Can the World Bank Group’s Pivot to Private Sector-Driven Growth Succeed?

In his keynote speech at the World Bank Group–International Monetary Fund Annual Meetings in Marrakesh, Morocco in October 2023, Ajay Banga, the newly minted president of the World Bank Group (WBG), articulated the ambitious vision of his administration: to recalibrate the WBG’s strategy to emphasise private sector-driven economic growth and development, and to unlock the vast financial resources of institutional investors – who collectively control about $70 trillion of investments – by persuading them to allocate a small portion of their funds to investment in private-sector enterprises and projects in emerging markets. As he said, ‘If done right, we could draw in institutional investors – pension funds, insurance companies, sovereign wealth funds – and put their $70 trillion to work in developing countries’.

The centrepiece for this private-sector pivot will surely be the International Finance Corporation (IFC), the 67-year-old institution within the WBG that has prime responsibility for investing in private-sector enterprises and projects in developing member countries. Although it will be enormously difficult to get it ‘done right’, success is not in doubt if the IFC can address three key strategic challenges: (1) securing the support and commitment of the IFC’s controlling shareholder group of 10 developed countries (G10) by aligning the IFC’s investment programme with the G10’s geostrategic priorities; (2) switching from a debt-centric investment strategy to an equity-centric investment strategy to better reflect higher levels of risk associated with the increasing frequency and volatility of force majeure events; and (3) reorienting the IFC from being an impact investor with a primary focus on social returns to being a commercial investor with a primary focus on competitive risk-adjusted financial returns, in order to better align its investment objectives with those of institutional investors.

The Geostrategic Priorities of the G10

The IFC is controlled by a group of 10 developed countries (G10) that collectively have a majority of the voting shares: the US, Japan, the UK, Australia, Canada, the Netherlands, France, Germany, Italy and Spain. These countries have converging vital national interests and threat perceptions. Per the World Bank, as of 2022, the G10 collectively has a GDP (calculated on the basis of purchasing power parity, or PPP) of $54.3 trillion and a population of 867 million. Within the G10, the US, with a GDP of $25 trillion and a population of 333 million, is primus inter pares. The US guarantees the military security of the other nine countries via either the NATO alliance (Canada, France, Germany, Italy, the Netherlands, Spain and the UK) or bilaterally (Australia and Japan). From the perspective of the US and other members of the G10, Russia is manifestly the most immediate short-term threat, but China is considered to be the greatest national security threat for the foreseeable future. The central challenge – of which green energy supply chain resilience is one facet – will be to fashion a geostrategic ecosystem of countries within the G10 and a carefully selected group of developing countries to counterbalance China, so that Beijing does not emerge as Asia’s hegemon. So, new trading and investment patterns shaped by geostrategic considerations – essentially a new form of mercantilism – will have to be developed to replace China-centric supply chains. As the world transitions from unipolarity and globalisation to multipolarity and neomercantilism, the G10 – as the controlling shareholders and key providers of the IFC’s capital – will expect that its investment programme is aligned with their geostrategic priorities.

Manifestly, the geostrategic framework that the IFC’s senior management will have to craft with the G10 will revolve around selecting the group of developing countries to be included in the IFC’s investment programme. As a consequence, the IFC is likely to have an investment portfolio that is far better focused on a clearly targeted set of countries that are geostrategically important for the controlling shareholders. For purely illustrative purposes, from the perspective of the G10 under the US’s leadership, a set of 25 geostrategically important developing countries (accounting for a collective 2022 GDP on a PPP basis of about $40.6 trillion and a population of about 3.4 billion, per the World Bank) could be grouped into five different tiers. Reflecting the geostrategic imperatives of the G10, China would not be included in the IFC’s investment portfolio. A model portfolio might have the following profile.

Tier 1 (suggested 60% of investment portfolio)

• India
• Indonesia
• Brazil
• Mexico
• Turkey

These five countries (with an aggregate GDP of $25.6 trillion and a population of 2.1 billion) would constitute the most vitally important developing countries from the geostrategic viewpoint of the G10. Notionally, the five countries included in Tier 1 could have equal weights in the model portfolio; historically, India, Brazil and Turkey have been key constituents of the IFC’s investment portfolio, and in terms of investment exposure were the top three countries in FY 23.

Tier 2 (20%)

• Bangladesh
• Pakistan
• Malaysia
• South Africa
• Ukraine

From the G10’s vantage point, the five countries in Tier 2 (with an aggregate GDP of $5.4 trillion and a population of 539 million) would be considered to be geostrategically very important.

Tier 3 (10%)

• Philippines
• Thailand
• Argentina
• Venezuela
• Nigeria

The five countries in Tier 3 (with an aggregate GDP of $5.7 trillion and a population of 481 million) would be viewed as geostrategically important for the G10.

Tier 4 (5%)

• Sri Lanka
• Nepal
• Egypt
• Iraq
• Morrocco

The five countries in Tier 4 (with an aggregate GDP of $3 trillion and a population of 245 million) would be considered geostrategically relevant by the G10.

Tier 5 (3%)

• Bhutan
• Myanmar
• Maldives
• Mauritius
• Seychelles

The five countries in Tier 5 (with an aggregate GDP of $860 billion and a population of 57 million) would be of geostrategic interest in the larger context of the G10’s ‘Indo-Pacific tilt’, which seeks to counterbalance China and support India. For their own geostrategic imperatives, India and China are competing for influence in these countries.

Other (2%)

The Other category would provide a basket for the IFC to explore regional or cross-regional opportunities.

