Building Bridges: In search of solutions for Africa’s infrastructure gap

ELVIPS.COM - The infrastructure and energy challenges currently facing sub-Saharan Africa are considerable.

Ellen Johnson Sirleaf, President of Liberia, provided a particularly poignant illustration when she lamented the fact that the AT&T Stadium near Dallas, Texas, home to American football team the Dallas Cowboys, uses more electricity than the total installed capacity of Liberia.

In 2011 the World Bank estimated that approximately $75bn would be required each year to address Africa’s infrastructure gap. At the time, sub-Saharan countries were spending approximately $40bn each year on developing and maintaining existing infrastructure, leaving a financing gap of $35bn. Recently the World Bank revised its figures and now estimates that, in fact, $93bn per year of infrastructure spending is required in sub-Saharan Africa. This number is even more daunting when one considers that the total capital inflow into sub-Saharan Africa for 2013 was only $86.1bn across all sectors.

In addition, the combination of a strong US dollar, low commodity prices and slowing Chinese growth have all contributed to a surge in capital outflow from emerging markets to traditional safe-havens. This shrinks the pool of available funds for infrastructure investments.  African countries will have little option but to consider alternative sources of finance.  One solution may lie in the rapidly expanding pool of domestic savings which, with the necessary regulatory and economic reforms and some innovative structuring, could be harnessed to provide a substantial domestic source of finance.

Lessons from South Africa

South Africa’s ambitious Renewable Energy Independent Power Producer Programme (REIPPP) has illustrated the hugely beneficial role that domestic capital can play in funding large scale infrastructure projects. In 2011, the South African government launched a competitive tender process for the development of renewable energy power projects.

Questions linger regarding the government’s choice to focus on renewable energy, particularly given South Africa’s abundant coal reserves and the long term cost of the renewable feed-in tariffs. However the initial indications are that the programme has been successful in drawing in private capital and expertise to deliver complex, high-value projects on schedule and within budget.

The projects attracted $14bn of funding from a mix of local and international financiers. A particularly striking feature was the significant role played by domestic institutional investors such as Old Mutual, Momentum, Standard Life and the Government Employee Pension Fund which have been active as debt or equity funders on a number of the projects thus far.

Lessons from Europe

Lessons can also be drawn from Europe’s Project Bond Initiative. This initiative was launched by the European Commission and the European Investment Bank (EIB) as a means of kick-starting infrastructure investment in Europe. Investment into these kinds of projects had slowed down in the face of the global financial crisis and regulatory reform (in particular, Basel III), which rendered the sort of long-dated loans typically required for infrastructure finance increasingly costly, and thus less attractive to international financiers.

The EIB identified the $50tn pot of capital managed by institutional investors (such as pension funds, sovereign-wealth funds and long-term insurance) as a way of plugging the gap left by retreating banks. The EIB has sought to make infrastructure investments a more attractive asset class by providing some form of risk-sharing instrument, such as subordinated debt and/or debt guarantee. This has been useful particularly for projects that are deemed too risky for institutional investors or have not been able to achieve an investment grade credit rating.

African Institutional Investors

Most African countries lack the necessary institutional, regulatory and economic environment for the successful issuance of project bonds. However, as the EIB has shown in Europe, development finance institutions (DFIs)  and multilateral institutions can play a crucial role in not only providing technical assistance but also in providing credit support where the conditions for a successful bond issuance are absent.  In the same way that the EIB has sought to boost non-investment grade bond issuances, there is a clear role for DFIs to provide credit support where the conditions for a bond issue are absent.

Guarantco, an initiative by the Private Infrastructure Development Group, a multi-donor organisation backed by various European governments (including the UK, Switzerland, Netherlands, Austria, Ireland and Australia) and the World Bank was established in 2002 to provide credit support for local currency loans and bonds to finance infrastructure in developing markets. Since its inception, Guarantco has provided credit enhancement in the form of partial guarantees for local currency loan financings or bond issuances in various African countries, including Kenya, Uganda, Nigeria, Chad and Tanzania.

The African Development Bank’s (AfDB) experience with local currency bond issuances has shown that there is real appetite among African institutional investors for low risk, local currency denominated debt securities. In 2014, the AfDB established an approximately $1bn Medium Term Note Programme in Nigerian Naira, and issued its first tranche of local currency notes for approximately $80m. Interestingly, these currency bonds were structured to match the underlying projects to which the AfDB will lend the proceeds, including infrastructure projects. The South African REIPPP initiative is proof that local pension funds and long-term insurers can play a key role in providing equity and debt funding for infrastructure projects.

Domestic savings

As Africa’s middle class continues to expand, pension assets are similarly increasing at a rapid pace. For example, Kenya’s pension investments grew by 27 percent in the decade up to 2013 and Nigeria’s pension fund industry has tripled over the past five years following the introduction of various regulatory reforms to the sector. In a 2012 study, Renaissance Capital projected that pension fund assets in sub-Saharan Africa’s six largest markets would grow to $622bn by 2020, and then balloon to $7.3tn by 2050.

In South Africa, the Government Employee Pension Fund currently has over $100bn in net assets. It has targeted infrastructure projects as a key investment class, not only because of their potential for developmental impact, but also because of the consistent long term returns and diversification benefits.

With the necessary regulatory and economic reforms and innovative approaches to developing suitable financial products for the growing African middle classes and where necessary, the introduction of credit enhancement tools, pools of savings in Africa could grow. In future, these could leveraged to finance the roads, ports, railways and power stations that will bridge the infrastructure gap.

Tinashi Makoni is a senior associate at global legal practice Norton Rose Fulbright.