5 Things You Need to Know About Engaging the Private Sector in Public Goods

By Lauren Yang, USAID INVEST Communications

Many USAID Bureaus and Missions grapple with how to engage the private sector in their work with public goods. Where can the private sector be engaged? What investments are viable? What investors may be interested? In the latest installment of the “FINsights: Mobilizing Investment for Development” webinar series, USAID India shared insights into how the Mission, with support from INVEST, assessed opportunities in WASH and Education with two private sector implementing partners: Unitus Capital and Boston Consulting Group. Here are some takeaways from their conversation on how USAID and the private sector can work together to improve critically needed public goods in WASH and Education.

These quotes have been edited for length and clarity.

1. With public goods, access must be paired with quality — and low quality drives down demand.

Garima Batra, Partner, Boston Consulting Group: In India, we have seen a trend of migration out of public schools for the last several years, which can be attributed in part to the low quality of learning that these schools have been providing — despite the access having gone up a lot in the last 15 to 20 years. So we have a school in pretty much every neighborhood, but the key challenge remains in terms of outcomes. As per our National Achievement Survey, 33 percent of students in grade three cannot read very simple text with comprehension. We have 37 percent of students in grade three that cannot do basic math, which goes up to 58 percent by grade 8.

2. Regulatory frameworks can be difficult to navigate, and government contracts present a particularly large obstacle for the private sector (especially small and medium enterprises) to engage with public goods.

Richa Natarajan, Director, Unitus Capital: [WASH] being a heavily regulated sector, the government has made a lot of strides here, to be honest: to increase interventions, to increase transparency, and to secure innovation, but there are still several challenges around payment delays, access to and high cost of finance, dependency on government contracts, and the financial viability of projects themselves.

Government contracts tend to be one-sided. They tend to have really stringent exit clauses, or no exit clauses at all, which makes it very difficult for the private sector to engage. And if you combine that with delays, it makes working capital a really, really big issue, which results in very limited private sector engagement, especially from the smaller private-sector players.

Besides financing interventions, I think there’s a need for a body like USAID to actually come in and work with the government on the contracts themselves, looking at the regulatory issues that are out there and helping to create alignment.

3. Increasing private sector engagement requires a good understanding of regulatory landscapes at all levels of government and how they do — and don’t — fit together.

Natarajan: Water resources are heavily regulated and there’s a very rigid government market and gatekeeping which has resulted in a lower private sector presence. While they’ve been working through a bunch of policies, both with the central and the state governments, there still seem to be issues or a disconnect between the two governments, which causes a lot of heartache and problems, especially on the private sector side.

Apoorv Shukla, Development Finance Specialist, USAID India: Things change from the central government level to the state government level to the city level, and just navigating all those rather complex regulatory landscapes is quite difficult. In India, education is really governed by state governments, and it really changes from one state to another on how the systems are run. We had to really understand those systems and see how those different regulatory landscapes can be worked through as we complement our overall flagship education program with a private sector engagement activity.

4. Assess the maturity of private sector actors, and pursue financial interventions that meet them where they are.

Natarajan: When we look at any sector’s life cycle, it typically goes from grant all the way to equity financing as the sector matures, and you have a large target addressable market and a significant growth trajectory. But in the case of WASH, especially in urban India, there has been some amount of debt and some amount of grants doing the rounds. There just isn’t enough in the way of funding models that meet the needs of businesses in this space. As you go down into the value chain, you’ll start seeing very few companies that have actually scaled up — it’s mostly family-owned businesses and things like that, and the understanding of financing mechanisms is nascent. There is a lot of innovation that needs to come in, and a lot of learnings that USAID can provide through the experiences they have globally. All of this has really put capital flow in the sector in jeopardy — today, there’s less than $300 million that goes into the sector annually.

There are a few things that I think would benefit entrepreneurs:

One thing that entrepreneurs really want is revolving credit line facilities that actually help them manage their cash flow cycles, which are very, very erratic. It’s important to have something to tide them over when they face payment delays — but also not to have high interest costs when they’re not needed.

Second, I think first-loss models are going to be really critical because companies are very early stage. It’s important to think through those blended finance models and bring in donors, CSR foundations, et cetera, along with USAID, to be able to provide that early, first loss capital before you can have more mainstream capital come in. This could be both through equity and debt.

And last, thinking through concessional capital models. Having your interest costs at 13, 15, 18 percent and having equity returns of 25 percent-plus is just not going to work in this sector. And that’s something we all have to accept. We need concessional models and investors and lenders that can come in, provide capital, and be okay with returns that are sub-10 percent. It’s important both to have that mindset going in and a product that suits it.

5. Identify “white spaces” — places where unmet, unarticulated needs can drive innovation and opportunities for private sector engagement.

Batra broke down a rough framework that BCG used to identify “white spaces” in India’s education sector:

1. Map the landscape. “We start by laying out a landscape of this number of schools, students, outcomes, and really mapping: what are the key barriers to attainment of outcomes, both in public systems and private systems?”
2. Map private sector engagement. “What is the private sector engagement that we see today? What is the impact that it’s having? What are some of the white spaces of the current models?”
3. Map funding and financial instruments. “Then the third thing was really looking at the entire funding and financial instruments landscape…from CSR philanthropic funds on the one end of the spectrum to commercial investing on the other, and then impact investment capital and all the other blended finance structures in-between: impact bonds, guarantees plus capital, et cetera.”
4. Put it all together. “Then finally putting it all together to say, okay, so here are the challenges, here’s the private sector engagement that we’re seeing, here’s how it’s funded today and here are the different instruments in use, but what are the areas in which you say can actually meaningfully play a role where some of these white spaces and gaps get addressed, and what are the appropriate financial instruments to actually do that?”
5. Zero in on specific opportunities to test interventions. “And then there was one final leg of this, which is to customize the answer itself to two or three specific states. Which states should we work with based on their capacity, in terms of availability of staff to execute interventions and their past history of fund utilization? How big are they in terms of their excitement to work and commitment to achieving basic educational outcomes?”

This webinar was part of the “FINsights: Mobilizing Investment for Development” series featuring members of the USAID Finance and Investment Network (FIN) as they share insights into partnering with USAID to mobilize private capital for development results.

This post is made possible by the support of the American People through the United States Agency for International Development (USAID). The contents of this blog are the sole responsibility of INVEST implemented by DAI and do not necessarily reflect the view of USAID or the United States Government.