78974 JUNE 2013 • Number 121 Investment Financing in the Wake of the Crisis: The Role of Multilateral Development Banks Jeff Chelsky, Claire Morel, and Mabruk Kabir Sustained growth in emerging markets and developing economies requires long-term, reliable capital to finance produc- tive investment, including in basic infrastructure. However, the availability and composition of long-term financing is constrained, partly due to fragile market conditions and cyclical weaknesses in parts of the global economy, as well as longer-term trends. This has had a particularly negative impact on developing economies that do not have reliable access to international bond markets and on sectors that have traditionally relied on bank lending (such as infrastructure). At the same time, fiscal space has been eroded by the crisis, and the direct lending capacity of multilateral development banks remains constrained. This heightens the importance of the catalytic role of the official sector in mobilizing long- term financing from the private sector by drawing on its ability to reduce and share risk. This note1 explores some of the ways in which MDBs are equipped to serve this purpose. At their June 2012 Summit in Los Cabos, Mexico, G20 flect the underlying fact that needs vastly outstrip available leaders pledged to “intensify efforts to create a more con- long-term financing. This is particularly true for infrastruc- ducive environment for development, including support- ture financing. ing infrastructure investment.�2 This focus grew out of Postcrisis Blues: The Long-Term concern that fragile market conditions in the wake of the Investment Financing Landscape global financial crisis were constraining the availability of long-term financing, particularly the type needed to sup- Over the past decade, emerging markets and developing econ- port productivity-enhancing investment for sustainable omies (EMDEs) have made notable progress in accessing in- growth. ternational capital markets. International long-term debt By some estimates, developing countries will need to in- flows to developing countries (defined here as bonds and syn- vest an estimated additional US$1 trillion per annum through dicated bank lending with at least five years of maturity) in- 2020 to keep pace with the demands of rapid urbanization, creased fourfold in nominal terms from 2000 to 2012 (figure growth, climate change, and the push for greater global inte- 1). However, progress has not been steady. The global finan- gration and connectivity. While such estimates are inherently cial crisis resulted in a protracted retrenchment in global bank assumption driven and influenced by the effectiveness and ef- lending, and a sharp but temporary contraction in long-term ficiency with which available resources are used, they still re- international debt flows. 1 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK    www.worldbank.org/economicpremise Figure 1. International Long-Term Private Debt to Developing the aftermath of the financial crisis, resulting in a 26 percent Countries fall in 2008, followed by 41 percent decline in 2009. Lending has remained weak ever since (figure 2). Much of the weakness can be explained by stresses in Eu- ropean banks, which were frequent deal participants in the syndicated loan market, particularly with EMDEs, with mar- ket shares typically higher than 80 percent. The volume of deals involving European banks dropped significantly in 2007, 2008, and 2011, when bank stress soared. Other banks took advantage of receding European banks, but while the volume of deals without European banks increased, other banks did not fully fill the gap, particularly in highly special- ized types of financing (such as infrastructure). Bond flows fared better and rebounded after the crisis, more than offsetting the reduction in bank lending. This was Source: Dealogic and The World Bank. partly the result of policy-induced low interest rates and quantitative easing in high-income countries, which prompt- A diagnostic assessment prepared for the G20 finance ed a search for yield by global investors. International bond ministers and central bank governors in February (G20 2013) flows to developing countries with maturities of at least five noted that all major categories of long-term financing—debt years have increased steadily since 2009, as conditions for flows, bank lending, bonds, portfolio equity, and foreign di- bond financing have become particularly favorable for many rect investment—have been affected by the crisis, but to differ- developing countries. ent degrees and in different ways. Since most EMDEs do not However, while bond issuance increased sharply in EM- have stable access to all types of financing, and different types DEs after the crisis, the rise was concentrated mainly in of financing are not perfect substitutes for one another, this Latin American and emerging Europe. Rather than financ- change in composition has impacted some sectors more than ing new economic activity, much of this bond issuance re- others. In the infrastructure sector, for example, bank and sulted from efforts to refinance existing debt at lower inter- bond financing are not perfect substitutes. Banks play a par- est rates or to refinance syndicated lending that was not ticularly significant role in the complex financing of the early being rolled over. Low-income countries, often lacking ac- stages of infrastructure projects. This is a concern, because cess to international bond markets, fared relatively poorly, long-term syndicated bank lending to EMDEs fell sharply in receiving less than 0.5 percent of their gross