African Infrastructure: Mobilizing Domestic Capital

Jan 25, 2013
Investing in and building out much needed infrastructure is one of the key challenges facing Africa. The task is vast and complex. But without making significant headway in meeting this challenge Africa’s promising economic renaissance could be imperiled. Africa is enjoying the benefits of a decade long boom in commodity prices which has propelled economic growth. It is hard to imagine this growth can be sustainable or that its benefits can be broadly shared without investment in roads, rail, ports and maybe most importantly power. Meeting this challenge will need African governments to think innovatively, to push forward boundaries on the development of their financial markets and to ensure they have ambitious and well thought out plans for infrastructure. Finance remains a crucial constraint. The African Development Bank and World Bank estimate the financing needs to be in excess of $93 billion per year (AICD, 2009). The Programme for Infrastructure Development in Africa (PIDA)
on key regional projects, endorsed by the 2012 African Union (AU)
estimates a need of $68 billion out to 2020 just for that particular list of projects. These numbers are daunting. But the challenge has to be met; the future of Africa demands it. In meeting these funding needs African governments need to be aware of several emerging and important trends. Firstly, it is increasingly felt that the financing strategy should be determined by African (ie the users of funds) not just by the international community (ie the traditional providers of funds). Secondly, African governments are aware that they can use the global markets as a source of funding at competitive rates and for significant amounts. The global investor base is more open to African credits than ever before. This has been well underlined by the recently successful bond offering by Zambia and by the performance of outstanding issues from the likes of Ghana and Nigeria. But a clear new departure for the way forward is for Africa to think about how to use its own resources to meet it financing needs. In particular how can African capital markets be developed to provide finance for infrastructure. One innovative instrument that has been used in other emerging markets is the ‘project bond’. This is eminently suitable for infrastructure finance because many infrastructure transactions are financed using ‘project finance’. Thus a ‘project bond’ is merely a bond instrument that works similarly to a project loan in that the financing is executed directly with the project vehicle or Special Purpose Vehicle (SPV) and the bond is repaid from the cash flows of the project. While the credit quality of the sponsors may in some affect the credit quality of the SPV, a project bond does not rely directly on the credit quality of the balance sheet of the sponsors. Project bonds have been broadly used in other countries most notably Chile, Malaysia and Korea (Mbeng Mezui, 2012). In each case the government implemented reforms in the pension and insurance sectors to unlock long-term capital. This created a deep pool of institutional investors with demand for low risk, long dated assets in domestic currency. This investor base is ideally suited to buying project bonds or infrastructure investments. That they have a preference to invest in local currency meant that the projects could avoid any currency mismatches between revenues and debt service. In addition to policies to develop an institutional investors base these governments also crucially implemented economic policies that prioritized macroeconomic stability particularly in bringing down inflation and prevailing interest rates. Indeed in Chile the economy undertook broad based indexation which gave long term fixed income investors additional comfort in holding long term assets. That was an innovative solution used by policy makers and financial institutions in Chile and there is nothing to say the same structure needs to be adopted by others. But what is important is to have a long term strategy of seeking economic stability and creating institutions that will accumulate capital and will focus investment on long dated assets. Alongside policies that can encourage the creation of pension funds is a need to ensure securities market regulations are in place to give investors comfort that their interests are protected and that procedures exist that enable institutions to invest and meet their fiduciary requirements. It is important once securities markets are created that legislation be passed to ensure that issuers provide satisfactory levels of disclosure and that the information given in prospectuses or other documents is transparent and meets the standards of institutional investors. It is vitally important that as domestic African capital markets develop they adopt internally acceptable standards. This is vital to building investor confidence. Finally, governments must establish professional and efficient infrastructure departments that undertake the work necessary to get projects approved and ready to be taken to the financial markets. If African governments can successfully implement these various policies not only will catalyze significant volumes of domestic capital into their infrastructure programmes but they will also set in motion the development and greater sophistication of their financial markets. This will be hugely beneficial to those economies as they face the challenges of development in the years to come. Project bonds can be the instrument to catalyze these various changes. Already many African have in place the institutions and regulatory framework to allow for the issuance of project bonds and other innovative products that finance infrastructure. These should be strengthened and stakeholders should be encouraged to use the domestic capital markets. Alongside this African banks should be encouraged to work across the continent and to augment the capabilities of the capital markets. International markets are undergoing great change. Many international banks are pulling back from infrastructure. But with supportive policies African countries can ensure they have increasing financial resources from its own markets. This will only serve to make Africa’s recent resurgent growth more sustainable and robust. Bim Hundal: Chairman Lion's Head Global Partners
Cedric Mbeng Mezui: Senior Financial Economist, African Development Bank

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