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2016DevelopmentFinanceForum

Unlocking Opportunities in Fragile Markets

Dublin, IrelandMay 18-19, 2016

2016 Development Finance Forum

Summary Report

June 30, 2016

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Introduction

It is estimated that by 2030, 62% of the global poor will live in fragile and conflict-affected situations (FCS). This will jeopardize the ‘leave no one behind’ commitment in the 2030-Agenda. In countries not marred by fragility, many among the poor are projected to be lifted out of poverty by substantial economic growth, accelerated technology adoption and slower population increases. Such progress will be heavily contrasted by stagnation in fragile countries, which have to deal with booming populations, weak governance and volatile economic growth.

This is not only bad news for those in a situation of protracted fragility. The growing disconnectedness of these enclaves of instability from a sophisticated global economy is bad news for all of us. It will make it more difficult for fragile countries to catch up once domestic stability has returned, increasing the risk of falling back into a destructive cycle of conflict, diminishing growth and extreme poverty. These stagnant conflicts are contagious and can threaten stability and economic growth elsewhere. They often lead to migration and forced displacements, and can create international crime havens, which fuel illicit financial flows around arms, narcotics and rare minerals. Ultimately, political processes elsewhere are at risk of becoming more vulnerable to patronage and corruption at the expense of transparency and accountability.

Scaling up private finance in FCS to support sustainable development and job creation is urgently needed and will significantly contribute to achieving the goals of the Addis Ababa Action Agenda (AAAA) and the 2030-Agenda. On May 18 and 19, 2016 over 200 experts and decision-makers from the public and private sectors, as well as academia and civil society, convened in Dublin at the 2016 Development Finance Forum (DFF) to identify challenges and constraints as well as significant opportunities to scale-up private investments in markets under stress of fragility and conflict. This summary report captures the rich information and ideas that came out of the intense deliberations in over 70 different groups and three plenaries. On the first day, the contribution from Paul Collier, Professor of Economics and Public Policy in the Blavatnik School of Government at the University of Oxford, helped to frame discussions and set a constructive tone for the entire event.

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Overview

In November 2016, it will be fifteen years since the World Bank assembled a taskforce under guidance of Paul Collier and Ngozi Okonjo-Iweala. The report put FCS, or Low-Income Countries Under Stress (LICUS) as they were called then, firmly on the map. The WBGs World Development Report 2011 was another milestone in the international approach to fragile and conflict situations.

Both reports flagged the pivotal role of the private sector in addressing the underlying causes of fragility and creating opportunities for citizens and households. The reports also paid full attention to the need to clear complex barriers to transparent private finance flows, inside and outside the resource extraction sector. Data deserts, weak governance, poor or no education, poor health and nutrition, adverse demographics and blatant opportunism and patronage hindered much-needed private finance for development and helped perpetuate a cycle of “deprivation, destitution and oppression”3.

Action is less costly than inaction and is even more urgent than fifteen years ago. In an ever-shrinking and connected world, no conflict is ring-fenced and local, even if they are perceived to be local. Their spillovers, whether forced displacement, international white-collar crime, terrorism, or corruption, affect global prosperity and security more than ever.

In addition to the pivotal diplomatic and grant tools, the global community will need to make full use of finance as a leveraging force in FCS. Deploying finance and financial innovation in a ‘way that supports the stewardship of society’s assets’4 requires concerted action to design new strategies and partnerships that improve public and private alignment and give a core role to blended finance.

Such strategies and partnerships need to radically change the risk-and-return landscape in FCS. The DFF demonstrated that public sector, private sector and civil society bring valuable experience and knowledge on risk and return to the table. Public sector and civil society operatives have deep experience in dealing with the instability risks in FCS, and with the challenges to mitigate these to a point in time where social stability returns. That is about the same point where commercial investments start to have full returns and become attractive. Private sector operatives know a lot about what is needed to make returns on commercial investments. This expertise and knowledge needs to come together, as was the case at the DFF in Dublin. Such efforts enrich decision-making and incentives in public and private sectors. MDBs, like the WBG, are well-placed to help provide the instruments, financial leverage, local knowledge, platforms and expertise to make such strategies and partnerships work in fragile states.

