How can DFIs foster private investment in sustainable infrastructure? | Experts’ Opinions

It is no secret that meeting environmental goals to mitigate climate change requires major public and private investments. One of the paths to address this is interlinked with sustainable infrastructure but unfortunately, many developing countries have insufficeint resources to fully transition to a sustainable infrastructure. According to the World Bank, low- and middle-income countries require a further US$15 trillion in investment to meet their infrastructure needs by 2040. The importance of this subject was proven by a dedicated discussion panel at the COP28 event which took place in November-December 2023. How can development financial institutions (DFIs) foster private investment in sustainable urban development? Check out some expert opinions below.

DevelopmentAid: How can DFIs foster private investment in sustainable infrastructure?

“The persistent annual shortfall in financing for sustainable infrastructure presents a formidable challenge to global development and climate goals. In this crucial context, DFIs emerge as pivotal facilitators, capable of unlocking substantial private investment flows. Their role transcends mere financial gap-filling. DFIs can strategically contribute to a broader transformation towards a resilient and sustainable future by advocating for robust pension systems and other institutional savings vehicles with integrated Environmental, Social, and Governance (ESG) principles within developing countries. This policy-driven approach, complemented by targeted technical assistance, knowledge dissemination, and capacity-building initiatives, will create a significant source of regulated long-term capital which is critical to fuel the necessary transition. Beyond setting the stage, DFIs can play a direct operational role in catalyzing investment through a variety of impactful strategies:

1. Co-investment and Investment Facilitation

• Strategically deploying concessional funding alongside private capital in priority areas, such as renewable energy and green transportation, to both mitigate risks and demonstrate confidence in project viability.
• Leveraging their extensive networks and established reputation to facilitate investor syndication and engagement, attracting a diverse range of participants, from established institutions to innovative start-ups.

2. Risk Mitigation

• Providing targeted support for early-stage ventures and clean technology incubators, mitigating crucial construction risks, and paving the way for subsequent private investment.
• Offering or facilitating project guarantees, credit enhancements, and political risk insurance, thereby reducing potential investment uncertainties in unfamiliar markets.

3. Capacity Building and Knowledge Sharing

• Equipping government officials and project sponsors with the necessary technical expertise and project management skills to develop high-quality, bankable projects that attract investor interest.
• Establishing knowledge-sharing platforms and best-practice networks to foster continuous improvement in project development processes and to attract responsible capital.

4. Exit Route and Liquidity

• Advocating for policy-driven interventions that establish regional secondary markets for sustainable infrastructure investments, providing investors with a clear pathway to liquidity.
• Exploring innovative solutions, such as standardized infrastructure investment vehicles and green bond exchanges, to create a vibrant secondary market ecosystem.

The strategy comprehensively outlines the critical role that DFIs can play in mobilizing private investment for sustainable infrastructure. By strategically deploying their resources, expertise, and influence, DFIs can drive the necessary global transformation towards a sustainable future.”

“As public sector entities, DFIs incentivize private sector investors to fund infrastructure in emerging markets by acting as a first-loss facility that can absorb the risks that the private sector cannot accept, making investments financially feasible over the long-term investment horizon characteristic of infrastructure. However, DFIs are not fully performing this catalytic role in blended finance. In recent years, DFIs have been overly concerned with preserving their AAA credit ratings rather than making impactful investments. They need to fulfill their policy-driven mandate to support borrowers that cannot access financial markets, leading the private sector rather than the reverse. Secondly, much more funding needs to be allocated to project preparation which can amount to 5-10% of the total cost. Presently, there is a dearth of bankable projects in emerging markets. Organizations such as the Global Infrastructure Facility were designed for the exact purpose of validating the conditions that need to be met to make these investments feasible and high-performing. But, as of 2023, the GIF has only facilitated US$108 billion in projects in its 10 years of existence. Much more needs to be done to build local capacity in the enabling environments where the funding is deployed.”

