Impacting SDG 8 in Developing Countries Through the Use of Blended Finance

Abstract

For most countries, the targets set in the sustainable development goals for 2030 are far from being met. The main cause is a lack of financing, due to the relatively high risks and low rewards associated with sustainable projects. This has caused a financing gap in developing countries of upwards of 2.5 trillion US$ annually, equal to 3% of global GDP. These unattractive aspects of sustainable investment projects result in a lack of private investment, leaving public investment as the main source of funding for these projects. A vital area within the financing gap is the lack of financing for SMEs in developing countries, which are important for economic growth and job creation. The issues faced by these countries and especially SMEs have been compounded by the COVID 19 pandemic, which has claimed countless lives, but also countless jobs in developing countries and has caused extensive economic damage. In this light, achieving impact on SDG 8: ‘Decent Work and Economic Growth’ was deemed critical for the whole of sustainable development.

Recently, blended finance, an investment type utilizing public and philanthropic capital to accelerate private investments, has become more popular. However, effective practices of using blended finance to foster job creation in developing countries through SME financing are lacking. Furthermore, there is little to no literature on investment decisions that goes into selecting projects for blended finance. In this light, this research aims to answer the following question: “What are effective practices and key investment decisions in using blended finance to fund SMEs in developing countries, focusing on impact towards achieving SDG8?

To answer this question, a literature review of the concept of sustainable development, sustainable financing methods and the role of SMEs in the developing countries was conducted. This highlighted the potential of blended finance when compared to other sustainable financing methods in being able to aid these SMEs and impact SDG 8. Afterwards, a data analysis of the performance of recent SME financing projects in developing countries, as well as a case study consisting of interviews with blended finance investment experts was conducted, in order to find effective practices of financing SMEs in developing countries to facilitate the targets set by in SDG8 and highlight how investment decisions are (to be) taken when considering blended finance projects.

It was found that even though the projects in lower-income countries within the could have stronger performance, a balance has to be struck between projects in these countries and those in slightly less low-income countries, in order to achieve consistent results. Furthermore, the use of public loan guarantees seems like a promising method but is currently suffering from a lack of willingness by banks to engage in blended finance transactions, due to solvency issues and general lower risk appetite and unfamiliarity with the methodology.

Furthermore, key investment decisions from an investor perspective lie in the specific business case of the project and whether the investment is ‘additional’ to the market. Furthermore, the attitude and capabilities of the entrepreneur behind the project are essential, as investors prefer projects in which the entrepreneur has enough skin in the game and is open to collaboration with a multitude of investors, such that one investor does not have to bear all the risks. Furthermore, it is important for investors to balance impact with financial performance, as only achieving impact through risky projects is not a sustainable business practice. More investment decisions could be made in the future if more and different blended finance methodologies would become more readily available. However, many of these, such as higher-leverage loan guarantees and first loss guarantees, are hampered by a lack of willingness again of private credit suppliers to engage in these transactions with public blended finance institutions. Furthermore, larger fund sizes would help investor diversity more, and thereby reach a wider range of projects and achieve more universal impact.

Therefore, it is recommended that if blended finance investments globally were to be expanded, that policy makers such as the UN, local governments, and the World Bank find ways to increase awareness of private credit suppliers and for them engage in more blended finance transactions. Furthermore, concrete law and regulation changes should be considered to the use of collateral, both physical and non-physical, by SMEs in developing countries, as to ensure SMEs will become more capable of engaging in loans with banks, which could then be supported by public investors in various blended finance arrangements. It is finally recommended that further research is done on this topic, especially at a larger scale and perhaps slightly into the future, when more projects will have been completed and therefore results will have become clearer. This could further explore the effectiveness of blended finance compared to other investment methods, and if found to be more effective, convey this to private parties. If these measures are to be taken and the knowledge on blended finance is expanded, it stands to reason that blended finance could be one of the tools to reduce the investment gap in sustainable development and aid in the creation of jobs in developing countries, where people need these most.