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Private Sector Development Strategy : The strategy

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Strategic thrusts

Under the strategy, ADB will utilize the capabilities of both its public and private sector operations to deliver synergistic solutions to problems that impede private sector growth in the DMCs and the contribution of the private sector to poverty reduction. In public sector operations, the strategy has two thrusts: (i) to support DMC governments in creating enabling conditions for business, and (ii) to generate business opportunities in ADB-financed public sector projects. The third thrust is in PSO: to catalyze private investments through direct financing, credit enhancements, and risk mitigation instruments. All of ADB's instruments for advice and financing will be used to pursue PSD outcomes targeted by the three strategic thrusts (Table 1).

The three thrusts of the strategy are mutually reinforcing when brought to bear on a development challenge. Such has been the experience of ADB. In Bangladesh, for example, there was a need to develop fresh power supply without relying on government funding. ADB responded by providing TA, first, to create the right environment for the entry of private investment (sector restructuring, regulatory framework, tariff reform), and then, to prepare a build-operate-transfer (BOT) power-generating project for international competitive bidding. The winning bidder was to be supported by ADB with direct loan, cofinancing, and guarantee facilities to catalyze the project.

ADB’s experience has shown that creating the enabling conditions to open a sector to private investment may not be sufficient to attract entrants. Sometimes, a model project is needed to provide demonstration effects, and funds have to be catalyzed to actually make the project happen. By the same token, a single private sector project, made possible with ADB support, may achieve little if it cannot be replicated without ADB support because the enabling conditions are not in place. ADB recognizes the two sides of this equation and will have to tackle the twin challenges in tandem.

Creating enabling conditions

ADB uses public sector operations to help DMC governments establish the right conditions for business and a policy environment conducive to pro-poor growth. Reforms that spur entrepreneurial development and stimulate foreign and domestic private investment are designed to enlarge the private sector’s role in the economy. As the transition occurs, the government must reduce its presence as owner-producer and concentrate more on facilitating and regulating private sector activities to ensure markets work and to protect public interest. This shift in the government’s role will make government a neutral and objective regulator, and free public resources (such as those used to support loss-making state enterprises) that can then be redirected to basic education, health services, and social safety nets. In many DMCs, growth and, ultimately, poverty reduction depend on such a shift.

One of ADB’s strengths lies in conducting policy dialogue with government on needed reforms. Under the PSD strategy, the reform agenda will seek to achieve the following: stable macroeconomic management; investment, trade, and price liberalization; reduced barriers to competition; well-functioning financial and capital markets; flexible labor and land markets; good physical, social, and technological infrastructure; equitable tax systems; and legal and judicial systems that protect property rights, enforce contracts, and provide for dispute resolution. Improving the business environment for SMEs will be part of the reform agenda. In addition, the policy agenda will include measures to enable DMCs to maximize the benefits of globalization (e.g., increased trade and capital flow) and minimize the risks associated with it (e.g., sudden and disruptive movements of short-term capital). This will require, for instance, the introduction of regulatory frameworks to strengthen market institutions and establish social protection programs, including social safety nets and labor laws that protect workers. Measures may also be considered to regulate short-term speculative capital flows and encourage more stable, long-term investment.

Specific policy advice on these areas of reform will be based on economic and sector work. In addition, TA will be provided to governments to formulate the regulatory and institutional frameworks needed to make markets work better and to build the capacity of market regulatory authorities. ADB will also support policy and institutional changes to encourage private sector participation in key sectors through program and sector development loans as well as by linking project investments to progress in needed reforms.

An adequate physical environment is also important for the private sector. ADB will help governments build infrastructure facilities such as ports, roads, telecommunications, and power plants needed to enable the private sector to undertake business efficiently. Where found desirable based on benefit-cost analysis, the location of such facilities can deliberately be chosen to influence the flow of private investment to less-developed (and poverty-stricken) areas of a country.

