16 JUNE 1998/WORKING DRAFT/IN# INFORMATION NOTE ON THE NEED FOR FINANCIAL RESOURCES FOR SUSTAINABLE FOREST MANAGEMENT (IFF Programme Element II.a) New York, June 1998 This is a non-official document, for information only, prepared by the IFF Secretariat, in collaboration with United Nations Development Programme (UNDP), a member organization of the informal, high level Interagency Task Force on Forests (ITFF). It provides additional background information to delegations attending the second session of the Intergovernmental Forum on Forests (Geneva, 24 August-4 September 1998). Published in English only. Executive summary Substantial financial resources are needed for sustainable forest management of all types of forests but new and additional resources are not seen forthcoming as expected, despite the commitments, from both international as well as domestic public sources. The financing situation in developing countries with low forest cover is even more serious. Private capital flows to forest activities are increasing, mostly from international sources but also from within some of the developing countries. However, such capital flows, aimed at more traditional extractive operations, may not contribute significantly to sustainable forest management (SFM). Private sector also faces problems in accessing the start-up capital, overcoming fear of risks and uncertainties involved in newer SFM operations. Private sector capital flow is unevenly targeted and is aimed generally to countries with extensive forest cover. There is a need for policy reforms providing tax, financial and other incentives conductive to SFM while eliminating subsidies detrimental to SFM. The Note discusses some conventional and innovative financial mechanisms used in other sectors and countries and their potential use in the forest sector of developing countries. Also discussed are the issues related to an international forest fund, existing GEF and other instruments, and recent developments such as, Kyoto Protocol that has potentially opened up a whole new window of opportunities for forest sector financing through its carbon emission offsets potentials, while the Asian financial crisis has different implications on capital flow to forest sector. The main conclusions and proposals for further actions are summarized in Section V. CONTENTS I. Introduction A. Mandate B. Scope II. General Overview of IPF Conclusions and Proposals for Action III. Current Status and Issues of Forest Financing A. Current Status 1. The Trend 2. Financial Need and Sources for Financing Sustainable Forestry 3. Implementation Status of the IPF proposals for Action B. Issues of Forest Financing 1. Constraints 2. Opportunities IV. Recent Developments A. Climate Change, carbon and Forest Linkage: A post-Kyoto Development B. Asian Currency and Financial Crisis V. International Forest Fund and other Innovative Financial Mechanisms A. International Forest Fund B. Innovative Financing Mechanisms for Forestry 1. Introduction 2. Domestic Public Sources 3. Private Sources 4. International Public Sources 5. Some Emerging Innovative Financing Concepts VI. Preliminary Conclusions and Options for Further Action A. Conclusions B. Proposals for Action REFERENCES -------------------------------------------- I. INTRODUCTION A. Mandate 1. In its program of work, the Intergovernmental Forum on Forests (IFF) decided that at its forthcoming sessions, it should: 2. "Consider urgently the following options for action, as contained in paragraph 68 of the report of the IPF on its fourth session (E/CN.17/1997/12): (i) to urge the establishment of an international fund to support activities for sustainable forest management; (ii) to pursue action to enhance funding in other ways, inter alia, by inviting the United Nations Development Programme and the Bretton Woods Institutions, together with other relevant international organizations, to explore innovative ways both to use existing financial mechanisms more effectively and to generate new and additional public and private financial resources at the domestic and international levels in order to support activities for the management, conservation and sustainable development of all types of forests." Scope 3. This Information Note provides updated information and a preliminary analysis of IFF Program Element II.a designated for background discussion at the second session of the Forum. This Note builds on previous IPF reports on financial assistance and other areas as specified in the first session of the IFF namely, the establishment of an international fund and the exploration of ways to use existing financial mechanisms more effectively and to generate new and innovative mechanisms. 4. In particular, the Note: (a) reviews the IPF conclusions and proposals for action related to financing; (b) assesses current status, new developments and issues of financing; (c) identifies further work needed and suggests some preliminary conclusions. 5. This Note was prepared by the UNDP, in consultation with the IFF Secretariat. II. GENERAL OVERVIEW OF IPFžS CONCLUSIONS AND PROPOSALS FOR ACTION 6. The Intergovernmental Panel on Forests, at its fourth session in the issues of financial resources for the sustainable forest management (SFM) concluded that (paragraphs 59-66 in E/CN.17/1997/12): - the issues of financial assistance were crosscutting, interlinked and essential; - current financial resources were insufficient; - financial needs should be met by domestic sources but international financial sources are vital; - the Overseas Development Assistance (ODA) remains the main source of external public funding, particularly in those developing countries with low forest cover; - the declining trend of ODA is a matter of concern; - forestry projects contributing to global environmental benefits should also get support through available international mechanisms such as the GEF programs; - private capital flows to developing countries is an encouraging phenomenon, but their flows are uneven; - there is a need for an enhanced international cooperation to address developing countries debt problems; - market-based instruments, such as taxes, levies, user fees and domestic public investments desirable; - properly valuing forest resources and creating markets that reward sustainable forest management would contribute to SFM; - in-country coordination among donors is crucial. 