African infrastructure financing: Closing the gap under tight fiscal constraints

October 7, 2013 2:02 am0 comments by:

By Feri Gwata

Inadequate infrastructure continues to be a major binding constraint to Africa’s quest for sustained economic growth. The region has attained impressive growth rates over the past decade, buoyed to a large extent by a commodity boom from 2000, albeit now subsiding, and an improvement in the macroeconomic environment of many countries. Still, Africa continues to grapple with a massive infrastructure gap, notably in the water, sanitation, power and health sectors, which have a high social return, but which private investors often avoid due to their limited revenue-generating capacity.

This situation has been exacerbated in the past few years by the global economic crisis, which has created a new financial landscape with a tightening of public budgets in Organisation for Economic Co-operation and Development (OECD) countries, traditionally Africa’s major infrastructure funders through official development assistance (ODA). At the same time, the global shift in economic power has seen the emergence of several non-OECD countries as major sources of finance for large-scale infrastructure projects in African countries. What does this mean for infrastructure development and financing in Africa?

The uncertainty created by the economic crisis for future infrastructure investment flows has necessitated innovative approaches to raising long-term financing for infrastructure development and rehabilitation in Africa. This paper discusses several of the financing mechanisms implemented and under consideration in many African economies, including the use of infrastructure and diaspora bonds. The paper emphasises the importance of harnessing African domestic capital for infrastructure development through the development of local capital markets, diversifying sources of financing for this purpose, and fostering sound institutional and regulatory frameworks to attract both domestic and international private investment.

Africa’s infrastructure gap

The World Bank in 2010 pegged Sub-Saharan Africa’s (SSA) total infrastructure investment needs at US$ 93 billion per annum, a third of which accounted for operation and maintenance costs, which are often omitted from the infrastructure development conversation.(2) Power supply is Africa’s major infrastructure challenge, requiring an estimated US$ 40.8 billion a year (see Table 1 below). Unreliable power supply is a significant transaction cost for firms operating in the region, and they often resort to self-supply through the use of generators. Water supply, sanitation and transport similarly require substantial investment of an estimated US$ 40.1 billion collectively.

Africa’s infrastructure gap, defined as the difference between investment needs and actual spending, is estimated at US$ 48.1 billion in the World Bank report, as shown in Table 2. The report notes that even when accounting for possible efficiency gains, such as tariff cost recovery and elimination of operational inefficiencies, Africa’s infrastructure deficit stands at US$ 30.7 billion per annum.

Overall Infrastructure Spending Needs for Sub-Saharan Africa
US$ billions annually

Table 1. Sub-Saharan Africa infrastructure financing needs(3)
Table 1. Sub-Saharan Africa infrastructure financing needs(3)

Table 2. Sub-Saharan Africa Infrastructure Financing Gap(4)
Table 2. Sub-Saharan Africa Infrastructure Financing Gap(4)

Power, water and sanitation – sectors with relatively low financial, but high social, returns – have the largest financing deficit at US$ 29.2 billion and US$ 14.3 billion respectively (see Table 2). These sectors are key economic and social development drivers, and have traditionally been funded by domestic public budgets supplemented by ODA. Aid funding from OECD countries fell by 2.7% in 2011 as a result of the global financial crisis, and further reductions are likely in coming years.(5) The decline in ODA places a heavy burden on domestic public finance raised primarily through tax revenues, in light of Africa’s growing infrastructure needs.  Similarly, private investment in African infrastructure fell to US$ 11.4 billion in 2011, a 13% decrease from the previous year’s investments and 20% lower than the pre-financial crisis peak in 2008.(6) The power sector received 12.3% or US$ 1.4 billion of total investment commitments, with the United States (US), China, India (co-investing with Zambia), Israel and Turkey (co-investing with Botswana) leading the development drive. This indicates the increasing importance of non-OECD countries in Africa’s infrastructure development.(7) The telecommunications sector received 80%, or US$ 9 billion, of private investment due to its high commercial returns, yet even this is 20% lower than investment in the sector in 2010.(8) Furthermore, there has not been any private participation in the water and sewerage sector in Africa since 2008 (9), which is worrying as an estimated 330 million people in SSA do not have access to safe drinking water.(10)