Establishing platforms for dialogue is essential. There is no prototype action plan for ‘solving’ fragility, with sequenced steps and careful divisions of labor. The challenges in each fragile situation are complex, idiosyncratic and interrelated. To be effective, approaches to address these challenges must be based on local capacity and analysis. The success of the global “Billions to Trillions” agenda depends on the ability of all stakeholders to support a balanced approach between local action and global support. Enable businesses and households to ‘’tap into opportunities where they exist”. Simultaneously, work to create “opportunities such that you can have big players in the economy” as Sierra Leone Central Bank Governor Marah emphasized during the DFF opening panel.

Several ideas, practices and proposals that surfaced in Dublin emphasize this need for a balanced approach. Getting to scale in FCS requires connecting to the reality and choices of the individual, households, villages, refugee communities and urban neighborhoods - enabling the empowerment of local entrepreneurs to tap into existing potential as much as the arrival of innovation through external players. For example, crowdfunding and crowd investing– including the engagement of successful and entrepreneurial diaspora communities around the world -

3 - Amartya Sen, “Development as Freedom”

4 - Robert Shiller, Finance and the Good Society, Princeton 2012

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has the potential to rapidly connect local innovative ideas to distant and voluminous financial sources in a context of transparency and proximity. Smart-, pico- and mini-grids, powered by renewables provide quick and clean access to electricity and open-up opportunities for economic development to the poor. The transformation to climate-resilient crops can be accelerated if local factors are incorporated in the design and financing of global research. To get initiatives like these to scale, to sustain productivity, and to develop human capital and capability, it is imperative to connect to local reality and – where needed - change habits, practices and policies.

Effective leverage of the DFF-output will contribute to a change in approach to fragility and conflict. Each of the ideas and proposals at the DFF in Dublin requires leadership and a willingness to commit to long-term cooperation. In the coming months, the DFF-team will discuss with experts inside and outside the WBG the merits of the various proposals made, zooming in on their scaling potential in particular. A select number of proposals will be the topic of a high-level side event at the WBG-IMF Annual Meetings in October 2016. In the first or second quarter of 2017, this DFF on opportunities in fragile markets will be followed up by a regional event with the same topic and under the same format, most likely in Sierra Leone.

About the 2016 Development Finance Forum: A Community of Leaders and Practitioners in Development Finance

The annual Development Finance Forum (DFF) is a global event focused on public-private alignment for increased investment in developing countries. As in Rotterdam in 2015, the Dublin meeting was organized as a “design forum” focussed on exploring new ideas and approaches. Facilitated by the Value Web - www.valueweb.org, the Dublin DFF provided an open space that brought together individuals with unique experiences and perspectives. Throughout the two-day event, there was a strong and common resolve to connect the firepower of global public and private finance to the creation of opportunities for people and households in fragile situations. The discussions were shaped by a shared understanding of the urgent need for realistic partnerships and innovative financing solutions to stimulate private sector investment in fragile markets. The candor, creativity and willingness of participants to share their expertise and experience produced a rich output and good basis for action. In addition to generating ideas, important connections were made and strengthened, indispensable to catalyze partnerships and action.

Ideas and proposals put forward in this report are the product of these open discussions among knowledgeable and experienced professionals. They do not reflect formal policies or positions of organizations or institutions but serve to influence future design of transformative approaches and inform the global dialogue around private investment in FCS.

