According to the Global Infrastructure Facility, the Infrastructure Financing Gap of Africa (the difference between the required infrastructure and the current economic infrastructure) stands at $1.7 trillion for the next 20 years. Energy, telecommunications, and roads works are the sectors with the strongest financing needs, which results in large proportions of the population being under equipped and underserved in terms of basic amenities. 2/3 of the global population who does not have access to electricity are in Africa, 53% of the roads are unpaved with 225 thousand deaths every year attributed to road safety issues and nearly 700 Mn people live without clean cooking facilities (African Development Bank – AfDB).
The absence of those investments leads to significant economic costs which are hampering African countries from fully unleashing their potential. Demographic growth, urbanization and aspiration for economic opportunities are likely to put pressure on the existing amenities and increase the need for modern infrastructure.
Closing the infrastructure financing gap has become even more relevant with the outbreak of COVID-19. On the demand side, having a resilient health sector, basic amenities at home and adequate digital connectivity have become priorities. On the supply side, border controls will affect tourism and hospitality while declining prices of raw materials will adversely affect economic growth. Investing now in infrastructure projects could be an appropriate response by African countries as it would stimulate investment and employment in the short-term and improve the quality of infrastructure and living standards in the long-term.
Dry powder remains abundant …
Over the last decade, capital deployment in the African infrastructure space has seen an encouraging momentum. Between 2013 and 2017, the average annual funding for projects in the region was $77 Bn, which is twice the average recorded between 2000 and 2006 (Infrastructure Consortium for Africa). An emblematic project is the 420 MW Nachtigal Hydropower Plant in Cameroon which required a total amount of €1.2 Bn and secured hybrid financing with 15% in equity (financed by public and private institutions) and 85% in debt with a blend of Development Finance Institutions (DFIs) and commercial banks loans. This illustrates the ability of various stakeholders to engage in bankable projects.
However, the declining fiscal space of states in recent years has reduced their ability to launch new infrastructure projects. Sovereign debt in Sub-Saharan Africa (SSA) has increased from 40% to 59% of GDP between 2010 and 2018, making Africa the fastest growing debt accumulation continent among developing regions. With the prospects for growth deteriorating associated with the current crisis, especially for countries which rely heavily on exports of raw materials, public resources available for infrastructure will be scarcer.
The picture is different for institutional investors who maintain a strong appetite for the asset class. Infrastructures have delivered superior returns compared to other asset classes mainly due to their low volatility and are therefore attractive investment opportunities, especially in the current context of market dislocation and low-interest rates. This should maintain the current fundraising momentum. Unlisted infrastructure funds have secured $38 Bn in 1Q20 (Preqin), the third-highest quarterly total ever recorded. In May, BlackRock closed on $5.1 Bn for its Global Energy & Power Infrastructure Fund while 248 private fundraisings are currently in the market with an aggregate capital target of $174 Bn.
Yet only 16% of the total dry powder to be invested in infrastructure in the next 12 months targets emerging countries (Preqin). African infrastructure projects will corner an even smaller piece: for instance, in 2018, only 4% of global infrastructure deals were made in Africa, behind Latin America (7%) and Asia (14%). It becomes clear that there are some major pitfalls which are preventing these significant amounts from reaching African shores.
… but project bankability is a hurdle for investors
The level of risk-return embedded in African infrastructure projects is not in par with the expectations of leading institutional investors for multiple factors:
- Credit risk. As capital-intensive projects, infrastructures generally require large amounts of debt to complement equity, increasing the risk of default
- Currency risk arising from exchange rates volatility between local and foreign currencies
- Construction and Operational risk arising from construction defects and delays as well as contractual, regulatory, or economic changes impacting project profitability
- Legal and Political risk arising from political and regulatory instability, corruption and other compliance issues, and the lack of efficient dispute resolution frameworks
- Environmental risk arising from major natural disasters damaging the asset
Those risks are generally heightened for projects in Africa. The region instability results in a high level of “macro” risk which in turns increases currency and credit risk. African currencies from countries which are not part of a monetary union generally suffer from a higher level of volatility. The South African rand (ZAR) for instance, despite South Africa being the most developed economy in SSA, was reported to be the most volatile major currency worldwide by Bloomberg in mid-2019. On the debt side, those higher risks are compensated by higher interest rates and tighter terms such as shorter maturity, increasing credit risk.