The Importance of a Tilt to Equity for Patient Capital

The IFC must ensure that its investment portfolio is financially resilient enough to face the headwinds of the coming decade. The transition from unipolarity to multipolarity is occurring in an extremely challenging environment, encompassing geostrategic tensions; economic fragmentation, decoupling and regrouping leading to new trading patterns; increasing volatility, instability and uncertainty with respect to price levels, interest rates, and foreign currency exchange rates; elevated financial and economic uncertainty, which is reflected in severe pressures on the cash flow of governments and enterprises; and rising risk aversion among investors, triggered by increasingly frequent force majeure events – whether manmade or otherwise.

Patient capital is the key to financial resilience. It has a long-term horizon and low requirements for current income and liquidity, and seeks to balance capital preservation and capital growth. Patient capital is willing to share downside risks over the short and medium term in return for the potential upside rewards of economic growth over the long term, while debt focuses on the capacity to pay per contractual terms and is risk averse. Growth financed via equity will ensure financial resilience, encourage privatisation of state-owned enterprises, boost local capital markets and stimulate foreign portfolios and direct investment, and is the surest way of avoiding sovereign debt traps.

The IFC is a debt-centric investor. Per the IFC’s Annual Report FY23, debt products accounted for $42.4 billion or 80% of the IFC’s FY23 investment portfolio of $52.8 billion (at cost), while equity products accounted for only $10.4 billion, or 20% of the portfolio. Per the IFC’s Annual Reports over the most recent five-year period, FY19–FY23, the IFC’s investment portfolio (at cost) averaged $46.3 billion, of which debt averaged $35 billion (76%) and equity averaged $11.3 billion (24%). So, the IFC’s debt orientation became increasingly pronounced over the past five years as it pivoted away from equity. From a financial perspective, deemphasising equity investments (funded by IFC capital) – which delivered higher realised returns (net of related administrative expenses) – in favour of debt investments (funded by IFC external borrowings) – which delivered lower realised returns (net of related administrative expenses and borrowing costs) – was not helpful.

Over the past five years, the IFC’s investment portfolio has delivered an average annualized net realised rate of return of 1.5%. Clearly, the IFC will need to reconsider the appropriate mix of debt and equity for its investment portfolio as it seeks a better balance between capital preservation and capital growth. Five years ago, equity investments represented 30% of the IFC’s investments. At a minimum, the IFC’s goal should be to restore this balance over the next three to five years. British International Investment, the UK’s development finance institution – which has a strong focus on impact investing – has a FY2022 investment portfolio represented by equity at 72% and debt at 28%.

Transitioning from Impact Investor to Commercial Investor

As an impact investor, the IFC’s focus has understandably been on delivering social returns rather than risk-adjusted financial returns, and consequently its investments reflect this bias. If the IFC wishes to persuade institutional investors (who are focused on risk-adjusted financial returns rather than social returns) to invest in private-sector projects in developing countries, it will have to ensure that its investment objectives are more closely aligned with theirs. Such a realignment will involve two dimensions: financial returns and political risk considerations. By focusing on developing countries that are geostrategically aligned with the G10, the IFC will be able to assure institutional investors that its country selection criteria reflect the vital national interests of its key shareholders (G10), rather than poverty alleviation or other social impact factors. Also, by highlighting financial returns in its project selection process, the IFC will be able to assure institutional investors that the projects are commercially viable and not philanthropic projects aimed at addressing social needs. With respect to investment opportunities in private-sector enterprises and projects in emerging markets, the IFC would be the partner of choice for institutional investors.

Of course, if the IFC decides to reorient itself from being an impact investor with a primary focus on social returns to a commercial investor with a primary focus on competitive risk-adjusted financial returns, then a 60/40 equity/debt mix may be more appropriate. Institutional investors such as pension funds and university endowments typically have investment portfolios closer to 60% equity and 40% debt (the WBG pension fund is a good example in this regard). Also, institutional investors have clearly articulated and transparently disclosed competitive risk-adjusted financial rate of return objectives (again, the WBG pension fund is a good example in this regard). For instance, as disclosed in the IFC’s Annual Report for FY23, the target rate of return for the WBG pension fund for 2023 is 5.9% (the target rate of return averaged 5.5% for the most recent five-year period). So, the IFC has an ‘in-house’ model for understanding, adopting and adapting an institutional investor orientation and mindset.

In his keynote speech in Marrakesh, the new WBG president also highlighted the ‘Private Sector Investment Lab’ initiative, which he launched to help the WBG think outside the box with respect to the effort to mobilise institutional investors, and – quite pragmatically – emphasised his priority of a better WBG before a bigger WBG. For the IFC, the transition from impact investor to commercial investor will have three key considerations: (1) improving efficiency as measured by the ratio of administrative expenses to total investments (cost basis) from 2.4% to 2% (five-year moving average); (2) increasing the proportion of the IFC’s equity base (paid-in capital plus retained earnings) allocated to fund its equity investments from about 40% to about 60% (five-year moving average); and (3) explicitly setting a competitive risk-adjusted target rate of return for the IFC’s investment portfolio from the current 1.5% to about 6% (five-year moving average), which will require a laser-like focus on the risk-adjusted financial returns of potential investments in enterprises and projects. The suggested targets are purely notional – certainly, finding the right balance between impact investments and commercial investments will be challenging – but are indicative of the type of performance metrics that will have to be addressed before the IFC can think about expanding via organic growth and mobilising institutional investors to support private-sector enterprises and projects in emerging markets. Ultimately, by pursuing these targets, the IFC would transform itself into the premier specialist institutional investor and merchant banker for emerging markets. In doing so, the IFC – which coined the term ‘emerging markets’ in the 1980s – would be able to look towards a confident future.

The views expressed in this Commentary are the author’s, and do not represent those of RUSI or any other institution.

Have an idea for a Commentary you’d like to write for us? Send a short pitch to commentaries@rusi.org and we’ll get back to you if it fits into our research interests. Full guidelines for contributors can be found here.