Future of Development Assistance: Horizons Framework and New Financial Instruments

By M S Sriram

Abstract
This paper discusses financial instruments and aid using a framework called Horizons approach. The paper argues that we need to break up developmental activities in the development space into three time horizons: immediate aid which could be in response to a catastrophe; time horizon which involves one generation of humanity where we discuss two types of development intervention – invasive and non-invasive; and a very long horizon where the action is in the nature of conservation and regeneration.

The paper argues that the approach to financing a project has to be clearly under one of these horizons and within that too, specifically within the broadly identified activity types. We argue that the very short horizon has overriding humanitarian considerations and the most effective way to address these are by immediate response through aid with no conditions.

For the intermediate horizon, the paper advocates a range of financial interventions. For invasive projects, the paper advocates the structuring of a Prosperity Fund in Perpetuity to signal a commitment to local development and minimize the negative collaterals of invasion. The paper advocates a new instrument of a Ladder Bond to provide patient capital for market development and market intervention of activities.

For the very long horizon activities, the paper advocates an endowment for the initial capital investments but advocates objectively measurable Impact Notes to ensure greater accountability and measurability of even conservation like activities that operate on a very long horizon.

Introduction

The world is a much better place if there was less poverty and development was spread wider. This philosophy should apply to avoid the concentration of wealth in the hands of a few individuals within a country and in the hands of a few countries in the world. It is expected that aid would flow from the well-developed countries and private foundations to the least developed ones. While it is obvious that the least developed countries should have a prime position in deserving aid, there are several intervening variables that may not make this flow possible. These variables include geo-political considerations, the ability to handle aid with its non-negotiables, governance structure and ideological differences.

In addition to a general level of backwardness and poverty in a less developed country, there are other issues that plague the middle-income countries which may have overall growth, but widespread poverty represented by internal inequity and a failure of the State to effectively intervene through the taxation regime to reduce polarization and a failure to target subsidies effectively and efficiently. This would result in what could be termed as ‘islands of California in a sea of sub-Saharan Africa’.¹ Aid agencies need to be concerned about such regions because poverty as a result of polarization and inequity would eventually be a threat to peace and tranquillity of the region, and also of the world order.

This paper tries to address this rather complex issue of aid agencies, the recipients; the process of intervention; the instrumentality of the flow of aid; based on a measurable framework. The paper puts all these issues over differing time horizons to differentiate between alternative approaches to aid.

Philosophy of assistance

Providing aid or assistance is a tricky business. The donors would like to see that the grant gets the best possible results with very little leakage or wastage, and maximum efficiency. Over a period of time, metrics have taken a predominant position with multiple frameworks trying to attribute causality to every dollar of a grant made. These approaches could be found in the way the grant proposals are drafted, usually using results-based log-frames, commissioning of evaluation and impact studies and the recently popularized approach of randomised control trials.

Aid agencies also focus on the nature of governance structures, leadership quality – both in terms of structures and systems and the quality of human resources managing these systems. The aid agencies are worried about the sustainability of the activity post an intervention. Unlike the decades of the 70s and 80s, we now have more questions on user fees, levies, alternate resource generation and sustainability. These questions are nearer the frameworks used by the markets. Answers to these questions help the aid agencies to have an exit plan so that the next worthy cause can be supported. The language with the word ‘exit’ resonates with the term ‘exit’ used by private equity and venture capital firms.

Over a period of time, the language of aid has become increasingly ‘marketized’. For instance, the terms of reference for this essay itself start with talking of financial instruments having a mix of loans, guarantees, insurance and equity with varying degrees of subsidization. Clearly, the focus is looking at innovation in aid as distinct from old fashioned grants.

The challenge, therefore, is to look at aid purely from the agenda laid out by the recipient seeking aid. While issues of measurability and efficiency are important, we need to ask whether there is too much pressure on the immediate, thereby, sacrificing the long-term view that might be more complex to articulate and even more complex to measure. The instrumentality of structuring aid should be informed by the complexity of the issue addressed and the impact horizons.

The horizons approach

Providing aid is ultimately an act of faith. It is faith based on a promise of implementation and improvement that the recipient holds out. The dangers of making a wrong choice – which could be a wrong organization, wrong cause, wrong timing or wrong instrumentality – is a waste of limited resources that could have been otherwise applied to a worthier cause. Therefore, the concerns of the aid agencies are that aid should be applied to a worthy cause; it should serve a purpose; and it should serve it well. Providing aid is for multiple purposes and aid agencies choose their favourite causes and geographies.