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Main messages

A consensus emerged at the DFF that there are opportunities to help move markets and societies in fragile and conflict situations (FCS) to stability and prosperity. Private flows have come to dominate capital transfers worldwide. Net private capital flows to developing countries amounted to approximately US$ 1 trillion per year in the post-crisis period until 2013, with an increasing share representing South-South investment. In 2014, official development assistance (ODA) from members of the OECD’s Development Assistance Committee (DAC) totaled about US$135 billion. However, the destinations for global capital flows remain highly concentrated. Foreign direct investment targets a small number of primarily middle-income countries and sectors, and access to private credit in low-income and lower-middle-income countries remains difficult. This is particularly true for FCS, where private resources are limited and domestic resources constrained, with ODA continuing to play a critical role. To connect the sustainable development agenda to global private financing flows, FCS require more public investment, with significantly improved leveraging and mobilizing capacity.

Participants discussed opportunities to scale-up finance in FCS through the lens of three sectors: agriculture; urban development; and energy. Examples of constraints and solutions to overcome such challenges were identified. Ideas and actionable proposals on how to improve public and private alignment in FCS and increase private investments are described in the following chapters of this report. Below follows a summary of the main actions, which pivot around risk, innovation and governance.

• Scale-up the use of guarantees by international financial institutions. Risks in fragile markets are significant and different from those in non-fragile markets. In FCS, the risk of instability is most dominant. Because of their ownership structures and mandates multilateral development banks are well-positioned to insure these risks, and to mediate disputes before they turn into losses. Political risk insurance (PRI) in FCS is traditionally concentrated in the natural resource sectors but is expanding in other sectors such as infrastructure and financial services. There is strong potential for growth, however, in order to expand, investors will need to become more familiar with the range of products and services offered by PRI. The capital base of political risk insurance agencies such as the Multilateral Investment Guarantee Agency (MIGA) will also need to be sufficient to meet increased demand in FCS.

• Consider opening up MIGA to cover domestic investors. MIGA currently provides risk coverage only to foreign investment, with the exception of the West Bank and Gaza Investment Guarantee Fund. Domestic investors are a substantial source of finance and are equally at risk. Extending and scaling-up MIGA coverage to domestic investors, including for SME investment, would help create a level-playing field for all investors – international and domestic.

• Reduce the first loss risk of pioneer investors. This surfaced as one of the main topics of conversation in Dublin and a sine qua non to spur growth and opportunities in fragile markets. Pioneer investors in FCS face a number of risks— including lack of market information, political uncertainty and poor infrastructure. Also, they often see their first-mover advantage disappear as soon as new entrants appear in the market with significantly lower costs and risks. Helping pioneer investors hedge against these risks needs to be an important component in redesigning the use of ODA and the support of MDBs in fragile situations. In the absence of solid domestic finance in FCS, participants recommended that public development finance be used to support pioneer investors, for instance by (i) helping to finance better connectedness— digital- and hard infrastructure; (ii) helping to cover part of feasibility study costs for pioneering businesses; (iii) providing capital at below market rates to reduce capital risks; (iv) insuring against political, default and currency risks; and (v) active participation of publicly owned development finance institutions in investment partnerships. To ensure such derisking mechanisms are effectively scaled up where it is most needed and to avoid market distortion, participants called for transparency, for instance by using the value-added of multilateral platforms, such as the International Development Association (IDA), the International Finance Corporation (IFC) and MIGA.

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• Unbundle, or ‘top-slice’, risk. This was recommended as a means to attract patient capital investors to fragile markets. The Azito power plant in Cote d’Ivoire was cited. The project demonstrates that risks and costs change significantly over the lifetime of a project. The design stage of a project may be attractive for pioneering venture capital while the high-risk, large investment construction phase can only be financed by public risk capital. The operationalization phase requires large, low-risk investments, attractive to institutional investors with patient capital, such as European pension funds5 Moreover, ‘syndicating’ these investments into funds that also hold infrastructure investments from emerging and OECD-markets can further diversify and reduce risk.

