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08 Nov 18

Blended finance in the least developed countries

Blended finance in the least developed countries

Over 1 billion people live in the least developed countries (LDCs) – a group of 47 countries with the lowest levels of socioeconomic development. The LDCs face significant barriers to achieving the Sustainable Development Goals (SDGs) by 2030, including a substantial financing gap. Currently, the LDCs rely heavily on concessional financing (>60% of total external finance), with limited capacity to mobilize capital (e.g., foreign investment) or make effective use of financial resources (e.g., tax revenues).

While official development assistance (ODA) and domestic public finance remain essential, a more diverse international financing “tool-box” may offer LDCs new opportunities to leverage additional public and private finance for the SDGs. Blended finance is increasingly acknowledged as an important tool for mobilizing additional financial resources for the SDGs. However, less than 7 percent of the $5.5 billion of private capital mobilized through blended finance to date was for the LDCs. Convergence data suggests that only a quarter of blended finance transactions target one or more LDCs.

LDCs and blended finance 2

Mobilizing greater investment into the LDCs faces distinct challenges at both the ‘enabling environment’ and project-specific levels. A weak domestic enabling environment is a powerful deterrent to both domestic and international private investors, increasing the risk premiums and, in the worst case, dissuading investors altogether. Project-specific barriers vary over time and with investor experience, including costly and time-consuming pipeline origination, limited credit histories, and lack of market data. These challenges mean that the limited number of investors who are actively looking to invest in the LDCs are also looking for greater returns to offset the risks.

Nonetheless, the imperative to leave no one behind calls for fresh thinking and a proactive effort to explore how new solutions can change the status quo. Concessional capital providers can and should find innovative ways to take more risk and experiment with new solutions that are tailored to LDC-specific contexts. For example, blended finance transactions targeting the LDCs may require a larger proportion of concessional finance, more generous terms and pricing, or the use of multiple concessional instruments (e.g., technical assistance and concessional risk-participation).

If executed according to best practice principles, blended finance has the potential to maximize the catalytic impact of concessional finance by sharing risks between investors to improve the risk-return profile of deals, making them more attractive for commercial investors. In addition to bringing in critical financing at the project level, blended transactions can also send a broader signal that a project, sector, or market is investable, creating an important demonstration effect that could support commercial replication and inform national policy choices.

LDCs and blended finance 3

Yet, blended finance is not a panacea. Blended finance is not well suited to all sectors, especially those with limited revenue-generating potential. Well-aligned sectors include energy, financial services, and infrastructure (e.g., telecommunications, water and sanitation). There is a strong track record of blended finance solutions for these sectors that could be tailored to and scaled for LDC-contexts. Even in aligned sectors, the cost of blending may be too high in certain cases, and pure public financing might be a better option. Ultimately, project and country characteristics, macroeconomic conditions and national policy priorities should determine which financing model—public, private, or blended—is best suited for which SDG investment.

*Convergence is excited to be part of this landmark report on blended finance for the LDCs, prepared by UNCDF in collaboration with the Organization for Economic Co-operation and Development (OECD), Southern Voice on Post-MDG International Development Goals, and the United Nations Foundation. To date, there has been limited evidence of where, how, why, and in which sectors blended approaches are being deployed in LDCs. Through a rich evidence base, data analysis, and detailed case studies, the report explores how to implement and adapt blended finance approaches to LDCs to maximize their effectiveness in crowding in private capital while minimizing risks. *

By Justice Johnston, former Manager at Convergence

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