Speakers:
Alan Gillespie, Chief Executive, CDC Capital Partners
Michael McWilliam, author
Chair:
Simon Maxwell, Overseas Development Institute

1. Simon Maxwell provided a context for the presentations and discussion, describing how corporations investing in developing countries are beginning to move beyond the ad hoc funding of charitable community projects, such as health clinics, to thinking harder about how their core business operations can impact positively on poverty reduction targets such as the Millennium Development Goals. The business-case had to be clear for such a transition, but 'win-win' (poverty reduction plus business benefits) is a real possibility. Project finance and poverty reduction lies at the heart of this debate.

2. Alan Gillespie opened by referring to the quote in the title of the discussion , arguing that such a viewpoint was 'blind' to the role played by risk (equity) capital in business. He rephrased the question as: "you can't expect a development agency that distributes capital for poverty reduction aims, to bring a financial return on that capital for its investors" - and said he would be disagreeing with the proposition.

3. In the first world we don't question the link between risk capital generating returns and its benefit for society in terms of employment etc., so why should we suspend this model when we focus on poor countries? It is all about 'how' capital is allocated, making sure that it goes to enterprises that are commercially viable and profitable. Economic growth in the UK is based on this type of capital allocation. Why should we allocate capital to companies in developing countries regardless of their health and prospect for viability?

4. Referring to the recent World Bank meeting, subsidised aid and public sector loans have had little permanent positive impact on poverty. "Why has so much aid done so little over so many years?" Does not this point to a greater role for 'market-based' strategies, results orientated, and based on higher quality appraisal of how capital and aid is allocated. The aim should be for businesses to be sustainable in the long-term.

5. Since 1997, CDC has had its charter re-defined by Government. Its capital allocation is now about both developing financially viable businesses in developing countries and leveraging capital from commercial sources, eg pension funds etc. To achieve this, investments need to generate a commercial level of return for shareholders. CDC is thus a 'demonstrator' to the wider commercial markets, showing how to secure such a return, whilst concurrently achieving poverty reduction aims through generating wealth distribution, foreign exchange earnings, supply chain access, employment, fulfilling social aspirations etc.

6. To illustrate the poverty impact of good, commercial viable, business, almost 200,000 people are employed across those investments in which CDC has a stake. In India, CDC took a $2 million equity position in a BPO 'start-up' in the technology sector. This company now employs 2,500 and revenues of $30 million. In central Africa, CDC acquired a cement producer, and helped build the competency of the business to the point where its long-term viability was secured through sale to a major producer. These examples show capital invested for adequate return, cutting poverty, reducing unemployment and each mobilising additional capital.

7. CDC is a relatively small player in terms of aid-related risk capital. The IFC and European institutions are far larger. Further, in comparison to DFID, CDC represents the equivalent of 6% of the department's £2.4 billion budget.

8. In conclusion, investments do not always work out. Some fail due to inadequate management. CDC works in high-risk markets, being selective, and then working to strengthen their commercial viability. This is the CDC 'additionality'. Given the need for such additionality, it is worrying that the UK Chancellor talks of the need to mobilise $50 billion annually to meet the MDG goals, ie a doubling of the available capital, when capacity for effective use of the funds may be limited.

9. Looking ahead 25 years there are two future scenarios.
One: a widened gap between rich and poor nations, with weak governments in developing countries, civil war, international terrorism and fanatical opposition to the global economic system, leading to companies and capital being pulled back from the developing world.
Two: flourishing entrepreneurial activity in developing countries leading to 100 million new consumers in China, India, Brazil and South Africa prosperous a positive effect on neighbours countries, accompanied by reduced conflict and improved public sector governance. If the second, brighter scenario is to come about, capital must be allocated to the private sector, earning acceptable returns.

10. Sir Michael McWilliam opened by agreeing in general with Alan. We are all trying to be more discriminatory in selecting where to invest capital, and all recognise that businesses in developing countries creates employment, enhances GDP, has a positive effect on foreign trade, assists in technology transfer and contributes to standards of governance, health, safety and the environment.

11. On reflection, the question is about the essential ingredients of success when investing in higher risk countries, both for poverty reduction and commercial viability. The role for CDC in the past has been to shrink the 'perception' of risk to more realistic levels, ie to demonstrate that the perception of risk is overstated and that it is possible to invest profitably in such regions of the world. To give some examples:
(a) the rise in investments in Uganda following reforms;
(b) collaboration with other investor institutions,
(c) improvements in standards of business behaviour, ie that investments don't have to be exploitative, and
(d) improvements in business management competency, both in the selectivity of investments, and in their execution.