The power sector is set to receive a funding boost through the US$ 7 billion Power Africa Initiative announced by US president, Barack Obama, during his trip to Africa in June 2013. The project will be rolled out over five years and is expected to double access to electricity in SSA through the development of more than 8 gigawatts of new electricity generation.(11) The private sector has made an additional US$ 9 billion commitment towards this cause. The timing of this investment, which will be a significant catalyst for industrial development, has been interpreted as the Obama administration’s re-strengthening of the US-Africa commercial relationship and reassurance that the African Growth and Opportunity Act (AGOA) which expires in September 2015, will be renewed.(12) While it is a welcome investment, a significant shortfall of energy infrastructure financing remains, and existing maintenance backlogs and project implementation challenges will need to be addressed. In anticipation of some of these challenges, the initiative makes provisions for the transfer of US Government tools, such as policy and regulatory best practices, technical assistance, and prefeasibility support and capacity building.(13)

Infrastructure financing initiatives in Africa

The need to harness African domestic capital has increasingly been recognised on the continent, evidenced by a range of infrastructure financing schemes in recent years. One initiative is the Programme for Infrastructure Development in Africa (PIDA), a regional approach to infrastructure development approved by African heads of state at the eighteenth African Union (AU) Summit in Ethiopia in 2012. PIDA was formulated through a compelling awareness of the need to bolster intra-regional connectivity through implementation of critical regional infrastructure projects, with the overall objective of fostering trade, job creation and economic growth. The programme, which seeks to deliver 51 priority infrastructure projects by 2020, has a budget of about US$ 68 billion, with power and transport projects accounting for 95% of the programme’s total cost.(14) PIDA’s financing strategy rests on the realisation that traditional funding sources alone cannot cover the full capital cost.

The African Development Bank (AfDB) notes that a financing gap of approximately US$ 38 billion will need to be tackled as funding sources under business-as-usual scenarios can raise only US$ 30 billion by 2020.(15) There is therefore strong acknowledgement that Africa should lead its own infrastructure development by mobilising domestic capital resources through innovative financing mechanisms, particularly for countries which bear higher financing costs.(16) Some of these measures include the use of infrastructure bonds, which are described below, and loan guarantees, which provide some assurance to private investors. Financial contributions towards PIDA have so far been secured from various African development partners, including the African Water Facility, African Development Fund and the New Partnership for African Development (NEPAD). Additional funding has been sourced from international investors such as the Islamic Development Bank and the European Union.(17)

The Pan African Infrastructure Development Fund (PAIDF) is a 15-year fund initiated by leading African investors to raise long-term finance for regional infrastructure projects.(18) The fund comprises nine African investor participants, among them South Africa’s Public Investment Corporation (PIC), which invests funds on behalf of public sector entities and is one of the largest investment managers in Africa; the Development Bank of Southern Africa (DBSA); and Old Mutual and Liberty Life, leading wealth management groups. Launched in 2007 with investment commitments totalling US$ 625 million, the PAIDF is the largest independent infrastructure fund in Africa, and is the only fund on the continent launched purely with African capital.(19) In its second round of funding in 2008, the PAIDF focused primarily on attracting international investors with the aim of boosting capital to US$ 1 billion. Some of the investments PAIDF has made thus far include the Main One Cable, a 14,000-kilometre fibre optic cable system that provides additional capacity for internet connectivity between South Africa and Portugal.

Development finance institutions continue to play a pivotal role in African infrastructure development, with the DBSA announcing in recent months plans to significantly expand its role in lending to infrastructure sectors.(20) The DBSA approved loans worth ZAR 9.6 billion (US$ 968 million) in 2012 for power generation and transmission infrastructure under South Africa’s Renewable Energy Independent Power Producer Programme (REIPP), which is aimed at giving impetus to the development of the green economy and job creation.(21)

