Fragile and Conflict-affected states (FCS) are not only the world’s toughest markets: they are the most challenging places to live and thrive.
FCS are countries where access to basic services – education, health, infrastructure – is minimal and worsened by the absence of security and rule of law. These dynamics not only have immediate effects on lives and livelihoods, they affect generations to come. The World Bank expects around 80% of the global extreme poor to be living in FCS by 2030.
Due to the role fragility plays in inequality between countries, FCS are increasingly in the spotlight of development financial institutions (DFIs) as needing attention. Investing in FCS is one of the core strategic pillars of MASSIF, the Dutch government fund managed by FMO, to support MSMEs in low income countries (LICs) and fragile and conflict-affected states.
FMO has commissioned NIRAS and TrustWorks Global to conduct a study on the conditions for successful investing in Fragile and Conflict-affected States. The study relied for a large part on external sources of knowledge, through a literature review and interviews with experts and investors with experience in fragile contexts. Additionally, the study included case studies of six customers funded through MASSIF, to understand where we currently stand in its approach in fragile contexts.
While there is no widely agreed-upon definition of “fragility”, actors within the international community generically refer to it as a continuum rather than a binary concept, namely “the degree to which the state power is unable and/or unwilling to deliver core functions to the majority of its people: security, protection of property, basic public services, and essential infrastructure.” Despite this overarching concept, caution is warranted at treating fragile states as one homogenous whole. There is no one-size-fits all approach for situations affected by fragility, violence or risk. In any case, the literature suggests that internal implementation factors play a more important role than external factors in influencing projects. In other words, irrespective of the context, with the appropriate design and implementation, projects tend to be successful.
The report identified the following recommendations to invest successfully in FCS, applicable also to all DFIs:
First, a DFI should ensure a clear strategic position in FCS, having clarified the rationale and narrative of being active in these countries. DFIs may choose different strategic directions when it comes to their approach in fragile states, along two dimensions: i) approach to conflict, which can range from a minimal ‘do no harm’ approach to one of positively impacting fragility and conflict, and ii) approach to development, which can range from seeking narrow development impact to transformative development impact. Most experts suggest investing in fragile states in an impactful way requires shifting from a one-off deal approach towards a transformative one to maximise the use of scarce resources.
More strategic approaches focus on steering market development, fostering working conditions improvement, and spurring economic growth whileaddressing conflict fault-lines and societal divisions. Doing so comes with a need to understand and actively manage political, economic, societal and environmental dynamics when selecting countries, investees and partners. The report acknowledges that the 2017 MASSIF strategy has set FMO on the right path for its engagement in FCS, enabling a clear focus on the Base of Pyramid. It is well-positioned to be much more strategic in fragile states, ensuring a more transformative development impact with the scarce resources available. This could be achieved, for example, through in-depth country analyses and sector diagnostics, enabling FMO to better identify sectors most likely to have transformative impacts.
No matter which strategic profile is chosen, the report recommends that it is essential to approach investments in FCS through a lens of conflict sensitivity. DFI assessments of the country context tend to focus on state-centric, ‘formal’ rather than ‘informal’ actors and dynamics. However, the study states this is likely to be insufficient in fragile context, as such assessments overlook the fact that FCS are not characterized by the lack of governance but by competing sources of governance: informal institutions or personalised ‘rules of the game’. The informal aspects of operating in FCS must not be underestimated; informal power relations influence all business decisions. Moreover, state-centric analyses often overlook the unpredictable nature of FCS. Without combining country-level analyses of the context with customer’s specificities, it is difficult to assess what kind of impact the investment will have on drivers of conflict.
Therefore, it becomes crucial, especially in such contexts, to elaborate a country-based screening process that accounts for informal aspects of operating in FCS and combine it with rigorous due diligence approaches built upon sustainable peace perspective. The review of six case studies suggests that FMO is making increased efforts to tailor its approach to FCS, managing to capture many factors of fragility and obtain the maximum amount of information that will enable it to manage the risks that the investment poses to FMO. However, the approach could be broadened to account for the risks that the investment poses to the context itself, or on the ways in which the investment can have a positive impact on the dynamics of peace and security.
Especially in fragile states partnerships are essential. Room for improvement is possible by stronger cooperationbetween DFIs, as well as with other key strategic actors across the humanitarian-development-peace nexus. DFIs should not be competing for the same deals rather they should be working together based on their comparative advantages. Comparative advantage-based formulation of strategies would not only help maximise development impacts but also help share risk, especially if well-coordinated with the broad range of national humanitarian-development-peace partners.
The peculiarity of the context requires approaching each investment on a case-by-case basis. Ultimately, this also translates into tailored financing solutions and ad hoc structured instruments that are more aligned with the customer’s needs. The report finds that, even though lending still represents the most common instrument used by DFIs in FCS, there could be other financial instruments that prove to be even more effective (e.g. development impact bonds, or equity). Further, depending on the strategic profile, a DFI may also deliver Technical Assistance at the sector- or country-level, besides the customer-level.
A more strategic approach also requires a variety of skillsets of employees, including political economy analysis, conflict sensitivity and risk-management. Moreover, in order to maximize learning, it is imperative to collect granular data on fragility, including through collaboration with other DFIs to ensure monitoring and generation of data-driven insights, and investing in institutional learning and impact assessments. The report advises that there is room for improvement for FMO towards more comprehensively measuring the impacts of its investments over time on development or fragility, which would enable FMO to track its positive contributions more clearly, and more importantly, to avoid unintended negative consequences.
FMO appreciates the insights from this report. The report and the framework it provides are taken onboard during explorations on how FMO will shape activities in FCS going forward within its mandate. The report confirms that both the potential for positive development impact and levels of risk and uncertainty are high in FCS. Therefore, attention will be given to both recommendations from the report and the extent to which these can be implemented in practice in these fragile contexts. The report has also been shared with other DFIs and interested parties.