New report warns governments not to use public guarantees to increase private finance involvement. Developing countries are considered particularly vulnerable in this regard.
Governments increasingly try to use public funds or guarantees to attract private portfolio finance to realise public goals like infrastructure projects, or to deal with social or environmental problems.
The latest SOMO report ‘Harnessing private finance to attain public policy goals?’, analyses this growing trend and identifies the risks that come with it.
The arrangements examined in the report are new and unique in that they are not about the construction or provision of a public good, but about how such provisions are financed. New instruments and regulations are being designed to attract private portfolio investors, especially insurance companies and pension funds, to provide the money that cash-strapped governments increasingly lack. By creating new, lucrative instruments to invest in, policy-makers also try to fill another gap, between the income of pension funds and insurers and their payment obligations to their clients.
What sounds like a win-win is actually quite risky: harnessing private finance means ceding some control over project selection and policy goals to financial investors. There is a danger of incurring unnecessary and excessive fiscal risks, because of a lack of transparency and because governments may be tempted to entice private sector actors through excessive guarantees and risk transfers. Moreover, portfolio flows are unreliable and therefore unfit to be part of sustainable finance. Developing countries will be particularly exposed to these flows, but have fewer resources to deal with the resulting volatility.