African infrastructure development is increasingly being financed within the framework of South-South co-operation, with funds coming primarily from China and India.(22) The China-Africa relationship has received much attention in recent years, with some critical of China’s aggressive extraction of natural resources. Nigeria’s Central Bank Governor has described the relationship as “a new form of imperialism.”(23) However, while Chinese firms have targeted mainly extractive industries in Africa, they have made significant contributions to infrastructure development. The World Bank notes that Chinese financial commitments to Africa rose from less than US$ 1 billion per year from 2001 to 2003 to US$ 4.5 billion in 2007, distributed among at least 35 countries in Sub-Saharan Africa.(24) A sectoral analysis of the distribution of Chinese infrastructure investments in Africa shows that the two largest beneficiary sectors are the power (mainly hydropower) and transport (mainly railroads) sectors, and the largest transport deals are in Gabon, Mauritania and Nigeria.(25)  Chinese investments in the power sector include a US$ 600 million hydroelectric plant in Zambia.(26)

The Chinese presence in African infrastructure projects is dominated by large state-owned enterprises that have access to subsidised credit from the Chinese Government.(27) To this end, they have a competitive edge over other investors and are able to out-compete other developers in obtaining African procurement contracts.(28) In addition, the World Bank notes that African leaders have welcomed Chinese investments because of China’s policy of non-involvement in the internal political affairs of host countries.(29)

In spite of such investment flows, African governments continue to face constraints in raising long-term finance for infrastructure development. With the exception of South Africa and, more recently, countries such as Ethiopia, Kenya and Nigeria, African capital markets are generally under-developed. The relatively small size of the commercial banking sector has meant that most African capital markets lack the capacity to finance large-scale infrastructure projects due to asset-liability mismatch. In addition, the majority of African economies have traditionally suffered from low or non-existent credit ratings, which has restricted private investment and raised governments’ cost of finance.

Infrastructure bonds

Among the innovative financing tools under consideration is the use of long-term sovereign infrastructure bonds. This instrument has been implemented successfully in raising capital for large-scale infrastructure projects in Brazil and other emerging markets such as Chile and Malaysia. These bonds can be issued on international capital markets or domestic currency markets, although the latter has the advantage of mitigating foreign exchange risk. The investment base that is best suited to this financing tool comprises the pension and insurance sectors, as these investors prefer low-risk long-term assets in the local currency.(30) In Africa, Kenya was a pioneer in the use of infrastructure bonds, with its first issuance in 2009 of a 12-year bond which raised US$ 232.6 million.(31) Capital raised was earmarked to fund projects in rural and urban water infrastructure, irrigation and sewage systems and rural electrification.(32) To encourage bond purchases, the Kenyan Government has made use of incentives such as tax exemption. In addition, the bonds can be used as collateral when securing loans from commercial banks.(33)

Investors have been wary of African sovereign bonds in the past in light of the speculative credit ratings on most of these bonds. Inflation risk has been an additional deterrent. However, in spite of these concerns, it appears that the African debt market is becoming increasingly attractive. This is evidenced by several bond issuances which have been hugely oversubscribed, most notably Zambia’s US$ 750 million bond issuance in September 2012 which was fifteen times oversubscribed.(34) The new-found appetite for African sovereign bonds can be attributed largely to the improvement in the macroeconomic outlook of many African economies over the past decade. Governments in the region should leverage global and domestic resources by presenting credible fiscal plans to the markets. In particular, project bankability and consistency in policy application are critical in inspiring investor confidence.

Diaspora bonds

Diaspora bonds are an alternative financing instrument under consideration.  These are bonds issued by a government to nationals residing abroad to tap their savings for the purpose of infrastructure development in the home country. The World Bank describes diaspora bonds as “a retail savings instrument issued in relatively small denominations, for sale to that segment of the diaspora that has some money stashed away but lacks the capital-organising power of an entrepreneur.”(35) Africa’s diaspora accumulates an estimated US$ 53 billion in savings annually, and remitted approximately US$ 40 billion to their home countries in 2010, which indicates a strong saving capacity and potential for African governments to tap these resources for infrastructure development, particularly in African economies with a massive diaspora population.(36) Diaspora bonds have been used successfully in countries such as Israel, which has raised an estimated US$ 25 billion over the last 30 years through this vehicle.(37)

