Blending hopesBlended finance is the latest reincarnation of development finance. Traditionally, development finance was defined as specialised financing to bridge the gap between commercial investments and livelihood support doled-out by the state for social causes. In Nepal, development finance was simply understood to be analogous to microfinance.
Blended finance is the latest reincarnation of development finance. Traditionally, development finance was defined as specialised financing to bridge the gap between commercial investments and livelihood support doled-out by the state for social causes. In Nepal, development finance was simply understood to be analogous to microfinance. But the new concept of blended finance seeks to depart from a conventional definition of development finance at least in three substantive ways. First, it aims to bring in commercial or private financing; and yet, also seeks to blend them with public equities, essentially to fill in the gap left in ‘between’ by the aforementioned two sets of financing practices.
Second, this new financing instrument is being designed to substantially contribute to a huge financing gap, estimated at $2.5 trillion globally and $17.8 billion a year for Nepal, to achieve the ambitious Sustainable Development Goals (SDGs) and commitments of the Paris Climate Agreement by 2030. The Organisation of Economic Cooperation and Development (OECD) has devised a functional definition of blended finance as ‘the strategic use of development finance for the mobilization of additional finance towards sustainable development in developing countries.’ Nepal’s challenge is to customise such blended finance instruments from the ‘developing country’ context to ‘least developed country’ realities.
Third, the blended finance concept hopes to address the ‘missing middle’. It is important because, usually, mainstream commercial investors focus on larger, profit-oriented private ventures and the public sector’s easy financing is almost invariably targeted to uplifting the ‘poorest of the poor’. But a large section of the populace in every economy that has the scope to promote small or medium sized enterprises are often unable to access even the fairly smaller amounts required to embark on entrepreneurship. Because of this, the huge productive potential of economies remain untapped. Even viewed through the universal narrative that the rise of the middle class is a true symbol of economic progress, addressing the ‘missing middle’ may prove to be a right strategy to uplift the masses to the middle class.
Nepal in context
Needless to say, Nepal’s current status as ‘one of the poorest countries in the world’ is a direct causal outcome of the fact that she adopts new development instruments and global paradigms only after substantial time has elapsed. These instruments and paradigms are either taken up in distorted forms or only with partial understanding and, worst of all, implementation is left to bureaucratic self-selection. Blended finance, too, faces that risk.
For example, during last December, government agencies came out with two reports simultaneously, namely the Development Finance Assessment (DFA) Final Report by the Ministry of Finance, and Nepal’s Sustainable Development Goals Status and Roadmap (SDGsSR): 2016-2030 by the National Planning Commission. Both reports carried out, putatively, extensive and exhaustive analysis on the prospects of achieving the SDGs and explored the funding gap challenges. They concluded that up to 49 percent of gross domestic products (GDP) might require an entire period leading up to 2030 for this purpose.
However, both of these reports conspicuously fail to incorporate the phrase ‘blended finance’. Global think tanks like OECD, on the other hand, have been developing substantive research literature linking blended finance with the SDGs since 2014. Just before Nepal published these reports, the OECD study report entitled ‘Making Blended Finance Work for the Sustainable Development Goals (2017)’ was made public. It is gives us a glimpse of the speed—or rather the lack of it—with which Nepal embraces emergent and contemporary global ideas.
Nevertheless, blended finance has entered Nepal’s development discourse, perhaps, more emphatically than in many other LDCs. Nepal is one of the five (along with Bangladesh, Senegal, Tanzania and Uganda) countries jointly selected by the United Nations Capital Development Fund and the United Nations Foundation for a pilot study on ‘Blended Finance in the Least Developed Countries’. A joint meeting of experts, including from these five countries, is taking place in New York next week. Meanwhile, in Nepal, the private sector, commercial investors and government are coming together for the ‘Blended Finance Conference Nepal 2018’ that is taking place later this week in Kathmandu.
These indeed are welcome developments with a couple of caveats. First, the government’s inherent motive to control everything might ultimately leave the entire endeavour of creating a conducive atmosphere for blended finance to a few bureaucrats with half-baked knowledge on the subject. Second, it might simply be limited to another consultancy opportunity for a handful of ‘experts of everything’ technocrats because of whom Nepal’s development process has so far been effectively stalled.
Potential and risk
Nepal has a history of more than four decades of development financing. We have experimented with several models of microfinance and priority sector lending, public-private partnerships (PPPs) and impact fund models, among others. Lessons learnt from these endeavours are surely going to be valuable to implement blended finance for SDG-linked projects. However, this sole strength will not be enough for the ‘blended’ concept to actually materialise. First, the public sector must have the intent, policies, institutions and, of course, resources to participate in ‘blending’ with the private sector. Second, the commercial and private sector must visualise a secured profit opportunity and also have investible resources available.
The investment capability of Nepal’s public sector is now severely constrained as evidenced by the increasing deficits on the balance of payments, current accounts and trade. The inflow of workers’ remittances is also declining. The increased size of the government due to a federal structure has caused a near doubling of the pressure on the national exchequer. To meet the public equity obligation in blended finance, the government will be almost entirely dependent on financial flows from its development partners. The scope of commercial funding from domestic sources is also equally limited. The banking sector suffers from loanable funds. The ability of the domestic corporate sector has its own boundaries. Therefore, even private equity must come in the form of foreign direct investment (FDI).
In Nepal’s context, such financial blending, for all practical purposes, will thus be between international development aid and FDI. This in turn means that international aid will flow in only when the country’s credibility as an open economy is enhanced and policies are comparable to the best global practices. And, the FDI will come in only when the country’s risks are adequately hedged through the right policies backed by appropriate institutional set-ups. In the present context, institutional investors are looking for at least three sets of institutions to make blended finance viable in Nepal. One, an autonomous blended finance entity managed not by bureaucrats but by professional multi-stakeholder fund managers. Two, a viability gap fund (VGF) with a legal mandate to project finance proportionate to the size of the project and progress made in implementation. And three, the currency exchange (TCX) fund to hedge risks arising from the exchange rate vitality, mainly of the Indian currency as the Nepali currency is pegged against it.
It is important to recognise that for the next 12 years of the SDGs implementation period, all international development cooperation and FDI flow will take place within the blended finance framework. Therefore, Nepal needs appropriate and meaningful groundwork so it can develop blended finance and benefit from it.