Uncertainty and Multilateral Development Banks

One issue that helps us understand market functioning is decision-making in contexts of uncertainty. While investors and entrepreneurs prefer to operate in friendlier, more predictable environments, they are also interested in operating in more complex and unpredictable contexts, but only to some extent. After all, predictability is often associated with the ability to identify and mitigate risks, price formation, and the estimation of costs and rates of return.

So when the business environment is highly unpredictable and/or too exposed to new sources of uncertainty, investors and entrepreneurs often adjust, postpone or even cancel projects. In these contexts, projects with higher social returns often give way to speculative businesses or relocate.

That said, we live in times of great and intense change, often rapid, that are making the business environment less predictable and less conducive to higher social return investments, e.g. infrastructure. There are many new sources of unpredictability, including the pandemic, climate change, technological change, geopolitical threats, and the extraordinary and growing concentration of markets globally. These and other changes have already taken place but are likely to have even more forceful impacts on decision-making and market functioning.

While it is a global phenomenon, emerging countries, e.g. those in our region, are more exposed to these changes. This is because the sources of unpredictability and its consequences tend to be magnified by the multiple failures of the market and the economic, social and political circumstances of each of our countries. To give you a practical example: Think about the remarkably strong impacts of the pandemic on business mortality, economic growth, public finances, poverty, and the education of children and young people. And think also about the recurrent discontinuities in public policies resulting from changes in government and political voluntarism. These kinds of issues raise red flags for investors.

In fact, although they offer endless new business and investment opportunities, the uncertainties looming over the region are such that even the high liquidity of international markets has not had the expected effects on entry of Foreign Direct Investment (FDI). But the region needs to resume growth in order to offset the more immediate effects of the pandemic, and also the longer effects stemming from the economic downturn that was set off after the end of the commodity supercycle in the first half of the past decade. And to this end, it will need to rely on national and international investors, which requires offering a more predictable business environment.

Multilateral development banks (MDBs) are contributing to those efforts by allocating around USD 45 billion annually in Latin America to underpin projects and operations with the public and private sectors. These are representative amounts, but relatively modest in view of the needs. As a reference, they only account for about 20% to 25% of all annual FDI received by the region.

The branches of MDBs supporting the private sector have focused on operations that aim to identify and reduce costs and risks, and have tried to allocate funds more strategically, in order to reduce uncertainties, attract third-party resources and expand the market presence—think, for example, about the significant expansion of PPP and concession agendas in several countries in the region, which has made all the difference for development, and which had the decisive support of these institutions. Thus, rather than focusing on “how much,” banks have focused on “where” and “how” to intervene, in order to maximize direct and indirect impacts of their interventions.

In general, such support is moving in two directions. First, there are actions that help bring order to the functioning of markets and fund investment projects that would otherwise have greater difficulties in accessing the market. This includes supporting public efforts to develop and modernize institutional and regulatory frameworks for markets and capacity building in regulatory agencies, supporting pre-feasibility studies and project structuring, financial advice in favor of PPPs and concessions, technical cooperation for development and structuring of operations, and knowledgeable support for the development of new markets and new business models.

Second, there are actions that aim to provide access to funds in conditions according to the realities of the projects. This includes financing and co-financing on terms and conditions compatible with the needs and characteristics of high-yield social operations, support for the development of the guarantee market, subordinated loans and A/B operations, support for the issuance of thematic bonds, shares operations, expansion of the portfolio of operations in local currency, development of investment vehicles and specific-purpose funds to manage third-party assets, such as pension funds and family offices, among other instruments.

Lastly, MDBs are being structured to support countries in what will become the greatest source of unpredictability and uncertainty, which is climate change. Countries in the region will have to cope with the challenges of adaptation and mitigation, but also explore and advance the gigantic agenda of new businesses and the carbon credits market. To this end, they will need to ensure access to new financial and non-financial instruments and a great deal of knowledge.