12. Looking forward, the main regret is that, by shifting to a predominantly equity provider (rather than debt), CDC may be withdrawing from some sectors where it has great experience, such as agriculture. We see the current problems of agriculture in Africa in meeting the challenges of the changing international market, both its constraints and opportunities. Could not CDC preserve its expertise in this area? Perhaps one way forward is to widen or restore agriculture to the mandate of CDC.

13. Simon Maxwell summarised the main issues on the table. The first debate was about general issue of access to risk capital in developing countries, and the role of business in reducing poverty. He thought no-one would disagree with Alan Gillespie and argue that private investment had no role to play. There might, however, be questions about the range of poverty-reducing outcomes, about the characteristics of best- and worst-case scenarios, and about how to maximise the probability of best-case outcomes. The second debate might be about the particular role of CDC as a provider of risk capital, particularly in respect of issues to do with equity investment, rates of return and geographical and sectoral portfolios.

14. Alan Gillespie provided some additional information about CDC. Between 1940 and the 1990's CDC has principally provided debt capital (loans). In 1997, in response to the presence of other debt providers in this market, CDC moved to the provision of equity, ie a product change, coupled with a mandate to marshal additional private capital from other sources and to have a pro-poor geographic focus on Africa, South Asia and (to a lesser extent) Latin America. To achieve this requires a return on capital that would satisfy private sector capital providers. The typical return expected of CDC's equity investments is around 15-17% net (ie after fund manager fees etc.), 20-25% gross. This varies by geography and sector.

15. CDC has not withdrawn from agriculture, for example oil palm in PNG, sugar in Swaziland and horticulture in Kenya, but it needs to be recognised that in general agriculture does not often generate sufficient returns on equity capital.

16. Discussion. A number of points were raised:

a. Referring to an example unrelated to CDC, although returns need to commensurate with risk, why was an 18-19% net return insufficient to overcome the risk perceived by a retail bank when negotiating with CARE International UK to jointly provide banking services to the poor in East Africa? It seems that the critical factor here is how to reduce the 'perception of risk' so that the return thresholds become more realistic, ie lower.

b. What is the current role of MIGA and the other risk multi-lateral and bi-lateral guarantee agencies? Could not these agencies absorb some, though not all, of this risk.

c. There is a 'crying need' to measure the impact of investments on poverty reduction, using a standardised format to enable comparison across investments. For example, in which type of company is it better to invest to achieve poverty reduction targets, and oil company or an agricultural company?

d. It is not possible to have two targets (ie both commercial returns 'and' poverty reduction) and yet only one instrument (ie equity). CDC should concentrate on what commercial providers cannot do.

e. It is not true that FDI that makes a commercial return always contributes to poverty reduction. In some cases, for example, although investments may raise the average level of wages in a country or region, this benefits only those already with commercially relevant skills. Could not CDC use its management influence to push the benefits of investments outwards more, for example, to local SMEs via the supply chain.

f. Is there a blue print for achieving improved governance and business behaviour in developing countries. Alan - yes, in the shape of CDC's Business Principles and the rigour of our (CDC's) selection process.

g. DFID reaffirmed that CDC was a very small part of DFID, and that since 1977 no new money has been put into the institution. Far more resources are allocated to stimulating a link between private sector investment and poverty reduction through other aid instruments.

17. Simon Maxwell - in summary all agree that the private sector is a key driver of economic growth, and that FDI has a role to play within this. Where there is debate is in how to make this work when gross rates of return are 20% and above. Further, some FDI does help poor countries, but some does not. The worse case scenario is where FDI requires such high rates of return that the poor benefit little and where the safety net of CSR (corporate social responsibility) practices are insufficient to impact significantly on the poverty agenda.

18. Alan Gillespie - the distinctive nature of CDC with regard to contributing to poverty reduction is: (a) its 'poor country geography' commitment, ie to Africa, S Asia and Latin America - where other investment institutions do not focus; (b) the 'additionality' provided by attracting other risk capital; and (c) as a value-adding partner in terms of business management and HSE issues, as discharged through CDC's 'Business Principles'.

19. Sir Michael McWilliam - trying to marry commercial return with poverty reduction is difficult. Perhaps CDC needs other additionality instruments available to it such as 'debt' as well as some differentiation between the expected rates of return for different investment sectors.

20. Simon Maxwell - The challenge is how to both enlarge the volume of commercially viable FDI in developing countries and well as harness the maximum benefits of these investments for the poor. The role for the British Government in this needs to be further explored.

Michael Warner, ODI
18th October 2002