United Nations
Commission on Sustainable Development

Background Paper



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.  The preparation of the Secretary General's Report on IFF program element
II.a will benefit from additional guidance provided by the Forum.
     


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Date last posted: 5 December 1999 15:45:34
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