By Claire Provost and Liz Ford

The UK government's vision for greater private sector investment in developing countries was laid out this week in a report explaining how aid money will be used to directly fund businesses in poor countries and open "some of the world's most challenging markets" to British companies.

The report, published on Tuesday, says UK aid will directly fund up to 300,000 companies in poor countries and encourage foreign investors to take advantage of highly profitable opportunities.

Andrew Mitchell, the international development secretary and a former investment banker, said the new approach would help wean developing countries off traditional aid.

"Aid alone will never be the answer," he said. "It is business, trade and enterprise that will stimulate the economic growth that will help people, communities and countries to lift themselves out of poverty."

The report does not detail how much of the UK aid budget will be specifically directed to support business growth, and how exactly the Department for International Development (DfID) works with the private sector will depend on its country priorities. In Mozambique, for example, DfID will work to encourage private investment in rural roads and regional infrastructure. In Kenya, it will support the private delivery of services, and refocus attention on supporting private schools.

Overall, the strategy aims to support jobs for more than 10 million people and help more than 50 million gain access to savings, credit and insurance. It also pledges to help half of African countries to benefit from freer trade and to secure land and property rights for more than 6 million people.

It will give special support to companies that offer mobile banking services, and will help small and medium-sized businesses – which employ more than 45% of workers in developing countries – get access to credit. More broadly, the new approach will aim to make it easier to do business in poor countries by funding infrastructure, widening access to finance, and pushing governments to cut red tape.

DfID will also work with the private sector to invest in health, schooling and basic infrastructure, says the report, and will recruit people from the "commercial and financial world" for jobs and short-term assignments at the UK aid agency.

The announcement comes as the UK is under pressure to justify increases in its aid budget at a time of domestic public spending cuts. Mitchell said it was in Britain's interests to help developing countries develop vibrant private sectors and that the new strategy will help developing countries become more attractive trading partners for the UK.

"Promoting wealth and job creation in the poorest countries is not just morally right but it is in the UK's interest too," says the report. "Investing now in jobs and enterprise in these poorer countries means investing in the people and societies who will be the mass consumers of the future."

However, the shadow development secretary, Harriet Harman, said the private sector must never become a substitute for overseas aid, and that the UK government must do more to promote transparency and fight corruption if the strategy is to benefit the world's poorest people.

"Although the private sector can be a force for good, it can also be an engine of exploitation," Harman said on Thursday. "The government must insist on transparency and accountability from the private sector, particularly in the extractive industries, to ensure that those in the poorest countries of the world benefit from the wealth beneath their feet."

The report said DfID will work with investors, companies and governments to improve environmental and social standards. But Mitchell insisted that "most developing countries suffer more from too little private investment than from badly behaving investors".

Just 2% of foreign direct investment currently flows to the world's 48 least developed countries.

Charities will no doubt be closely monitoring how DfID implements this strategy.

Nick Roseveare, the chief executive of Bond, a British coalition of international development NGOs, said it hopes DfID's new approach will support charities to work with the private sector.

"We look forward to working with business to improve the way Britain implements its aid agenda and we hope that DfID will create additional opportunities by which the private sector and civil society can work together to achieve development results," he said.

CDC reform

This week, the UK government also released a new business plan for the Commonwealth Development Corporation (CDC), the UK government's publicly owned development finance body.

Following a one-year review of the CDC's activities by DfID, the organisation will now focus exclusively on low- and middle-income countries in south Asia and sub-Saharan Africa, where around 70% of the world's poorest people live. At present, the CDC invests about 50% of its capital in sub-Saharan Africa. No new investments will be made in Latin America.

The CDC had been previously criticised for lacking a development focus and for investing in areas already attracting significant commercial capital from other investors. Investments in India, for example, will, in the future, focus solely on the eight poorest states. The five-year business plan also stated that the CDC would avoid investment in sectors such as offshore oil and gas and late-stage mining.

Over the next five years, the CDC aims to invest £2bn, with a yearly average of £400m. At least £1.2bn will be invested in sub-Saharan Africa by 2015, while £0.8bn will be invested in south Asia over this period. The CDC will increase its direct investments, which are expected to account for 20% of its portfolio by 2015.

The organisation will have to clearly demonstrate the development impact of its investments, and make more information about its activities available on its website.

While the business plan did not specify any changes to salary levels for CDC top executives, which have been heavily criticised, it did state that the remuneration package would be more appropriate to a body working towards poverty alleviation.

The government rejected a recommendation from the House of Commons international development committee to split the CDC into two to allow one part to invest in more high-risk projects.