Industrialization, it need hardly be said, is one of the most important paths to economic development; and successful industrialization depends on a number of factors—entrepreneurship, access to modern manufacturing techniques, competent management, technicians, accountants and other skilled personnel, markets, and of course capital. Some of these requisites can be imported, as they have often been in the past. Indeed, contacts and cooperation with foreign firms are likely to be important not only in starting industrialization but throughout its progress, for various purposes—to keep abreast of the most modern technology, to open up export markets, to obtain financing for major projects, and so on. Even the most advanced industrial nations continue to supplement their domestic capital and know-how from abroad.
In an attempt to increase the supply of some of these ingredients of successful industrialization, virtually all the countries of the world, developed and underdeveloped, have established special institutions to mobilize their resources of capital and channel them into the productive economy. In the past 25 years, the governments of an increasing number of less developed countries have created, promoted, or encouraged the organization of entities variously called “development corporations,” “development banks,” or “development finance companies.” Those institutions have taken forms so diverse that, despite frequent similarity of formal title, they often have little resemblance to each other and often have little in common. Among them are such different institutions as the Etibank of Turkey, originally created to exploit mineral resources and to build power plants on behalf of the Government; the Corporación de Fomento de la Producción of Chile, first established to draw up and carry out a general plan to promote production in all sectors of the economy and to obtain credit from abroad; and the Pakistan Industrial Credit and Investment Corporation (PICIC), established to provide long-term finance to private industry. Although virtually all such institutions have been sponsored by governments, which exert a varying degree of influence on their policies and operations, some are owned exclusively by governments, others by private interests, and still others by a combination of the two. Some are devoted to the promotion and financing of government enterprises and others exclusively to private investment; still others act in both fields. Some have broad planning functions, some can only lend, some can both lend and invest in share capital, and some can set up and manage enterprises on their own account. Some are concerned with the entire economy, others with but a single sector. Some are regional, others national. Ownership, capitalization, degree of dependence on government, objectives, and methods of operation vary over a broad range.
No definitive list has been compiled of this type of institution, but their number almost certainly runs into three figures. The efforts of the World Bank and its affiliates, the International Finance Corporation (IFC) and the International Development Association (IDA), up to now have primarily been concerned with one type of development bank: the development finance company that is entirely or predominantly private in ownership. The Bank, IFC, and IDA have extended financial assistance to 19 development finance companies in 17 countries in Asia, Africa, Europe, and Latin America. The World Bank has extended lines of credit totaling $281.6 million to 12 institutions. Three IDA credits of $5 million each have also been granted. IFC, which handles relations with development finance companies for the World Bank group, has invested in 14 institutions, for a total original commitment of $17.3 million. In seven of these cases the World Bank and IFC have acted jointly, the former supplying loan capital and the latter share capital.
Financial assistance in itself is not the only measure of the activity of the World Bank group in this field. On a number of occasions the group has been asked to provide help and advice in establishing a new development finance company or in reorganizing an existing institution. In these cases, IFC may help to bring together a sponsoring group of investors, prepare a Charter or Articles of Association for the institution, advise on investment policies, and help to locate top management and staff.
The World Bank group, moreover, may play a continuing role in private development finance companies. IFC’s Development Finance Companies Department is prepared to help an institution to establish an effective system of project appraisal. The World Bank and IFC have helped to train staff members of development finance companies by arranging for them to visit Washington and study methods of project appraisal and administration, both with the staff and at the Economic Development Institute, the Bank’s staff college in Washington for senior officials involved with economic development. The Bank and IFC also arrange visits with well-established development finance companies in other countries.
Further, as an equity investor, IFC can accept representation on the boards of directors of development finance companies. Where the other shareholders want IFC to be represented, and where IFC feels that board membership can be a constructive influence, IFC has been prepared to take a seat. It has, in fact, done so in 7 companies. The close relationship with many development finance companies has facilitated IFC’s collaboration with them in joint investments; such action has been particularly important where the needs of industrial enterprises have proven to be too large to be met entirely from the resources of the local development finance company or the domestic capital market.
Scope and Purposes
Development finance companies can perform a valuable function by identifying promising fields for investment and helping to bring together the factors of production. By becoming active and important in a country’s capital market, they can help to mobilize domestic savings and, in combination with technical know-how, channel them into productive activities. At the same time, these companies can become a channel through which foreign and international capital and skills can flow into the national economy, reaching enterprises too small to be able alone to attract foreign capital and technology. Because they are themselves private, these finance companies have a unique role in helping the growth of the private sector, where problems of stimulating healthy growth are often particularly intractable.
The principal tools of development finance companies are:
A supply of long-term capital, which will be particularly useful if part is available in foreign exchange;
Experienced management, possessing both a world-wide acquaintance with modern investment techniques and a knowledge of national conditions, and capable of appraising objectively investment opportunities, market possibilities, and business risks, and of assisting clients to obtain technical and managerial aid; and
Contacts with foreign business and investment institutions and international financial and technical assistance agencies, which are indispensable in recruiting outside capital and know-how.
It is desirable that the institution should be regarded as a domestic institution in its own country; therefore, only a minority of its stock should be owned outside the country. IFC—since it is owned by its member governments—is usually not regarded as foreign, so that a combined domestic-IFC majority of shares in the finance company conveys the image of a national institution; in addition, when necessary to maintain domestic control, IFC is willing to confine its sales of the company’s shares to private investors within the country.
IFC prefers in general that ownership of the finance company be as broad as possible to demonstrate the national character of the institution. Such a representative pattern of ownership permits the government to recognize that the success of the company is in the public interest, and thus to extend certain financial and other benefits without which the finance company might have difficulty in surviving.