In this note, we argue that there could be an alternate approach to examine aid and design financial instruments appropriate to the objective and tenor. Distinct instruments are needed for interventions that benefit society at large in the long term with unknown outcomes and intrusive interventions for course correction in the marketplace. We argue that the design of the financial instruments should reflect the philosophy of aid and the expectation of impacts. Some of the impacts could be non-financial, and some could result in a profit. The design of the instrument should be dictated not only by the desired financial result but also by the consideration of perpetuating the aid beyond the active intervention of a particular financial instrument.

Dealing with the immediate: very short horizons

If the horizons are short, the donor will treat aid as an amount to be expensed. There would be no financial instrument here, (save the check!). In very short horizons, we envisage a tactical donation, just to get over an immediate problem, with no intention of engaging with the recipient over the long run. This sort of aid is to do with humanitarian aid as a result of a catastrophe or a war; aid provided in the larger interests of humanity transcending ideological leanings, governance structures and the other aspects of due diligence. Since the cause is so pressing and immediate, such aid just cannot afford to examine any aspect of measurability. It is immediate and it needs to be given in cash or in the form of specific aid but there is no luxury of time for analysis and impact issues. Such aid is entirely discretionary and usually impulsive, dictated by the agility demanded by the situation.

In a catastrophe situation, aid is to be seen as humanitarian, with no social or economic return expected. This is an aid to repose faith in the basic humanness of the world. It is an ‘expense’ in crude terms. Philosophically, it signals a deeper world view: in certain circumstances, humanity should transcend relatively smaller expectations of repayment, interest, returns and so on. It should take the argument to the base of the edifice, that of human life and the conditions in which human life survives.

Apart from a natural disaster, the next case could be that of an economic or a political disaster leading to the implosion of nations/states/organizations and these institutions moving to the brink without any visible central leadership. Usually, a large number of lives and livelihoods are involved in such a situation, and it is necessary again to engage with this situation unconditionally in the interest of larger peace. Anarchy anywhere is a seamless threat to the world at large. However, such issues (unlike natural disasters) cannot be dealt with without other considerations because they will have geo-political considerations. There might not be issues of measurement of impacts but who will participate in the aid program, and the motivations to participate in such a program have to be articulated. Unlike a natural disaster situation, the aid may not be impulsive, but it has to be immediate with very moderate expectations of outcomes. In general, all aid with an immediate term horizon should normally go as straight grants to be expensed in the books of the donor.

Looking at a generation: mid-range horizon

If we move the engagement horizon to a mid-range – and this is where the bulk of the action is expected to be – we would be looking at the aid more in the nature of an investment than as an expense. Globally, it is important for aid agencies to move in this direction. If we consider one generation as a timeframe for a mid-range horizon, it will help donors to focus on both social and economic returns on investments. The complexity of aid opens up because it is a zone of ‘investments’ as against expenses. The aid agency will have to structure the aid between a part that would give a financial return and a part that could be seen as a social investment without any associated financial return. The considerations of markets, trade, welfare and geo-politics come in this horizon.

In the mid-range horizon, aid can be invasive or non-invasive. Invasive aid focuses on the developmental aspects but usually has a larger collateral. Building infrastructure – ports, roads, airports, dams – encouraging projects that help employment generation etc, are what we would term as invasive projects. It is more likely that bi-laterals and multi-laterals partner in such programs as against private foundations. While these projects are required from a larger welfare and growth perspective, they would have their collaterals: displacement, disempowerment and aspects of rehabilitation. Some of the collaterals – particularly with regard to physical relocation, compensation and alternate livelihood generation could be quantified; but some collaterals specific to the cultural aspects, such as displacement of primitive tribal groups; loss of heritage; destruction of biodiversity; change in lifestyles etc., are difficult to measure. Invasive aid will usually face stiff resistance from the groups that are working on a longer horizon of preserving the environment, culture and heritage. While the resistance would come from arguments that are based on immeasurability, they have to be countered with difficult arguments on the measurements of cost-benefit analysis.