domestic prod- Figure 2. Long-Term Syndicated Bank Lending Declined Sharply in All Developing Countries and All Sectors Source: Dealogic and World Bank. 2 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK    www.worldbank.org/economicpremise uct (GDP), down from precrisis peaks of nearly 0.8 percent and expected revenues), using public resources complement- (but well above the level of the early 2000s). ed by legislative and institutional improvements to catalyze private financing. Bridging the Gap for Long-Term Financing: Official sector entities such as multilateral development Multilateral Development Banks as banks (MDBs) can play a useful catalytic and countercyclical Catalysts role, helping to share risk with private investors to enhance Undoubtably, the global financial crisis has strained tradition- the viability of investments and sustain productive invest- al sources of long-term financing, particularly for infrastruc- ment when private finance becomes scarce. Figure 3 illus- ture. Government budgets—a major source of infrastructure trates the extent to which MDBs, particularly the World financing—are overstretched, leaving little room for additional Bank, were able to ramp up lending volumes in the wake of spending. Financial fragility and the urgency to rebuild bal- the global financial crisis. ance sheets has significantly constrained the ability of the pri- How Do MDBs Achieve Additionality? vate sector to provide long-term financing, or reduced their risk tolerance and lending horizon. Banks, particularly Euro- MDBs can help their clients attract additional financing from pean banks, which have traditionally played a leading role in the private sector through a combination of a strong financial structured finance, are still recovering from the crisis and ad- position; preferred creditor status; technical expertise; pru- justing to tighter regulatory requirements. dent risk management policies; credible application of well Developing-country capital markets generally lack the understood standards in project design, execution, and corpo- depth and breadth to provide the type of long-term financing rate governance; a long-term perspective; and cross-country required for infrastructure. At the same time, heightened un- experience. Indeed, in a world of competing demands and certainty has translated into large pools of liquidity sitting scarce public resources, MDBs are increasingly being called relatively idle with few financial intermediaries to deploy on to demonstrate the value added of their engagement. Bu- them into infrastructure. This reality—and the overarching iter and Fries (2002) illustrate a useful framework identifying need to foster strong, sustainable, and balanced global several types of potential “additionality.� growth—calls for greater attention to policies and instruments According to their framework, MDBs can contribute that can lower risk and strengthen the confidence of investors their own funding and help build the confidence necessary to over a long-term horizon. attract commercial funding through a wide range of financing Even in normal times, private financing for socially pro- and mobilization instruments. MDBs achieve this financial ductive investments (including public goods) is often insuffi- additionality in many ways, with varying degrees of engage- cient, if not entirely unavailable, without official sector in- ment. The most direct demonstration of financial additional- volvement. The reluctance of private sector agents to provide ity (sometimes referred to as the “core� catalytic role) involves financing is often due to market failures, such as problems actively bringing financing partners into specific deals, for arising from asymmetric information. Additional constraints example, through syndications or cofinancing arrangements. stem from lack of investor experience with particular types of In some cases, this can provide partners with a level of credi- investments, economic activities (for example, infrastruc- tor status comparable to that of official creditors, in the event ture), or countries. Attracting private finance sometimes re- that the borrower runs into repayment difficulty. Box 1 high- quires closing the financial viability gap (that is, between costs lights a few instruments used by MDBs to mobilize resources. The impact of official-sector engagement goes beyond di- rect financing and core catalytic resource mobilization. Gaps Figure 3. Nonconcessional Financing from MDBs between investment needs and the availability of appropriate 45 financing often arise not only from the supply side of financ- IBRD 40 IDB ing, but also as the result of a weak underlying investment cli- EBRD 35 AsDB mate, lack of planning and institutional capacity, and the ab- IFC 30 sence of strong regulatory frameworks.3 billions US$ AfDB 25 MDBs catalyze financial resources from other sources 20 through what Buiter and Fries call design additionality. This 15 contribution derives from the technical expertise that 10 MDBs can bring to projects to improve their “bankability,� or 5 attractiveness, to private sector investors, and can occur 0 through promoting efficiency, transparency, and adherence 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 to accepted standards in project design, including environ- Source: Congressional Research Service, using data from MDBs’ annual reports. mental standards. As facilitators of knowledge, capacity 3 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK    www.worldbank.org/economicpremise building, and peer learning, MDBs can assist countries in Box 1. MDB Instruments to Mobilize