Ms. Shamshad Akhtar Assistant Secretary-General for Economic Affairs Department of Economic and Social Affairs
As we move forward to crystallize the future Post 2015 Sustainable Development agenda, thinking through a strategy for financing for development has assumed clear urgency.
In sharing my thoughts about this strategy I would like to:
- Underscore the extent of the challenge and the dark clouds hanging over the availability of public funds to address it;
- Illustrate how these new realities will affect the deliberations of the Intergovernmental Committee of Experts mandated in Rio+20 from day one;
- Highlight the need for rotating emphasis from public finances to directing private flows for development purposes;
- Illustrate the important gaps in financing provided by the private sector;
- Finish by highlighting the role of public policies to leverage and align incentives.
We need to cater to financing social, economic and environmental sustainability, which will require investments in multiple areas and both for developing and developed countries.
Coming back from G20 interactions in DC, it is clear that dark clouds over the ability of the public sector to mobilize funding for development may persist. I state this because:
- Sovereign debts in most advanced economies are at all time highs;
- Given the need to retain fiscal flexibility, it is hard for governments to commit to reductions to debt to GDP ratios;
- Fiscal austerity has had consequences for economic growth, which also subdue revenue growth – politically, raising new taxes is complex in hard economic times, though it is a preferred solution to achieve fiscal consolidation over the medium term;
- Official development assistance (ODA) flows stand barely at half the commitment level of 0.7% of GDP; and
- While South-South flows hold high promise, so far countries with resources are providing bilateral support rather than joining global partnerships around a multilateral development agenda.
Although not sufficient by any means, official financing will still remain crucial both directly and especially to leverage private resources. Accordingly donor countries should continue to aim at fulfilling their ODA targets.
Key pillars of a financing for sustainable development strategy in this context
For the deliberations of the Intergovernmental Committee of Experts, mandated in Rio+20 and soon to be established, this will imply an urgent need to rotate emphasis from international public finance to private flows in the design of a financing for sustainable development strategy.
Fortunately, there is ample scope to unleash the potential of other sources of finance. The deliberations would have to focus on:
- Domestic public resources mobilization;
- Innovative sources of finance;
- Unleashing the potential of private funds;
Domestic public resources mobilization – Government revenues also remain low in many developing countries. Tax bases are narrow and appropriate tax policies, along with combating tax evasion, are central elements in raising revenues to finance public investment. International tax cooperation should be further strengthened to curb tax avoidance and illicit flows.
Innovative mechanisms, such as financial transactions taxes, carbon taxes, and similar mechanisms can potentially be used to raise substantial new sources of public financing. It is important to highlight in this regard that realizing their potential on a large scale will require international agreement and corresponding political will, both to tap sources as well as to ensure allocation of revenues for sustainable development without compromising existing commitments.
It is clear that both private and public finance, as well as public sector policies and international cooperation will be necessary to finance large and growing needs. A fundamental challenge will be to ensure complementarities across different sources of finance, as each type of financing has unique investment objectives, fiduciary responsibilities, and associated incentives. These differences need to be better understood in order to design policies that can effectively leverage private financing and align private sector incentives with public goals.
Private flows will need to be directed for development purposes.
There is ample scope to unleash the potential of private funds. A prerequisite for this would be to ensure that the financial system is stable and that an enabling policy environment is present to effectively and efficiently allocate resources.
Foreign direct investments have and will continue to play a critical role not only in offering the required risk capital but also can serve to introduce innovation and technology. In addition, there has to be emphasis in developing financial and capital markets, which remain modest in developing countries affecting especially the supply of long-term investments.
The role of domestic financing will also be key. Strengthening local financial systems and encouraging a more effective allocation of resources is important. Developing long-term local currency bond markets can also play an important role. However, domestic capital and financial markets need to be monitored and regulated to minimize risks to the real economy, including those associated with short-term volatile capital cross-border flows.
In addition, financial inclusion and access to financial services by poor and vulnerable population groups has been found to be beneficial for economic and social development and domestic resource mobilization, and should be emphasized as a policy priority.
Financing gaps are large, especially in those areas that the private sector has not found attractive on a risk-reward basis.
This includes the following four categories:
- Long-term investments;
- Riskier investments;
- Financing of international cooperation;
- Additional financing for human development.
Let me now focus on some of them.
Long-term investments, such as infrastructure, including retrofitting existing infrastructure to reduce carbon-emissions are crucial. Despite the ever increasing need for long-term financing, especially for infrastructure, the long timeframe necessary for many types of investments is outside the investment parameters of most, even for those considered to be ‘long-term investors.’
For example, the liability structure of longer-term institutional investors has averaged around 10-15 years, which is already less than the time life of many infrastructure projects. Furthermore, the actual duration of their portfolios is shorter, due to financial market incentives and regulations, among other factors.
In most countries, bank lending has been the dominant form of financing long term investments in infrastructure, despite the asset-liability mismatch of short term bank deposits vis-à-vis infrastructure’s long-term capital requirements. This is particularly so in emerging markets, where corporate bond and securitization markets are relatively undeveloped, and unlikely to be able to generate the type and volume of long term financing that infrastructure financing requires.
The diagnostic long-term financing report for the G20, a collaborative effort of the WB, IMF, BIS, OECD, UN and other agencies, pointed out that the availability of long-term financing has declined since the financial crisis. In effect, the financial crisis and the wave of regulation that ensued have fundamentally changed the banking system and the role it may play in infrastructure financing in the foreseeable future.
Banks are now responding to higher safety margins vis-à-vis higher capital and liquidity requirements by increasing their lending rates, trimming risk assets, and being more selective. Basel III is likely to affect further the cost and willingness of many banks to allocate capital for project finance by applying a high risk weighting to long term loans, however well structured. The Solvency II requirement for insurers to hold higher provisions for long-dated assets could cause insurers to reduce the duration of investment.
Not surprisingly, the resulting deleveraging and retrenchment of banks from the global financial markets has left a huge gap to finance infrastructure. The general retrenchment by European banks in particular is constraining infrastructure and long-term investments not just in Europe but around the world. With banks retreating, non-bank financing for infrastructure is now emerging as the new imperative.
Riskier investments, including low-carbon investments, innovation, and financing of SMEs as well as other forms of inclusive finance remain underfunded. While the issue of a long investment horizon arises with traditional infrastructure investment, it is particularly relevant for low-carbon infrastructure projects. Similarly, there is insufficient financing for innovation and emerging technologies, which carry high risks that are often difficult to measure and price. Credit for SMEs, which are main drivers of employment and growth in many countries, remains limited. The deleveraging of the financial system since the crisis reduced lending in this as in other areas.
Public sector policies to leverage private finance and align incentives
Although there is a small (albeit growing) community of socially conscious investors, most private capital will remain driven by the profit motive. As a result, the private sector will continue to under-invest in the public good. Public sector policies will need to be designed to leverage private finance through risk sharing mechanisms.
Public-private partnerships have become increasingly looked to as a mechanism to leverage official resources with private finance through risk-sharing. To date, most of these mechanisms have been used for infrastructure investments, including low-carbon investments. Nonetheless, there are some examples of public-private partnerships and other new mechanisms geared toward financing the social pillar of sustainability, including social impact bonds and aid securitizations.
With limited private long-term direct lending capacity going forward, and fiscal constraints in many developed countries, national, regional, and multilateral development banks can play a catalytic role in mobilizing long-term investment financing, as well as a countercyclical policies that can help reduce volatility associated with financial markets.
I would like finish by highlighting that it is of outmost importance that all Member States are actively engaged with the UN in developing financing strategies for sustainable development.