Invasive projects usually have a physical structure or an asset. This structure is expected to have a multiplier effect in development. If we take the project as a whole, let us say, for instance, the development of a port, an airport, building a metro system, or establishing a thematic smart city that would cluster industries – there would be three components to this endeavour:

• The project per se would have the potential of a revenue model (depending on the identified class of users). For instance, it can be assumed that airports would have users who can afford to pay a user fee. Therefore, the project can be based on the premise that even if it is a public project, a substantial part of the funding can come from the users of the service. But a bus station is used by a wide range of people, particularly the poor, and, therefore, cannot be based on a user fee-based revenue model.
• There would be a larger set of unidentified beneficiaries who enjoy the multiplier effect of the infrastructure: due to better employment; greater business potential in servicing the facility, and other ancillary and subsidiary activities.
• There would be direct and unknown costs of land acquisition, rehabilitation, dealing with opposition and possibly legal expenses.

However, the larger interests dictate that such invasive initiatives need to be supported. The financial intervention in such projects should ensure a buy-in from the beneficiaries, and a commitment from the project to go that extra mile in the rehabilitation efforts. The recipient of the aid should also demonstrate skin in the game with a framework to share the upside benefits. So, for the three points discussed above, the ideal financial intervention strategies are as follows:

• The project per se should be funded like any business – on a public/state-owned infrastructure or public-private model. The obvious instruments are equity and soft debt. We do not discuss the structuring of the debt here. We assume that the debt contracts will be structured looking at the repayment horizon and capability of the project and would come with terms that evolve according to the project and there would be no upside for the provider of debt if there are more than expected returns. When returns are less than expected, the temporary or long-term infeasibility of the project will take it back to the negotiating table on restructuring the debt or renegotiating the agreement. However, we need to provide for the structuring of any profits or gains far beyond the expected threshold. Assuming that there are three parties involved – the donor, the recipient agency, which is also investing, and the private sector – the application of profits beyond the expected and agreed return should follow an allocative mechanism. The private party takes the upside gains pro-rata fully, the local state government and the aid agency have to deal with their share of the upsides – and how they deal with the upsides depends on the next two points.
• The large set of unidentified beneficiaries would be people residing/benefiting from the catchment area of the project. Therefore, the project itself will have to build an adequate ancillary infrastructure around the project so that the unidentified beneficiaries are proactively accommodated in this development story. This activity has to be funded exclusively by the project implementing agency. If we assume that the recipient is a state, then such infrastructure should come from allocated budgetary resources.
• The next set of costs – not directly associated with the new infrastructure being set up – acquisition of land, compensation, relief, rehabilitation, litigation costs etc., have to be borne through the recipient entity. This part of the cost is to be structured as a subsidy/grant upfront. However, we also argue that any pro-rata earnings from user fees and other returns on equity investments made in the project, the interest income on debt instruments and all upside revenues should also be applied to an escrow fund that deals with the collaterals of the project. Let us call this fund the Prosperity Fund, and this should be available in perpetuity to the pre-defined project catchment area.

The above argument is about strengthening the ‘local’ in an invasive project. When we look at the upfront financial inflows for the project, these inflows come from (a) participation by the local agency (the State) (b) aid from the donor agency and (c) private investors. There could be a window (d) for local investors from the project area. But it is evident that the bulk of the funding is coming from outside resources. When the project starts delivering on its intended consequences, it leads to prosperity in the area which pays back (a) the State in the form of taxes and (a, c and d), and the State, the private investor and the local investors in the form of dividends. They are generated from the local area but contribute to the centralized kitty. We argue that the dividends that accrue to the donor and the State should be converted into a Prosperity Fund to be used exclusively in the local area in perpetuity.

Such structuring sends out very powerful signals. The aid agency sends the signal that it is not there to earn profits through non-transparent means; the region deserves development, and the funding is a perpetual commitment. The state signals the commitment that a visible share of the benefits of invasive development is applied to the larger benefit of the project affected and project benefitted people, locally.

Non-invasive projects are projects that do not physically affect the local milieu but are aimed at building soft infrastructure that is necessary for the integration of a region/sector in a global marketplace. An example of this could be the development of a financial services market that involves the informal sector or the poor. Here, aid is needed to build the soft architecture – skills of appraisal; a risk mitigation mechanism; a rating service or an information bureau. Such projects would also have a large commercial component and a significant market development and a market intervention component. While these projects might start locally, they have the potential to grow nationally or transnationally quite seamlessly. The approach for such projects has to be fundamentally different from the approach to the invasive projects.

