Incentivizing the Private Sector to Support UN’s SDGs
November 29, 2020
Riyadh, Saudi Arabia
Achieving the SDGs by 2030 demands a coordinated resource mobilization approach as the global financial flows appears to have plateaued. Developing countries had been facing major challenges in mobilizing private financing to implement the SDGs at grassroot level. In this regard, incentivizing the private sector has been a widely discussed topic within SDG financing discourses. Given that, traditional approaches to mobilize private finance seem to be ineffective to bridge the annuals SDG financing gap of around of US$2.5 trillion, reinventing the incentive structure to catalyze the private finance mobilization efforts is highly important. In this context, this policy brief proposes the G20 community take action in six key areas: a) Economic modernization and inclusive business tax reform; b) Investment in R&D and market innovation; c) Promoting gender equality-focused development institutions; d) Leveraging innovative financing vehicles; and e) Maintaining sustainable public finances over the medium-term f) Streamlining Credit Rating Systems.
The SDG Funding Gap
In an era marked by populism, climate change, and upheaval in the geo-politico scenario, development fund is shrinking rapidly as manifested through the drastic fall in foreign aid in recent years. Between 2015 to 2018, foreign aid from official donors fell by 5.7 per cent with a declining share going to the poorest countries. On the other hand, the scale of development finance requirement has roughly doubled over the last decade. With the SDGs putting special focus towards initiatives that ensure gender equality, this funding decline has disproportionate impact on women’s empowerment.
At its current state, the global economic wheel is inadequate to deliver the ODA target of the Sustainable Development Goals (SDGs). To attain the SDGs by 2030, an annual investment of around US$3.9 trillion is required, whereas the current annual investment on SDGs is US$1.4 trillion, resulting in a substantial annual investment gap of US$2.5 trillion. According to UNCTAD (2014) report, private sector has the potential to bridge the gap of at least US$0.9 trillion annually while greater participation might result annual financing up to US$1.8 trillion.
The private sector has repeatedly been heralded as the prime catalyst towards mobilizing funds for the SDGs. The introduction of various instruments such as Green bonds, Blue bonds, and Sustainability bonds have indeed channeled private funds towards SDG aligned projects. During FY 2015-16, an estimated US $966 billion of SDG aligned private investment has been mobilized through Foreign Direct Investment (FDI), long-term and short-term debt instruments. However, OECD estimates that there is an approximate gap of US$ 498 billion that the private sector can mobilize.
Challenges of Private Sector Engagement
While mobilizing private sector finance has evidently been difficult, the opportunities are indeed there. According to a Standard Chartered Report, there is a potential for almost US $10 trillion high-impact investment in high-growth economies. However, progress has often been hamstrung due to the inherent challenges of engaging the private sector on development projects. Private sector investment by structure works on the basis of the business motive and profit mindset while, SDGs are more development oriented and people centric. Besides, private sector investors demand attractive risk-return rates along with affordable and accessible logistic facilities. For instance, the operations of private sector financing are governed by various risk factors, and the developing economies that require the bulk of the SDG financing, perform poorly in the Doing Business Risk Indexes. This raises operational costs and increases uncertainty, hence discouraging private sector entities.
In this regard, incentivizing the private sector has been a widely discussed topic at global leadership forums on SDG financing discourses. Despite adequate debates and discussions, it seems the existing modalities and ODA centric interventions has been inadequate to mobilize private capital for SDGs. To overcome these structural concerns, it is important to reinvent the incentive structure and intervention modalities to mobilize private capital in the areas where markets usually fail causing a developmental lagging.
Channeling funds from private sector towards achieving the SDGs are constrained by lack of adequate incentives, common definitions, standards, and impact measurements, as well as the fact that reported sustainable investments do not necessarily represent investing in real assets but also in financial assets. To meet the estimated investment gap of US$2.5 trillion per year, it is crucial that global economic policies and financial systems are aligned to the 2030 agenda. As MDBs and development financial institutions (DFIs) struggle to meet the gap, intervention from the private sector needs to be supported through innovative mechanisms that leverage other sources of finances, and are backed by global forums such as the G20.
