Private sector finance

Private sector finance is the type of finance obtained from private sector sources of finance. These financing sources are drawn and used to finance development projects, and they include responsible private finance and blended finance.

RESPONSIBLE PRIVATE FINANCE

The essence of responsible finance is to outline standards to ensure that lending and investments actively deliver positive development outcomes. In a responsible finance, there are three key primary actors that work together to ensure that responsible finance is achieved in any economy. These include the government, which provides consumer protection and regulation; financial intermediaries; and clients themselves, who need to possess a certain degree of financial literacy. The Great Recession of the 1930s and the recent global financial crises of 2008-2009 left lasting scars on the global financial system and have had protracted impacts on the poor across the world. Financial inflows to developing countries are increasing, as are the outflows. This calls for urgent attention that needs the work of the government, financial intermediaries, and clients as a whole. For instance, financial inflows from developing countries for responsible finance include net FDI to developing countries, new loans to developing countries, developing countries migrant remittances, and global ODA. Also, outflows include developing countries debt service, profit remittances on FDI, and illicit financial flows (Molina, 2011).

BLENDED FINANCE

Blended finance is one of the complementary tools used by the International Finance Corporation (IFC) to create markets and foster development impact. According to the IFC (2017), 'blended finance refers to a financing package comprised of concessional funding provided by the development partners and commercial funding provided by IFC and co-investors'. These types of funding are provided for projects with a high-impact factor, especially to society, the environment, and the ecosystem. This is because such projects do not attract funding on a commercial basis, given that the returns from these projects are not commensurate with the level of risk. Since development projects need different funds at various stages of their completion, it is prudent to use blended finance to avoid the risk of delay in financing the projects. The IFC uses a number of financial instruments for blended finance. These include risk mitigations/ guarantees, concessional debt (senior and mezzanine), equity (direct investments and private equity), and performance-based incentives. The IFC (2017) had earmarked four priority areas for blended finance, which follow:

• The Global Agriculture and Food Security Program (GAFSP) is a

private sector window that targets countries with the highest rates of poverty and hunger. The essence of this programme is to provide support in the form of short-term and long-term loans, credit guarantees, and equity to support smallholder farmers and small and medium enterprises (SME) farmers so as to enhance productivity growth, create, and deepen links in the market space and increase the capacity and technical skills of these business owners.

  • Blended climate finance includes investment in renewable energy, energy efficiency, climate-smart agriculture, clean technology, and adaptation that would otherwise not be funded by the private sector. The private sector will view this kind of investment as too risky to venture into. The concessional financing vehicle paves the way for financing on complete commercial terms because the viability of these projects will make it a profitable venture for the private sector to engage in.
  • The Global SME Finance Facility supports SMEs that are women based. They include SMEs from fragile and conflict areas, those in education and healthcare and companies that are located in the rural markets. IFC uses blended financing to increase access to finance for marginalized businesses in the form of loan guaranteeing as well as deepening financial intermediation in those markets.
  • The IDA 18 IFC-MIGA Private Sector Window (IDA-PSW) is a new financing tool used for crowding in private sector investment in the lowest-income, post-conflict, and fragile states that do not have a commercial solution or where no other IFC or MIGA tool can be used. For instance, an allocation of USD2.5 billion from World Bank support will enable private sectors working with IFC or MIGA to take risks at a level that is commensurate with returns to promote sustainability. A three-year pilot has been earmarked that started 1 July 2017 and goes until July 2020. The aim is to increase private sector capital investments in large-scale infrastructure and public-private partnerships and across all sectors, such as manufacturing, education and health, SMEs, climate finance, and technology. The financial instruments used include loans, equity, guarantees, and local currency solutions.

Innovative sources of finance for sustainable development

Apart from the various sources discussed, there are different innovative sources of financing sustainable development. These include international finance facility, IMF special drawings rights, global lottery, and global taxes.

INTERNATIONAL FINANCE FACILITY

International finance facility (IFF) was first proposed by the Her Majesty's Treasury (HM Treasury), also referred to as the exchequer, in conjunction with the Department for International Development of the UK. IFF was designed to frontload aid to help MDGs. In this facility, bonds were issued to the global capital markets against the security of government guarantees in order to maintain future aid flows, which will be used to buy back the bonds over a long period of time. This idea was used by France and other European countries in 2006 to finance immunization in the International Finance Facility for Immunization (IFFm). It was initiated to rapidly accelerate the availability and predictability of funds for immunization. The IFFIm sells bonds, officially called the vaccine bonds, to raise funds on the capital markets for the GAVI Alliance, a public-private partnership, which works to save children's lives and protect people's health by increasing access to vaccination in developing countries. Box 12.4 describes the detailed information regarding how GAVI raises funds through the use of IFFIm.

BOX 12.4 GAVI Vaccine Alliance IFFIm

GAVI, the Vaccine Alliance, finances vaccine programmes in low-income countries. In 2006, GAVI recognized that to reach high vaccine coverage levels as soon as possible, significantly more funds were needed than were available. In response, the British Department for International Development, the Gates Foundation, United Nations Children's Fund, and the financial services industry created the independent charity, the International Finance Facility for Immunization (IFFIm).

