A Win-Win: The Prosperous Combination of Open Data and Impact Investing

 

By: Nathan Jayappa

From a multinational business opening an office offering products and services in developing economies, to a local microfinance institution (MFI) offering loans to entrepreneurs, private-sector-driven international development can occur in many forms. In all cases, however, collaboration between the private sector and government policies are instrumental in developing efficient capital markets. The 2013 Africa Progress Report states, “private capital flows have increased to the point where they rival development assistance – another outcome that would have appeared implausible at the end of the 1990s.” These claims were made by the Africa Progress Panel, an organization chaired by Kofi Anan, that also stated the private sector is playing an increasingly important role in poverty reduction.

However, the private sector, left unregulated, can create high financial returns at the expense of social progress In July 2010, India’s largest microfinance institution, SKS, was 13 times oversubscribed when it went public. New banks quickly set up shop after realizing the potential of this lucrative new industry. As MFIs began to prioritize shareholder returns over its customers, lending practices became increasingly predatory in nature. By the end of the year over 80 impoverished Indians took their lives, fearing their inability to repay their high interest rate loans.  Much like the 2008 subprime mortgage crisis in the United States, an unregulated industry can have a downward spiraling effect on lending practices.

The gift of natural resources paired with the lack of regulation and transparency can also lead to extortion in the private sector. With an estimated $60 billion a year lost in illegal outflows and price manipulation in the extraction of resources in Africa, the private sector needs to work alongside the public sector for sustained economic growth. Governments need to thwart the “resource curse” of short-term private-sector economic gains through exploitation at the expense of long-term development. The solution to this suffocating dilemma starts with open data.

A recent report by McKinsey & Company discovered that open data, the release of information by governments and private institutions and the sharing of private data to enable insights across industries, can generate significant economic value. The study states that open data can help unlock $3-5 trillion annually throughout the world across seven sectors (education, transportation, consumer products, electricity, oil and gas, healthcare, and consumer finance). Moreover, open data allows the private sector to gain critical information from the government via market research in order that they may seek to increase productivity and value through market segmentation. Consumers can capture value through making more informed decisions with the addition of new information and gaining a better understanding of price transparency.

Launched in 2011, The Open Government Partnership (OGI) seeks to provide a platform for increased accountability, innovation, citizen participation and, most importantly, transparency. So far 60 countries from around the world have joined the OGI to secure over 1,000 commitments to make their governments more open and accountable. However, only four African countries have joined the partnership, with Kenya becoming the first sub-Saharan African country to launch an open-data portal. The Kenyan government discovered that the country could save $1 billion annually just by creating this transparent portal and making it available online. Government transparency is a necessary condition to building trust in the private sector of an economy.

CREDIT: Kenya Open Data | SOURCE: Kenya Open Data

 

 

The presence of open data, along with private capital inflows into a country, can have a profound impact on reducing unemployment and increasing economic growth. According to the International Monetary Foundation, favorable economic policies and increased investment is one of the main reasons as to why, over the last decade, Africa has seen its inflation cut in half along with private consumption doubling during this time. Consumer and investor confidence is tied to strong macroeconomic policies, and Foreign Direct Investment in sub-Saharan Africa increased fivefold between 2000 and 2011. One of the fastest growing sectors within FDI is private equity (PE) investments. PE deals in Sub-Saharan Africa grew 45% over the last year, with $850 million invested in the first half of 2013 for a total investment of $57 billion.

However, sustained economic development is not accomplished solely by the injection of capital in an open data country. Furthermore, investors can be guilty of exploitative practices that actually increase long-term unemployment. Contrasting this, investments by private equity companies in emerging markets has the potential to produce measurable social impacts along with market-rate financial returns. This practice is called “impact investing” and is defined by Paul Brest and Kelly Born from the Stanford Social Innovation Review as:

“Actively placing capital in enterprises that generate social or environmental goods, services, or ancillary benefits such as creating good jobs, with expected financial returns ranging from the highly concessionary to above market.”

It has been suggested that the total market size for impact investing could be as big as $500 billion, with the ability to surpass the amount of U.S. philanthropic giving within the next decade. This new style of investing is gaining popularity because individuals, corporations, and non-profits are realizing that social, financial, and environmental returns can be made with contributions in the for-profit sector, rather than providing grants to address the same cause. It is important to understand the practice of impact investing entails providing “additionality,” which are social or economic outcomes that would not otherwise result without the impact investment. For example, investing in a tea processing factory that sources its tea leaves from 5,000 local smallholder farmers will not only generate additional income for those farmers, it will also create jobs in the factory and increase state revenue through additional tax payments. This would not be considered impact investing, however, if the investment would entail importing automated tealeaf processing equipment in a large tea estate, thereby neglecting all of the smallholder farmers.

Sub-Saharan Africa is home to 23 of the world’s 50 largest impact investing organizations. Each of these organizations specializes in specific industries and investment size, with a majority investing in small to medium sized enterprises (SMEs). Organizations of this size are often trapped, unable to access financing because they are too small for large banks to offer affordable loans, as the due diligence process does not make it cost effective given the size of the investment. Furthermore, SMEs are too large for microfinance institutions. It is estimated by the World Bank that over 200 million formal and informal SMEs are un-served by financial institutions, aggregating to a $2 trillion gap. Impact investors fill this gap by offering affordable loans to these organizations along with measurable social returns on investments.

 

After speaking with tea farmers and processors throughout East Africa during due diligence of an investment, it is clear that entrepreneurs are hesitant to give up equity in their company in fear of having their shares diluted and subsequently losing control of their company. Additionally, committing 140% of a loan through collateral makes for debt financing proves to be too risky for underfinanced and sprouting businesses. Some socially responsible funds, such as my employer, the Grassroots Business Fund (GBF), offer a hybrid debt and equity investments for borrowing organizations, called mezzanine finance. The benefit of this investment structure is threefold. The borrower does not need to risk the seizure of collateral, give up equity shares, and repayment occurs over an extended period of time with increased flexibility compared to traditional bank loans. GBF also houses a non-profit branch to provide technical assistance to clients with finance, operations, and marketing strategies and services. This blend of investment and grant-based technical assistance helps organizations achieve their financial goals while increasing social impact in the region.

The proliferation of impact investing and other forms of private sector development are dependent upon favorable economic policies and transparent governments. Sub-Saharan Africa remains a region where political instability and the lack of political trust hinders foreign investments and efficient capital markets. Providing open data to citizens is a necessary condition for sustained development, from both a domestic and international perspective. As a continent trying to dispel an entrenched curse of corruption, Africa has a long way to go to convince the remaining 50 out of 54 countries to join the Open Government Partnership. The emergence of a new financing class, impact investing – although no panacea – may be the remedy needed for these countries to achieve long-term economic prosperity premised on ethical practices.

 

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Nathan Jayappa works for The Grassroots Business Fund as a BizCorps Associate. He assists the impact investing fund in deal sourcing and delivery of Business Advisory Services through conducting due diligence, financial modeling, assessing social returns, and strategic planning. Nathan graduated in 2013 with both an MBA from the Tepper School of Business and an MSPPM from the Heinz College at Carnegie Mellon University. He currently resides in Nairobi.