A development finance company is not likely to be very profitable in its early years, and its initial stockholders must therefore be people who are not thinking in terms of quick returns. In most countries some public-spirited institutions and individuals can be found who take the long view and are willing to back it up by investing. There also are investors in the industrialized countries, mainly financial institutions with a general interest in reinforcing their connections with, and promoting economic growth in, the developing country concerned, which in the past few years have demonstrated their willingness to subscribe to the share capital of development finance companies. IFC’s presence may induce other investors, domestic and foreign, to come in; and in fact, all the finance companies in which IFC has invested represent a blend of domestic and foreign ownership.
The investment policies of a development finance company reflect the fact that it is at the same time a development institution and a profit-making institution. In appraising a project, it should place as much weight on the economic and financial prospects and the management of the enterprise as upon security. Yet it cannot ignore security. The terms of its investments must be closely related to the needs of the projects that it finances; a balance must be struck between placing an unduly heavy burden on the client enterprises and the interest of the IFC in revolving its funds.
Various factors have to be balanced. Thus, new enterprises often need substantial equity capital. Most development finance companies are willing to make equity investments, provided this does not require them to assume managerial responsibilities (except perhaps in an initial promotional phase). On the other hand, following the principle of matching the duration of their resources with the duration of their investments, they would be unwise to hold, in their portfolios, equities amounting to more than their paid-up capital and free reserves.
Support of new enterprises is probably one of the most useful contributions that finance companies can make to development. This function was illustrated by the situation involving the cement industry of Pakistan and the Pakistan Industrial Credit and Investment Corporation (PICIC). A dramatic factor was the settlement late in 1960 of the dispute between India and Pakistan over the division of the waters of the Indus River system. The settlement involved a huge public works program, including the construction of a giant dam and storage reservoir and the building or rehabilitation of a far-flung web of irrigation canals. The demand for new cement capacity was a clear and urgent one. The Pakistan Government called for a general review of the industry, and PICIC volunteered to be responsible for the study.
In a report presented at the end of 1960, PICIC’s consultants recommended the expansion of existing plants and the construction of three new ones. Responsibility for promoting construction of two of the new plants fell to PICIC, which soon found two prominent industrialists in Pakistan willing to sponsor and invest in the cement companies. For one company, PICIC subsequently arranged financing from the Commonwealth Development Finance Corporation in London, and for the other it received assistance from IFC; and in both cases PICIC itself provided a substantial part of the financing required.
Assistance to Development of Capital Market
One of the development finance company’s broad objectives is to fill a gap in, and contribute to the growth of, the national capital market. One of the ways that it can do this is to sell, from its own portfolio, securities of enterprises that have passed initial hurdles and have become successful. Not only does this encourage broader ownership of industrial shares and increase the supply of marketable securities, but it also replenishes the finance company’s resources from domestic sources and enables it to continue and expand its new investment activities.
Another technique used by development finance companies is the underwriting of public issues of shares (and other securities). For instance, about one fifth of PICIC’s recent commitments have been for underwritings. The finance company’s appraisal of the enterprise and its willingness to invest some of its own funds help to create in the investing public confidence that the prospects of the enterprises being assisted are good. Through underwritings, development finance companies can assist industrial enterprises in obtaining investment capital which it would be difficult, if not impossible, to raise in any other way. Underwriting is particularly important for large-scale enterprises or for medium-sized companies which have undertaken major expansion programs.
Recently in Colombia, for example, IFC in cooperation with two domestic development finance companies helped to promote and finance the establishment of Forjas de Colombia, the first modern forge in the country. The total amount of financing involved exceeded $14 million, large by the scale of Colombian industry. IFC was approached by the development finance companies after they had almost exhausted the possibilities of raising further equity capital in the Colombian capital market. IFC appraised the project and recommended that additional equity capital should be raised; it agreed to invest directly in shares of the enterprise and, in cooperation with the two development finance companies, to underwrite the placement of additional shares.
The underwriting agreement represented a new development in Colombia, where publicly owned companies generally rely on private placement (for instance, through rights issues to existing shareholders) to raise share capital, if it can be done at all. In the case of Forjas, the Colombian finance companies and IFC guaranteed to place the shares with private investors, both inside and outside Colombia, or to take up any shares that were not placed within a specified time. As a consequence of this firm commitment on the part of the underwriters, the sponsors of the project were able to proceed with the assurance that the financial plan was substantially complete.
By promoting new enterprises and assisting the development of domestic capital markets, development finance companies are able to fill some of the gaps that exist in financial institutions in developing countries. The provision of share capital, the broad distribution of the ownership of industrial enterprises, the mobilization of private domestic savings, and the introduction of foreign capital are some of the tasks which development finance companies are performing. The readiness to take the risk of investing in equity is an essential part of the operations of a development-oriented institution. Further than this, such an institution must encourage the emergence of an investing public if it is to make sales from its portfolio in order to free resources to make new investments.
In the final analysis, however, the success of development finance companies depends not only on the skill of their management and the determination with which they pursue their objectives of stimulating industrial enterprises, but also on the existence of an economic climate conducive to private investment. They are thus dependent on government policy toward the creation of conditions that will encourage domestic and foreign investment in industrial enterprise. They are dependent, too, on the existence of local laws and practices that are likely to build the confidence of investors in holding equity. Under conditions where development finance companies can play their full role in assisting industry and the growth of a capital market, they can contribute materially to expansion of the private sector of a country’s economy and to the ultimate objective of raising living standards.
Articles appearing in The Fund and Bank Review: Finance and Development may be quoted or reprinted in their entirety, provided that due acknowledgment is made. The Editor would be glad to receive two copies of publications containing such reprints or quotations.