How blended finance is transforming investment in emerging markets

ifc BTN Q3-24
Common frameworks exist for the effective use of blended finance to ensure it is not distorting markets, writes Joon Park, senior manager, blended finance at International Finance Corporation.

Emerging markets, already seen as riskier destinations for investors, have faced unprecedented crises in recent years. High levels of public debt, resulting from the Covid-19 pandemic, political instability and geopolitical fragmentation, have lowered growth prospects and stunted investment. Consequently, capital flows (excluding remittances) have halved compared to a decade ago for the world’s poorest countries, reflecting the growing caution among global investors.

Despite these obstacles, recently released data on emerging market risk and innovative public-private financing facilities show how investors – both public and private – can overcome emerging market risk, diversify portfolios and achieve their environmental and social sustainability goals.

For the first time, the Global Emerging Markets Risk Database Consortium, a grouping of 25 multilateral development banks and development finance institutions, released data on recovery rates for private and sub-sovereign borrowers in emerging markets. Complementing this, the World Bank Group released sovereign default and recovery rate statistics to promote transparency and inspire investor confidence. By providing investors and credit rating agencies with transparent, detailed data, the World Bank Group and GEMs Consortium are facilitating improved decision-making and unlocking the potential for transformative private investment in emerging economies.

At the same time, the International Finance Corporation published private sector default statistics that showed its private sector portfolio had a low default rate of 4.1% from 1986 to 2023. This suggests the untapped potential and resilience of private sector investments in emerging markets.

For the IFC, one critical element in achieving lower default rates has been the alignment of financial returns with social and environmental goals. Sustainable business practices rely on integrating corporate governance considerations into the decision-making process.

Even with greater transparency and a commitment to environmental, social and governance standards, risks persist in harder to reach, more challenging markets, requiring innovative risk mitigation strategies.

Blended finance for EMs

The strategy of blended finance refers to the tactical combination of public and private funds, often using development finance and philanthropic funds to mobilise private capital flows to emerging markets. This approach mitigates risks for private investors, making investments more attractive and affordable. Blended finance can be structured through financial instruments like guarantees, concessional loans, equity investments and technical assistance. For example, a development bank might offer a partial guarantee on a project, thereby enhancing its creditworthiness and attracting private lenders.

By absorbing risks that private investors are unwilling to take on, blended finance multiplies the impact of limited public resources, mobilising larger volumes of private capital. One example of this is in the green, affordable housing segment. Three breakthrough green housing projects in India are catalysing India's affordable housing space, promoting green construction and supporting India's climate goals.

The IFC’s investment includes a performance-based inventive supported by the UK’s Market Accelerator for Green Construction programme, a blended finance facility, as part of the financing package. Blended finance incentivises self-constructors to partially offset the incremental costs of building green. This enables clients to help their retail clients overcome additional costs to obtain EDGE green-building certification and for green design features that support greenhouse gas reduction and support green transition in India. The MAGC programme has been an excellent test case for the leveraging potential of blended finance: the UK’s $50m investment has catalysed $1.4bn of financing in green buildings to date. That means that every $1 of UK funds has created $20 of financing for green buildings.

Successful blended finance projects can demonstrate the viability of investments in emerging markets, encouraging further private sector participation and creating new markets for climate, in places like Uzbekistan, Jamaica, South Africa and Zambia. The enhanced DFI principles for blended finance provide a common framework for the effective, efficient and transparent use of blended finance, and ensure that blended finance is not distorting markets.

DFI agreed principles

Blended finance is not limited to investment-grade emerging markets either. For the lowest-income and fragile markets, in 2018, the World Bank Group launched the Private Sector Window from the highly concessional International Development Association, which is now attracting private investment in the world’s most challenging markets. To date, $4.8bn of PSW funds from IDA have mobilised $24.3bn of investment in low-income and fragile countries – a mobilisation ratio of 5:1.

Take the example of a commercial solar power project in Somalia, a country where over 50% of the population lacks access to electricity. The PSW offset some of the risk and enabled the Multilateral Investment Guarantee Agency and co-investors to proceed, while making sure that electricity tariff rates remained competitive on the market and thus affordable for users.

By aligning financial returns with social and environmental goals, blended finance fosters sustainable development. Tools like blended finance point the way for both public and private sector actors to navigate these challenges and seize the opportunities.

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