To be sustainable, the private sector has specific interests in securing long-term production along commodity supply chains, and reducing their environmental and social impacts and risks. Private firms have already shown progress in their risk assessments, as they increasingly take into equation the environmental, social, and governance aspects of projects, which help provide a more realistic risk scenario by involving a wider range of stakeholders. This has enabled them to realize the long-term economic impacts of funding projects that support the sustainability agenda. However, capital needs to further move into areas that address the risks appropriately. For example, there remains much to be done in terms of incorporating the impacts of climate change as a risk variable in emerging markets which also have the biggest financing gap to achieving the SDGs. It is imperative that international regulators start to build in the risk of climate change into their models, equally focusing on what can be done to ensure that climate risk does not create a further impediment to financing in emerging markets.
The private sector can today play different roles ranging from policy-driven solutions to voluntary investment. In this context, the G20 platform can be a major player to initiate reforms across the globe by reinventing the framework for the private sector to support the SDG 2030 agenda. Multiple potential solutions have been tabled in this regard, with varying outcomes, hamstringed primarily by the aforementioned challenges. UNCTAD proposed a strategic framework for private investment in SDGs where, public financing schemes could be used to attract additional private investment in sustainable development projects. In this regard, governments need to play key roles in providing localized leadership and strategic guidance towards materializing the mutually rewarding partnership modalities between the development partners and private sectors through market development. A classic example of this is in rural Bangladesh where, development organizations like, Swisscontact, iDE and water aid have worked on private sector market development and skill development.
The global governance systems like G20 must also play an active role to initiate this kind of innovative approaches to engage private sector in hard to reach areas. Moreover, G20 leaders can initiate a framework to create sector specific partnerships between private entities. This can generate and mobilize resources to the lesser-focused social sectors of SDGs through various financial instruments such as corporate bond issuances, securitization structures, covered bonds and debt funds (World Bank 2015). Public-Private Partnerships (PPP) have also found to enhance enhanced women’s accessibility and empowerment in many sectors. A PPP based gender mainstreaming agricultural project in India increased women’s income, employment generation, access to market and resources, and psychologically help them by building up their confidence.
With the right set of incentive tools and an offering of win-win solution for all, the assets from private sector, if channeled properly, can mitigate the SDG gap and meet the individual goals by 2030. For example, the Project Last Mile (PLM) partnership between The Coca-Cola system and its Foundations, USAID, The Global Fund and The Bill & Melinda Gates Foundation facilitates knowledge transfer from The Coca-Cola system to Ministries of Health and develops their capacity to create and sustain efficiencies to improve health outcomes in Africa. This represents a definitive example of how private sector engagement as well as financing helped achieving SDG 7 and SDG 13 targets in Africa. Mobilizing the private sector will not only unlock financing options but also help achieve specific targets under SDG 8: Decent Work and Economic Growth. According to IFC, the private sector is the source of nine out of every ten jobs in developing countries. However, considerable interlinkages among the SDG targets further reinforces the significance of private sector in terms of achieving the SDGs.
The G20 Solution:
The changing geo-political scenario and emergence of many competing infrastructure initiatives at regional and global level poses significant challenges for G-20 economies as they look to leverage the framework in incentivizing the private sector to support SDGs. From that perspective, it is highly important for the G-20 economies to promote inclusivity and facilitate policy reforms, that can act in complement to those of the competing infrastructure initiatives. All measures need to adequately incorporate the need for increasing women’s participation, rights, and accessibility, which are socially and economically beneficial for all stakeholders. Since the private sector is primarily guided by a profit incentive, the G-20 needs to drive the private sector’s agenda in realizing these economic merits. Studies have found the empowerment of women in emerging markets to have increased organization profits. In addition, a number of policy reforms can be considered to incentivize the private sector to support the UN’s SDG agenda 2030.