“It has been widely observed that private sector investments in a safe, legal, and competitive environment have contributed to an advanced track of societies’ development. Not only the local private sector but also international investors should be encouraged to engage in regional and local development processes. The main idea of this approach is to encourage local and international investors to participate, if not lead, the development process, and especially the infrastructure development. Why and how? Infrastructure projects require mega budgets that governments, especially in developing countries, cannot attain alone, even with the support of ODA. Investors can afford such budgets if they are allowed to access an attractive investing environment, including proper political and regulatory conditions. DFIs are rethinking how ODA could be used to leverage private sector funds for more engagement in infrastructure development. For example, investing $1 of public money that could reduce the high profitability risk of an infrastructure project will encourage local/international investors to co-fund (co-invest) such a project with an additional private investment of $10 which means unlocking huge private funds with limited public funds. Such an approach will incentivize building the necessary infrastructure projects like toll roads, bridges, clean energy facilities, information technology infrastructure and other investments that adhere to climate change mitigation requirements. Of course, this limited public funds contribution requires governments to accompany it with an enabling regulatory and investment environment. The approach described above is one of the many numerous funding mechanisms that DFIs could utilize to leverage private investments. Many terminology connotations describe this approach, for example: “development finance”, “blended finance”, “leveraging public money for larger private money”, etc.”

“DFIs play a crucial role as intermediaries between aid funds and private investment, facilitating international capital flows and providing a range of financial services in developing countries, particularly for public infrastructure projects. Their investments significantly contribute to global sustainable development. The OECD projects a global infrastructure investment requirement of US$71 trillion by 2030, encompassing sectors such as transport, electricity, water, and telecommunications. This figure represents about 3.5% of the annual world GDP from 2007 to 2030, with greater importance for developing countries. DFIs play a pivotal role in boosting infrastructure investments to meet social needs beyond that which governments can achieve through tax revenues and aid, thereby fostering accelerated economic growth in developing and emerging economies. However, the success of these investments hinges on government guarantees to mitigate the risks associated with DFIs’ participation. It is imperative to establish regulatory and institutional frameworks to make private investment in infrastructure feasible, ensuring the allocation of the necessary resources and creating infrastructure networks that are attractive for the private involvement of DFIs.”

“Beyond the international agenda, low and middle-income countries, and even developing countries, should be concerned about achieving sustainable and resilient infrastructure, especially in critical services. The private sector that does not support this goal will experience and bear the costs of inaction in sustainable infrastructure, either through direct losses or a reduction in business opportunities due to the effects of climate change. To involve the private sector in sustainable infrastructure initiatives, the first step is to clearly and specifically outline the possible losses resulting from inaction in every economic sector. This requires ongoing research and studies. Secondly, countries and DFIs should take sustainable infrastructure more seriously, essentially meaning they need to “put their money where their mouths are”. Moreover, one of the most crucial aspects is to establish a governance system for sustainable infrastructure similar to the Public Investment System used in 19 countries in Latin America and the Caribbean for public infrastructure. This governance system should be guided by international organizations, creating an environment where the public and private sectors can cooperate, share information, and enforce the application of sustainable infrastructure standards, requirements, and methodologies to achieve specific sustainable goals.”

“The lack of well-functioning market mechanisms and paying bankable end users are often key obstacles to raising project finance for infrastructure projects in developing countries. Traditionally the World Bank and other DFIs have been the source of long-term funding for infrastructure projects in the developing world which have limited their impact due to the immense size of the financing needed to tackle the problem. The use of loan guarantees and credit insurance have been used as a tool, but the size of funds allocated for these instruments has been limited when compared to direct lending. However, loan guarantees and credit insurance can play a much bigger role and provide risk coverage for project finance loans by the private sector for sustainable infrastructure projects. In some cases, such as hydrogen use as a fuel, the public sector or industries in the developed world can also be partial off-takers of the output of the projects thus providing a boost to the bankability of the projects.”

“Recent studies show the wealth gap between the Northern developed world and the less developed countries in the Global South has to some extent stabilized, yet the wealth gap between the rich and poor internally in developing countries has increased. This does raise the question as to how the existing aid has been managed. Inequalities remain as the biggest threat to sustainable development. Political, human rights, and COVID-19 situations in particular have slowed development growth globally. Therefore the need to re-ignite those drivers for sustainable development and to find equitable conditions for growth is as essential as ever. Inequalities exist in developing nations primarily though gender, age, race, political class, religion. These factors are clear obstacles to opportunities as well as hindering social and economic development. Investments that empower the poorest by reducing the inhibiting characteristics of soft or hard regressionist cultural or political policies seem to be one key solution to providing Sustainable Development Infrastructure through the independence and freedom of aid recipients as the principal goal of development policy.”

See also: Advantages and disadvantages of carbon credits | Experts’ Opinions

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