Topic Guide: Blended finance for infrastructure and low-carbon development (full report)

Abstract

This guide provides an overview of both the theory and practice of blended finance. Blended finance is defined as the complementary use of grants (or grant-equivalent instruments) and non-grant financing from private and/or public sources to provide financing on terms that would make projects financially viable and/or financially sustainable. Given that certain infrastructure investments may not be commercially viable, innovative instruments have been sought to close this ‘viability gap’ and make a larger number of projects bankable. By blending grants with loans, this innovative approach to development finance aims to achieve a number of objectives – from increasing the volume of development finance in a context of constrained resources, to increasing the viability of investments, to enhancing the overall effectiveness of aid. Moreover, by demonstrating the long-term viability of markets, blending can potentially trigger an increase in private investment without the need for a grant element (although the evidence on this so-called ‘demonstration effect’ remains relatively weak). The objective of this guide is threefold: to define and provide the theory and rationale behind blending, to highlight key considerations for donors and development finance institutions (DFIs) of blended finance, and to illustrate how blending occurs in practice. The guide addresses blending primarily from the perspective of donors and DFIs and is structured as follows: Section 1 defines blended finance and describes the various grant and non-grant instruments that can be used in blending. Section 2 provides an overview of the underlying rationale for blending as well as multiple criteria that govern decisions such as the size of grant and type of instrument. It also looks at the relationship between official development assistance (ODA) and blended finance. Section 3 demonstrates how the European Union (EU) and the International Finance Corporation (IFC) of the World Bank Group have engaged in blending to explore practical considerations around its use and application. It identifies the current entry points for donors in their respective processes. Section 4 assesses the main underlying issues that practitioners need to be aware of in order to ensure that they use this innovative financing tool efficiently and effectively. This is important since, although the potential benefits associated with blending are significant, questions have been raised in some cases regarding its effectiveness, development impact and potentially distortive effects. The main challenges include balancing financial incentives and development principles, avoiding crowding out of private markets, debt unsustainability, transparency, accountability and monitoring and evaluation (M&E), as well as the possibility of negative demonstration effects. Section 5 concludes by identifying a set of critical questions for consideration by donors and DFIs when designing a blended finance package, as well as areas where further research is required in order to develop a more comprehensive understanding of blending. The guide assesses blended finance in the context of financing infrastructure and low-carbon infrastructure projects in Sub-Saharan Africa and South Asia with case studies of relevant projects used throughout to illustrate the following main points: The different motivations for blending. Various forms of the value added of the grant element. Potential improvements in donor coordination. This peer reviewed Topic Guide has been produced by the Overseas Development Institute (ODI) with the assistance of the UK Department for International Development (DFID) contracted through the Climate, Environment, Infrastructure and Livelihoods Professional Evidence and Applied Knowledge Services (CEIL PEAKS) programme, jointly managed by HTSPE Limited and IMC Worldwide Limited