Recent events in the region underscore the need for greater attention to labor market issues. The Asian financial crisis bared the vulnerability of people living close to the poverty line. Indeed, a stable macroeconomic environment is important for the welfare and protection of the poor. This justifies ADB’s involvement in financial sector reform issues from a poverty perspective. Experience in some DMCs indicates that distorted and fragmented labor markets generate inequality of labor incomes. To address this problem, ADB and the DMCs must be committed to effective labor market policies to generate private sector-led employment. Improved labor market policies can be achieved through policy dialogue and project interventions in active and passive labor programs. Dialogue on labor market policies may include the elimination of labor distortions, and the reform of discriminatory codes and practices. Active labor market programs include employment services (e.g., job brokerage and counseling) and redeployment and training programs. Passive labor market programs cover unemployment, injury and disability insurance, income support, and labor standards. Through these labor market interventions, ADB can enhance the role of the private sector in promoting employment and contributing to poverty reduction in the region. However, some labor protection policies (e.g., occupational safety legislation) may, in the short run, lead employers to substitute capital for labor on the margin, or to move production facilities to countries with less stringent labor laws. The situation should improve as corporate responsibility becomes more widely accepted and the playing field for labor becomes more even across countries.

Generating business opportunities

ADB’s public sector projects can be formulated in such a way that they provide specific opportunities in which the private sector can participate. Such opportunities may include model private sector projects that are designed to include poverty reduction impacts. Indeed, ADB has long been involving the private sector as suppliers and contractors in the implementation of its public sector investment projects. Under the PSD strategy, ADB will take deliberate steps to ensure that, in its public sector projects, where appropriate, business opportunities are generated for the private sector, particularly for the domestic private sector. This will be done in various ways. When preparing a public sector project, ADB will explicitly consider the scope for private sector participation, and include the nature and timing of this participation in the project design. For example, a state-owned sewerage treatment plant being processed for ADB financing can be required to subcontract its operation and maintenance to a qualified private sector entity to be selected on a competitive basis. Investment opportunities may also be created by considering the private sector alternative to a government-proposed investment project, as was the case with the Colombo port project approved in 1999.⁵ In support of government efforts to encourage private sector participation in key sectors in more DMCs, ADB will continue to support privatization programs and prepare model BOT-type infrastructure projects that can be competitively bid to the private sector. As a rule, ADB must ensure that its public sector investments do not crowd out the private sector, and that ADB and DMC governments explore all possible opportunities to ensure private sector participation where this can be done effectively and efficiently.

Catalyzing private investments

ADB provides direct financial assistance to private sector projects through PSO. While ADB’s participation is usually limited, it leverages a large amount of funds from commercial sources to finance these projects.⁶ ADB is viewed as a neutral long-term investor committed to the highest standards of corporate conduct; its presence is seen as a source of comfort by other lenders and investors. To facilitate mobilization of commercial debt finance for cofinancing, ADB will intensify the use of two instruments to mitigate perceived sovereign risks: the complementary financing scheme and the partial risk guarantee (PRG).⁷ ADB’s role in sovereign risk mitigation is now much more critical as the crisis-affected DMCs try to regain the confidence of foreign investors and lenders. Where appropriate, ADB’s partial credit guarantee, which provides comprehensive protection to lenders, will also be used to mitigate credit risks and stretch the maturity of commercial loans in local currency for long-gestating private sector projects. Aside from contributing finance that is not available on reasonable terms elsewhere and catalyzing funding from other financiers, ADB’s involvement can, more importantly, exert influence on project design and implementation so that environmental and social concerns are addressed more effectively. ADB can also selectively attempt to encourage sponsors to incorporate project components that, for instance, extend essential services to the poor with government support.

ADB will seek to catalyze private sector projects that deliver specific development impacts and related demonstration effects in line with ADB’s strategic priorities and country-specific operational strategies. While ADB’s participation helps ensure successful project launches, ADB also benefits from the insights it gains into the workings of the private sector and the constraints the sector faces. The resulting institutional learning at the project level provides an important complement to ADB's macroeconomic and sector policy work to create enabling conditions. The individual ADB-assisted private sector projects themselves are also a potentially important influence on and input to policy. They can (i) pilot test the sufficiency of the enabling environment in a sector and open the sector to private sector involvement by providing demonstration effects, (ii) provide a template for other investors to replicate, and (iii) pioneer experimental projects that could provide the basis for a policy framework for private investment in a new sector.

As a multilateral development institution, ADB does not finance private sector projects based solely on their financial viability. Projects must have clear development impacts and/or demonstration effects that go beyond the benefits captured in the financial rate of return. ADB assistance to the project, whether in the form of offshore or local currency financing, must be (i) catalytic (leveraging ADB’s financial resources by attracting other investors and lenders), or (ii) additional (complementing, not substituting for commercial sources of finance), or (iii) adding value (influencing project design or structure to make it more environmentally or socially friendly, create more jobs, impart better skills or technology, or raise the standards of corporate governance).

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