Redefining the sovereign's role in blended finance for sustainable development

With official development assistance and multilateral institutions becoming selective, and public budgets under pressure, blended finance offers a route to scale up private and philanthropic investment towards sustainable development.

Blended finance works by leveraging public capital to encourage private and philanthropic funding of sustainable development by lowering risk for investors.

However, its ability to deliver catalytic capital at scale depends on understanding the contextual factors that determine the bankability of blended finance structures, and enabling a consequential shift in the role of sovereign bodies – governments or state-owned entities – from risk absorbers to risk strategists.

Take Indonesia's SDG Indonesia One platform as an example. Established by state-owned entity PT SMI, the platform unites multiple financial institutions for co-financing and de-risking projects that are working towards achieving the United Nations’ Sustainable Development Goals (SDGs). This approach has enabled the use of innovative structures to mobilize private capital for development objectives and transformed the sovereign into a strategic enabler.

So, what can other blended finance actors and institutions learn from such examples?

The first step to achieving catalytic impact through blended finance requires understanding three interlinked contextual factors: nature of funded projects, beneficiary profiles and regional context.

By analysing these, sovereign actors can design targeted transactions that reduce perceived risks and mobilize private capital, thereby scaling up investable transactions. Here’s how:

Projects aimed at consumption rather than production end uses may struggle to generate predictable cash flows, since income assessment in informal or low-income occupations is tough. In such scenarios, a sovereign's strength is being able to deploy grants to develop income appraisal systems or underwrite partial guarantees in order to reduce credit risk.

Long-gestation projects often face repayment pressure before revenues begin. Here, sovereign interventions could stabilize returnsthrough interest subsidies or delayed repayment.

Certain sectors may involve repayment periods beyond the typical duration of bank loans. Sovereign-led platforms can help stagger investor entry according to project stages and reduce liquidity risk.

If technologies are early-stage, sovereigns may act as innovation enablers by funding pilots, providing equity for proof-of-concept or default guarantees – thereby reducing technology risk.

Even proven technologies face barriers if costs remain high. Policy interventions including import duty waivers, targeted subsidies or budgetary alignment with industrial policy can make new technologies affordable.

The Brazilian National Climate Change Fund, for example, saw the government absorb initial risks to encourage private investors to fund small and medium-sized renewable energy projects – transforming the government's role into a strategic catalyst.

If repayment magnitude exceeds repayment capacity, sovereigns may lend at below market interest rates or provide interest subsidies, ensuring fair returns for funders and extending funds to underserved groups.

Where beneficiaries lacking expertise may fail to produce bankable proposals, sovereigns could provide capacity building and advisory support.

Meanwhile, lack of visibility of demand can discourage capital commitments in emerging sectors. Here, sovereign-backed purchase guarantees or anchored subsidies that secure long-term demand contracts might be useful.

In addition, grants to improve income assessment or partial guarantees to reduce credit risk could help unbanked beneficiaries. The Rwanda Women's Entrepreneurship Finance Initiative, for example, uses sovereign guarantees and technical assistance to de-risk projects for female entrepreneurs and mobilize commercial finance.

Remote locations increase transaction costs. Sovereigns could facilitate cost-effective engagement through community-based delivery models or mobile platforms.

If gaps in supportive infrastructure exists, sovereigns may use policies, incentives or concessionary funds to support the ecosystem and value chains.

Political risks, or currency volatility, may require sovereign-led hedging facilities, pooled guarantees, or risk insurance schemes to stabilize the operating environment, and reduce market risk.

An example is the Africa50 platform founded by regional governments and the African Development Bank. Using public funds to attract private investment in large cross-border infrastructure projects, it demonstrates sovereign entities can work in challenging regional contexts to unlock private capital.

The second step is for sovereigns to transition from risk absorbers to risk strategists by aligning the type of sovereign tool with the contextual factors of the transaction.

This would require targeted interventions where the government covers any initial loss, political risk insurance, subordinated debt layers, grants and operational support, deployed precisely to address specific bottlenecks.

Evolving roles for sovereigns include acting as market convenors by aligning multilateral development banks (MDBs), development finance institutions (DFIs) and private investors into integrated financing ecosystems. Different players intervene with tools to reduce liquidity, market and credit risk and improve risk-adjusted returns.

Governments may serve as regulatory enablers by implementing investor-friendly regulations. Linking this to specific sectors and regions would mitigate policy risks and unlock new interventions that enhance returns. Sovereigns are co-investing alongside private investors with clear exposure limits. This signals market confidence, which reduces liquidity and market risk without over-burdening public balance sheets.

Governments are innovating with credit enhancement by developing sector-specific risk pools, revenue-backed financing structures, and layered credit enhancements. This improves credit appraisal, reduces credit risk, and increases investor appetite. They are also becoming data builders by creating data platforms to strengthen project preparation and due diligence and enable better investment decisions.

Precision in deploying the right instrument, at the right stage, to address the right barrier would allow sovereigns to stabilize returns, reduce risks and attract catalytic capital, to scale-up blended finance.

Based on evolving roles, sovereigns can design innovative platforms that crowd-in private capital. These include regional public debt funds that pool risk across countries and reduce the cost of debt, or risk mitigation platforms that integrate public budgets with private-sector matchmaking.

Platforms may be designed to hedge macroeconomic risks. Brazil's FX-EDGE platform, for instance, mitigates currency risk with hedging facilities.

Governments may establish specialized development banks targeting priority sectors, like the National Water and Sanitation Finance Entity in Egypt that enables project aggregation, or build project pipeline platforms linked to specific SDGs or readiness benchmarks based on the IMF frameworks.

Other structures include consortium models that invest into different categories of capital, hybrid funds that blend equity and debt aligned to project stages, and multi-tenor structures allowing investor entry as per stages of project maturity.

Outcome-based finance models, like the skill and education impact bonds in India, may deliver measurable impact. In a creative approach, Belize used debt-for-nature swaps for debt restructuring.

Such examples highlight how sovereigns, acting as platform architects, can enable risk reduction, return stabilization, and catalytic capital mobilization, to scale-up blended finance.

The trajectory of development finance will hinge on sovereigns evolving from traditional risk absorbers into strategic risk architects, shaping market conditions to attract private capital while safeguarding fiscal prudence and sustainability.

Sovereigns must use precision and strategic approaches to initiate and co-create blended structures, thereby scaling blended finance from $18 billion in 2024 into a systemic enabler of future sustainable development.