Long-Term Finance is critical for attracting patient capital in developing sustainable African economies

The website of the Africa Long-term Finance (LTF) Initiative launched in a Webinar on July 8^th, 2021. The initiative’s overarching objective is to promote the intermediation of Long-Term Finance (LTF) to close the financing gaps experienced by the infrastructure, housing and enterprise sectors in Africa. The Initiative takes a two-pronged approach. First, it seeks to improve market intelligence on LTF in Africa through the LTF Scoreboard and second, it provides the impetus for effective reforms to deepen long-term finance markets at the national level through a series of Country Diagnostics

What has been done?

So far, country diagnostics have been conducted for Côte d’Ivoire, Ghana, and Ethiopia. Data for the LTF Scoreboard were compiled from two different sources, namely: i) international databases (external sources) and ii) the LTF survey undertaken by the Statistics Department of the African Development Bank (AfDB) with contributions by central banks/country coordinators throughout Africa. Since the inception of the LTF project, two rounds of data collection have been carried out. The data gathered provide information about the sources and uses of long-term finance in Africa – whether provided by governments, donors, foreign direct investors or the domestic private sector.

Hitherto information and data on the availability of long-term finance in Africa has been scarce, spread across numerous sources, or simply unavailable. Thus, the long-term finance initiative brings together existing sources of information as assembled by third parties and augments the availability of data as regards long-term finance through collection of primary data. In addition, the Scoreboard provides benchmarking that facilitates comparison of how countries are performing vis-à-vis one another, thereby engendering interest in long-term productive finance and applying peer pressure among country stakeholders. Availability of the long-term finance indicators will contribute to creating greater investor knowledge and confidence in financial markets in Africa, and thereby catalyze new partnerships in the development of long-term financing markets in Africa.

Accelerating the SDGs and the COVID-19 recovery need long-term finance

Access to finance, particularly medium to long-term capital, is a common and major challenge affecting key economic sectors in Africa. The magnitude of finance and investment required to meet the Sustainable Development Goals (SDGs) is significant. The United Nations estimate that achieving the SDGs in Africa will require annual commitment of USD 1.3 trillion, potentially rising to USD19.5 trillion by 2030. The continued uncertainty around how and when economic recovery from the pandemic will occur adds further to the financing and investment challenge. The bulk of required capital will need to be long-term. However, mobilizing the needed long-term resources for sustainable development require deep and efficient financial markets in a way that permits effective allocation of capital. Today, finance in Africa remains insufficient in scale, too expensive and heavily geared towards the short end of the market that it becomes inadequate to support economic growth and to deliver on the SDGs.

Africa’s long-term funding gaps

In Africa, most investments can attract funding only of shorter maturity than the assets being financed. The limited penetration of LTF across African markets is of particular concern given the huge long-term investment gaps related to fulfilling Africa’s infrastructure, SMEs, and housing needs. Estimates for the Africa-wide infrastructure gap have increased dramatically in recent years. According to AfDB estimates, the annual infrastructure investment needs in Africa are between USD 130 billion and USD 170 billion. At the rate of current spending, this translates into an annual funding gap of USD 68 billion to USD 108 billion.[1] Governments supported by multilateral and bilateral donors are still the predominant providers of long-term funding for infrastructure, most often circumventing the domestic intermediation process.

Development of the domestic intermediation process is therefore fundamental both to enhancing domestic savings and the efficient deployment of scarce domestic resources, and to reducing exposure to potential foreign exchange risks. To close the large infrastructure gap, both public and private investment are needed. However, the volume of Private Participation in Infrastructure (PPI) is still quite low, as it places considerable demands on implementation capacity and the supporting legal and regulatory framework. Gradually reducing reliance on government financing can only be achieved by strengthening the local legal, regulatory, and institutional environment needed to stimulate private sector investment.

SMEs also face serious challenges in accessing adequate long-term financing in Africa. Although traditional banking products are available to most formal enterprises, they often come at a high cost. Legal, financial, and business environment factors limit the depth and availability of products and services. Alternative sources of finance, including private debt and equity, public equity raised via stock markets, and corporate bond markets – even factoring and leasing – play only a marginal role on the continent. A more diversified set of options for SME financing is required to support long-term investment, which will in turn create better employment opportunities arising out of business expansion.

Deepening the domestic market for long-term finance

The LTF initiative highlights the need for deepening the domestic market for long-term finance (LTF). While foreign borrowing entails foreign exchange risks, and its availability is volatile, domestic saving rates are still quite moderate (ca 20% of GDP across the continent, compared to an average of 25% of GDP in lower middle-income countries). Deepening of domestic financial markets is paramount in order to enhance the availability of resources and deploy them more efficiently, and to reduce exposure to potential foreign exchange risks.

The assets of the financial sector in Africa are heavily concentrated in banking. However, in many countries, banks are unwilling to expose themselves to longer-term risk, even where they have the capacity to do seen from the perspective of matching the maturity risks on their assets and liabilities. Addressing the pressures brought to bear on domestic savings by the need to fund the fiscal deficit through the banking system and improving the regulatory framework to increase recovery rates in insolvency is necessary in stimulating banks to finance long-term investments.

Institutional investors also hold a significant portion of their assets as term and savings deposits with banks. Among institutional investors, pension systems are growing in size and importance in Africa. Some countries have undertaken reforms that led to the introduction of very dynamic pension schemes. This led to growth in pension industry assets, for example in Nigeria where assets under management (AuM) have grown from USD 7 billion in December 2008 to USD 30 billion in December 2020. However, even when reform of the pension industry has taken place, risk diversification opportunities remain limited due to underdeveloped fund structures. Most pension funds find investment in government securities more secure and attractive, particularly in markets where interest rates are high.

There is also a need to explore how best to enhance the capacity of local markets for longer-term securities. With the exception of a handful of financial centres, such as Johannesburg, Nairobi, Casablanca, Cairo and Lagos which account for about 90 percent of the total market capitalisation, capital markets in Africa remain narrow, shallow, illiquid and inefficient. The absence of suitable local investment vehicles that might provide adequate diversification opportunities for local institutional investors, suggests that traditional capital market-based asset-allocation mechanism can contribute only marginally towards filling the long-term investment and financing needs of smaller economies.

The green finance opportunity

The green transition presents significant opportunities for Africa as it seeks to reconcile economic development with climate change mitigation and adaptation in African markets. Long-term finance is needed to accelerate the take-up of green bonds as a financing tool in the African region to tap into domestic and international capital markets to finance green projects and assets. This is expected to lead to a holistic development of the markets in the African region in a way that is sustainable and will lead to increased uptake of green bonds and related products thus catalyzing long-term capital.

From a climate change mitigation and adaptation perspective, green finance products are a more sustainable alternative and contribute towards building of resilient markets and economies against climate change. According to Environmental Finance bond database, global green bonds issuance jumped to USD 125.4 billion in 2021 from USD 54.1 billion, for the period between January and March. In Africa, countries like Kenya, Nigeria and South Africa have taken the lead in attracting long-term finance via green bonds in various sector to fill in the financing gaps. With such successful issuances and increasing global demand for green investments, other countries like Ghana and SADC region countries are also considering green instruments as a way of attracting long-term finance.

The Africa Long-Term Finance Initiative is a joint Initiative of the African Development Bank (AfDB), the Financial Sector Deepen­ing Africa (FSD Africa), the German Federal Ministry of Economic Cooperation and Development (BMZ, imple­mented by GIZ), and the Making Finance Work for Africa (MFW4A) Partnership. Launched in 2017, the Initiative is hosted by the AfDB in Abidjan, Côte d’Ivoire.