Ethiopia, which has a sizeable diaspora population and was among the world’s 10 fastest growing economies in the past decade, launched its second diaspora bond, the Grand Ethiopian Renaissance Dam Bond, in 2011.(38) Capital raised is intended to fund construction of the Grand Renaissance Dam, a large-scale hydroelectric dam.(39) The country’s first diaspora bond issuance, the Millennium Corporate Bond, which was aimed at raising capital to fund the Ethiopian Electric Power Corporation, faced several challenges.(40) The bond was perceived as a high-risk investment due to soaring inflation and a lack of trust in the government’s ability to service the debt. Consequently, uptake was low. With its second bond issue, the Ethiopian Government embarked on an aggressive marketing campaign to raise awareness and to encourage buy-in. To expand the investor base, the bond was offered in minimum denominations of US$ 50.(41)  Infrastructure and diaspora bonds are promising financial instruments. However, they are relatively new financing mechanisms, so there is a need for African economies to understand the associated intricacies and learn from the experiences of early adopters.

Public-Private Partnerships

Another way of reducing dependence on public sector financing is through Public-Private Partnerships (PPPs), broadly defined as contractual agreements between the public and private sectors that are geared towards developing infrastructure assets and encouraging service delivery. Under this framework, partners share risks, responsibilities and rewards associated with a particular project. PPPs have several benefits, including faster project completion, and transfer of technology and skills to the public sector. They are gaining traction as private sector participation often adds financial credibility to a project, driving the mobilisation of finances for long-term infrastructure projects.

However, in spite of these benefits, the model is under-utilised in African economies mainly due to limited institutional capacity in undertaking large-scale and often complex infrastructure projects. The AfDB cites lack of skills, in particular investment, financial planning and coordination capacity, as the major constraints for the successful implementation of PPPs in Africa.(42) Extensive experience is required in conducting PPP feasibility analysis, appropriate risk allocation, procurement, and resolving contract disputes. In a bid to address some of these challenges, the Nigerian Government launched a US$ 31 billion capacity-building programme in 2010 partly funded by the AfDB.(43) The objectives of this programme include provision of specialised training to key public sector personnel in areas such as project feasibility studies, procurement processes, and hands-on project management training.(44) The experiences of emerging markets suggest that PPPs are an attractive financing option which should be explored in tandem with the development of sound legal and regulatory frameworks.

Concluding remarks

There is a compelling awareness that Africa needs to take ownership of its infrastructure development drive. Current financing initiatives by African institutions are encouraging and appear to be gaining momentum. However, there is a need for strong national leadership to send clear policy signals and create sound regulatory frameworks that will not only stimulate, but maintain, investor confidence in regional markets. Furthermore, resources should be directed towards bankable projects that will have the greatest impact in terms of economic growth, social upliftment and sustainability.(45)

NOTES:

(1) Feri Gwata is a CAI Consultant, and a socio-economic consultant focused on economic development, environmental economics, and rural livelihoods in Sub-Saharan Africa. Contact Feri through Consultancy Africa Intelligence’s Finance & Economy Unit ( finance.economy@consultancyafrica.com). Edited by Nicky Berg.
(2) Foster, V. and Briceno-Garmendia, C. (eds.), 2010. Africa’s Infrastructure:  A time for transformation. World Bank. http://siteresources.worldbank.org.
(3) Ibid.
(4) Ibid.
(5) ‘Aid to developing countries falls because of global recession’, OECD, April 2012, http://www.oecd.org.
(6) Van Eard, R. and Militaru, A., ‘Private activity in infrastructure in Sub-Saharan Africa falls to six-year low’, World Bank, September 2012, http://ppi.worldbank.org.
(7) Ibid.
(8) Ibid.
(9) Ibid.
(10) ‘World Water Day: The EU helps more than 32 million people to gain access to safe drinking water’, European Commission, 22 May 2012, http://ec.europa.eu.
(11) Harith Fund Managers website, http://www.harith.co.za.
(12) Lande, S., Matanda, D. and McDonald, S., ‘Analysis: Obama in Africa. Basis for an AGOA Enhancement Work Program’, Wilson Center/Manchester Trade, July 2013, http://www.wilsoncenter.org.
(13) Ibid.
(14) ‘Strategic infrastructure in Africa. A business approach to project acceleration’, World Economic Forum, May 2013, http://www3.weforum.org.
(15) Ping, J., Kaberuka, D. and Janneh, A., ‘Programme for infrastructure development in Africa. Interconnecting, integrating and transforming a continent’, http://www.afdb.org.
(16) Ibid.
(17) Ibid.
(18) Phatisa Fund Managers website, http://www.phatisa.com.
(19) Ibid.
(20) ‘DBSA to revive infrastructure’, Fin24, 15 April 2013, http://www.fin24.com.
(21) ‘DBSA approves R9.6 billion for renewable energy projects’, South African Government News Agency, 23 October 2012, http://www.sanews.gov.za.
(22) Foster, V., ‘The changing landscape of infrastructure finance in Africa’, October 2008, http://www.eu-africa-infrastructure-tf.net.
(23) Walli, W., ‘Africa warned of China exploitation’, Business Day, 13 March 2013, http://www.bdlive.co.za.
(24) Foster, V., Butterfield, W., Chen, C. and Pushak, N., ‘Building bridges: China’s growing role as infrastructure financier for Sub-Saharan Africa’, The World Bank, https://openknowledge.worldbank.org.
(25) Ibid.
(26) Broadman, H., ‘Separating fact from fiction in the China-Africa relationship’, PricewaterhouseCoopers, 2013, http://www.pwc.com.
(27) Ibid.
(28) Ibid.
(29) Foster, V., et al., ‘Building bridges: China’s growing role as infrastructure financier for Sub-Saharan Africa’, The World Bank, https://openknowledge.worldbank.org.(30) ‘Strategic infrastructure in Africa. A business approach to project acceleration’, World Economic Forum, May 2013, http://www3.weforum.org.(31) Agarwal, V., ‘Infrastructure finance. Uncertainty and change in Sub-Saharan Africa’, PricewaterhouseCoopers, 2013, http://www.pwc.com.
(32) Ombok, E., ‘Kenya extends sale deadline on infrastructure bond to December 1’, Bloomberg, 19 November 2009, http://www.bloomberg.com.
(33) Brixiova, Z., et al., 2011. Closing Africa’s infrastructure gap: Innovative financing and risks. African Development Bank Africa Economic Brief, 2(1), pp. 1- 8, http://www.afdb.org.
(34)  Sulaiman, T., ‘Zambia euro bond could be African tipping point’, The Globe and Mail, 5 October 2012,http://www.theglobeandmail.com.
(35) ‘Harnessing the diaspora’s resources to boost African development’, World Bank, 16 June 2011,http://web.worldbank.org.
(36) Ibid; Ncube, M., ‘Harnessing remittances for Africa’s development,’ African Development Bank, 4 March 2013, http://www.afdb.org.
(37) ‘Unlocking the potential of diaspora bonds’, Africa-EU Partnership, 21 June 2013, http://www.africa-eu-partnership.org.
(38) ‘Africa: The link between aid and growth,’ Fin24, 12 September 2013, http://www.fin24.com.
(39) Kayode-Anglade, S. and Spio-Garbrah, N., 2012 . Diaspora bonds: Some lessons for African countries. African Development Bank Africa Economic Brief, 3(13), pp. 1-13, http://www.afdb.org.
(40) Brixiova, Z., et al., 2011. Closing Africa’s infrastructure gap: Innovative financing and risks. African Development Bank Africa Economic Brief, 2(1), pp. 1- 8, http://www.afdb.org.
(41) Kayode-Anglade, S. and Spio-Garbrah, N., 2012 . Diaspora bonds: Some lessons for African countries. African Development Bank Africa Economic Brief, 3(13), pp. 1-13, http://www.afdb.org.
(42) Brixiova, Z., et al., 2011. Closing Africa’s infrastructure gap: Innovative financing and risks. African Development Bank Africa Economic Brief, 2(1), pp. 1- 8, http://www.afdb.org.
(43) Ibid.
(44) Ibid.
(45) ‘Strategic infrastructure: Steps to prioritize and deliver infrastructure effectively and efficiently’, World Economic Forum and PricewaterhouseCoopers, September 2012, http://www3.weforum.org.

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