Resources improving project management and supporting institution- Investment and project loans. MDBs have a comparative ad- al capacity. By bringing enhanced transparency, sound prac- vantage in meeting long-term investment financing needs tices, and internationally accepted standards to projects, and mobilizing long-term foreign and local currency financ- these interventions address certain information asymme- ing at more affordable rates. While MDBs do lend at interest tries faced by potential investors, helping to reduce risk and rates that adequately reflect risks, they generally offer rela- attract investment. tively longer maturities and grace periods than the private Policy additionality can derive from the support that sector, and are sometimes the only entities willing and able to provide financing with the appropriate maturity. With high MDBs provide to improve the policy and regulatory environ- credit ratings—since backing by shareholder governments ment for investment and to mitigate the risk of significant can reduce, if not eliminate, default risk—and higher levels policy reversals. MDB policy-based lending can contribute of liquidity, MDBs can often hold riskier portfolios than pri- to enhancement of the environment for productive invest- vate investors, enabling them to intervene where private ac- ment at the macro- or sectoral level, thereby helping to at- tors would be reticent to act. Between 2000 and 2013, on average, investment and project lending accounted for 75 tract additional financing, particularly from the private sec- percent of African Development Bank (AfDB) lending, 76 tor. A considerable part of the impact of official engagement percent of Asian Development Bank (AsDB) lending, 79 on the mobilization of long-term financing derives from the percent of Inter-American Development Bank (IDB) lend- advisory services and technical assistance provided to bor- ing, and 64 percent of International Bank for Reconstruc- rowers. This type of support can improve the investment tion and Development (IBRD) lending. climate, including competition policy, consumer protection, Equity investments. Many MDBs also have mandates to en- property and creditor rights, trade facilitation, judicial re- gage directly with the private sector, rather than exclusively form, budget and debt management capacity building, or through governments. This allows the MDBs to purchase market reforms. Buiter and Fries note that MDBs have equity in firms in strategic or catalytic sectors. In addition to unique characteristics, related to the design and implemen- direct equity finance, MDB participation is often augmented tation of structural reforms and institution-building pro- through representation on corporate boards and by knowl- edge of global good practices, including sound corporate grams adopted by governments, that afford them a compara- governance standards. This in turn can provide a higher tive advantage in providing finance. Moreover, MDBs degree of comfort to other investors, encouraging them to generally enjoy greater access to policy makers than do their also purchase equity in those firms. The International Fi- private counterparts, and commitments made to MDBs are nance Corporation (IFC), the European Bank for Recon- less likely to be reversed due to the longer-term relationships struction and Development (EBRD), and the AsDB have that MDBs maintain with their clients. This suggests that been the most engaged in the direct provision of equity fi- nance. Certain official sector entities also promote equity MDB engagement can have the biggest impact in sectors investments by supporting private equity funds, such as the where the returns to private investment are strongly depen- IFC through its Asset Management Corporation. dent on government policies and practices. Demonstration additionality refers to the potential for Risk mitigation: guarantees. Official entities like MDBs also projects supported by official sector entities to illustrate the have an edge over the private sector because their official status and financial structures enable them to absorb more possibilities of success (for example, by improving private risk—both default risk and political interference risk—mak- sector perceptions of the risk-return trade-off for certain ing them particularly useful in the early stages of a deal. types of investments). The greatest potential lies in frontier MDBs frequently play an important role in drawing private markets and innovative, riskier sectors and technologies. Bu- capital into long-term projects in destinations where the iter and Fries argue that this form of additionality is particu- market perceives high risks associated with inexperienced larly valuable in economies where “businesses are often institutions and regulatory and judicial weakness. MDB risk mitigation arms provide coverage projects that, although fi- more focused on seeking rents than on undertaking the in- nancially and economically viable, would have been chal- novation and investment that is necessary to exploit newly lenging without protection against noncommercial risks. created profit opportunities and to expand.� However, as Source: Authors’ compilation. Spratt and Collins (2012) note, when projects fail, the “dem- onstration� effect can also undermine subsequent private sector engagement. systematically require clear demonstration of impact in the Selection additionality, while not part of the Buiter and projects they agree to support. This helps to identify, priori- Fries framework, could be considered a fifth form of addition- tize, and mobilize financing for investments with the highest ality: the support provided by official entities when they en- payoff in terms of growth and development, and can mitigate courage better project selection by governments. Because of undue political influence in the selection of projects to be their governance and accountability structures, many MDBs supported. 