By Eric Naranjo, Field Investment Officer, USAID/India

There's a lot of buzz in the world of international development about using private finance in new ways to tackle development challenges and boost sustainability. I’ve been in just over a year and am now starting to gain a greater understanding of the financial innovation around this robust market, differentiating it from most USAID posts. Using private finance in development is still a bit outside the sweet spot for some development professionals, but there is momentum in India that is adding to the enthusiasm for the new phrase: “blended finance.” India’s rapidly growing economy is the perfect laboratory for development finance enthusiasts. India’s rich capital markets, meaningful market reformation, and the continued expansion of the development sector are combining to create an astounding crescendo of innovation.

To add to the excitement, the Government of India mandated in 2013 that 2% of corporate profits be directed to the development sector, boosting the spending pool for corporate social responsibility (CSR) activities by an estimated $7 billion. While the initiative started out slowly, many CSR professionals, impact investors, and donors are now actively exploring creative channels to best combine the CSR mandate with the rich financial innovation in the market. In fact, the Mission just signed an MOU with AMCHAM to engage directly with this mandate. New ideas include development impact bonds, venture grants, and first and second loss guarantees. Appropriately, members of the high-finance crowd and the development finance crowd are increasingly more comfortable in what we call blended finance: using catalytic capital from public or philanthropic sources to mobilize private-sector investment for sustainable development.

Blended Finance with Private Equity: USAID/India is at the forefront of the evolving conversation with a portfolio of activities that will continue to lead the development charge. For example, the Health Office is supporting the establishment of a social impact fund that blends private equity (shares of a company), debt (repayable loans to a company), and grant funds (non-returnable capital). This first-of-its-kind fund aims to blend capital with public and private grants to reduce the cost of capital (interest rate) and pair with direct technical assistance to small and medium enterprises to strengthen the private care healthcare sector.  The fund will start with $45 million in equity and have access to more than $60 million in debt. This debt includes the support of a $10 million USAID Development Credit Authority (DCA) loan portfolio guarantee to encourage women entrepreneurs in the provision of health clinic technology. With blended finance, the fund will improve access to urban healthcare for at least 10 million beneficiaries and reduce out of pocket expenditures from the public purse by 30%.

First Loss Guarantee: USAID/India also uses financial innovation to enhance an existing USAID tool: the DCA. Among its many applications, the DCA supports sustainable landscapes through a credit guarantee that aims to slow or halt greenhouse gas emissions from unsustainable land use.  The forestry sector has traditionally been a challenge for the use of private capital because the policy environment in India, and many other countries, has lacked the level of transparency needed for investors demanding returns. Investors in India; however, are comfortable with a first loss structure: a financial mechanism that is used to repay any defaults before our credit guarantee is utilized thus reducing the overall credit risk exposure. Given this unique preference, USAID/India’s Forestry team successfully attracted a group of commercial lenders to the sector. As a result, our DCA credit guarantee can essentially guarantee more credit with a first loss mechanism than without.

Bonds: Development impact bonds have created much excitement as a new asset class in the development finance tool kit.  USAID is no stranger to results-based financing; however, the private capital community is increasingly comfortable with the new nomenclature. As a result of USAID’s $8 million Maternal and Newborn Health Development Impact Bond with UBS Optimus Foundation, the local market has become increasingly comfortable with the financial instrument and has subsequently reduced the interest rate of similar impact bonds from a 15% rate compounded annually to an 8% flat interest rate. Even at this rate, bankers are still attracted to finance development with private capital in the health and education sectors.  Currently, the excitement is focused on Masala Bonds (rupee-denominated bonds issued outside of India) to offer a lower cost of capital to socially-oriented enterprises. The development sector, always looking for value, can utilize this instrument to offer precious less expensive capital to socially conscious entrepreneurs who are limited in the level of debt they can afford.

India’s development finance sector is evolving quickly: the host is a rising star globally with an impressive technology sector, an expanding middle class, and an improving banking sector.  As the government continues to enable development in key sectors, USAID/India has successfully positioned itself at the forefront of the development sector to catalyze traditional investment to attract investors to a new asset class. The creativity and innovation is a direct result of the rapidly progressing financial markets of India. Our partnership with India continues to evolve, but now with high value impact dividends.