The case for impact bonds in India

India is actively taking efforts to achieve the Sustainable Development Goals (SDGs) adopted by the United Nations in 2015. Any effort to achieve SDGs requires robust and sustainable funding. According to a study by TARA (Technology & Action for Rural Advancement), the estimated financing gap for achieving the SDGs, over the mandated 15-year period, stands at a staggering ₹533 trillion. Despite the estimate being preliminary and arguably conservative, it still demonstrates the dire demand for financing to achieve the SDGs. 

Government aside, key players such as the private sector could potentially be of aid in achieving SDGs and bridging the financing gap. In a recent survey conducted by the Federation of Indian Chambers of Commerce and Industry (FICCI) among its member companies, a promising 85 per cent of their respondents stated that they were working towards SDGs that are directly linked to their businesses. Many companies are also leading efforts in provision of clean water, sanitation and healthcare, thanks to the Corporate Social Responsibility (CSR) spending requirements stipulated in the Companies Act of 2013. In the 2015-16 financial year, a total of Rs 9,822 crores was spent for CSR. However, these efforts remain at a small scale and are often fragmented as government agencies are hesitant to scale up these innovative and new projects.

There are three major reasons that impede the scalability of these projects. The first is the potential risk of failure and the huge political and financial risks involved. Governments deprioritise such projects and hesitate to spend taxpayers’ money as the financial and political ramifications of failure could be devastating. 

Secondly, many successful projects that have been scaled up often lack a proper system of checks and balances. While it is simple to ensure the effectiveness and efficiency of small-scale projects through close monitoring, such monitoring is not feasible for national or state level projects. This often leads to leakages and an overall deterioration in quality of output.

To address this, many funders (government and foreign agencies) have implemented homogenous and rigid practices across the board, causing the third problem, excessive rigidity. The lack of leeway for local project implementors to make changes and adjustments to a project based on local circumstances often leads to a drop in the overall efficiency and effectiveness.

Impact Bonds (IBs) offer an innovative solution to addressing all these issues and have potential to be effective in the Indian context. Simply put, IBs are non-marketable bonds where repayment is contingent on the outcomes of the project they fund.

To understand how it works, let us consider an example of Impact Bond in education. Consider an NGO that has perfected an intervention to improve reading and math skills of rural children in Bihar. Impact Bond comes in as a handy tool for governments to raise capital for scaling up these interventions, without incurring huge risks. The government can issue Impact Bonds to private impact investors to raise upfront capital for the NGO to scale their project. Unlike normal bonds, for Impact Bonds, repayment by the government is only triggered if certain pre-determined targets are achieved. The targets would generally be measurable by quantitative metrics (such as average reading scores in standardised tests) that are evaluated by an independent evaluation agency. If the targets are met, the government pays back the principal along with a return to the private investors. 

This way, the government transfers risk of failure onto private investors and only pays for successful projects, NGOs get the capital they need to scale up their innovative solutions and private investors get an opportunity to make profits from projects that do social good. This is a true win-win situation for everyone involved.

While any outcome-based financing system removes the risk of failure, many such systems pay only after targets have been achieved. This means that service providers often have little or no working capital and would have to dedicate a lot of time and effort to galvanise financial support for their working capital needs. By providing upfront capital, IBs remove a major headache for the service providers. 

Impact Bonds solve the incentives problem too. Given that investors lose all their money if the project fails to deliver, they would want to get constant updates and would scrutinise the progress carefully. This would both improve transparency and add a layer of checks to ensure success. Impact Bonds are outcome focussed and hence promote innovation by giving a substantial degree of freedom to the service providers. No other existing funding contracts provide this mix of benefits, that address most of the major issues that impede funding for large scale innovative social projects. 

In order to successfully implement IBs we need mature engagement from both sides, the government and private investors. Of course, one must not get irrationally exuberant and claim Impact Bonds to be the panacea to all issues surrounding the funding of social infrastructure projects. A successful bond would need to be transparent and would need to enlist all relevant details for stakeholders to understand the risks involved and their severity. The lack of a proper understanding of the risks involved can lead to catastrophic failures, denting the overall image about their efficacy. One might wonder if the Indian private and public sectors are ready for such high requirements of transparency and cooperation. 

India’s government agencies and private sector are arguably capable and ready for Impact Bonds given their long experience with Public-Private Partnerships (PPPs). PPPs are similar to impact bonds in that they enable private players to take the risks related to project implementation and outcomes. In either case, there is a requirement that the private sector players (be it investors or service providers) understand the associated risks and that the government remains transparent throughout the process. Given the uptake of PPPs in India, it would not be far-fetched to expect mature engagement between the government and investors through Impact Bonds. 

Impact Bonds provide an incredible opportunity for local, state and central government agencies to leverage India’s private sector to source funding for the implementation of innovative solutions to reach SDG targets.

Bhalaki is co-founder & director and Natteri is research associate at Athena Infonomics.