Between 2000 and 2015, two-thirds of GAVI's funding (i.e. USD11.6 billion), came from donations by governments. Every five years, governments pledged to donate a certain amount and then make regular payments to GAVI. IFFIm enables governments to make a legally binding long-term commitment to IFFIm - for example, an annual payment of USD20 million for 20 years, instead of donating directly to GAVI. Next, IFFIm creates bonds - that is, a type of long-term loan to the value of the total amount committed by governments (in this example,

USD400 million). International investors then buy these bonds, thus immediately providing IFFIm with USD400 million. GAVI will have access to these funds by applying to IFFIm. IFFIm pays back bondholders over time with the annual payments from the governments.

The proposed benefit of IFFIm was to make the money from future donations available immediately, so that vaccine programmes could be scaled up to reach the goal of herd immunity earlier. However, there are two costs involved in this financing mechanism. First, the administration costs of IFFIm have been estimated at between 4.1% and 4.6% of the pledged amount over the 20-year duration of the current commitments. Between 2010 and 2014, these costs averaged USD115 million per year, the World Bank acting as treasury manager. The second cost is the payment of interest to bondholders, which is difficult to calculate because it depends on currency and market conditions.

Between 2006 and 2014, IFFIm has received in total USD6.5 billion of long-term commitments from ten donor governments and has raised USD5 billion for GAVI through selling bonds (the difference of USD1.5 billion is held by IFFIm to reduce financial risk). Thus, IFFIm has provided around a third of GAVI's funding to date. GAVI also receives funding (USD1.5 billion) from the advanced market commitment, which was an agreement by GAVI donors to pay for the creation of a new pneumococcal vaccine.

In the January 2015 pledging event to secure funds for GAVI for 2016-2020, GAVI requested USD1 billion to be committed through IFFIm. However, only USD252 million in new commitments were made by France and the Netherlands. In contrast, GAVI received all the USD7.5 billion that it had requested, through direct donations. The change in funding profile compared to the last round reduction of funds pledged through IFFIm has been described by credit ratings agencies as a result of the diminishing policy importance of IFFIm for the future financing of GAVI's immunization programmes.

Source. Crocker-Buque and Mounier-Jack (2016)

IMF SPECIAL DRAWING RIGHTS

Special drawing rights (SDRs) are international reserve assets created by the IMF in 1969 to supplement its member countries' official reserves. In other words, it is like a global currency maintained by the IMF. As of September 2017, 204.2 billion SDRs (equivalent to about USD291 billion) had been created and allocated to members (IMF, 2017). SDRs can be exchanged for freely usable currencies. The value of the SDR is based on a basket of five major currencies: the US dollar, the euro, the Chinese renminbi (RMB), the Japanese yen, and the British pound sterling (IMF, 2017). The IMF borrows money at 0.05% from member countries and lends at 1.05% to member countries that need the funds. Since the IMF accumulates the funds through the interest payments, a special account can be created from this fund to support financing sustainable development goals. Countries normally leverage on SDR for the purpose of export so that they can help their export partner countries' currencies appreciate by buying a corresponding amount of SDR in their currency. This helps their exporters receive a good deal for their export commodities. The IMF can charge extra fees on this kind of arrangement to support sustainable development finance. Additionally, developing countries are the countries that most suffer climate change problems. SDRs will serve as a lower cost reserve for them. The gain could be used to finance sustainable development, because countries would not have to borrow from other countries or the international financial markets at a higher cost so as to shore up their reserves. Furthermore, developed countries could take the SDRs they receive and donate it to nongovernmental organization (NGO) programmes that support sustainable development and climate change- related activities (Flerman, 2013). The development SDRs would be grants that the awarded NGOs would convert into hard currency at their national central bank, whose SDR holdings would thus increase at the expense of the hard currency paid to the NGOs (Soros, 2002, pp. 181-186).

GLOBAL LOTTERY

This is a corporation which designs and markets lottery and pari-mutual systems to government, lottery operators and pari- mutual operators worldwide. There are three categories of draw-based games. These are instant games, sports games (pari-mutual), and sports games (fixed odds). Huge revenues can be mobilized from lottery to sustainable development finance. Also, the World Lottery Association (WLA, 2014) should vote on part of this revenue to finance climate change and other biodiversity and ecosystem activities. We argue that if on an incremental basis, the lottery amount could continue to increase by approximately 4%, such a percentage should be charged for sustainable development finance on the total lottery amount generated. 12.5.3.4 GLOBAL TAXES Taxes are an important source of revenue generation for countries. In recent times, a number of innovative taxes have come on stream to help finance government expenditure. In most developed countries, innovative taxes such as a currency transaction tax, a carbon tax, an international air transport tax, and an arms export tax serve as key sources of raising finance (Kapoor, 2004; Brzoska, 2017). In scaling up financing mechanisms for financing sustainable development, developed countries need to allocate part of these funds to the developing world to help finance sustainable development.

 
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