Non-invasive interventions would have lesser negative collaterals. These interventions can be funded on the basis that would go nearer the commercial world that grants. However, even in this case, the intervention may have a larger developmental purpose (reform, policy change, development of soft infrastructure, education, business development services etc.,) than a commercial purpose (institutions that develop the market, intervene in the market and invite commercial players into the market by demonstrating viability and profitability).

The instrumentality of aid would move from an endowment, and from specific project/program-based grants, soft debt, commercial debt, patient equity, and commercial equity. These instruments are well known. We would like to propose a new instrument that addresses the vital issue of the viability gap on new complex reform interventions through market-based institutions.

We call this the Ladder Bond. Every new initiative that involves market development would start with some doubts on the feasibility, till it is established on the ground. Some might have a short break-even period, and some have a longer break-even period. But if it is an institution operating in the market and has to get the faith of the market players and draw more mainstream investments, it will have to turn profitable as quickly as possible. In order to accelerate this process, we propose the instrument of a ladder bond.

The ladder bond is a market, like an instrument. The objective of such a bond is (a) to provide ample soft funding for a project that might have a large viability gab (b) to ensure that liquidity essential for the smooth running of the project is not severely affected and (c) to skim the upsides of the success of the intervention.

The ladder bond starts with a zero-coupon for the pre-agreed moratorium period. The bond money is just parked for that period with no expectation of return. This is superior to plain moratoriums where the interest on the bonds will have to be accrued during the periods even if there are no cash outflows. Once the moratorium is over, it will start paying interest on the bonds on a laddered basis based on the viability gap and the profitability parameters. The minimum interest rate, after the moratorium, could start at one percent (1%) and can be pegged to the average cost of borrowing of mainstream commercial loans or bank rates.

The discount on the bank rate keeps reducing as the profitability increases and at a stage where the expected rate of profits starts accruing to the project, the bond-holder will have the option to (a) convert the bonds to equity at a discount in comparison to the market rate (to compensate for the foregone profits in the initial periods) or (b) to exit by selling the conversion rights to a new investor and keep the premium. While we do not envisage an active market for the ladder bond during the initial phases, it is possible that based on the expectations of the valuation at the time of conversion, an active market might emerge for the ladder bonds.

If an active market for the ladder bonds emerges, then the aid agency could even look at an early exit and use those resources for deployment elsewhere based on its priorities and it provides a source of liquidity to the aid agency. The downsides of the ladder bonds are that the timelines will not be met, the valuations would be low and a possible default may occur. Since the purpose of the investment is in any case developmental, failures should be acceptable.

Ladder bonds, by definition, cannot have a valuation that is superior to the initial equity holders at the time of conversion. Ladder bonds are expected to have a return lower than equity investments, carry higher risks than regular bonds and a return that would match up the return for the debt providers with a timing difference making it unattractive at the start and disproportionately attractive towards the maturity point if the project is successful. A ladder bond as a financial intervention can also be used in invasive projects described above.

Conservation-regeneration aids: extremely long horizons

In an aid scenario, there are multiple purposes that require the attention of aid agencies. The agency could be torn between asymmetries in the marketplace that need a pump-priming which would have a market-based multiplier effect (a classic example of this is microfinance); and an agenda of being a conservationist (where the market principles are far away). It is, therefore, important to develop a worldview that is applied differently in distinctly different situations.

In this section, we examine something that needs a very long horizon and could be in the conservationist-regeneration mould. If we are dealing with this particular problem, then the resources spent on this approach would not show immediate or precisely measurable results. We could count the number of saplings that have been planted to understand what is being done in the regeneration of forests. But how do we measure the intervention of organisations to prevent deforestation? Or undertake the preventive role of maintaining a balance of natural resources that provides inter-generational benefits? This applies to natural resources, art forms, wildlife and to anything that the society, at large, might treasure but does not fall into the rules of the market system.

This question on conservation is tricky because both the donor and the grantee should have the patience to stay on course for a fairly long horizon and often it is not possible to measure the efficacy or attribute causality. Most of the happenings, both on the policy front and in the field, are a result of an amalgam of initiatives for which attributing causality might always be a problem.

Ideally, whenever there is a third sector initiative, it is in some way addressing the failure of the market or the state. Whatever does not fall into the realm of the market, falls residually into the realm of the state. It is expected that the state, having a larger welfarist agenda will take up issues that do not appear rational from a pure cost-benefit perspective on the immediate horizon.