7. Based on those findings, the Panel proposed a few specific activities for sustainable forest management for member countries (paragraph 67-71). The Panel urged all countries, both developed and developing as well as international organizations to: - act collectively to increase financial resources; - increase the ODA but also improve the absorptive capacity of developing countries to use such resources, and enhance their domestic revenue generation capacity; and - improve coordination among donors and recipient countries, base coordination and collaboration on country-driven national forest programs and avoid duplications and inefficient allocation of international public funds. 8. The Panel urged the developing countries to: - prioritize forestry activities, internalize externalities associated with land use and forest policies, maximize rent capture, reinvest greater share of forest revenues in sustainable forestry, and better coordinate; - encourage private sector investments in forestry through various financial and tax incentives; - increase revenues through market-based instruments; - encourage voluntary codes of conduct by private sector; - encourage mobilizing local community financial resources. 9. The Panel also recalled the Rio declaration stating the need for new and additional financial resources for developing countries, and urged donor community to: - work with developing countries to identify the need and resource availability of those countries for SFM; - increase concessional lending through international institutions; - continue efforts to find efficient, equitable, development-oriented and durable solutions to debt problems of developing countries; and - encourage their private sector to invest in SFM activities in developing countries through appropriate financial incentives and guarantees. 10. While the panel invited international organizations such as UNDP and Bretton Wood institutions to explore innovative financial mechanisms, it found the world community not yet ready to establish an international fund devoted to sustainable forest management. 11. By revisiting the issue of an international fund, and urging the UNDP, Bretton Woods and other institutions to continue engaging on innovative financing mechanisms, the Intergovernmental Forum on forests (IFF) at its first session indicated a continued willingness of the world community to consider ways to generate and allocate resources for sustainable forest management. III. CURRENT STATUS AND ISSUES OF FOREST FINANCING A. Current Status 1. The Trend 12. The Fourth Expert Group Meeting on Financial Issues of Agenda 21, co- sponsored by the Governments of The Netherlands and Chile, United Nations Department of Policy Coordination and Sustainable Development (UN/DPCSD), United Nations Economic Commission for Latin America and Caribbean (UN/ECLAC), and the Inter-American Development Bank (IDB) in early 1997 (E/CN.17/1997/18)) observed the following three general financing trends under the Agenda 21 in the sustainable development activities in the world since the 1992 Rio Conference: (1) policy reforms favorable to environmental conservation and economic development are increasing; (2) both official development assistance (ODA) and domestic resource mobilization have fallen far short of the commitments made at Rio; and (3) private capital flows from developed to developing countries have increased significantly. 13. Generally speaking, the forest sector has a similar experience. Several countries, both developed and developing, are embarking upon policy reforms in forest sector focusing on sustainable conservation, management and sustainable development of all types of forests. 2. Financial Need and Sources for Financing Sustainable Forestry The need 14. The UNCED stipulated a need for $31.25 billion annually for the period 1993-2000 to promote sustainable forest development through four programs namely, (i) institutional development, (ii) resource development, (iii) sustainable utilization, and (iv) assessment and monitoring. The UNCED estimate, however, does not account for the economic, social and environmental losses due to deforestation. The estimate also does not include the costs of implementing various forest components under other chapters of Agenda 21, under the Conventions, and the full cost of implementing Forest Principles. Therefore, the UNCED estimate is very conservative. When the costs to counter depreciation of forest capital due to deforestation, and other social and environmental effects are taken into account, it has been estimated that the required funding for sustainable forest management would exceed $70 billion per year (Chandrasekharan 1997). However, actual funding available in the forest sector from all sources fall far short of even the more conservative estimate of the UNCED. Domestic public sources 15. The UNCED aimed to raise $25.58 billion (82%) of the $31.25 billion annually from domestic sources (both public and private) and $5.67 billion (18%) from foreign sources. Given the social and economic constraints of most developing countries, the capability to mobilize such a large share of domestic funds appears very ambitious. Some countries like Bangladesh and Tanzania can finance less than 20 percent of their current forestry expenses through domestic resources (CSD 1996a). For various reasons, many countries are unable to raise public funds for the forest sector. Problems