2024 Public Sector Perspectives

Local currency lending delivers big benefits An estimated 80%-90% of development finance lending occurs in foreign currency. 3 While this lending is invaluable, it exposes projects to substantial foreign currency (FX) risk. Should a local currency depreciate against the lending currency, the debt burden is effectively increased, creating challenges for borrowers without corresponding foreign currency revenues. This phenomenon has been a hallmark of various debt crises, including the ongoing debt stress in several nations such as Sri Lanka and Zambia. FX risk impacts all projects – and ultimately increases overall project risk, which deters investors and prevents the scaling of development finance from billions to trillions. It also has several repercussions for small and medium-sized enterprises (SMEs). These companies constitute the lifeblood of numerous emerging market economies, employing approximately 60% of the population. 4 Many SMEs have local currency- denominated cash flows and lack the in-house capabilities to effectively manage FX risk using hedging tools. Facilitating financing solutions that mitigate such risks is therefore paramount – especially in emerging markets where financing solutions in local currency can be most impactful. Mobilizing finance in local currencies is a solution that delivers financial stability by reducing risk, aligns with responsible banking practices, and has the potential to help countries achieve their SDGs. Local currency lending can mitigate the volatility of debt burdens and ensure a more stable and sustainable financial landscape for borrowers. Supplying clients with local currency lending is not only a fair and equitable approach but also an efficient one. It empowers borrowers to navigate their financial obligations with greater confidence, fostering economic stability and resilience in the face of external shocks. Given the anticipated ramp- up in SDG financing, the scaling of MDB/DFI local currency lending in key sectors is especially important. Accelerating local currency solutions Commercial banks have an important role to play in helping MDBs and DFIs to increase local lending, especially global institutions that have a presence that aligns with their geographical focus. Relevant expertise and capabilities and a proven track record and commitment to development initiatives are also important. For example, Citi’s has committed to a $1 trillion sustainable finance target by 2030 to support the SDGs. Citi is the world’s most global bank with an on- the-ground presence in 95 countries, including in many middle- and low-income countries. As a global deposit-taking institution, Citi serves the needs of multinational corporations, financial institutions, and governments around the world. Its branches and subsidiaries play a key role in facilitating and managing local currency assets especially in developing countries across Asia Pacific, Latin America, Middle East, Africa, Central and Eastern Europe. Citi is committed to facilitating the systematic sourcing of local currency. With access to a diversified liquidity pool, Citi is well placed to address the currency mismatch faced by MDBs/ DFIs and their borrowers by providing direct lending solutions to highly-rated entities (such as the World Bank, IFC, IDB, ADB and AfDB) which can then on-lend to their borrowers in local currency. Mobilizing finance in local currencies is a solution that delivers financial stability by reducing risk, aligns with responsible banking practices, and has the potential to help countries achieve their SDGs. Local currency challenges Without the support of a global commercial bank, local currency lending presents potential challenges for MDBs and DFIs, such as: 1. Shallow capital markets: While some institutions may be able to issue local currency denominated bonds to raise funds to lend to local projects, emerging markets may be insufficiently deep to be cost efficient. Even if issuance is feasible, MDBs/DFIs are often required tomaintain a fully dollarized balance sheet, andmany emerging markets have insufficiently liquid hedging markets to facilitate this. 2. The need to maintain a high credit rating: If not properly hedged, local currency lending may put pressure on the creditworthiness of MDBs/DFIs, making it harder to access affordable financing in the international capital markets. 3. Established processes, systems, and practices: Operations tailored to foreign currency lending are difficult to adapt to local currency financing, as each local market has different laws and regulations, increasing resource requirements. 4. An underdeveloped interest ratemarket: If borrowers cannot easily engage in interest rate swaps, it is harder for MDBs/DFIs to efficiently allocate capital and promote sustainable economic growth. 3 Kapoor, Hirschhofer, Kapoor, and Kleiterp, 2021 4 World Bank Citi Perspectives for the Public Sector 9 8 HowGlobal Development Finance Institutions Can Solve the Local Currency Lending Conundrum