Project Case Study
Tax incentives for investment in developing countries
Assessing the feasibility of setting up a new fund to support developing economies
Historically, much UK aid has been delivered to developing economies in the form of grants to central government, due to apprehension concerning the ability of local markets to handle such investment. However, during the 1990s, people began to see that investment into local markets slowed the negative cycle of reliance on central aid grants, and promoted further, sustainable, investment into local markets. This allows viable commercial entities to spring up, in turn bringing employment and education benefits for local people.
In order to assess how private sector investment flows into low-income countries might be increased, in 1998 the Department for International Development commissioned us to undertake a study of the feasibility, costs and effects of providing fiscal incentives for a new investment vehicle called Development Resources Trusts (DRTs). A DRT is a fund into which ethically minded private investors in the UK, encouraged by tax incentives, could contribute some of their capital, as an alternative to investing in the stock market. The fund would then be used to invest in commercial enterprises in low-income countries, providing much-needed liquidity and helping to close the equity gap that affects many of them.
We interviewed a number of UK-based fund managers, plus the International Finance Corporation, the European Bank for Reconstruction and Development and the Commonwealth Development Corporation in order to gather an industry perspective on DFID’s DRT scheme.
From these surveys, we identified a number of benefits of DRTs, most of which centred on the idea of them having a knock-on effect in drawing in further funds to supported enterprises in low-income countries, both from local investors and from the UK, helping to create a sustainable economic environment. They would also improve human resource capacity, both in-country and by developing experience of emerging economies amongst UK fund managers, in the hope that this would facilitate future investment. We additionally identified the risk factors for such a scheme, recommending that it be constructed to spread the risk of investing in a DRT, because UK investors are typically very risk-averse.
We provided a prospective model for the DRT scheme alongside these recommendations. We also advised that, despite reservations brought about by the 1998 Russian financial crisis, establishing the DRT model and providing technical assistance to the stock markets of developing countries would offer a good opportunity of injecting sustainable funds. The concept we developed reached the final stage of the World Bank’s Development Marketplace competition.