are further compounded by low levels of general economic growth, lower priority of the forest sector in national policy (thus smaller budget allocation), and the attitude to treat forests as a source of quick revenues or even as an obstacle to economic development. Domestic private sources 16. Domestic private sector participation is an important source of financing forestry and forest industries. Despite the new wave of economic liberalization, many developing countries have limited private participation in forestry, particularly in the areas meaningful to sustainable forest management. Only a few developing countries such as Brazil and Chile have substantial private investment in forest products industries. International public sources 17. Traditionally, international funding from bilateral and multilateral sources in the form of official development assistance (ODA) has remained the primary sources of assistance to the forestry sector in developing countries. ODA generally includes grants, concessional loans and technical assistance through bilateral or multilateral mediums. 18. The ODA generally shows a declining trend in the 1990s. The ODA in forestry for the year 1993 was only $1.54 billion, a little more than a quarter of what was estimated at the Rio. Ironically, ODA in general is declining in the years following the UNCED summit. Moreover, the flow of ODA is not quite equitable among the countries. International private sources 19. The rapid globalization of the economy has seen an increasing mobilization of international financial capital in developing countries. Growth in world trade is one major factor in the expanded globalization process; developing countries in general are increasing their trade volume at much faster rates than the industrialized nations, Asia being the top performer (ADB 1997). 20. In 1996, total private capital flows amounted $244 billion, for all sectors and accounting for 80 percent of total long-term capital flows ($285 billion) in developing countries. The private capital flows have increased by more than five times in 1996 compared to that in 1990. However, such private investments do not flow to regions or countries in a uniformly (WB 1997, ADB 1997). 21. Private capital flows in the forest sector, although difficult to measure, are growing and estimated to be around $8 billion to $10 billion a year from both domestic and foreign sources. Such private capital flows originate mainly from developed countries but flows between developing countries also are growing. As with the general trend, Trans-National corporations (TNCs) are the main source of private foreign capital flow in forestry in developing countries. 22. These foreign capital flows in forestry in developing countries represent both a potential opportunity to attract private investment in forestry, particularly in light of declining external public funding, and a possible threat to long-term forestry if business as usual continues. Much of current private capital flows is directed to conventional extractive operations and export trade with an objective to capture as much rent as possible (Chandrasekharan 1997). 23. Yet, the involvement of TNCs could complement developing countries in capital formation as well as facilitate transfer of technologies, human capital development and expansion of markets. Nevertheless, investment by TNCs and other private sources are driven by their profit motives and may not always coincide with the national interest of the recipient countries. Moreover, such capital flows generally favor countries with substantial forest cover and other comparative advantages, while developing countries with low forest cover are less attractive for private sector investment. 24. Despite the increasing trend of private capital flows to developing countries, the decline in official international capital is a matter of serious concern because long-term development aid catalyzes and complements private investments. Cutbacks in international aid affects forestry and environment programs which are essential elements for economic and social development of a country, and yet generally attract little private sector funds due to their "public good" characteristics. This has a severe impact on a number of least developed countries that have little capacity to attract domestic and foreign private savings, and traditionally dependent on official development aid (Anonymous 1997). 3. Implementation status of the IPF proposals for action 25. Some countries with the help of international organizations have moved forward with the IPF proposals for action. Recently four countries: Costa Rica, Cameroon, Guyana and Vietnam started implementation of the IPF proposals for financial assistance with the help of the UNDP Global Program on Forests (GPF). The participating countries have started working independently to design financial mechanisms most suitable to their own contexts. 26. Guyana has recently adopted a new forest policy and is in the process of passing a body of laws to implement the policy. Vietnam has adopted a National Reforestation Program to mobilize its communities to finance substantial reforestation activities. 27. In another initiative, six countries, namely Finland, Honduras, Germany, Indonesia, Uganda and the UK, have planned to work together to implement the IPF proposals for action, including those on financing. B. Issues of Forest Financing 1. Constraints 28. Financing in forestry is a complex process due to many special features of forestry. Sustainable forestry is an emerging sector creating further complications. Forest represents both inventory and capital. A long rotation period causes investment uncertainties because of biological and market risks affecting final returns on the investment. Such time requirements also highlight other characteristics of forestry: irreversibility and delayed cashflow. A forest can be liquidated rather quickly but replacing it is difficult and uncertain. These uncertainties create problems in gaining access to credit and in setting terms. There are externalities associated in growing trees and other forestry operations that are not always reflected in conventional market transactions (McGaughey and Gregersen 1988). 