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GREAT insights Magazine

Unlocking Private Finance for Africa’s Infrastructure Development

May 2012

Dalleau, M. 2012. Unlocking private finance for Africa’s infrastructure development: Tips and Traps. GREAT Insights, Volume 1, Issue 3. May 2012. Maastricht: ECDPM

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Addressing Africa’s infrastructure deficit has gradually become a national, regional and continental priority. For proof, one just has to look at the recent approval of the Programme for Infrastructure Development in Africa (PIDA) during the January 2012 Session of the African Union Summit to be convinced. This is not surprising. Research has shown that catching up on infrastructure could boost per capita economic growth in Africa by an average of 3 percentage points.(1) But whilst the prospective benefits are enormous, so are the financial means needed to unlock them. 

The total requirement to address Africa’s infrastructure needs in Sub-Saharan Africa has been estimated at about $93bn a year.(2) In the current international context, marked by worldwide economic instability and changing donors priorities, there is therefore a sense of urgency among African countries to tap new sources of financing to address this challenge.

The good news is that Africa is on the rise to become one of the most attractive regions for investment and a pole for growth, offering an opportunity for governments across the continent to mobilise new resources, both domestically and internationally. Among these innovative sources of finance, those emanating from private channels are increasingly recognised as having a significant (and relatively under-tapped) potential, as stressed at the Busan High Level Forum on Aid Effectiveness.

Private sector involvement (PSI) — in the form of foreign direct investment, portfolio investment, private equity, private infrastructure funds, Public-Private-Partnerships (PPPs), etc — could help finance infrastructure development, releasing public debt pressures on African governments already engaged in arduous efforts to mobilise more domestic public resources. Moreover, as they bring on board private sector expertise and technical know-how, PSI, and PPPs in particular, could also help ensure more efficient project design and service delivery, and help spread the risks that large-scale infrastructure projects may entail — risks that are even greater when the project at stake is cross-border and multi-national in essence. 

The challenge is to transform these opportunities into concrete deliverables for equitable, inclusive and sustainable development throughout the continent and avoid the technical and political traps that may lie down the road. Six such challenges are detailed below. 

Six challenges to greater PSI in infrastructure development

Enabling Environment
First, PSI can better be triggered in a conducive business environment. Poor property rights, unclear regulatory requirements and procedures, as well as hurdles to establish legal relations between governments and the private sector, may limit the possibilities of infrastructure projects getting off the ground and/or their financial/commercial viability in the long run. Yet, ensuring the appropriate enabling environment and addressing market failures requires some political will and capacity still too often absent in African countries. Admittedly, when there is a shared interest to engage in productive investment, informal relations between private and public elites could generate sufficient trust among actors to trigger private investments without the need for formal rules-based institutions.(3) Whether informal structures are sustainable in the long run and can successfully deliver on public goods are however questions worth raising. Serious risk exists of collusion and corruption. Besides, without strong regulatory institutions, implementation and enforcement mechanisms in place, there may be in many instances little legal recourse for governments to take if a project does not deliver.

Project Preparation
Second, identifying viable infrastructure projects, conducting feasibility studies, and bringing them to a bankable status is a process requiring considerable preparatory work, which implies in many instances huge upfront sunk costs, typically ranging from 6 to 9% of total project costs (if not more in the case of arguably more expertise-demanding PPPs).(4) A number of project preparation facilities and support services have recently been set up to meet this challenge. However, African countries and regions still often lack both the resources needed to roll out services on such a large scale and the local professional expertise on those legal and financial structures that is required for initiating and managing such projects. Moreover, whilst building capacities in that regard would tremendously benefit from more donor assistance, stakeholders from all sides will also need to pay careful attention not to fall into the pitfall of the fragmentation in resources devoted to that area.

Risk Mitigation
Third, developing instruments to mitigate political, economic and financial commercial risks is important to catalyse private investments in general and in infrastructure projects in particular. Some potential risks relate, for instance, to long pay-back periods, with significant periods of negative cash-flow during startup, dollar-denominated inputs that can translate into currency risk; lumpy assets that are fixed in place with limited residual sale value except for the designated purposes (meaning limited collateral value of fixed investments); and government-regulated prices, often denominated in local currency terms and subject to political pressures in their adjustment over time.(5) Concrete risk mitigation instruments may not be directly available in all countries. For instance, the development of debt and equity insurance and guarantee instruments is often limited by the capacity of low-income countries to borrow externally on competitive concessional terms. Similarly, mitigating foreign exchange volatility through devaluation liquidity schemes or currency hedging may not be an affordable solution for many African countries.(6)

Information and Negotiating Capacity
Asymmetry of information and negotiating capacity is a key factor in public-private contractual relations. In the case of PPPs, such asymmetry may place developing countries in a less favourable position to assess project proposals and negotiate the specific terms of contracts, which may leave them carrying a greater burden than they otherwise would. While this might relate to tax incentives (with private sector negotiating subsidies), it can also extend to the terms of contract for maintaining a PPP project, resulting in some instances in high costs and poor performance.(7)

Coordination 
Besides, involving the private sector requires a high degree of capacity and willingness to coordinate and collaborate among/between government agencies. Whilst a few countries in Africa have shown how a country can successfully establish PPP units in the Ministries of finance, it is probably not the case of most.(8) Moreover, intra-agency frictions, lack of communication and separated systems can often hold up government work where collaboration and coordination are required. 