The aid interventions that fall in the realm of conservation or regeneration would, in general, be away from markets, though there would be components of the activity that can be put in the marketplace. That would be the limited financing coming from the market. Therefore, how should aid for projects of extremely long horizons be structured? The problem is not as much in finding a financial instrument to structure the aid, as it is in finding an objective way of evaluating the performance of a recipient on an ongoing basis and in reviewing and tweaking commitments as the situation emerges.

The organisations and initiatives serving very long horizon causes, would need three types of funding:

1. Funding for capital investments that any organization might need to comfortably operate. These could be fixed assets. For instance, an educational institution would certainly, at the bare minimum, need land, building, classrooms and residential facilities if it is to be an operating identity. There could be other similar needs to be met for organisations having long horizon causes.
2. Funding is needed for recurring costs. Part of these could be structured as user fees and an element of cross-subsidy could be provided, but there might be some years of initial support needed before fee-based, commercial revenue models [if any] are established.
3. There would be a need for a comfort cushion that provides liquidity and assurance for bridging temporary mismatches in point (2) above.

For capital investments, the only way funding could be provided is through an endowment. This endowment would usually be an act of faith when the track record of the agency is not known. However, based on the evaluation of the plans and the track record or the intent of the key management personnel, this investment has to be made. There is no point in even trying to evaluate its effectiveness or impacts.

However, on points (2) and (3) above, we could be more imaginative. The challenge would be to structure financial instruments that have built-in clauses and triggers that get activated if there is a drift, while the commitments, in general, remain stable.

Organisations working in this space might actually be at cross purposes with the developmental projects that we referred to in the ‘medium horizon’ section. These organisations might be the ones that raise questions about the collaterals of an invasive developmental intervention. They also fall into the same aid space. While donors’ ideology and prioritization would dictate which donor supports what cause, let us, for a moment, imagine that a single donor supports both types of causes. Then how would the donor reconcile these causes that have an apparent contradiction?

The only way to deal with this issue is to have an objective measurement. This measurement is to be broken up into two parts: conservation and restoration. For instance, in the above situation, when there is a clash between the developmental imperative and the imperative to contain the collateral damage, the onus of measurement of the negative impact of the collateral would rest on the organizations working to minimize the collateral. The minimization of the collateral is to be weighed with the costs of relief, if the project has to go ahead.

We have to realize that while the cause itself could represent a very long horizon, the requirement of finances for working towards such a cause need not be of a very long horizon. Indeed, it would be better – unless that there is a compelling case made for a long-term commitment of funding – to commit on an ongoing basis, but not on the basis of the programmatic expenses incurred, overheads or the activities carried out, only on the basis of outcomes.

We have a basic framework provided by the carbon trading market which shows us that it is possible not only to measure the environmental impacts but also trade in them. We are not suggesting a trading platform yet. What we propose is a well-defined matrix of looking at positive impacts of activities undertaken in a given period that has potentially benefitted the long-term cause. When these are put into a measure, the organization can get certified Impact Notes. These notes can be exchanged with the aid agency for cash which helps the agency to continue to work for the cause in perpetuity. The aid agency will have to make a long-term commitment to honour the claims that would be objectively verified.  While to start with, it is important to have a prior understanding of aid agencies honouring Impact Notes in order to create activity and stabilize the initiative, it is possible that a natural marketplace would emerge for these notes in the long run, where it is possible that the agencies undertaking the intrusive developmental activities actually fund the Impact Notes to deal with their negative collaterals of intervention.

The implementation field agency working on causes of long-term impacts could gain supreme efficiency by controlling its own costs, finding effective and superior ways of working for the long horizon costs and getting far superior returns than what it costs them for undertaking the activities.

The most complicated piece in this puzzle would be to evolve objective matrices and that should be allowed to evolve over a period of time. In this way, it is possible to get the discipline of the market to even causes that have a very long horizon.

Summary

I conclude this paper by suggesting that looking at the time horizons of a project impacts the larger orientation of whether they are commercially or developmentally oriented; and having a good understanding of their invasiveness helps us to devise strategies and financial instruments to suit the intervention.

Author
M S Sriram, Visiting Faculty, Indian Institute of Management, Bengaluru and Azim Premji University, Bengaluru.

Featured photo by Pok Rie from Pexels