• Standardize. Researching the characteristics and specific requirements of individual projects drives up the preparation time and preparatory cost of infrastructure projects in fragile states. It makes these projects hard to value. Investors are easily deterred as they are used to and in need of a single, short effort to understand and value projects. Creating an environment that allows infrastructure securities to become an asset class is essential for attracting investors, in particular in the fixed income segment. This kind of standardization is a public good, which governments and multilateral organizations can help develop.

• ‘Reset’ investment authorities and ‘commercial’ diplomacy. Creating attractive conditions for investment requires a change in the way the public sector engages investors. Countries receiving investment need to shift the scope and level of services provided by their local investment agencies, from ‘one-stamp’ windows focused only on regulations and approvals, to advisory services, much like the way the Irish Development Authority (IDA) attracted investment into Ireland. Similarly, the diplomatic network of the investing countries should not just carry out ‘commercial’ diplomacy, with a short-term transactional focus, but rather embed ‘economic’ diplomacy in their foreign- and development objectives, with a longer-term transformational focus.

• Invest in the enabling environment for technology adoption. The success of mobile phone technology in Sub-Sahara Africa is often referred to as proof that FCS have ‘an advantage of backwardness’6 i.e. the potential to leapfrog in their development by adopting new technologies. Yet, participants in Dublin felt that it is actually difficult for technologies to be adopted at a large enough scale to ensure genuine leapfrogging. During the DFF, the need for enabling interventions was emphasized. Investments in the right kinds of knowledge and training are needed, for instance facilitated through the creation of technology hubs. Moreover, as is clearly demonstrated in agriculture, technologies do not stand a chance of being widely adopted if there is no supporting ecosystem for pioneering technology providers. This means investments in value chains (e.g. supplier reliability, access to finance), in public goods such as broadband and power, and in regulation, such as quality standards and licenses. Last but not least, a pioneer technology business entrepreneur whose innovation and product is too far in the front of the market, runs high risks of not getting to scale. In the complex FCS markets, the adage of ‘scale begets scale’ rules and it is often better if new technologies can piggyback on other new technologies from competitors and partners.

• Systematically explore crowdfunding/crowd investing possibilities. During the Energy, Agriculture and Urban Development sessions, the potential of crowdfunding in FCS was emphasized. Innovations in these sectors may be well suited for crowdfunding because they are universally needed (such as food and energy), local in nature, dependent on local market acceptance and relatively challenging to fund through traditional mechanisms, in particular in FCS. The radical transparency in crowdfunding is a powerful mechanism for investment selection and deal-sourcing. Within the FCS context, crowdfunding’s social feedback mechanisms help build community- and social cohesion. Moreover, crowdfunding is particularly fit to be a more effective channel for remittances from the sizeable FCS-diaspora. Trusted institutions, such as the WBG, can help support the adoption of crowdfunding, help governments design and adapt the ‘light touch’ regulatory framework to it and help build

5 - See also the example of Climate Investor One6 -The phrase originates from Thorstein Veblen’s 1915-analysis of industrial growth in Imperial Germany. In this book, Imperial Germany and the Industrial Revolution (New York: Macmillan, 1915), Veblen refers to the “merits of borrowing” and to the “penalty of taking the lead”. He used these concepts to show that Imperial Germany drew many advantages from its state of relative backwardness.

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capacity. The WBG is also uniquely positioned to deploy infrastructure, enable capacity, and invest (both directly and indirectly) in ways that could extend the impact of crowdfunded investment and reduce the barriers to financing pioneer entrepreneurs and technology-focused SMEs, among others.

• Provide local currency loans. Exposure to currency risks when lending in hard currency can be devastating for local entrepreneurs and needs to be minimized. Opportunities to hedge currency risks for local entrepreneurs will need to urgently expand in a context of growing private capital flows to FCS. Such initiatives will help develop local financial markets and provide entrepreneurs with the long-term horizon they need to invest in scaling up.