Economic Modernization and Inclusive Business Tax Reform
Economic Modernization theory of development refers to changes in societies that make them more productive, better educated, and receive better welfare services. Inclusive business tax reforms refer to tax reforms that help attain inclusive growth ensures equality of growth, incorporating the poor and marginalized, during economic progress. Economic modernization along with local business tax reform will provide businesses with a more attractive environment for growth, competition and innovation purposes. In this regard, the G20 leaders might consider leveraging the G20 Inclusive Business Framework which was formulated to explore the structure incentives that simultaneously advance business and development. The world’s multilateral development banks have invested over US$15 billion in inclusive business approaches and private investors have raised US$6 billion in funds for businesses with not only commercial viability, but also with explicit social objectives.
Inclusive business frameworks tend to be most effective in those sectors that link the poor population with the basic services of livelihood, health, etc. For instance, M-PESA being an inclusive business has revolutionized the access to credit and financial services of 15 million people in Kenya. Similarly, Jain Irrigation Systems Limited has facilitated the economic empowerment of 30 million rural farmers of India by training them on deep irrigation. At fiscal level, supporting an inclusive tax reform agenda can trigger significant boost of income to rural and local suppliers. For example, in Mauritania during 2010 to 2014, the government provided slight tax rebate for the businesses in coal and mining industry, which purchased their raw materials from formal domestic suppliers. Besides, encouraging interested developing countries to participate in the G20/OECD BEPS project (Base erosion and profit shifting) and other international tax mechanisms can ensure a fair share of resource mobilization by preventing the tax avoidance by the MNEs. This will also help to promote fair market competition in international sphere.
1. Investment in R&D and Market Innovation
Focusing on “growth-friendly” fiscal consolidation by increasing the public sector efficiency, while incentivizing private sector to invest in R&D can unlock unexplored markets. This has the potential to enhance product diversification resulting in enhanced competitive advantage in the international sphere. A 1% increase in public expenditure on R&D will lead to between 0.48% and 0.68% increase in private expenditure on R&D. However, apart from public sector anchored R&D investment, several countries have also experimented with R&D investments using public private partnership (PPP) modalities. For example, Netherlands enacted Public-Private partnerships for innovation initiative through its four Leading Technology Institutes (LTIs), which have been evaluated as a proven good practice. In this regard, the push and pull mechanisms that stimulate both the demand for and supply of private R&D—if carefully designed, adequately funded, and politically backed—could generate desirable stimulus effects.
2. Promoting New Development Institutions Focusing on Gender Issues
Capital flows of bilateral donors and multilateral institutions are usually directed towards developing and underdeveloped economies. These capital flows may involve grants, donations, or low-interest loans, which are often backed by sovereign guarantees, hence reducing their risk profile when compared to solely private finance. The growth of new regional and multilateral development institutions can help expand this ability by increasing the fund portfolio. The introduction of the Asian Infrastructure Investment Bank and the New Development Bank, added $200 billion to the global development portfolio, expanding the available sources of finance. In addition, newly created bilateral donor governments such as International Development Finance Corporation (USA), National Investment and Infrastructure Fund (NIIF), and FinDev (Canada), add innovative governance and operational models capable of leveraging private investment.
While these development institutions enhance the reach for private sector investment, there is a need, gap, and scope for creating institutions that a target financing focused on gender equality. Even though gender equality has its own distinct goal under the SDGs, its impact is spread in all the other 16 SDGs and remains a vital factor today. G20 economies need to back such kind of an initiative to promote gender equality focused development institutions that not only provide the private sector access to capital with lower risks, but also enables them to tap into increased returns by eliminating gender biases and differences. In this regard, G20 community should particularly explore the feasibility of pro-poor PPP projects for developing countries to make the development outcome of the projects more inclusive and equitable.