4 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK    www.worldbank.org/economicpremise Looking Ahead: G20 Work Plan on vi. assessing the impact of regulatory reform on long-term Long-Term Investment Financing financing in EMDEs. This work, in addition to furthering the World Bank Recognizing the essential role that long-term financing plays Group’s fulfillment of its development mandate, will inform in supporting the goal of strong, sustainable and balanced G20 discussions of the challenges faced in mobilizing long- growth, G20 finance ministers and central bank governors term financing in support of achieving strong, sustainable, agreed at their meeting in Moscow in February 2013 to estab- and balanced growth. lish a Study Group on Financing for Investment, which will work closely with the World Bank Group, the Organisation About the Authors for Economic Co-operation and Development (OECD), the Jeff Chelsky is the Lead Economist and Coordinator, Interna- International Monetary Fund (IMF), Financial Stability Board tional Policy and Partnerships Group at the Poverty Reduction (FSB), the United Nations (UN), the United Nations Confer- and Economic Management Network of the World Bank. Claire ence on Trade and Development (UNCTAD), and other rele- Morel is a Consultant in the International Policy and Partner- vant international organizations to consider issues raised in ships Group at the Poverty Reduction and Economic Manage- the diagnostic Umbrella Report and determine a work plan ment Network. Mabruk Kabir is a Consultant at the Poverty Re- for the G20. The Presidency of the G20 asked Germany and duction and Economic Management Network. Indonesia to cochair the study group, which was set up in March 2013. Notes The study group adopted a work program that focuses on 1. This note draws on Chelsky and Morel (2013). five key topics: 2. “G20 Leaders’ Declaration,� Los Cabos, Mexico, June 19, i. country-specific factors that influence a country’s ability 2012, http://www.g20.utoronto.ca/2012/2012-0619-losca- to attract long-term financing; bos.html. ii. capital markets, highlighting the role of domestic capital 3. See, for example, World Bank (2012). markets, including local currency bond markets, in mo- bilizing resources; References iii. private sources of financing that could be a viable source Buiter, W., and S. Fries. 2002. “What Should the Multilateral Devel- of long-term financing, including for infrastructure; opment Banks Do?� Working Paper No. 74, European Bank for iv. official sources of financing, focusing on actors catalyz- Reconstruction and Development. ing long-term financing from other sources; and Chelsky, Jeff, and Claire Morel. 2013. “Official-Sector Non-Conces- v. global financial regulatory reform, and the extent to which sional Long-Term Financing: The Role of Multilateral Develop- ment Banks.� Issue Note prepared for the World Bank’s (2013) it may impact the availability of long-term financing. “Long-Term Investment Financing for Growth and Develop- To support the study group, the World Bank Group is ment: Umbrella Paper.� leading and/or participating in several of these work streams, G20 (Group of 20). 2013. “Long-Term Investment Financing for the results of which should be available within the next 6 to Growth and Development: Umbrella Paper.� Presented to the 12 months. The World Bank Group will be pursuing work on Meeting of the G20 Ministers of Finance and Central Bank the following topics, among others: Governors, February, Moscow, Russian Federation. Prepared by i. enhancing the catalytic role of the World Bank Group in World Bank staff based on input from the staffs of the Organiza- tion for Economic Co-operation and Development, Internation- mobilizing financing; al Monetary Fund, United Nations Conference on Trade and ii. improving the quality of infrastructure project section, Development, United Nations Department of Economic and design, and management in EMDEs as a catalyst for mo- Social Affairs, the World Bank Group, and Financial Stability bilizing private sector financing; Board. http://www.g20.org/news/20130228/781245645.html. iii. developing domestic capital markets as a source of long- Spratt, Stephen, and Lily Ryan Collins. 2012. “Development Fi- term financing; nance Institutions and Infrastructure: A Systematic Review of iv. identifying practical approaches for mobilizing institu- Evidence for Development Additionality.� Institute of Develop- tional investment in infrastructure in EMDEs; ment Studies and Engineers against Poverty, January. World Bank. 2012. “Restoring and Sustaining Growth.� Prepared v. discussing the challenges involved in using sovereign by the staff of the World Bank Group for G20 Finance Minis- wealth funds for domestic investment; and ters and Central Bank Governors, June. The Economic Premise note series is intended to summarize good practices and key policy findings on topics related to economic policy. They are produced by the Poverty Reduction and Economic Management (PREM) Network Vice-Presidency of the World Bank. The views expressed here are those of the authors and do not necessarily reflect those of the World Bank. The notes are available at: www.worldbank.org/economicpremise. 5 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK    www.worldbank.org/economicpremise