Water and Sanitation Finance: The Challenge with Blended Finance

A recent study estimated the annual global investment needed to cover WASH-related services by 2030 at $264 billion. Figures from the UN2023 Water Conference varied between US$182 to more than US$600 billion annually. These figures are commonly used to support the position that neither public finance nor official development assistance (ODA) are sufficient to fill the funding gap, hence we must tap private finance.

This position is simplistic. It fails to address why private finance would be interested in the high (political) risk, low (financial) return sector that we know water and sanitation to be. It also places little emphasis on using existing funds better.

Blended finance is often proposed as the best way to bring private finance into the water and sanitation sectors. This two part blog will look firstly at the success (or as we argue, lack thereof) of blended finance, including the challenges of loan repayments and fiscal space, and in a follow up, at the neglected yet developing area of how to better use existing funding.

 

NO SILVER BULLET

Over the last decade there has been increased interest in blended finance as a solution to the funding gap in water and sanitation – using ODA or public funds to incentivise private investment in developing countries where commercial returns alone are not sufficiently convincing to attract private money. The argument is that by using some public money to attract private finance, the rest of the money that would otherwise have been spent can be released to be used elsewhere. Behind this argument is, often, the idea that if private money is leveraged in to provide services for those who can afford to pay (e.g. middle-class urban dwellers), then freed up public money can be spent reaching those who cannot.

In reality, however, it is again not that simple: blended finance “does not necessarily support pro-poor activities, often focuses on middle-income countries, and may give preferential treatment to donors’ own private-sector firms.” Blended finance programmes may also not align with country plans, and are often weak on transparency, accountability, and participation.

Maria Jose Romero, Policy and Advocacy Manager for Eurodad’s work on development finance argues that “[b]lended finance is yet another iteration of privatization and financialization, whereby publicly funded aid programs increasingly serve the needs and goals of the private sector.” She further outlines the risk that aid funds end up “subsidising private companies for investments they would have made in any case” – investments on which they expect to make a profit, with little evidence of the achievement of additional goals. At a time when aid budgets are being squeezed, there is a real risk that these ‘innovations’ divert aid from poorer to richer countries, and from poor people to wealthy corporations, without us learning from, for example, the established lessons of tied aid, which has been shown to cost 15-30% more than untied aid.

A report commissioned by the European Parliament reflects similar concerns, finding that public funds may flow to private shareholders rather than to sectors and regions in need; that blended finance may create risks for development agencies and costs for recipient governments over the longer-term; and that blending may promote the interests of financial investors rather than development outcomes.

Even supporters of blended finance recognise some of the challenges. Joan Larrea, Chief Executive of Convergence, the Global Network for Blended Finance, states that “[t]here are many cases where straight-up aid should remain straight-up aid, and there are also many cases where private sector investors don’t need any encouragement to do something because it already is lucrative enough to roll the dice and take the risk on whatever they’re staring at”.

 

LIMITED UPTAKE AND RISKS

The challenges are implicit in blended finance regardless of the sector being invested in. The water and sanitation sectors face additional challenges.

Firstly, blended finance is not flowing into the sector. Overall, blended finance approaches mobilised around US$258 billion between 2012 and 2019 in emerging markets, but little of this was for water and sanitation. Between 2017 and 2019 water and sanitation accounted for less than 1.5% of the commercial finance mobilised – which covers less than 2% of the estimated funding gap.

Secondly, the blended finance discussion is taking place in a context where fiscal space in emerging markets is limited, particularly in the poorest countries. Such countries have little or no room to take on further loans. Fiscal space is the “room in a government’s budget that allows it to provide resources for a desired purpose without jeopardizing the sustainability of its financial position or the stability of the economy”. Fiscal space is strongly linked to fiscal sustainability and whether government has the capacity to service debt obligations arising from any borrowing. Common factors that limit fiscal space include a narrow tax base, high levels of debt, low economic growth, recessions and competing demands for public spending. Inefficient public financial management systems, corruption, inadequate governance structures, and political constraints can also limit fiscal space.

Thirdly, including commercial loans as part of blended finance, may pose significant foreign exchange risks to developing countries, where revenue is earned in local currency but loan payments are in a foreign currency. Local currency investments may not be readily available or may come with high interest rates, forcing utilities or governments to seek international investments. Changes in the exchange rate may then mean that loans, including private sector loans through blended finance models, become much more expensive than initially planned for.

 

FINDING NEW WAYS TO CLOSE THE GAP

There are significant constraints to financing the water and sanitation sectors in developing countries through blended finance. While it may be working on a small scale in some locales, it is not, and is not likely to, deliver sustainable finance on the scale needed to meet SDG 6. Despite the allure of words like ‘innovative’ and ‘blended’ we need to find other ways to close the funding gap.

In the meantime, while more equitable, less risky methods of deploying private finance to the water and sanitation sector are being investigated, there is significant opportunity in lowering the costs of water and sanitation service provision. Much greater investment is needed in reducing corruption, improving infrastructure management, and addressing revenue collection. Using existing funding better should be the priority for the sector, and the necessary time, effort and investment should be put into this by development finance institutions, development banks, bilateral and other donors, and national and local government.

Our next blog will address some priorities in using existing funds better.

 

This blog is part of a series exploring water and sanitation sector finance from an integrity perspective, in the run up to the publication of our next Water Integrity Global Outlook on Finance in 2024. To stay in the loop with updates from the series, get in touch here.

 

Linked references

Strong, C, Kuzma, S., Vionnet, S., and Reig. (2020). Achieving abundance: understanding the cost of a sustainable water future, WRI Working Paper.

United Nations. (2023). Press Release: Historic UN conference marks watershed moment to tackle global water crisis  and ensure water-secure future.

Pereira, J. (2017). Blended Finance, what it is and how it works. Research Report. Oxfam.

The Blended Finance Project. (2021). Interview with María José Romero – Eurodad.

Crabb, J. (2022). Why blended finance risks being bad for SDGs. Capital Monitor.

Global Partnership for Effective Development Co-operation, (2020). A Knotty Problem: Turning Words into Action on Tied Aid.

Bayliss, K.; Bonizzi, B.; Dimakou, O.; Waeyenberge, E.; Laskaridis, C.; Sial, F. (2020). The use of development funds for de-risking private investment: how effective is it in delivering development results? Policy Department for External Relations. Directorate General for External Policies of the Union

Farr, J.; Stodulka, K.; Holland, E.; Wedl, I.; Fletcher, K.;  Mason, N. (2022). Mobilising capital for water: blended finance solutions to scale investment in emerging markets. WaterAid and the Blended Finance Taskforce. Washmatters. Wateraid.

OECD. (2019). Making Blended Finance Work for Water and Sanitation: Unlocking Commercial Finance for SDG 6, OECD Studies on Water, OECD Publishing, Paris, https://doi.org/10.1787/5efc8950-en.

Money, A. (2022). Blended Finance in the Water Sector: Challenges and Attributes. World Water Council.

Heller, P. (2005). Back to Basics — Fiscal Space: What It Is and How to Get It. Finance and Development. Volume 42, Number 2. International Monetary Fund.

Heller, P. (2005). Understanding Fiscal Space. IMF Policy Discussion Paper. PDP/05/4. International Monetary Fund.