Aligning Incentives and Interests for the greater good.
Lastly, keeping in mind the interests of the various stakeholders and accountability relations between them is an important consideration when bringing in the private sector. The larger the number of parties involved, the more complex the set of incentives and the greater the need for coordination. Further, profit-seeking incentives of the private sector may not necessarily align with public priorities and motivations. This may lead to rent-seeking, corruption and “crony capitalism”, as well as inefficient outcomes. There is also a risk that increased PSI results in “sector orphans”, with a pattern of concentration in well-performing sectors where commercial returns are high.

In the absence of “public authorities capable of undertaking core governance functions”,(9) it would be illusionary to believe that PSI could systematically bring socially beneficial outcomes. The degree of public accountability, budget transparency and effective governance are key factors to consider. So are the drivers behind political and economic elites’ decisions. 

Towards a Pragmatic Approach
Despite the big opportunities offered by African growth rates, attracting private finance for Africa’s infrastructure development and establishing mutually beneficial public-private project finance schemes in a sustainable and accountable manner will be a challenging exercise, and in some countries more so than in others. Whilst increased PSI may bear a number of technical and financial benefits that help close Africa’s infrastructure gap, the road to achieve this (arguably worthy) objective will certainly be bumpy, especially in those least-developed and fragile states where weak regulatory and legal frameworks may hamper investments, and which may be lacking the financial, technical and institutional capacity to prepare, implement and monitor large-scale infrastructure projects alongside private sector actors. Embarking on this journey may still be a sensible enterprise, however caution will be required to avoid failing negotiating the bend! 

Most importantly, broader political considerations in specific country settings and the institutional context in which PSI are being implemented matter as much as technical (technocratic) considerations. This calls for a greater understanding of the costs and risks associated with PSI, and a fortiori for a balanced approach. This requires not only to factor in country specificities in terms of level of development, financial and technical capacities, governance indicators, level of indebtedness, and regulating environment, but also to seek to unfold political economy drivers or obstacles to the interaction between public and private actors and their respective incentives.

Finally, let’s remain pragmatic. Promoting better management of public spending — in infrastructure development, as in any other sectors — also means keeping in mind “value for money” concerns. In those lower-income countries where PPPs have their limitations, exploring other forms of innovative financing may be required. In this regard, the benefits of attracting private sector capital should be set against the current international low cost of capital globally, in terms of concessional loans for developing country governments, but also in terms of other possible innovative sources of financing that may be worth exploring. This may include tapping bond markets in those countries not too over-indebted, and/or the increasing opportunities offered by the African diaspora (diaspora bonds, securitization of remittances…). Regional options should also be examined. Ways to further involve African financial institutions, such as the African Development Bank and Regional Development Banks (for risk mitigation or for lending opportunities) should be considered. Currently, for instance the incapacity of regional economic communities to borrow (not least given the lack of guarantees to back up loans) limits their possible involvement in regional/cross-border projects financing. Regional development banks could yet play an important financial role in providing concessional loans to support projects in infrastructure areas where PSI has in the past been limited. Whether this is feasible (legally and technically) and desirable (in view of the factors that shape political elites’ incentives and interests) are questions that should also be addressed moving forward. Similarly, defining strategies to make the most out of South-South cooperation and the presence of new emerging players in Africa could be critical. 

In the face of Africa’s huge need, looking at ways financial sources may be combined to greater effect may therefore be where true innovation in financing may best reveal itself.

Melissa Dalleau is Policy Officer Trade and Economic Governance at ECDPM. 

This article draws from Lui, D.et al. (2012), Rethinking Aid for Trade in the context of Innovative Financing, ECDPM Discussion Paper 127ECDPM has been working on issues related to Innovative Sources of Financing, including for cross-border/regional infrastructure, and will continue to stimulate informal dialogues on these themes. Comments and suggestions should be sent to: [email protected].

This article was published in GREAT Insights Volume 1, Issue 3 (May 2012)

Footnotes

1. Estache (2011). Regional Infrastructure in Africa: Learning from Research and Experiences. Presentation made during the Growth Dialogue. 7 June 2011.
2. Foster, V., and C. Briceño-Garmendia, eds. (2010). Africas InfrastructureA Time for Transformation. World Bank.
3. Unsworth, S. ed. (2010), ‘An Upside Down View of Governance‘,CFS, IDS, Brighton
4. NEPAD. African Union. AfDB. (2011) Study on Programme for Infrastructure Development in Africa (PIDA). Phase III. PIDA Study Synthesis.
5. Kharas, H. and K. Sierra. (2011). Time for a Big Push on Infrastructure in AfricaWhat the G-20 Can Do. Washington: Brookings Institution.
6. Brixiova, Z. Mutambatsere, E. Ambert, C. Etienne, D. (2011) Closing Africas Infrastructure GapInnovative Financing and Risks, Africa Economic Brief Vol. 2(1) African Development Bank. 
7. See Gantsho (2010) Can the Private Sector add value to Public Sector infrastructure development, 6th Annual CABRI Seminar, 19 May 2010, Mauritius.
8. Brixiova et al. (2011). Stanley and Mikhaylova (2011). Mineral Resource Tenders and Mining Infrastructure Projects Guiding Principles. Extractive Industries for Development Series #22 September 2011. World Bank.
9. Unsworth, 2010.

Economic Transformation and TradeBusiness and DevelopmentDevelopment Finance and TaxationDomestic resource mobilisationInfrastructurePrivate sector

External authors

Melissa Dalleau