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How to Maximise the Development Impact of Private Investments

Policies should be made to encourage investment

Infrastructure remains seriously underprovided throughout the developing world. The OECD estimates:

More than 1 billion people lack access to roads

1.2 billion do not have safe drinking water

2.3 billion have no reliable sources of energy

2.4 billion lack sanitation facilities

4 billion are without communication services.

And yet the World Bank finds that investment in Africa alone falls short of the level required by $48 billion a year.

However, it is not just the quantity of investment that matters, it is also the quality. New facilities that provide low quality services, or which poorer sections of society cannot access or afford, may tick boxes with respect to quantity, but do badly in terms of quality. Bilateral and multilateral Development Finance Institutions (DFIs) seek to use their resources to improve outcomes in both areas: they aim to attract private investment (quantity), but also try to enhance the development impact that this finance can achieve (quality).

It is in this context that I recently undertook a systematic review of the evidence for the Private Infrastructure Development Group (PIDG) to see how DFIs are performing in both areas (PDF). The results were encouraging in many ways, but less so in others.

On the positive side, we found that:

DFIs have been successful in attracting additional private finance into infrastructure. They are particularly important in leveraging the long-term finance which infrastructure projects require.

DFIs are able to influence project selection and design to boost growth. For example, they tend to select infrastructure projects that relieve bottlenecks and then try and influence their design – and the policy framework in which they operate – to further boost growth effects.

Less positively, we also found that:

DFIs do little to influence projects to increase direct poverty impacts. We found surprisingly few examples of DFIs seeking to influence projects positively in vital areas such as access or affordability for the poor. Interestingly, projects where this was the case all had some form of concessional finance. This suggests that purely commercial finance may be incompatible with maximising development impacts in some areas – a very important finding.

DFIs could do more to amplify the economic impact of projects. The supply of good jobs for local people, and linkages with small local firms, for example, are crucial for enhancing the long-term impact of infrastructure projects. While there were some positive examples, where DFIs sought to influence projects in these areas, there is considerable scope for more. Again, this was quite surprising.

Demonstration effects have hard limits. A priority for DFIs is to demonstrate the commercial viability of infrastructure projects, so that private investors will then invest without needing DFI support. While there is scope for this in some areas, there are limits. Often, DFIs are able to do what they do because they are DFIs. Political backing allows them to borrow on favourable terms and to lend with greater confidence. It is simply not possible for private investors to replicate this in many cases, as they do not enjoy the same advantages.

We were also asked to make suggestions for how DFIs could increase their impact:

Project appraisal and selection is key. Only projects with the largest possible development impact should be selected, but this requires a much more thorough assessment than currently takes place. Projects should be selected solely on their potential development returns, irrespective of potential financial returns, and results should be rigorously assessed and fed back into the appraisal process.

Project finance should be structured to fulfil development potential. Some projects, such as in the telecom sector, produce high financial and high development returns. Others have quite low financial returns but very high development impacts, water and sanitation is a good example.

Being clear about these distinctions and structuring finance accordingly is crucial to realising these impacts. In some cases it may be necessary to combine commercial investments with concessional finance such as grants, to ensure that water projects supply rural areas at prices the poor can afford, for example. While some progress has been made here much more could and should be done.

DFIs should cooperate much more with each other. In areas such as project appraisal, design, financing, delivery and impact assessment, there is huge potential for DFIs to coordinate. While there are many positive examples of this, they are quite ad hoc. Competition is just as likely as cooperation.

So, while DFIs are having a positive effect, they could do more, sometimes much more. It is particularly important that they are not pulled towards the most commercially viable projects at the expense of those that may not be so lucrative but have large development potential. To do this, DFIs need to maintain a complete focus on development results, and use private finance to further these goals. This requires:

Much stronger appraisal and selection procedures than currently exist, linked to effective impact assessment mechanisms

Finance to be structured to realise development results rather than suit private investors

Well-crafted incentives, where staff are rewarded for the development results they achieve, not the amount of deals they bring in

Reform of some DFI mandates, which do not allow concessional finance to be used, and insist that DFIs are self-financing, creating an inevitable pull towards the most commercially viable types of project.

More transparency: one of the problems that comes with private investment is their habitual insistence on ‘commercial confidentiality’. Evaluations of publicly funded projects are made available as a matter of course; the same should be true of projects with a private investment component. If not, it is not possible to assess their impact, or to compare with the impact of other forms of financing.

Given the urgent need for infrastructure in low income countries, the increasing focus on private investment is understandable. However, the goals of private investors do not always align fully with development goals. As donor-funded agencies, it is the DFIs job to ensure that maximising development outcomes is the goal of all their projects, and that these are carefully structured and designed to achieve this. Leveraging private finance is a vital part of this process, but it needs to be always remembered that private investment is a means to a (development) end, not an end in itself.


By; Stephen SPratt

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