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Thus far, the “billions to trillions” vision is not coming to fruition. The greatly expanded private capital flows that people hoped for, especially for SDG-related infrastructure and for low-income countries (LICs), have not materialized. Given stagnating aid flows, attempts to accelerate spending have raised public debt, putting macroeconomic stability at risk in many LICs. Many call for more catalytic use of donor resources to mobilize private finance, but others question whether blending public and private monies would just subsidize the private sector, or divert public funds from social and infrastructure investment in LICs and fragile states aimed at reducing poverty. CGD research focuses on building the evidence base for better understanding the challenges and devising innovative solutions in synergizing public and private finance. We are analysing private capital flows to LICs after the global financial crisis; examining the factors limiting the role development finance institutions (DFIs) are playing in mobilizing private finance; exploring the characteristics and sources of finance of infrastructure projects in Africa; assessing the impact of blended finance on poverty; and proposing changes to the development finance architecture to boost DFI risk tolerance, mobilization, and impact.
Center for Global Development
WASHINGTON – Foreign private investment now supplies about as much finance as foreign aid in many low-income countries in Africa and Asia, according to a study published today by the Center for Global Development.
The study examined foreign private capital flows—meaning foreign direct investment (FDI), portfolio equity and debt, and bank and other lending—to low-income countries, a group of 27 countries primarily in Asia and Africa.* It found that for the median low-income country, the ratio of foreign private investment to GDP is about the same as the ratio of foreign aid to GDP.
“This was a surprise,” said Nancy Lee, a senior policy fellow at CGD, a former senior official at the Millennium Challenge Corporation, and the lead author of the study. “We thought that foreign private capital flows would not contribute much to investment in low-income countries, especially after the global financial crisis. Instead, we found that these private capital flows are a major source of finance—and they’ve mostly increased since the financial crisis. That’s in contrast to aid, which has declined sharply as a share of GDP.”
“Most of these inflows are in the form of FDI, which is a more stable, less volatile source of finance,” she continued. “That’s good news for these economies.”
Some of the study’s other findings include:
It’s not all about natural resources
These investments are not all captured by resource-rich countries. In 2017, more than half of capital inflows went to countries that are not rich in oil or other natural resources. “It’s increasingly clear that policies, not just resource endowments, shape FDI destinations for low-income countries,” Lee said.
China is a growing investor, not just a lender
Much of the new investment in Africa, where most low-income countries are located, is coming from China. China more than doubled its total foreign direct investment in the continent between 2011 and 2016—and the amount is now closing in on that of the largest traditional western investors like the US, UK, and France, which have mostly stayed flat over that same time period.
“There’s been a lot of focus on China’s role as a lender to African countries, but China has also emerged as one of the most important investors in Africa,” Lee said. “It’s clearly making a long-term commitment to the region.”
But foreign and domestic investment don’t necessarily reinforce each other
Low-income countries with higher rates of private foreign investment don’t tend to have higher rates of private domestic investment. That raises concerns, said the authors of the study.
“We would expect foreign and domestic private investment to be complementary, as is the case in lower-middle-income countries,” Lee said. “But we’re not seeing that pattern in low-income countries. They need to think about how to spread the benefits of foreign investment more widely in the economy.”
Policies make a difference
Foreign investors care about the policy environment for investment. The study finds a significant positive relationship between foreign investment/GDP and the perceived quality of the regulatory environment in low-income countries without resource riches.
“Foreign aid is still important for poor countries, but private investment is already as big and growing. That’s especially true for FDI to non-resource-rich countries. These countries are showing that their resource endowments no longer determine their destiny. Their policy choices matter,” Lee said.
You can read the full study at https://www.cgdev.org/publication/trends-private-capital-flows-low-income-countries-good-and-not-so-good-news.
* The study covered 27 countries: Afghanistan, Bangladesh, Benin, Burkina Faso, Burundi, Cambodia, Democratic Republic of Congo, Ethiopia, Guinea, Haiti, Kenya, Kyrgyz Republic, Liberia, Madagascar, Malawi, Mali, Mozambique, Myanmar, Nepal, Niger, Sierra Leone, South Sudan, Tajikistan, Tanzania, Togo, Uganda, and Zimbabwe.
There are arguments for and against “spending through the tax system.” On one hand tax incentives are relatively easy to implement; they don’t require an outlay of cash and they make use of information that revenue agencies already collect. But on the other, loading the tax system with too many policy objectives conflicts with the drive for a coherent, simple, transparent tax system. Despite decades of advice from international organisations to curtail tax incentives, they remain a popular tool for governments.
The future of development policy is in development finance. Developing countries need aid less and less as their incomes rise and economies grow. What they need now is private investment and finance. US development policy, however, has failed to bring its development finance tools in line with this reality. Related US efforts have not been deployed in an efficient or strategic manner because authorities are outdated, staff resources are insufficient, and tools are dispersed across multiple agencies.
Other players are doing more. Well-established European development finance institutions (DFIs) are providing integrated services for businesses, and these services cover debt and equity financing, risk mitigation, and technical assistance. Moreover, emerging-market actors — including China, India, Brazil, and Malaysia — have dramatically increased financing activities in developing regions such as Latin America and Sub-Saharan Africa.
Governments, donors, and public sector agencies are seeking productive ways to ‘crowd in’ private sector involvement and capital to tackle international development challenges. The financial instruments that are used to create incentives for private sector involvement are typically those that lower an investment’s risk (such as credit guarantees) or those that lower the costs of various inputs (such as concessional loans, which subsidise borrowing).
Kingsley Moghalu, former Deputy Governor of the Central Bank of Nigeria, believes that Africa’s development potential lies in the hands of Africans themselves and that underdevelopment is due to the lack of a suitably ambitious worldview.