New Paths to Funding

• Author: Suhas Ketkar / Dilip Ratha
• Position: Professor of Economics at Vanderbilt University / Lead Economist in the World Bank’s Development Prospects Group
• Pages: 43-45

Page 43

When financing is scarce, developing countries may try innovative approaches to raise capital

DEVELOPING countries have an outstanding short-term debt of nearly a trillion dollars. According to the World Bank, they face a financing gap of $370–$700 billion. Given the severe crisis of confidence in debt markets, it will be extremely difficult for countries to obtain private financing using traditional financial instruments. Innovative financing approaches are required, especially for private sector borrowers in developing countries, who face even harsher credit rationing than public sector borrowers.

Scarcity of capital threatens to jeopardize long-term growth and employment generation in many developing countries, which have limited access to capital even in the best of times. Official aid alone will not be adequate to bridge near-or long-term financing gaps. Ultimately, it will be necessary to use official funding to catalyze private flows to developing countries—adopting innovative financing approaches such as targeting previously untapped potential investors or using structures with credit enhancements to tap existing investors.

Stimulating such approaches is easier said than done, especially during the deepening financial crisis. But the debt crisis of the 1980s was ultimately resolved via an innovation—the creation of Brady bonds in 1989. Those bonds, named for then–U.S. Treasury Secretary Nicholas Brady, securitized the bank debt of mainly Latin American countries into tradable bonds that could be purchased by a broad investor base.

Some innovative market-based financing mechanisms that developing countries could use include borrowing from their expatriate (diaspora) communities, securitizing future revenues, and issuing bonds indexed to growth. Preliminary estimates suggest that sub-Saharan African countries could raise $5–$10 billion by issuing diaspora bonds and $17 billion by securitizing future remittances and other future receivables.

Diaspora bonds

The governments of India and Israel have raised about $40 billion, often during liquidity crises, by tapping into the wealth of their diaspora communities to support balance of payments needs and finance infrastructure, housing, health, and education projects. Diaspora bond issuance by the Development Corporation for Israel (DCI) has been a recurrent feature of that nation’s annual foreign funding program, raising well over $25 billion since 1951. The State Bank of India (SBI) has issued diaspora bonds on just three occasions—in 1991, following the balance of payments crisis; in 1998, after the country conducted nuclear tests; and in 2000. The SBI has raised $11.3 billion. Jewish diaspora investors paid a steep price premium (perhaps better characterized as a large patriotic yield discount) when buying DCI bonds. Indians living abroad purchased SBI bonds when ordinary sources of funding for India had all but vanished.

The rationale behind diaspora bonds is twofold. For the countries, diaspora bonds represent a stable and cheap source of external finance, especially in times of financial stress. For investors, diaspora bonds offer the opportunity to display patriotism by helping their country of origin. Furthermore, the worst-case scenario for diaspora bonds is that debt service payments by the issuer are in local rather than hard...