Private capital for public goods
Impact investors are keen to influence people’s lives through their capital by making the world better – healthier, less polluted, and safer
India needs more jobs, better infrastructure and a higher rate of economic and social development. The demand for basic goods like education, health, clean energy, agriculture and housing does not match with the supply. Despite an incremental change in the central government's capital expenditure to GDP ratio, resource crunch remains a chronic concern. Private capital can play a crucial role in bridging this gap. The resources from the private sector can be directed towards the social sector for better outcomes and value creation.
Today, many young investors and wealthy boomers are willing to invest in business models or social enterprises that primarily focus on improving the society and environment along with realising a sustained financial return. The social entrepreneurs with sound business models and high-risk appetite are young, mostly less than 40 years old. All they are looking for is funds for their projects. The surge in the supply of capital investment from 2005 has propelled the number of social enterprises in the country which has risen to around 2.5 million in India. The investors taking a foot forward in this direction believe in making their money more impactful, more disruptive and more transformative. Such investors identify themselves as 'Impact Investors'.
Impact investors are keen to make an impact on people's lives through their capital by making the world better – healthier, less polluted and safer. In addition, they target financial returns that range from below market (sometimes called concessionary) to risk-adjusted market rate. According to a study, the median internal rate of return (IRR) for impact investors in India is around 10-12 per cent. The higher end of IRR is sometimes between 20-25 per cent, as per the industry, for sectors like clean energy and financial inclusion.
Before moving forward, we must understand the fundamentals of impact investing and how it is distinct from philanthropy or charity or corporate social responsibility. Impact investors, unlike others, are more connected to the social and environmental problems and invest their money in a local entrepreneur's businesses that can solve local social problems in a sustainable, for-profit way. These highly-motivated investors invest in the early stage of the businesses and help them grow over time with their capital and expertise to derive assured return after exiting the business.
Impact investing involves innovative business models where the investors integrate social and environmental dimensions into investment decision making. Such investments are made into companies, organisations, and funds striving for social and environmental impact alongside a financial return. One must understand that impact investing is not only for the recognised impact investors but it is also profitable for the commercial investors who primarily desire an assured return on their investment. It encompasses a variety of impact investors, both individual and institutional, like fund managers; diversified financial institutions/banks like Black Rock, JP Morgan, Deutsche Bank and Morgan Stanley; private foundations, pension funds and insurance companies; family offices; individual investors; NGOs and religious institutions.
Status of impact investing
In 2016, the value of annual global impact investments topped USD 22 billion. Around 45 per cent of this investment has taken place in emerging markets which offer wide-ranging options for making social and/or environmental impact with an assured financial return.
India offers a wide horizon for the impact investment industry which has already attained a growth rate of 14 per cent per annum in the country. Being one of the fastest growing economies, the country grapples with providing adequate health, education, jobs and quality of living to around 300 million poor living in the country. The government has been trying consistently to eradicate poverty and provide housing, schooling, access to clean energy, food and electricity to all. The performance of the government schemes, however, has been vitiated by a large population and problems of last mile connectivity. A private-public partnership in this regard can accelerate the process of development and improve millions of lives through its capital. Such partnership has the potential to uplift not only the population at the bottom of the income pyramid but the overall society at large.
Sectors like health, agriculture and education are in dire need of higher expenditure to pull them out of the chronic lower rate of growth. India holds immense opportunity for investors in terms of large investment demand coupled with stable and vibrant financial markets. As per a study by McKinsey and Company, impact investments have the potential to grow at 20 to 25 per cent a year to reach USD 6-8 billion by 2025. Central government's schemes like Start-up India, Stand-up India, Mudra Yojana have brought around a revolution in the country and given a big push to the small entrepreneurs. This has led to a surge in the supply of investment capital in the country.
Many impact investors like ASHA Impact, Omnivore Partners, Lok Capital, Acumen, Leapfrog, Omidyar have been making an impact by improving the livelihood of the people through investments across social sector projects under various flagship programmes like Start-up India, Skill India, Digital India and JAM (Jan Dhan Yojana, Adhaar and Mobile Payments). SIDBI, in 2016, launched INR 60 crore fund called ASPIRE – A Scheme for Promotion of Innovation and Rural Entrepreneurship and agro-industry. Impact investing companies raise capital from ASPIRE fund to support start-ups and new enterprises in rural areas.
The health sector in the past has employed a range of innovative measures with an objective to increase the effectiveness of funding in the sector. Social and Development Impact Bonds (SIB/DIB) are examples of such innovation. These are the evidence of outcome-based financing under which the investors cover the upfront cost by investing in the first stage of the project implemented by the service provider while the government agency acts as a middleman and commits an assured return to the investor after the pre-defined outcomes are realised. India is the first country where the Development Impact Bond was launched in 2015 called 'Educate Girls' that focused on improving the learning outcomes of out-of-school girls within a predefined time period. Many such setups are in place in the healthcare sector and are learned to be performing well. A similar approach can be replicated in other social sectors taking industry-specific requirements into account.
Since 2010, the cumulative impact investment in India has been around USD 5.2 billion. There has been an increase in the average deal size but the volume of deals has remained stable (60-80 a year). Over the years, clean energy and financial inclusion sectors have received a significant proportion of the total impact investment flow. The companies in these sectors have expanded and matured, over the decade, deriving benefit from the government-backed initiatives. The enterprises funded by impact investors are estimated to have touched 60 million to 80 million lives today. The sector spread is in need of greater diversification so that areas like education, health, waste management, job creation, food processing, housing and others are given higher priority as they incorporate wide investment opportunities and have multidimensional benefits.
Role of the government
Though the quantum of impact investment is around one billion per year, India has some way to go in comparison with developed countries like USA and UK. For the impact investors to invest in India, the government being a key stakeholder has to play a crucial role by developing an investor-friendly ecosystem in the form of greater flexibility and a stable social market. The government can provide a fillip to the impact investing industry by undertaking measures that define social and environment output metrics for projects in each sector to foster greater transparency for the investors. The government can set up more innovative funds like ASPIRE which can finance the SIBs. It can also allow the impact investors to leverage the corporate social responsibility (CSR) funds for the purpose of better outcomes. For impact investing to thrive, it needs co-investment from commercial capital, philanthropic capital and development funds of the government.
In a nutshell, India undoubtedly has a vast untapped market opportunity in the social sector industries. The commitment to Paris Climate Change Agreement and Sustainable Development Goals 2030 demands massive investment for achieving a sustainable growth path. The government spending is not sufficient to meet these obligations and, therefore, utilising private capital for public goods is crucial. As a strong financing mechanism, impact investing can act as a tool to address some of the major challenges like shortage of public spending and issues of last mile connectivity in the country.
(The author is Young Professional, EAC-PM, NITI Aayog, New Delhi. The views expressed are strictly personal)