Debt Management--(how much) Should the Fed and Treasury Coordinate?
Government capital can cost as much or more than corporate capital
October 2015 | by Robert Harris
Private equity is an enormous source of global wealth that has not historically played as significant a role in development as its scale would suggest. This is not for lack of interest. Public-Private capital is constantly seeking investment opportunities. However, it only commits to those prospects that meet its appetite for risk and reward. Due to a variety of factors, many opportunities in developing countries are often perceived as overly risky or uncertain for the majority of investors. Institutions that offer to guarantee portions of loans made for such investments help investors rebalance their assessments of risk and reward and subsequently unlock considerable capital into developing countries. For example, in the past decade, the World Bank has approved 28 guarantees worth a total of $1.4 billion. These guarantees have stimulated more than five dollars of private capital for every dollar spent by the World Bank. Yet this type of support remains a very small portion of the bank’s approach to financing in developing countries. Since the G20 summit in London in 2009, multilateral development banks have stepped up efforts to do a better job of leveraging private capital. There is an opportunity for the G8, the G20, or individual governments to use their influence and encourage multilateral development banks—and potentially bilateral agencies—to create innovative instruments that stimulate private flows. Since guarantees may be more difficult to get through national budget processes than traditional financing, a starting point could be to work on ways to address these institutional barriers.
One exciting way for private capital to contribute to development is by fueling the growth of small and medium-size enterprises (SMEs) in developing economies. Such companies are often underfunded in these regions because they typically are too small for commercial lending but too large for microcredit financing. There could be an opportunity for multiple players to collaborate in the creation of a set of financial instruments to serve this segment. Local commercial banks could provide the capital and deliver the funds when sharing some of the risk with large multilateral organizations or major foundations that provide first-loss guarantees. Donors could play a role in funding pilot programs or supporting demand-side capacity-building initiatives such as credit-scoring initiatives or skill building for entrepreneurs. One promising area to test this is the agricultural sector, a driving force of growth in many developing economies.
Two other growing sources of capital that hold many trillions of dollars of capital are sovereign-wealth funds and pension funds. Sovereign-wealth funds typically have longer investment time horizons and often have more flexibility in their investment rules than other types of investors. Although sovereign-wealth funds are not new, some recently have been forming innovative coalitions—bringing together such diverse players as Chinese funds, Middle Eastern funds, multinational corporations, and developing-country governments.
Not all sovereign-wealth funds are created equal; each has its own objectives and rules. One characteristic most of them do share, however, is that, like private investors, their investment decisions are driven by a risk-reward equation. Beyond financial rewards, many funds also seek political-security and industrial-policy dividends for their home countries. But the problem in Africa is that, at least for the time being, available capital may exceed the viable investment opportunities. While some asset classes such as infrastructure are more developed, others are not yet deep enough to attract large pools of capital. Multilateral development banks can potentially play a role by offering risk-sharing vehicles to improve the risk-reward profile and, over the long term, help foster an environment that encourages viable businesses to emerge so that capital can flow accordingly.