29. Private investors will always compare investment opportunities, potential profits and risks in different sectors and ventures. Despite the complexities inherent in forestry, studies suggest that investment in timberland, the most conventional forestry business enterprise, fare well. For the period 1946-88, for example, data on the U.S. capital markets indicated that timberland outperformed many popular investments on a rate of return basis (Zinkhan et al. 1992). 30. Private capital flows in sustainable forest products industries and trade depend on real and perceived openness in industrial and trade policies of specific countries, political and economic stability, and domestic and international environmental concerns. Low business orientation of forestry administration in most developing countries inhibits formulation of policies, which encourages private sector participation in forest products sector. In many instances, the forest sector fails to market itself as a viable investment option and gain political and other support. Moreover, lack of coordination among main stakeholders including donors constrains sustainable forest industry development. 31. There are number of other constraints specific to the forest sector in developing country: forestry commands a low priority in public policy decisions resulting in marginal resource allocation for its sustainable management. Due to accounting distortion, its contributions to national economic growth are undervalued in favor of other sectors like agriculture and animal husbandry. Thus, forests are liquidated to encourage conversion to other land uses without compensation. Additionally, the general problems of low economic development of most developing countries constrain resources, willingness (resolution), capability and regulatory as well as market institutions to finance long-term activities such as forestry. 2. Opportunities 32. Demands for timber and other products from forests tend to increase with the increase in population and income worldwide. The demands for environmental services produced from forests, particularly those from tropical forests are also rising. In this context, the opportunities for new and additional forestry investment seem to be rather increasing. A FAO survey involving senior forestry officials and donor representatives in developing regions indicated favorable investment opportunities in creating new forest plantations, forest products industries (both small- and large- scale), processing facilities for non-wood products, eco-tourism prospects, and emerging environmental services such as carbon sequestration and bio- diversity prospecting (Chipeta 1996). 33. A typical commercial forestland in private ownership exhibits many analogies to the conventional capital markets such as government or corporate bonds. However, there is also much dissimilarity between investments in forestland and on stock markets. Forestland investment has remained to be a prudent choice for some investors in the USA. The forestlands generally offer greater inflation protection because biological growth of timber is less sensitive to the financial and economic fluctuations that influence common stocks and bonds (Zinkhan et al. 1992). 34. Due to distinct characteristics of forests described above, many institutional investors in the United States, such as the insurance companies, pension funds and mutual funds are increasingly finding forestland as an attractive investment vehicle in their portfolio diversification scheme so as to meet their financial goals based on their expected rates of returns, risk-tolerance and stability desired. I. RECENT DEVELOPMENTS A. Climate Change, Carbon and Forest Linkage: A post-Kyoto Development 35. The Kyoto Protocol of the United Nations Framework Convention on Climate Change (UNFCCC) in 1997 (FCCC/CP/1997/L.7/Add.1) has created new interests in forests. Its recognition of forests as a carbon sink and an agreement to establish an international emission offset trading regime has opened a potential source of revenues in forest sector. Countries that grow and maintain forest resources thus can be financed (compensated) by countries or industries that emit carbon dioxide using a market-based instrument. 36. The potential for mitigating carbon dioxide emission through the conservation of existing carbon pools and sequestration of carbon in new forests, substitution of more energy intensive materials with forest products and substitution of fossil fuels with biomass fuels has opened up a whole new array of revenue generating capacity from ecological/environmental benefits and services provided by forests. Forests may now be put to produce services in offsetting carbon emission. Nevertheless, many technical and legal issues are yet to be clarified. For example, the carbon storage values of forests are highly speculative at present. While a growing forest sequesters carbon, once matured it may produce equal amount of carbon, as it sequester producing a zero effect on net carbon sequestration. Being global in dimension, it also calls for a global mechanism to resolve issues, and regulate and monitor transactions. 37. Although much needs to be examined and resolved, in terms of biophysical, technical, legal and economic aspects of forestry and carbon offsets there are new possibilities and opportunities almost beyond the capability of the sector and which could impact in a very significant way on how forests would be managed in the future. There could be number of trends flowing from the Kyoto Protocol in the forest sector: - increase in plantation forests, - increasing use of forest biomass as an energy source, - a substitution of other more energy intensive materials by wood products, - an increase in conservation or protected areas, and - a lowering or reversal of the rate of deforestation. 