Blended finance, both as an innovative approach and practice, is lately gaining currency as an emerging tool for development financing in the developing countries where financing needs are acute. According to the OECD (2017) definition, "blended finance is the strategic use of development finance for the mobilisation of additional finance towards sustainable development in developing countries". The strategy is to attract commercial capital to projects that contribute to sustainable development while providing financial returns to private investors. Many see blended finance as a new departure in development finance to leverage private funding for public utilities, traditionally seen purely as the government's responsibility.

According to an assessment by the government of Nepal, the annual average development financing gap in Nepal towards achieving the sustainable development goals (SDGs) by 2030 would be about $17.70 billion, which in aggregate would account for approximately 50 percent of the national GDP for the period leading up to 2030. Given due ambience to implement it, blended finance can undoubtedly help bridge this gap in Nepal's development finance and business development.

The classical blended finance approach aims to bring in commercial or private capital to blend it with public equities, development assistance from development partners, and lately, other private investors. The three key characteristics of blended finance are concessionality, additionality and addressing the financing needs of the "missing middle". Concessionality enables the end-users of products and services of "blended" projects to enjoy concessional costs, and additionality is the goal which could not have been achieved without the blended intervention. It aims to cater to middle-sized investments that are covered neither by large profit-oriented investors like banks nor by small ticket-sized, often publicly incentivised, investments. Of course, a decade-long practice of blended finance has given rise to a variety of new offshoots of investment models.

In the case of Nepal, for all practical purposes, development finance is essentially understood to be analogous to microfinance. Nevertheless, several studies have realistically evaluated Nepal's prospects of promoting the blended nature of financing. Nepal has lately presented an example of "private sector only" blended finance, which is a departure even at the conceptual level in that the experiment proved to be a success without equity participation by the public sector.

The new model

The Covid-19 pandemic-induced lockdowns have had a severe economic impact, particularly on Nepal's micro, small and medium enterprises (MSME). Meanwhile, a blended finance programme called The Covid-19 MSME Fund Nepal was launched in October 2020 with the objective of supporting pandemic impacted MSMEs. It leveraged grant support from the Swiss Agency for Development and Cooperation and FMO, the Dutch Entrepreneurial Development Bank. The fund embodied the critical principle of blended finance; concessionality by providing interest or collateral-free loans to meet the working capital needs of businesses, and additionality through technical assistance in the form of business development services. Yet, it took an important departure that deserves to be called the "only private sector" blending model. It was entirely managed by a private fund managed company, One to Watch, which did not involve the domestic public sector in equity and management, and instead of the missing middle segment, it focused on the "left out bottom" segment of MSMEs.

Nepal's MSME sector is largely deprived of access to finance from the mainstream financial market even in normal times. Although Nepal's monetary policy announces schemes of collateral-free loans and concessional interest rates to small businesses and imposes lending regimes like deprived sector lending, actual disbursement in the sector has historically remained extremely low. Commercial banks lend through an additional layer of intermediaries called microfinance institutions. This adds to the cost of funds exorbitantly, oftentimes making it unviable for small-scale businesses.

The most excruciating among the constraints are associated recovery risk to banks in collateral-free lending, and trust deficit between lenders and borrowers. Borrowers often fell behind in repayment, not always intentionally, but because they lacked basic financial skills like cash-flow management aligned with the business cycle. In the said project, the role of the fund manager in assuaging the participating banks in recovery, and training the enterprises in managing the business and their finances has created a successful model of private sector blended finance that may be replicable even in other developing-country settings where productivity and employment dominantly rest on MSMEs. It ameliorates the hardship of MSMEs in accessing formal finance for businesses.

The prospect

The portfolio mobilisation of Rs170 million to 100 beneficiaries to revive their businesses affected by the Covid-19 pandemic may not sound like a project of a very impressive scale. But the model's possibility of replication and scaling-up certainly presents a fresh promise. Spanning across all seven provinces of Nepal, the fund not only helped to save 2,000 jobs, which otherwise would have evaporated, but also created about 400 new employment opportunities. The most remarkable outcome was nearly 100 percent timely investment recovery, which is unheard of in collateral-free MSME financing in Nepal. Interestingly, the range of businesses covered included highly technology-intensive ventures to trade and service-related traditional enterprises.

Perhaps the most important is the enthusiasm of the participating development partners like the Swiss Agency for Development and Cooperation and FMO to scale up this blended investment model across the geographical regions and different domains of businesses, even in the post-pandemic, new normal economic atmosphere. To take this initiative forward, policy facilitation and institutional support from the government and regulators remain critical regardless of whether it participated in equity or not. About MSMEs in particular, the role of local level governments that enjoy extensive powers under Schedule 8 of the constitution related to local economic management and have just elected a new set of leaders for the next five years can both be instrumental in policy support and equity participation wherever possible. The widening of the network of participating development partners and banks and financial institutions will be another crucial factor in expanding private blending finance on a national scale.