ShiftingWealth

A key pillar of the G20 Africa Partnership is the ´Compact with Africa´ (CwA), an initiative within the G20’s finance track, coordinated by the German Federal Ministry of Finance. In its resolution adopted by G20 finance ministers and central bank governors in Baden-Baden, the G20 has acknowledged “its special responsibility to join forces in tackling the challenges facing the poorest countries, especially in Africa”[1]. The ´Compact with Africa´ initiative aims to boost private investment and investment in infrastructure in Africa. To this end, the World Bank, the International Monetary Fund and the African Development Bank have produced a joint report (“The G20 Compact with Africa: A Joint AfDB, IMF, and WBG Report”), which proposes a catalogue of instruments and measures designed to improve macroeconomic, business and financing frameworks as a way to boost investment [2]. The document is a dense, well-argued and documented text, albeit written in fairly technocratic language.

The CwA Financing Framework aims at increasing the availability of financing at reduced costs and risks, with a focus on long-gestation infrastructure projects. It targets in particular pension funds and life insurers. These institutional investors are characterized by the long-term nature of their balance-sheet liabilities, which enables them to invest in infrastructure projects with long gestation periods. They would indeed make a very good fit for funding Africa’s infrastructure. Projected to reach $100 trillion by 2020, institutional investors (pension, funds, life insurers and sovereign wealth funds) would need to invest one percent of their annual new inflows to fund Africa’s infrastructure gap, estimated at $ 50 billion per year [3].

The CwA makes some important ideological presumptions. First, it is solely driven by the Anglo-Saxon financing model with a focus on direct securities (equity and bond) markets rather than bank-based financial intermediation, which has underpinned (Continental) European and East Asian economic and social development.  Second, the CwA Financing Framework is silent on the important role that the public and semi-public sectors may have played in early stages of development via mandatory public pension plans (East Asia) or not-for-profit financial ccoperatives (such as agricultural credit unions).  Third, it is silent on the “financing gap” (also known as the MacMillan gap), which has come to indicate that a sizeable proportion of economically significant SMEs cannot obtain financing from banks, capital markets or other suppliers of finance. The MacMillan gap requires an important role of public development institutions and public policies in tackling underlying market imperfections. Lastly, it seems that the German Ministry of Finance that commissioned the CwA report in the first place has missed a unique chance to bring in the specific German history of bank-based intermediation, of rural credit unions and of public infrastructure push in the context of late industrialization. This would indeed be relevant for the African context.

Instead, the CwA Financing Framework consists of three linked components to tap the global pool of private finance: The first peddles blending instruments and facilities - the use of public or philanthropic funds to attract additional investments from private sector actors into development projects - to lower African country risk to private investors (the new Private Sector Window under the IDA18 replenishment is mentioned explicitely); the second aims at support of domestic debt markets and at a more supportive global regulatory environment; the third aims to promote new public infrastructure investment funds, such as Managed Co-Lending Portfolio Program (MCPP) initiated by The International Finance Corporation (IFC), part of the World Bank Group.

Because most African countries remain poor, they are not considered creditworthy. Even though the African Development Bank (AfDB) has 54 member countries, of which only 17 are not eligible to African Development Fund (AfDF ) funding, most countries have a per capita income below an operational cut off (fiscal year 2015-2016: $1,215). Recent Brookings forecasts project that the number of people living in extreme poverty (the headcount of those falling below $1.90) will rise in 19 African countries by 2030.

Apart from general investment barriers, common project risks for infrastructure investments need to be considered in the African context. These include: completion risks (failure to complete the project on time and on budget); performance risks (the risk that the project fails to perform as expected on completion, maybe due to poor design or adoption of inadequate technology); operation and maintenance risks (relates costs, management and technical components and obligation to provide a specific level of service); financing risk (which may arise from an increase in inflation, interest rate changes etc.); and revenue risks (which relates to the possibility of the project not earning sufficient revenues to service its operating costs and debt and leave adequate return for investors).

Legal, regulatory and institutional challenges of Private-Public Partnerships (PPPs) should not be underestimated in the context of Africa’s low-income countries. Long-term commitments in the infrastructure sector depend on a set of legal, regulatory and institutional frameworks. From the time of project preparation, to bidding and finally operation, the regulation of PPPs requires an independent regulator and the handling of disputes by an independent judiciary. Other institutional prerequisites are property and collateral registries, reliable accounting and reporting procedures, tested and reliable foreclosure mechanisms. The longer the term of contracts and the larger the funding commitments, the more important such ‘basic’ institutional and legal infra­structure becomes. Moreover, fiscal contingencies of PPPs could burden weak public finances in countries where debt tolerance has proven low. In particular when privately financing large infrastructure projects in immature markets, there is a risk that private returns come at the expense of long-term fiscal costs (contingent liabilities).