38. Forest management to date has been dominated by wood production objective although other multiple objectives such as soil, water or wildlife conservation and provision of recreational service are also accommodated to a varying degree. The possibility of the carbon sequestration and storage in forests as a commercial reality could significantly impact the silvicultural practices and economics of forest management. 39. Traditionally, private investments in forestry were limited to forest products industry and in shares in companies with large forest estates. Later, in recent decades third party investments in plantations has emerged in many developed countries, for example, pension funds, insurance companies and mutual funds in the USA. As a result of the Kyoto Protocol, many new kinds of investors may emerge in forestry, including straight speculators looking for windfall profit if carbon trading becomes viable and groups including nations and industries that need carbon credits. The potential financial scale of carbon trading is large, with price estimates running from $10 to $100 per tonne. Some use of carbon offset mechanisms can be currently seen in Belize, Costa Rica, Czech Republic, Ecuador, Guatemala, Indonesia, Malaysia, Paraguay, Russia, Uganda and certain states of the USA (Brand 1998, FAO 1997). 40. Several countries and organizations are interested to examine the carbon offsets potential of forests and financial opportunities in it. Many initiatives are under consideration. The World Bank is studying prerequisites for creating carbon offsets markets, feasibility of using such offsets markets to promote forest conservation goals, issues related to various climate change instruments including carbon investment under its Global Carbon Trading Initiatives. UNDPžs Programme on Forests concentrates on innovative financing opportunities for forest programmes including carbon offset trading. FAO, in collaboration with the UN Framework Convention on Climate Change, interested countries and other partners, is involved on several aspects including, the role of wood fuel as a renewable-carbon neutral- source of energy, definitions of forest cover and biomass related terminology and assessment of forest resources and related capacity for carbon sequestration and storage by forest vegetation, in the context of FAOžs Global Forest Resources Assessment 2000. 41. Costa Rica has been successfully using carbon offset trading to generate funding for sustainable forest management (SFM). Guyana is exploring market potentials and marketing strategies of its forest-based carbon offsets market. 42. Some initiatives from private sectors of industrialized countries are also seen in this direction. The Sampson Group in the USA is an example of private sector implementing forestry projects for carbon offsets. Similarly, Alabama Power Company offers financial incentives to private landowners to plant trees to offset carbon emission. B. Asian currency crisis 43. The currency and financial crisis in a number of Asian countries in 1997 has far reaching consequences in national, regional and global economies. In the forest sector, the immediate impact was severe; probably it has a greater impact on the region's forests than any other event during the last 15 years (CIFOR News, March 18, 1998). In timber producer countries, import costs for consumables and spares rose and the costs of financing soared. 44. In timber producer countries, the costs of financing soared while the price of many timber products dropped. The instability of the banking sector made it difficult for timber exporters to obtain loans for working capital or commercial credits to import machinery and spare parts. The currency devaluation created some economic opportunities as certain commodity exports become more competitive on the international market. However, it limited the governmentžs capacity to maintain subsidies deemed necessary to achieve certain social and economic goals (CIFOR News, 18 March and 1 April 1998). 45. The crisis in Asia has given heightened attention to the role of capital flows in economic development. Although the crisis did not undermine the role of capital movements in economic progress in the Asian countries before the crisis erupted, it however, did reveal the weaknesses and shortcomings of those economies, exposed the risks of uncontrolled capital flows amidst weak national financial institutions. It also underscored the importance of orderly and properly sequenced liberalization of capital movements, the need for appropriate macroeconomic and exchange rate policies, the critical role of sound financial sectors, and effective prudential and supervisory systems. It showed that without sound and transparent financial and banking systems in a country it is difficult to sustain an economic growth. 