The higher level of risks in African projects disqualifies them on a relative basis compared to OECD countries and even middle-income emerging countries in Latin America and Asia. The global financial distress following the COVID-19 outbreak may lead to an even more bearish investment thesis for African projects as investor’s risk perception worsens. In addition, distressed infrastructure opportunities may emerge in OECD countries as a result of the current recession, leading to more competition for African projects as investors may find projects with significant upside potential in better-known markets.
In addition to the highly risky environment, institutional investors must deal with operational and administrative inefficiencies. First, the cost of corruption is heavy and adversely impacts the success of infrastructure, hence weakening the track record and credibility of African governments. The OECD Foreign Bribery Report indicates that nearly 60% of foreign bribery cases occurred in four sectors related to infrastructure. Biased political decisions with little regard to the economic rationale and Sustainable Development Goals (SDG) criteria affect the outcome of the investment decisions very early in the life cycle of infrastructure projects and often result in “white elephants” with little value for money.
Second, the African infrastructure deal flow does not allow an efficient underwriting process for investors. Projects are smaller and fewer than in other emerging regions with clearer growth perspectives such as Brazil, Turkey, China and India. Historical data provided by Preqin shows that annual deal number is 3 to 4 times as high in Asia as in Africa, while the average deal size is about twice as big in Asia. Investors cannot scale acquisitions and leverage existing knowledge and networks.
Besides, institutional investors need to rely on audited financial and non-financial data to appreciate the track record of African countries in delivering quality infrastructures in an efficient way. Delays in obtaining licenses and permits, the inefficiency of government agencies, inability of the government to secure sovereign guarantee result in significant loss of money and time. For instance, according to a report by McKinsey, up to 38% of global infrastructure investment is not spent effectively because of bottlenecks, lack of innovation, and market failures.
Lifting those hurdles is possible by combining public sector efficiency, innovative financial tools, and fruitful partnerships throughout the life cycle of investment
- African countries should not only adapt to global legal developments but also be proactive and anticipate by preparing their legal framework to regulate innovative financial instruments that will attract institutional investors to finance local projects. For instance, recent amendments on European Financial Regulations (MIFID 2 and UCITS) define new categories of products related to Environmental, Social and Governance (ESG), require asking investors for their ESG preferences, and impose information disclosure on the sustainable impact of their decisions. Private investors have already started to take the lead on integrating ESG and SDG’s criteria in their investment guidelines. For instance, in 2019, Meridiam has published for the first time its Impact Report using a proprietary analytical tool to assess its fund performance against the ESG and SDG’s criteria. African countries could cash in this new opportunity by coming up with legal frameworks defining environmentally sustainable activities, establishing a classification for green financial products and imposing disclosure requirements for financial products that are labelled as environmentally sustainable. On the other hand, since the investment horizon of an infrastructure project is typically 20 to 30 years, government agencies should engage with climate, environmental and demographic experts to have a better understanding of key projections which might impact infrastructure projects profitability and viability when defining the national strategy. For instance, the World Bank predicts that by 2050, in Sub Saharan Africa 86 Mn people will be displaced within their countries due to climate change. Therefore, the national strategy should be forward-looking so as not to allocate resources in areas which might be exposed to natural catastrophes and where populations will not be able to settle sustainably.
- Once a framework has been validated with the involvement of various stakeholders, the initial phase of preparation and planning should be monitored closely. 2 to 10% of total investment are spent on studies, environmental and social impact assessments, structuring, and preparation of project agreements. This is where donors and multilateral or bilateral stakeholders can contribute with financial and technical assistance. State agencies should then define KPI’s to monitor the execution performance and track potential cost overruns.
