- A persistent $2.5 trillion annual financing gap stands in the way of the Sustainable Development Goals.
- Bridging that gap requires removing the constraints to the supply of, and demand for, capital.
- Development banks must focus on catalysing new sources of financing.
Despite a tremendous increase in the number of initiatives dedicated to sustainable development since the adoption of the 2030 Agenda in 2015, a persistent $2.5 trillion annual financing gap stands in the way of the Sustainable Development Goals (SDGs). The international community has committed to turn promises into reality as we enter the “decade of action and delivery”, acknowledging that the progress made so far has been very slow in many areas.
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The first step in financing the SDGs is to ensure that capital is actually deployed where it has true sustainable development impact. Global GDP in 2018 amounted to an estimated $85 trillion. This means that if only 3% of the global GDP was invested for sustainable development, the world would be able to close the SDGs financing gap – the global community would be able to meet our sustainability ambitions and collectively achieve the 2030 Agenda.
Many obstacles, however, stand in the way. The Global Future Council on Development Finance, convened by the World Economic Forum and comprising 24 experts active in the field, is focusing on innovative ways to overcome the systemic challenges that limit the flow of development finance. For the Davos Annual Meeting 2020, we created the new Development Finance Transformation Map, summarizing the key dimensions characterizing the ecosystem.
The Council brings together representatives from national governments, donors, multilateral and bilateral development finance institutions (DFIs), private investors, finance leaders and academia. It believes that conventional approaches to development finance are inadequate to address the market failures that manifest themselves at the national level. This is why the action taken so far has not achieved the scale and speed needed to mobilize the capital required for the SDGs.
With a focus on identifying solutions, the Council recognizes that enhanced action is needed from all participants – the providers of capital (supply), the users of capital (demand) and the institutions that link the two (intermediaries) – while also realizing that only limited progress will be achieved if those areas are explored in silos, given how interconnected they are.
An integrated approach that considers how all elements interact is needed. This approach is one where public and private stakeholders at a global and domestic level work together to bridge the SDG financing gap, achieving more than they could on their own. Furthermore, for global thought leadership to have an impact on the ground, it must be harnessed to action at a country level, allowing the system to work in sync and achieve the speed and scale required to move the needle in the decade of action.
Supply side: aggregate investment opportunities to attract more capital
The private sector seeks investment opportunities that match return expectations and risk appetite. Weak global economic growth forecasts and the proliferation of negative yield bonds mean that projects in developing and emerging economies that contribute to the SDGs should be offering attractive investment opportunities.
However, market failures disincentivize private participation in financing the SDGs. High levels of perceived risk, local currency volatility, information asymmetries between capital providers and project developers and deal size – to name a few – often transform what might be an attractive investment opportunity into a very complex deal where the final expected return does not justify the risk and effort that the investor must undertake to deploy the capital.
Consider an example: Small Islands Developing States (SIDS) represent a group of 58 island countries that face similar development challenges related to vulnerability to natural disasters, need for climate change resilience and their small size. Though SIDS have urgent needs for new sources of capital to finance their 2030 Agenda plans, they find themselves struggling to attract private sector investment given their high perceived risk and lack of projects with scalable returns.
The Council is developing a framework to help SIDS attract capital and overcome their size problem through the use of aggregation vehicles at the country, regional or sectoral levels. These vehicles can group smaller investment solutions into larger opportunities that can more easily attract private capital. This could develop into a viable mechanism for SIDS to find new sources of capital for the SDGs.
Demand side: take a strategic approach to using all types of capital
Market failures also stem from the demand side. One such source of inefficiency is the lack of coherent strategic development planning: countries should link their national allocation processes to the SDGs and create a national financing plan for the 2030 Agenda.
Governments must move away from a confined project-by-project approach towards a holistic financing strategy for the SDGs, involving all sources of capital across the various stages of the investment value chain.
During its previous term, the Global Future Council on Development Finance recommended that countries should pivot from “funding” to “financing”, thereby moving away from relying on official development assistance (ODA) and other public funding, and instead clearly mapping the right type of capital for each project, having a holistic consideration of all the capital sources – domestic, international, private and public capital – that could be deployed at a national level.
Moreover, the Council believes that governments can make or break the attractiveness of a country for investors. By fostering a sense of “investable governance” and creating an enabling environment that boosts investors’ confidence the country can set itself up for success.
For instance, implementing a regulatory framework that attracts private investors through business-friendly policies will enhance further business investment. To achieve this, multi-stakeholder collaboration is essential so that the public and private sector can align on the right type of action needed to improve a country’s investable governance.
The changes will only have a lasting impact if they build on the consensus of both public and private stakeholders and therefore allow the country to stick to an overall governance framework that continues to support domestic and international investors operating in the country.
Intermediary institutions: act as the catalysts in the interest of the countries
The supply and demand dynamics outlined above will unfold within an existing development finance landscape, and it is crucial that the relevant intermediary institutions improve their ability to link the supply of, and demand for, capital for SDGs. This requires a fundamental reassessment of the role of various development financiers and other stakeholders.
In particular, Multilateral Development Banks (MDBs), Regional Development Banks (RDBs), National Development Banks (NDBs) and Development Finance Institutions (DFIs) should prioritize their role as catalysts that help countries move from “funding” to “financing”, embracing a change some institutions have already started.
As countries pivot away from a “project by project” approach to strategic efforts to create private markets and attract a diverse set of capital providers, intermediaries should enhance their ability to bring investors and countries together. This requires a deeper understanding of the different types of capital that are needed for achieving the SDGs (all the way up from standard project financing to the most impactful type of equity risk capital) and an ability to work well with both the public and private sector.
The Council believes that it is crucial for existing intermediaries to focus on catalysing new sources of financing including from pension funds, insurance companies, and retail investors that have traditionally not been active suppliers of SDG financing.
This involves mobilizing private financing at different stages of the project lifecycle. For example, MDBs have had a tendency to focus on deploying their own capital in their own bespoke projects and keeping that capital tied up throughout the life of the project.
MDBs should find a way to bring in more private investors alongside them at the start of the project and then subsequently attract additional more risk-averse investors by allowing a refinancing of the MDB financing once the project has been derisked. This would help mobilize a whole new class of SDG investors and also enable the MDBs to recycle their own capital more efficiently.
MDBs could use their comparative expertise to identify more bankable projects while also making it easier for private financiers to get involved. There is an urgent need to attract more private investment in sustainable development in middle and low-income countries where MDBs and DFIs in 2018 jointly mobilized only $69 billion across the globe.
In Davos, members of the Global Future Council on Development Finance will meet with representatives of both the public and private sectors to engage them in reigniting the energy required to meet the ambitious targets of the Decade of Delivery.
Bridging the SDG financing gap is not a matter of reinventing the wheel. It is about understanding and removing the constraints to the supply of, and demand for, capital and improving how we link the two. We need only 3% of global GDP in investment to close the SDGs financing gap. With it, the world would be one step closer to realizing the goals of the 2030 Agenda and achieving the inclusive growth and sustainable development we all desire.