46. How could the Asian crisis impact on financial mobilization in forestry, particularly, for sustainable forest management (SFM) is yet to be seen. However, it may have made the financing in long-term SFM operations even more scarce and difficult. International community needs to closely monitor the events and consider developing emergency funds for crisis management. II. INTERNATIONAL FOREST FUND AND OTHER INNOVATIVE FINANCING MECHANISMS A. International Forest Fund 47. The first session of the IFF explicitly urged all concerned to consider the establishment of an international fund to support activities for sustainable forest management. There exist a number of international instruments with some bearings to forests. Most notable are the Convention of Biological Diversity, the Convention to Combat Desertification, the International Tropical Timber Agreement and Global Environment Facility. UNFCCC has been discussed above. Those instruments are designed to meet their own specialized activities and may address sustainable forest management issues only partially. Sustainable forest management involves all aspects of forestry and land use including conservation, management, utilization, processing industries and trade of timber and non-timber products and services and welfare of forest-dependent communities. Therefore, the comprehensive need of an international forest fund cannot effectively be met by these specialized international funding mechanisms on their own. 48. Some developing countries have low forest cover and low GDP, which limit their capacity to invest in sustainable forest management. Many such countries therefore, fail to attract foreign private sector funds to finance in their forestry sector because of commercial reasons but sustainable management of their forests could be vital for their economy. Specialized international instruments mentioned earlier may not be forthcoming to support forestry issues holistically in those countries. In such cases, international forest funds could be very important source of financing. 49. The Global Environment Facility (GEF) is one such specialized funding mechanism which has some bearing on financing some forestry activities that have direct global environmental benefits. Activities concerning land degradation, primarily desertification and deforestation are eligible for funding from GEF but it does not finance other aspects of forestry specific to SFM. A comprehensive evaluation of GEF and other international financial mechanisms could help assess whether a special international forest fund is desirable. B. Innovative Financing Mechanisms for Forestry 1. Introduction 50. Innovative financing involves strategies that address special features of forestry (e.g., long rotation periods, uncertainties, risks, environmental benefits) and take benefits from available established private sector financial/capital markets and public sources. 51. The "debt-for-nature swap," perhaps the oldest innovative financing mechanism in forestry operations has retired $159 million in face value of debt so far. However, the use of this program has declined in recent years (WB 1997). 2. Domestic Public Sources 52. Strategies to increase domestic public funds for forestry should address increasing public revenues from forests and allocate funds appropriately to promote SFM. Methods to increase forest revenues should include proper pricing of goods and services produced from public forests so that market prices reflect true scarcity values of forest resources. 53. Forest Fund is a set up commonly used to finance specific activities for forest development. Most Latin American countries have such funds in use, so with Indonesia and British Columbia, Canada. Sources for most such funds come from earmarked taxes and receipts from sales of forest products. Although the funds provide a ready source of financing for forestry, they do face criticism from optimal investment criteria of public funds. Earmarking of sectoral revenues for specific purposes is a common practice, for example, property tax revenues for school financing in many states of the USA. However, it is also a controversial policy, and is criticized as making a public finance system very inflexible and resource allocation inefficient (McGaughey and Gregersen 1988, Crossley et al. 1996). 54. Use fees, levies, charges are other ways to increase revenues by charging beneficiaries for the range of services provided by forests, particularly for watershed protection. A mechanism that required downstream beneficiaries to pay the upstream forest landowners for their watershed services has long helped to fund upland conservation in Japan. In Costa Rica, the national electricity company, the Instituto Costarricense de Electricidad (ICE) has remained the major source of funding for upland watershed and forest management, while all hydroelectric companies in Columbia transfer 2 percent of their revenues for watershed management programs. Such mechanisms are easily adoptable in other developing countries to generate additional public funds for sustainable forest management (McGaughey and Gregersen 1988, FAO 1997). 3. Private Sources 55. The issue in increasing private sector financing (both domestic and foreign) involves "selling" forestry opportunities as equally viable and competitive as other investment options. The lack of interest in forestry investment by private landowners is a problem common to both developing and developed countries. In general, strategies to generate interest in forestry investment include: (1) increasing private returns through financial subsidies and public technical assistance; (2) reducing investment risk and uncertainty; and (3) eliminating or significantly reducing the cash flow problems associated with long-term nature of forestry operations. 56. Some of the ways to address the low financial rates of return include: (i) fiscal subsidies and incentives; (ii) beneficiaries cost-sharing; and (iii) increasing productivity and efficiency of operation. 57. Reducing cash-flow problems in forestry investment would be a significant incentive to attract private investment in forestry. For this, special forestry concessional loans with longer grace and payback periods, contractual arrangement with industries and other forest product users, and cost-sharing by public sources (both domestic and ODA) need consideration. 