According to the African Development Bank, poor infrastructure has cost the continent a cumulative 25% in forgone growth in the past two decades alone; equivalent to the growth rate achieved in the past ten years ( https://www.afdb.org/en/annual-meetings-2017/programme/financing-african-infrastructure/). This productivity gap between Africa and the rest of the world continues to grow, and the World Bank estimates that the continent requires in excess of US$ 90 million per year to begin bridging the infrastructure gap.
Despite emerging markets long being known as key drivers of economic growth in the global economy, maintenance of this status requires extensive development and infrastructure finance. Investments in infrastructure, however, are often big ticket, long term commitments with fixed locations and structures that require substantial financial buy-in. The risks and potential for stranded costs in infrastructure investments in emerging markets are further exacerbated by the effect of volatility on emerging markets (being the first to suffer in times of uncertainty, given their higher public debt, lower foreign reserves and shallow financial markets), lack of political will/support and inadequate legal and regulatory frameworks (according to a 2015 research paper by the IMF titled Corporate Investment in Emerging Markets: Financing vs Real Options Channel).
In the midst of this prolonged volatility, coupled with low credit ratings and a lack of exposure to private investors, emerging markets, and Africa in particular, require innovative financing solutions to bridge the gap between public and private investment. This is where the Development Finance Institutions (DFIs) play a pivotal role.
DFIs as a substructure
Africa is not crippled by a lack of infrastructure investment capital but rather by a lack of bankable projects. Apart from general investment barriers, infrastructure projects are coupled with completion risks (regulatory or policy uncertainty), performance risks (both during and post construction) and revenue risks (ensuring that the project not only repays its debts, but also provides an adequate return for investors), which affects the project's overall "bankability".
In this regard, DFIs are vital in ensuring such projects are bankable, by bringing capital, technical expertise and capacity where private sector players were unable, ill-equipped or unwilling to do so on their own. The key role that DFIs have to play in making a project bankable can be divided up into three distinct categories:
1. Funding source: DFIs can provide a broad range of financing products and can act as a loss absorber on both greenfield as well as brownfield projects (see by way of example, Eskom in South Africa, which stated that the DFIs are to form the "backbone" of its capital raising in the next five years). Similarly, many DFIs have A-grade credit ratings which enables them to source capital on more competitive terms.
2. Quality and experience: Beyond providing financial support, DFIs have a developmental mandate which goes beyond pure funding, and are also actively engaged in creating enabling environments to address regulatory and institutional challenges. DFIs can also provide support for complex commercial transactions, and can assist in the contribution to local government capacities by assisting with negotiations, conducting feasibility studies and providing access to external legal and technical resources.
3. Risk mitigation: The impact of DFIs can be crucial, especially in the early stages of a Greenfield project, which is often accompanied by high levels of risk, uncertainty and lack of private investment. DFIs offer a multitude of risk mitigation products which help to attract private sector capital. Examples of these include inter alia the International Finance Corporation Partial Credit Guarantee for credit enhancements and the African Development Bank Currency Exchange Fund for hedging of currency and interest rate risks.
The need for a solid foundation
The 2016 McKinsey Bridging Global Infrastructure Gaps Report found that during the period 2012 to 2015, DFIs, multilateral and bilateral banks and their development partners provided 47% of the financing for African infrastructure. However, despite the advantages of including DFIs on projects in Africa, one must be wary of an over reliance on them to create bankable projects. Nor should they be viewed as "cheap finance".
In conjunction with the reliance on DFIs, African developers need to aspire to achieve the highest standards of infrastructure project development. This requires the active engagement of all parties from an early stage – from conducting a pre-engagement due diligence allowing for an identification of red flags early on, to the implementation of appropriate measures to mitigate and allocate risk accordingly. Unfortunately for many African developers, this results in a cart before the horse situation – on the one hand, in order to attract further investment, they require a solid track record that shows an understanding of the market, key deliverables and technical know-how – on the other hand, developers cannot build such a record without being given the opportunity, and most notably the financing, to develop their projects in the first instance. This is where grant funding may be of assistance to developers. Nonetheless, these preliminary steps and general market know-how are vital factors which influence and shape a project's financing structure.
It must also be remembered that DFIs generally provide finance in hard currencies. As such, the currency risk associated with the repayment of these amounts is usually borne by the local governments, project companies and state-owned entities. In Africa in particular, funding is usually USD based, which results in excessive additional hedging costs. Given that developing markets are the first to be affected by any market volatility, it is crucial that there is not an overreliance on DFI funding where local currency funding is available. DFIs should act as an aid to private sector investments from local commercial banks and pension funds. Similarly, the use of institutions such as the New Development Bank (which has already started extending loans in local currencies) must be considered in an attempt to mitigate the potential adverse effects of borrowing in foreign currencies.
Creating the superstructure – Africa 2063
In response to a continent whose growth is still mainly premised on natural resource exploitation and exports which do not maximise local retention of wealth, the African Union has developed Agenda 2063 - a strategic framework for the socio-economic transformation of the continent over the next 50-years ( https://www.au.int/web/en/agenda2063). Agenda 2063, states its aspirations for the "Africa we want" as:
1. A prosperous Africa based on inclusive growth and sustainable development;
2. An integrated continent, politically united based on the ideals of Pan Africanism and the vision of Africa's Renaissance;
3. An Africa of good governance, democracy, respect for human rights, justice and the rule of law;
4. A peaceful and secure Africa;
5. An Africa with a strong cultural identity, common heritage, values and ethics;
6. An Africa, whose development is people-driven, relying on the potential of African people, especially its women and youth, and caring for children;
7. Africa as a strong, united, resilient and influential global player and partner.
Understandably, Agenda 2063 emphasises the need to connect Africa to the rest of the world through world-class infrastructure. In this regard, the role of DFIs in achieving these goals cannot be understated.
The challenge of addressing Africa's infrastructure gap not only requires collaboration between the various stakeholders but, moreover, it requires an understanding and appreciation for facilitating inclusive socio-economic transformation and development of African economies towards a state of self-reliance.
Stolp is a Partner, Banking & Finance practice, Whyte is a Partner and Scribante an Associate, Energy, Mining and Infrastructure Practice, Baker McKenzie (South Africa).