Across the Continental Divide: Why Private Capital Matters

The Rockies.We reached Independence Rock three days ago and commenced our passage of the Continental Divide through the South Pass. Grass is sparse and the animals are laboring in the thin mountain air. Our party has passed by many lonely graves (counted at least eight in the last two days) and several broken-down wagons. Yesterday one of the Randolph’s mules was bitten by a rattlesnake and had to be put down, so they had to lighten the wagon and leave Mrs. Randolph’s prized Chippendale chest by the side of the trail.  You could tell it was hard on her, but she is a strong woman and bore her sorrow with a stoic grace.

We have crossed the Sweetwater twice today. There was great excitement when one of the boys spied gold in the riverbed – it was, of course, just fool’s gold (mica). But it sparkled and shone none-the-less, and despite our tribulations the party is buoyed by knowing that we will soon reach Pacific Springs. And with that, they are more than halfway home to their new promised land. 

Risk-reward banner.The last time we spoke we took on the topic of risk, and noted that risk is high in most of the countries in which USAID is present. In fact, it’s often high enough that deals which would be completed in the U.S. or Europe won’t qualify – even though the projected cash flows are the same. Because of the higher risk (as well as higher transaction costs), the required return by the investor or lender is much higher – and often above what the cash flows from the investment can produce. 

We also discussed the four different approaches available to change that risk/return balance (to bring down the risk or bump the yield to compensate for the risk):

  1. Risk mitigation – absorbing some of the risk
  2. Blended capital – lowering the cost of debt by mixing concessional funding with commercial financing
  3. Partial grants – lowering the cost of capital by contributing equity
  4. Output-based incentives – payments to bump yield for targeted transactions 

Each approach has its merits and each has its proponents. Personally, I see output-based incentives (cash payments made upon accomplishment of desired outcomes) as a precise and efficient way to administer a subsidy to facilitate the desired transaction – and particularly when done through a competitive process. (But at the end of the day, to be clear, all of these four tools in one way or another offer a subsidy.)

When we last broke up to bed down for the night, we promised to talk next about why all of this matters –why is this “mobilizing private capital” business germane to what we do? 

Graph.Here are three good reasons why:

  1. Attracting private dollars will stretch our public dollars further – allowing us to do more (particularly important in an era where development dollars are flat-lined). 
  2. Bringing in private dollars means bringing in the private sector, and the private sector wants to see their dollars well-invested. When that happens, the outcomes are generally going to be better (and certainly more sustainable). 
  3. USAID and other development actors are increasingly interested in incorporating private capital and private sector engagement into their programs. Our implementers are more likely to win awards if private capital mobilization is a significant part of their proposed development approach. 

Now let's turn our attention to this week's vignettes.