58. Access to credits to small forestland owners and entrepreneurs can be improved through concessional micro-finance programs through private and public sources. While access to concessional credits is essential, steps to reduce risks of loan defaults to lending agencies are equally important. Public loan guarantees and other legal safety mechanisms to lenders, and some kind of cooperative arrangement among borrowers, particularly, small farmers improve credit availability. Access to credits can be improved through innovative concessional micro-finance programs through private and public sources. Grameen Bank of Bangladesh with the help of many NGOs is promoting community and private forestry in Bangladesh. There are as much as 2500 such small groups engaged in social forestry (CSD 1996b). CARE- Guatemala, FINCA-Costa Rica and the five country FINNIDA-PROCAFOR projects provide similar micro-finance services and technical assistance for small- scale community enterprises (Chandrasekharan 1997). 59. Other examples of low-interest concessional credits for forestry investments include: 1. Columbia, Fondo Forestal provides low interest guaranteed loans through private commercial banks for tree planting and other forestry activities. 2. Kenya, Government owned Agricultural Finance Corporation provides loans to individuals and cooperatives for growing fuelwood. 3. India, National Bank for Agriculture and Rural Development under its Farm Forestry Program facilitates loans for farm forestry to individuals and farmer organizations. 4. Brazil, The National petroleum Council finances the Small and Medium Property Reforestation Program. 5. Poland, Polish Environmental Bank, a national bank with 44 percent share from the National Fund provides loans with preferential terms to environment- sensitive projects, which can be replicable in forestry projects too. 60. While access to concessional lending is essential for landowners interested in forestry investment, steps to reduce risks of loan defaults to lending agencies are equally important. Public loan guarantees and some kind of cooperative arrangement among borrowers, particularly, small farmers improve credit availability. Appropriate legal framework to help secure lenders from defaults is essential. Similarly, mechanisms that help access of credits to landowners must also have a built-in mechanism to assure repayments. These micro-finance schemes not only provide access to credits for small farmers, but also ensure repayment by farmers through group collateral and peer pressures. These micro-finance schemes provide support to cash-poor entrepreneurs in various community businesses and show remarkable loan repayment record (Henderson 1998). 61. Tax incentives, subsidies, and abatements. Many governments use tax incentives such as tax holidays, exemptions, and abatements, lower tax rates, outright cash grants and other incentives to encourage private investment in particular economic sector such as manufacturing. Brazil has a long history of providing very generous tax incentives for establishing plantation forests. Similar program has been put in place in Panama since 1992 (Law no. 24 of November 23, 1992). Malaysia started giving full tax exemptions for plantation forestry under its two programs (for 10 years under the Pioneer Status and 5 years under the Investment Tax Allowance programs). A central issue with tax incentives is to understand what role such incentives play in investor's decision calculus and avoid subsidizing investors unnecessarily with public money. 62. Cost-share programs. Innovative financing in sustainable forestry may adopt some cost-share programs used in the USA. Under these programs, federal and state governments offer cost-sharing payments to partially offset private landowners' expenses for tree plantation and forest management activities. 63. Incremental tax financing is a mechanism used to pay back public financial support to establish a private industrial facility through a special fund. This mechanism can also be used in leveraging private sector investment in forest product industries. In addition, joint enterprises and modified conventional capital market instruments to finance sustainable forest management projects show good prospect. 64. Joint enterprises. Partnership between foreign, domestic, private and public sectors can also provide financial and technical resources in forestry development. 65. Capital market instruments. Engaging conventional capital markets through innovative infrastructure to channel capital to sustainable forest management show tremendous prospect. Such infrastructure mobilizes capital through equity and debt financing. Some emerging examples in this direction are (CSD 1996a): 1. Xylem Investment, Inc. 2. The Forestland Company, and 3. Precious Woods Ltd. 4. International public fund for forestry 66. In the context of stagnant or declining trend of ODA, available ODA should be used more efficiently and effectively. One such way could be to use ODA as a Seed money/Venture capital to leverage private funds. The World Bank's Sustainable Forest Market Transformation Initiative (SFMTI) demonstrates the use of international public funds to coalesce with private sector managers and leverage private capital in forest management and conservation activities. Finnish International Development Agency (FINNIDA) provided fund to the PROCAFOR, a Costa Rican NGO to help create local capital market infrastructure for poor rural farmers for forestry- related activities in Latin America is another example of using international public resources to leverage private funding in sustainable forestry activities. 5. Some emerging innovative financing concepts 67. New innovative mechanisms aiming to capture the value of global externalities and environmental benefits of forests include internationally tradable instruments or measures for international transfer payments. Most of these instruments are still at conceptual stage and require much dialogue and research before they actually are installed. Nevertheless, some ideas are getting serious consideration and a few are even being tried (FAO 1997). 68. Biodiversity patents or bio-prospecting fees involve creating an international legal basis for licensing biodiversity use and extracting a payment commensurate with its economic value. 