To a large extent long-term funding of infrastructure in Africa is provided circumventing the intermediation process altogether, including via foreign direct investment. As for low-income Africa, the CwA’s focus on an important role for private institutional investors to fund the infrastructure gap lacks realism: Most African countries are at the first two steps of the Infrastructure Funding Escalator, where public investment and concessionary aid remain the major funding sources.

The first component of the CwA Financing Framework pins high hopes on blended finance and leveraged finance via development finance institutions (DFIs). Table 3, however, shows that private funds mobilized by DFIs seem to have shied away from the ‘Bottom Billion’ (to paraphrase Paul Collier). Within the group of countries attracting blended finance investments, LICs generally (not just in Africa) receive much less on a per country basis compared with other developing countries [4]. LICs obtained, on average, US$60 million of private investment per country between 2012 and 2014; the equivalent figures for other developing countries were six times higher – US$352 million for LMICs and US$404 million for UMICs. Little of blended finance and of foreign direct investment (FDI) goes to low-income countries compared to ODA, as both categories of private-sector flows seem to favour middle-income countries. Despite policy efforts to mobilize private finance through official DFIs, they so far have represented a small fraction of the flows directed to low-income Africa.

Three commitments addressed to partner countries are derived from the first component: support ongoing de-risking initiatives; support various de-risking instruments (IDA18 Private Sector Window, AfDB´s PSF; support the further refinement of a commonly accepted set of principles for ´blended finance´. This is more of a self-promotion of the World Bank and the AfDB than a helpful commitment for low-income Africa. In reality, new AfDB initiatives have had a low uptake, especially in low-income Africa. A study finds that the growing complexity and fragmentation of private-sector mobilization initiatives created my multilateral development banks seems confronted with “little awareness or understanding of these private sector mechanisms and initiatives” on the ground [5].

The second component of the CwA Financing Framework calls for domestic debt market development, as already exist in Egypt, Nigeria and South Africa. The CwA document is well aware (in some paragraphs, at least) of capacity constraints that impede Africa´s securities market development. To be sure, there has been limited progress in developing markets for long-term finance on the continent. Except for South Africa the depth of equity and bond markets falls far short of the capitalization and liquidity of financial markets in other developing regions, despite recent issuance of Eurobonds and local currency bonds in some places. The largest and most important segment across financial sectors in Africa is the banking system, not an ideal source of intermediation for long-term finance, given the maturity transformation of banks’ short-term liabilities and consequent risks.

To avoid currency mismatches in private and public balance sheets, local currency bond market development is primordial. Most poor countries do not borrow in their own currency, which has time and again triggered debt crises as a result of strong currency depreciation (as currently observed in African commodity exporting countries).  Substituting external, foreign currency debt with domestic, local currency debt may increase rollover and interest rate risks because of shorter maturities of the latter; this implies it will have to be refinanced more frequently and possibly at a higher rate. Ghana is an example of the risks involved: In the recent decade, Ghana had issued three Eurobonds with tenors between 10 and 12 years, whereas the average tenor of its local currency bonds at issuance was about two years only; moreover, their yields stood at no less than 23% in 2014.

Four commitments addressed to partner countries are derived from the second component: introduce an appropriate regulatory and supervisory framework; establish over-the-counter trading as well as custody and settlement mechanisms to minimise costs and risks for debt securities; support the development of pensions funds, life insurance companies and mutual funds to develop a domestic institutional investor base; implement ´sound´ debt management policies. I have major doubts whether scarce African government resources are really best employed by facilitating an Anglo-Saxon system of direct securities markets, and what the risks are in terms of fraud and gambling.

The CwA finance framework tries to put the cart before the horse, especially for LICs in Africa, by trying to appeal to institutional long-term finance. It ignores the financing model of successful development that has been largely based on public infrastructure preceding industrial development, corporate savings via retained earning, rural credit associations and bank-based finance. It also ignores the risk of debt sustainability linked to blended finance, especially as multilateral development banks are reducing the share of concessionary finance, including to African countries with a long default history.

Low domestic savings levels, weak government finances and a low debt tolerance militate against forcing foreign private debt and contingent fiscal liabilities upon countries where infrastructure deficits are most blatant. The risk of lasting current account deficits, which are mostly financed privately, is that they tend to end with balance-of-payments crises. Many African countries have benefited from comprehensive debt restructuring and relief efforts in recent decades, but since 2010 countries have accumulated foreign debt again as raw material prices weakened, growth slowed and concessional debt was replaced.  Both investors and Africa’s governments should consult the Joint World Bank-IMF Debt Sustainability Framework for Low-Income Countries before raising the finance they need to meet the SDGs, including through grants when the ability to service debt is limited.