NAJIB SAAB 14/9/2020

Contrary to what was expected, governments, central banks, international finance institutions and development funds have succeeded in attracting a surplus of liquidity to face the economic repercussions of the Covid-19 pandemic.

The money collected from markets, at historically low rates, exceeded all estimates. Worldwide, economic investments in national recovery plans are expected to exceed $20 trillion for the next 18 months.   The problem, then, is not lack of liquidity but an excess of it. This new liquidity is not only available in developed countries, but in emerging markets as well.

What we have to deal with today is how to allocate this liquidity in the right way, to ensure the sustainability of the private financing sector, and direct a fair share of this liquidity towards social and environmental investments.   We have heard many promises in recent months that environmentally friendly “green” projects will receive an ample share of liquidity earmarked for economic recovery from the pandemic.

This was confirmed by multiple countries, development funds and financing institutions around the world, especially the European Union and the World Bank Group. While the priority will be to address the health complications of the pandemic, the largest part of the funds will go towards stimulating the economy, in a way that protects and creates jobs.

However, despite the green promises, the desire to quickly increase demand and raise national income figures threaten to divert a large part of the new money into consumption rather than investments that create long term societal benefits. While such spending is necessary to meet urgent challenges, it should be limited, as the payoff is short-lived. It is the type of spending as a “one-off” stimulus versus investing creating long term cash flows.  

Major investments in infrastructure, such as water, energy, and transportation, come under the umbrella of governments, even if the private sector participates as a primary or partial owner, or operator. For the private sector to finance projects with an environmental and social agenda, such as solar and wind energy, energy efficiency, waste management and sustainable agriculture, it requires guarantees which reduce risks. These usually come from international financial institutions, development funds and governments, coupled with tax exemptions and other fiscal benefits.

What makes it more urgent now to allocate the bulk of the liquidity to projects that preserve the integrity of the environment, is that this also helps in combating the emergence and spread of viruses. This is because it has become certain that many deadly viruses are due, in a large part, to environmental causes.   Before the pandemic, a report issued by the Arab Forum for Environment and Development (AFED) estimated that Arab countries would need a minimum of $230 billion annually until 2030 to support the achievement of the Sustainable Development Goals (SDGs). It also warned that the final price tag will increase substantially, due to the cost of wars and conflicts, which triggered economic losses of about one trillion since 2011.

In addition, the financing gap will widen significantly due to the catastrophic effects of the pandemic, and the continuing destructive wars and conflicts in more than one country.  

What governments, central banks, international financial institutions and their development funds are able to secure is not sufficient to bridge this huge financing gap, a large part of which must come from the private sector. There is a growing array of interesting financing solutions on the market, ranging from green bonds to hybrid financing tools.

Globally, there has been a 23-fold annual increase in green bond issuance, from $11 billion in 2013 to around $250 billion in 2019. However, despite this rapid growth, green bonds are still far from being a decisive contributor to financing the cost of sustainable development, and certainly very far from the size of the global bonds market, which exceeds $100 trillion. Green bonds in Arab countries, though still in their infancy, have already made some shy debuts. In 2013 the African Development Bank issued green bonds, the proceeds of which were partly used to finance two projects in Tunisia and Egypt. In 2017, the National Bank of Abu Dhabi issued the first green bonds in the Arab region, worth $587 million, due in 2022. In March 2020, Egypt announced plans to issue the first green sovereign bonds in the region.  

Attracting financing from the private sector for sustainable development projects requires greater efforts, whether in infrastructure or investment projects, large, medium and small. This includes encouraging investment of savings, through financial tools that can attract remittances of immigrants, develop financial markets, and attract direct foreign investments through appropriate policies and incentives. Countries should develop mechanisms that encourage partnerships between the private and public sectors, such as blended finance funds, and use liquidity from donor institutions and development funds as a first loss/equity tranche to obtain additional loans from the private sector.  

We must remember that financing sustainable development is not limited to major infrastructure projects. The equitable distribution of development benefits requires support for investment in small and medium enterprises, whether, for example, in energy, water, food production, clean industry, or environmentally-friendly tourism. As the private financial sector remains the best and most reliable source of funding to finance such projects in a sustainable manner, it is necessary for it to be supported by governments, international financial institutions and development funds, as long as it applies practical but stringent sustainability standards.  

What is happening now in several regions of the world is that central banks, government funds, international finance institutions and development funds have started to increase their funding to financial institutions, corporates and projects, at rates which are well below the market levels, in order to use the surplus of cheap liquidity that they have collected for corona recovery.

This practice will potentially lead to mispricing actual credit/project risk, creating future losses and threatening to put specialized private financing institutions providing funding to commercial financial institutions, corporates and projects, out of business. This will cause an irreparable economic and financial damage, as today’s surplus liquidity is temporary, and sustainability requires adherence to market economy rules.  

The main role of governments, central banks, international finance institutions and development funds should be bridging funding gaps where the private sector cannot do this, especially where perceived financial and political risks are high; establishing the right conditions for private money flow, including governance and compliance; and assisting in the creation of local debt and equity markets. Instead of competing with the private financial sector in investment financing, they should support the sector and channel investment capital through it, while focusing on their main business.