12 projects, the subsidy elements ranged widely from 4-40 percent (equivalent to about 5 percent of project cost on average), with the LCR requiring especially high levels of support. Overall leverage ratios are so far roughly 1 to 1—$1 of public funding mobilizing $1 of private funding. The $185 million in PSW funding plus over $600 million from MIGA and IFC are projected to mobilize $800 million from the private sector, not an especially high ratio but perhaps not unreasonable for IDA countries.
The IDA donors’ initial response (at the IDA-18 mid-term review in November 2018) was generally positive. Likewise, board members have enthusiastically welcomed the first set of transactions, including the greenfield processing plant in Afghanistan, an inaugural bond issuance in Cambodia, and the first ever P/E fund in Kyrgyz. Broadly speaking, donors are hopeful that after the initial startup pains, the PSW will rapidly scale.
Evidence-based adaptations needed: four proposals
In our view, however, the midterm review is signaling that some core changes are needed to boost the chances for effectively and efficiently deploying all of these resources. Donors should use the forthcoming IDA 19 negotiations to launch four modifications:
1. Unified sectoral compacts for IDA countries
To be fair, the Bank Group is working to bring its public and private arms together, and in fact the PSW appears to be functioning as an important positive force in that effort. But the review and evidence so far suggest that overcoming the siloes that limit the PSW’s effectiveness would be accelerated by a more direct and systemic approach. At the moment, progress crucially depends on whether individual Bank country managers decide to be well-disposed.
The issue in fact extends beyond the question of whether the Bank is effectively supporting policy, legal, regulatory, and institutional reform. Public finance will likely remain dominant in much large-scale infrastructure investment in these countries (as in most countries), but it can be deployed in ways that either open up or close off private investment opportunities. For example, off-grid commercial opportunities are rapidly emerging, but the economics of these energy and water projects are inextricably tied to the performance and expansion of publicly financed grids, as well as to decisions on subsidy deployment in the sector. Decisions about how and when to use IDA finance for public vs. private investment should be driven by explicit, transparent comparisons of efficiency and development impact.
To systematize these policy-project interactions, efficiency and impact comparisons, and synergies, the Bank Group would do well to adopt the MCC compact approach where negotiations on a given sector with country governments regarding project investments, reforms, and institutional strengthening are all part of one conversation, which in this case would include the staffs of the IFC and MIGA as well as the World Bank. The aim is a coherent and jointly owned financing plan at scale for the sector. In theory, this is what is supposed to happen in the negotiation of World Bank Group country strategies with governments. But in practice, country managers decide who has a seat at the negotiating table, and key decisions that affect the mobilization of private investment can take a back seat to other priorities. It is also hard to address these difficult issues at the level of a strategy for the whole country. Formulating sectoral compacts (in addition to the country strategy) for key sectors where governments are interested and motivated, by sharpening and deepening the focus, would likely raise the quality and coherence of the identified policy and investment priorities. (Importantly and rightly in MCC compacts, the private sector does not itself have a seat at the negotiating table or any decision-making role in allocation of public finance.)
2. Adding catalytic grant instruments
At the risk of heresy, it’s time to face reality: some of the PSW funding in these inherently high-risk operations is not coming back. Yet more heretically, donors should consider limited use of grants under the PSW. At a portfolio level, this is not necessarily at odds with the long-term financial goal of preservation of capital for the PSW. After all, for sovereign lending, 25 percent of IDA resources are used as grants in countries where debt sustainability is severely constrained.
Why not deploy a small share of PSW resources as grants in ways that make pro-poor and pro-inclusive growth projects viable at scale? Outcomes and performance-based payments can boost revenue streams and incentivize private investment as powerfully as risk sharing, while also tying resources directly to development impact. Viability gap financing can be a more efficient use of public finance than publicly funding the whole project. Using PSW resources to buy down expensive currency swap rates from other providers can make more sense than shifting the full currency risk to IDA. Deploying grants or near-grant equity as early stage capital to test and adapt innovative technologies and business models can help launch businesses that work in IDA country environments. As proposed by CGD colleague Charles Kenny, access to some significant share of these grants could be auctioned through open bidding to minimize subsidies.
As donors prepare for the IDA 19 negotiations, now is the time for them to task the Bank to begin calculations on the right scale for grants, given the complicated financial and impact trade-offs involved. We would also urge that donors insist on strong PSW access to existing project preparation and advisory resources for creating markets that are available from the IFC and other parts of the Bank Group.
3. Enabling MIGA to deploy its non-honoring of financial obligation (NHFO) tool in more IDA countries
A significant constraint on MIGA’s ability to use the PSW is its policy against providing coverage in countries rated below BB- to protect against losses resulting from non-payment by governments (or related sovereign entities)—which rules out the majority of IDA borrowers. Because risk is shared between the PSW and MIGA (e.g., the PSW can only be deployed in conjunction with MIGA’s balance sheet), changing this policy would represent a significant departure from current practice. Here again the “One Bank” approach is crucial. The additional risk can be mitigated if other parts of the Bank Group are supporting robust solutions to the causes of government payment problems, e.g., insolvent public utilities. Reportedly there is significant demand for this instrument among potential investors for understandable reasons: it is a powerful tool that addresses a whole range of key investor concerns, especially in this group of countries. Managing risk sharing and risk mitigation among MIGA, IDA, and other parts of the Bank Group will, of course, be complicated. A key objective for MIGA, for example, is to protect its access to private reinsurance. But IDA donors have an essential role to play in driving consideration and analysis of this important change in policy.
4. Access to the IDA PSW for other MDBs
One more heretical idea: why not give regional development banks access to IDA PSW resources? All agree that project transaction costs in these countries are high and project development timeframes are long. At the moment, these burdens are concentrated on the IFC. Opening up the possibility for the PSW to collaborate with regional development banks in IDA countries could boost the pipeline, share risk and project due diligence costs across a broader set of institutions, and could even encourage MDB collaboration for scale and impact. The risk-tolerant IDA PSW resources are very scarce on the global development scene. Providing access to them in a way that encourages MDB collaboration rather than competition could help advance the elusive, yet widely endorsed, goal of having the MDBs work as a system.
Nancy Lee is a senior policy fellow at the Center for Global Development. Karen Mathiasen is the former US Executive Director (acting) of the World Bank.