- DFIs should ensure scalability to offer investors exposure to a wider investment universe by pooling projects together through innovative investment vehicles. The International Finance Corporation (IFC) launched in 2016 the Managed Co-Lending Portfolio Program (MCPP) Infrastructure, a global loan syndication platform raising capital from institutional investors and investing it as senior debt throughout its global infrastructure portfolio. Investors benefit from both the IFC’s extended pipeline and track-record in emerging countries including SSA as well as a streamlined underwriting by committing capital only once to the facility. This allows them to invest large amounts of money in a very efficient way and appear as a promising tool to mobilize capital: $1.6 Bn has been raised to date and African projects amount for 8% of approved investments. The facility is targeting new commitments of $5 Bn, one of the top five fundraisings currently in the markets.
- Risk mitigation instruments for African infrastructure projects are available to investors but are often perceived as too complex and lacking standardization. Risk mitigation providers should focus on harmonizing and streamlining their solutions while raising investors’ awareness on how to use them. For instance, the MCPP Infrastructure facility includes a credit-enhancing component: the IFC invests in a “first-loss” tranche, therefore, providing investors with an investment-grade risk profile.
- Besides, currency risk can be addressed by deepening local capital markets and involving private sectors partners to structure products and market them widely. The most advanced SSA economies like South Africa, Nigeria or Kenya have made good progress to that extent through the green bond local currency market. Acorn Holding, a Kenyan property developer, just issued in February 2020 the first-ever Kenyan shilling (KES) green bond on both the Nairobi Securities Exchange and the London Stock Exchange to finance the development of an affordable and green-certified 5,000-unit student housing facility in Nairobi. Local currency bonds materially decrease currency and credit risk by mitigating currency change volatility. Partnerships between DFIs and the private sector in Africa have taken the distribution of risk-mitigating instruments to the broader international community even further. For example, the AfDB together with the Mauritius Commercial Bank (MCB) launched the first African multijurisdictional fixed income Exchange Traded Fund (ETF) in 2018, listed on the Stock Exchange of Mauritius (SEM). The vehicle aims at tracking the performance of an index composed of local currency sovereign bonds from eight African countries. The ETF allows marketing the local currency instrument, whose proceeds can be used to finance infrastructure-related projects, to the global investor community. Furthermore, it mitigates various risks including currency and credit by diversifying the investor’s portfolio across multiple underlying bonds in different countries. Last it enhances liquidity since the ETF is a publicly-traded instrument allowing investors to exit more easily.
- In addition to using mitigation tools to reduce downside risk, investors should team-up with the best-qualified stakeholders to ensure the best possible chance of success to the venture. CSquared is a great example of how bringing expertise together can be instrumental to ensure development and operating success. In 2017, the IFC, Google, Convergence Partners (a leading pan-African Information and Communication Technology private equity fund), and Mitsui (one of the largest global finance, infrastructure, trade and services conglomerate) entered into a Joint-Venture to invest $100 million equity in the company to build over 2,200 kilometres of wholesale metro fibre optic equipment in Ghana, Liberia, Uganda and Kenya.
- With a small universe of potential buyers, African infrastructures suffer from the absence of clear exit scenarios, hence the need to enhance the liquidity of the asset class in the region. Open-ended funds are a first answer to this challenge by allowing investors to liquidate their position within the fund without requiring the sale of the entire assets. More generally, DFIs and the private sector must work toward transforming investment in African infrastructure into a traded asset class. Initiatives such as listed green bonds and ETF mentioned above have been the first successful steps toward this objective. Securitization of project finance debt or listed infrastructure investment trusts are additional avenues that should be explored.
Jean-Laurent Pyndiah and Thibaud J. Favier, May 21st 2020
The opinions expressed hereby are those of the authors and do not reflect the views of their employers.
This article has been published with permission from the authors. The original can be viewed here
Want to know more? Get in touch