• Improve the regulatory environment. Charters, laws and regulations matter. Much progress has been made over the past decade in establishing international norms for conduct and transparency. But more is needed, in particular to attract blended finance solutions where profit and purpose can transparently go together. From upholding the sanctity of contracts to public expenditure rules, an effort is needed, with public money, to build capacity to design and uphold regulation. This is not only a matter of domestic regulation in FCS. A stronger effort also needs to be made to improve policy in the FDI source countries, particularly to help combat illicit financial flows. The Extractive Industries Transparency Initiative (EITI) serves as a model to follow and has inspired new initiatives in different markets, such as the Construction Sector Transparency Initiative (CoST).

• Invest in governance. Public investment in government capacity is essential for a return to stability. These can never be short-term interventions. They need to be carefully coordinated and require long-term commitment from development financiers, multilateral institutions, NGOs and political actors across factions.

• A ‘whole-of-government’-approach remains critical: the three D’s (Development, Diplomacy, and Defense) need to continue their close cooperation.

• Better generation of and access to data will help make governance interventions and investments far more effective. Technology and finance can be deployed and scaled up to support increased international public investments in basic statistical systems, vital registration exercises and population censuses. Use of technology and crowd-sourcing techniques need to be intensified in order to provide real-time data for policy makers in FCS, essential for the speed and effectiveness of interventions in complex circumstances. These interventions require stamina, patience and a willingness to spend substantial development funds (ODA) on important but not so mediagenic long-term capacity building programs.

• Scaling up support to the capacity of subnational governance is critical. Service delivery at subnational level has the potential to connect far better to the needs of people and businesses.

• Such programs, if designed right, can help the public sector capture the positive spillovers of FDI, such as stronger value chains, improved competitiveness and product quality, worker protection and transitions from the informal to the formal economy. It is in these kind of benign public sector circumstances that the flywheel effect of Foreign Direct Investment can help lift FCS out of the cycle of instability, and connect societies, households and people to the global economy.

• ‘Reset’ investment authorities and ‘commercial’ diplomacy. Creating attractive conditions for investment requires a change in the way the public sector engages entrepreneurs and investors. Countries receiving investment need to shift the scope and level of services provided by their local investment agencies, from ‘one-stamp’ windows focused only on regulations and approvals, to advisory services, much like the way the Irish Development Authority (IDA) attracted investment into Ireland. Similarly, the diplomatic network of the investing countries should not just carry out ‘commercial’ diplomacy, with a short-term transactional focus, but rather embed ‘economic’ diplomacy in their foreign- and development objectives, with a longer-term transformational focus.

• Invest in skills and jobs for young people. FCS are characterized by booming population growth. Of the 67 countries in the world that are currently experiencing a “youth bulge”, 60 are affected by unrest and fragility.

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In all the sessions in Dublin, the urgency to address youth employment came up, both in terms of seizing the opportunity of the demographic dividend, as well as avoiding stagnant or deteriorating labor markets in FCS. Investments in the educational opportunities for adolescents, in addition to primary education, need to increase. Likewise, the creation of technology hubs (see above on technology) explicitly should enable access of young people to new skills and technologies in the field of digitization. Lack of reliable data and evidence of the impact of youth-related development programs are a bottleneck in carrying out credible and effective youth-related programming. Such programming is in particular relevant for addressing the challenges of refugees and the forcibly displaced and ensure that their lives and livelihoods are incorporated in robust economic and social structures.

• Above all, stay committed! Participants in Dublin emphasized that short-term approaches and interventions can be counterproductive in FCS. Measures described above should increase the comfort to engage in FCS and bring down the risk perceptions of investors and public financiers. There is also a need to address internal factors that are less related to risk, but more to the patience of the broader constituencies of investors and public authorities, whether shareholders or parliamentarians. The emphasis in the global Financing for Development agenda on long-term approaches, is a central design principle for programs and partnerships in FCS. Long-term engagement, in combination with agility and flexibility, will help create a culture of cooperation and partnerships, and build the unity of purpose needed to transform.