69. Tobin tax is a tax on foreign exchange transactions that can fund environmental cleanups and sustainable forestry in developing countries. This tax is expected to generate substantial revenue as well as discourage short-term speculative type transactions across currencies and nations. Such speculative international capital movements are potential contributors to currency crises (e.g., Mexican peso crisis). 70. There are many political and economic implications in this proposal. The dominant players in foreign currency markets are private banks. Banks and other key players of international financial community, which benefit the most from such transactions are not ready to the idea of such taxing scheme. While volatile currency markets are bad for the national economy, they are advantageous to this community. Thus, it would be too optimistic to expect this concept becoming a reality in near future (McQuaig 1998). III. PRELIMINARY CONCLUSIONS AND OPTIONS FOR FURTHER ACTION 1. Conclusions 71. The conclusions reached at the fourth session of the IPF, regarding the issues of financial resources for sustainable forest management in developing countries, still hold true today. Financial needs for sustainable forest management are substantial while the capability of most developing countries to mobilize domestic resources is limited. Many policy reforms on improving public funding as well as in encouraging private financial inflows into SFM are yet to be achieved albeit some positive actions are seen in the case of some countries. 72. For many developing countries, particularly those with low levels of economic development and with scarce forest resources, the ODA will continue to be the major source of financing their forest sector activities. With the help of ODA and domestic public funds, private capital could be directed to more sustainable forestry activities in forest stands, industry and trade. 73. Recent developments in the Climate Change negotiations and the Asian currency crisis have once again revealed the interlinkages of forestry with broader economic and environmental aspects. 74. The UNDP under its Global Programme on forests has launched a number of pilot cases in collaboration with four countries to design and test innovative financial mechanisms suitable to specific countries. Similarly, the World Bank is working on a Carbon Investment Fund mechanism. Many other countries and international organizations are exploring new ways to generate resources through policy reforms. 75. Lack of reliable data on financial resources is a serious limitation to understand the magnitude of the problem and the achievements made by different countries. In the past, FAO used to maintain data on many aspects of forestry for all countries. However, lack of resources and other support have limited its capacity to gather and synthesize such data. This matter should get serious consideration from global community, in general and IFF in particular. 2. Proposals for Action 76. To support financing SFM activities, the Forum may wish to consider a number of proposals for Action, such as: Urge countries to increase their ODA contributions targeted at SFM in developing countries; Urge countries to support higher priority and increased budgets for forest programmes in multilateral organizations; Urge countries and relevant organizations in forest such as ITTO, UNDP, FAO, World Bank and regional banks to seriously consider works in exploring the possibilities and needed frameworks for carbon offset trading and other emerging potential revenue sources of forests; Request relevant organizations in forest to work collaboratively with country forest and finance agencies to introduce and continue using market-based-instruments such as user fees, and increased rent capture, payments for environmental services, devise incentives for investing in SFM practices and eliminate subsidies and impose taxes on unsustainable forestry and land use practices that impact forest sustainability. Urge developing countries to formulate policies that facilitate private investment in sustainable forest management; Urge developed countries and multilateral organizations to support capacity-building efforts of developing countries to improve planning and implementation of sustainable forestry activities as well as their absorptive capacity of ODA. Urge developed countries and multilateral organizations to provide loan and investment guarantees, matching funds and other support to promote private sector investments in sustainable forestry in developing countries. Urge developed countries and multilateral organizations to foster partnerships in forest financing between the external private sector and the domestic private and public sectors in developing countries. 77. In view of the inadequacy of information on forest investments, the Forum may wish to urge countries to support activities for systematic data collection and analysis, in order to make reliable, update information available periodically and to foster information sharing. 78. GEF is one international fund that could provide information and lessons on the proposal to establishing a new international forest fund. The Forum may wish to urge organizations directly involved with GEF, and other countries to thoroughly review the GEF mechanism and learn from it. 79. In view of the importance of the Kyoto Protocol under the UNFCCC, the Forum may request the IFF Secretariat to work closely with the UNFCCC Secretariat in further clarifying the role of forests in mitigation efforts concerning the impact of greenhouse gas (GHG) emissions, and supporting the development of appropriate institutional and financial mechanisms to compensate for forest-based carbon offsets. 80. 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Date last posted: 5 December 1999 15:45:34