3. Leveraging Innovative Financing Vehicles
Various innovative financing vehicles such as blended finance and results-based financing mechanisms, have gained prominence in recent times, which address the development needs as well as the interests of the private sector. While, blended finance is a PPP like model where government shares the risk of the investment along with the private entity, results-based financing arrangements are approaches where investors’ financial returns are linked to agreed-upon and measurable development impact. However, these innovative finances demand integrated approach by fixing inconsistencies across resources to finance sustainable development.
For instance, in Bangladesh blended finance has helped MFIs develop sanitation products and extend their reach to poorer households through the provision of an output-based aid (OBA) subsidy by the World Bank and Government of Bangladesh to microfinance institutions (MFIs). In this context, G20 community being the mostly development partners, can push for blended financing in development projects and also can consider mainstreaming blended finance in national planning processes of the developing countries.
In terms of results-based financing mechanisms, a classic example is Development Impact Bond in India which had increased enrollment of girls and improved learning outcomes of about 18,000 children in Rajasthan. In this regard, concessional capital on catalyzing private sector investment through such instruments such as the blended finance can help attract funding through a greater private sector participation. However, such financial instruments, which are often complex in their structure, need to be structured and supported in ways that help the development sector or the public entities get associated and ensure seamless and effective operation.
Within the regional and multilateral institutional frameworks such as the OECD, World Bank, or ADB, the G20 needs to support addressing some of the issues that innovative finance instruments such as blended finance face today. These include the development of effective measurement metrics for additionality, value for money, and leverage, while also raising awareness and understanding among the donor community, the full complexities of such innovative financial instruments.
4. Maintaining Sustainable Public Finances over the Medium Term
There are few developing countries endowed with development finance institutions holding healthy balance sheets. These countries also lack sufficient fiscal strength to undertake massive public investment in infrastructure projects across energy, transport and water. It is precisely for this reason that instruments such as public private partnerships (PPPs) are increasingly seen as silver bullets for building infrastructure in the developing world. Sustainable public financing can have considerable leverage on private investment through its ‘crowding in’ effect.
In many cases, a robust fiscal health is a precondition to undertake strong and brave policies that might have the potential to generate long term benefits at the cost of short-term profit loss. While, such policies usually favor socially desirable projects, they are not lucrative commercially as they may entail short term loss. In such projects, public finance plays a key role in mobilizing private financing from home and abroad. A classic example of this case can be the efforts on shifting towards low carbon infrastructure options. While this might discourage the private investors as it stands less profitable compared to carbon intensive alternatives, public sector can intervene to provide the private entities adequate incentives to compensate their forgone profit. This policy has been proven highly effective in Southeast Asian region. While these policies serve the business, it also simultaneously helps achieving specific SDG goals in a sustainable manner. G20 community can push for incorporating such innovative and proven policy options in national planning framework of the developing countries across the globe.
5. Streamline Credit Rating Systems for Developing & Underdeveloped Economies
Credit rating mechanisms-systems that evaluate ability of a debtor to pay back their debt, is inadequate in many developing and underdeveloped economies This creates impediment for foreign private financiers when they look to invest. While many such economies may have good business opportunities, the general perception of an underdeveloped economy being business-unfriendly may discourage private financiers despite an opportunity being there.
In this regard, the G20 group needs to extend their support towards ensuring a transparent and reliable credit rating framework for all countries, to provide the private sector the comfort of investment in SDG-related activities. Financial institutions already provide pro bono advice to underdeveloped/developing countries on how to get or improve their ratings that support the standardization of SDG/ESG criteria. Such initiatives need to be supported by the G20 through a multilateral framework, so that it can be scaled and streamlined smoother and more effective collection of finances.
G20 countries being the group of global developments partners of the developing countries, must realize the urgency and scope of private capital mobilization for SDG implementation. While the above-mentioned policy recommendations have the potential to engage private sector in investing in SDGs, the development outcome of the investment largely depends on the macroeconomic stability and institutional environment of the economies. Given the diversity of context and stages of development, G20 communities should also realize there is no ‘one size fits all’ solution to developmental challenges; rather policy reforms need to be designed in the country context to mobilize private financing for SDGs in the countries that are left behind.