Feature

Expect a Marathon, Not a Sprint

Africa’s need for massive investment in infrastructure is clear. But how to unlock the investment in new power project, pipelines, ports, roads and railways is not so obvious. Securing sustainable funding for projects, argues Sameh Shenouda of CDC, will take time and important economic reforms.

 

Africa’s burst of economic growth in the last ten years has been extraordinary, transforming this vast continent into a region now capable of achieving its massive potential.

And all the signs are that the growth witnessed in recent years is likely to continue. The IMF has calculated that, in the five years to 2019, of the 22 countries expected to see GDP growth of at least 7% – the rate needed for an economy to double in size in the space of a decade – 14 are African nations.

But if Africa’s massive need for new infrastructure is to be met, three things need to happen. First, good development teams with deep and broad experience need to be set up to tackle the problem; second, patient investors with long time horizons need to support these developers; and finally, governments across the continent need to create the right enabling environment for private investors.

There is a direct correlation between the provision of efficient infrastructure – whether that’s power generation and distribution, gas pipelines, ports, roads, rail or ICT networks – and increased economic output, and Africa’s record in modernising its infrastructure has been uneven, to say the least.

Indeed, the World Bank has calculated that Africa loses the equivalent of 2% of GDP growth a year just because its existing infrastructure is so poor and because countries are struggling to attract finance for new projects.  There’s a big gap between demand and supply, and the numbers used to describe that gap are not for the faint-hearted.

It’s been suggested, for instance, that Africa would need to spend USD93 billion a year for ten years to bridge the gap – about two-thirds of that on entirely new infrastructure, the rest on maintaining existing assets. Actual spending by governments is said to be running at only a quarter of that giant figure, today.

Take power, for example. With only an estimated 30% of Africans having access to electricity, it is reckoned that some USD490bn needs to be spent on new generation capacity and USD345bn on transmission and distribution networks to connect up people to power and, then, to reap the economic benefits in terms of increased output.

Caution

These figures are designed to be eye-catching and they do illustrate that Africa has a real and huge challenge in modernising its infrastructure.

But I am a little cautious about them. Often they come from top-down desk studies, which tend to project Western levels of consumption on to African countries that – for reasons of affordability, access and simple geography – are probably never going to be able to afford the sort of total utility-type provision of infrastructure seen in the West.

And they don’t, in themselves, explain the real hurdles that lie in the way of increased investment. There is no doubt the gap between demand and supply is huge, but, while financing projects is a big part of the story, it really isn’t all about money.

And the simple fact is that – even if all that money was available tomorrow – the process of building much-needed infrastructure would not happen overnight. Infrastructure investment is all about moving in incremental steps. That’s particularly true in Africa – you develop a project, win approvals, line up financing, make mistakes, hit legal or bureaucratic roadblocks, go back to the drawing board and start all over again.

So investors need to be clear: there will not be a life-changing supply of new infrastructure in a year or two or even ten – it’s a very long process. 

Demand

Nevertheless, it’s easy to understand what is driving demand for infrastructure investment. This vast continent has a youthful and growing population. Incomes in many countries – although not all – are rising relatively quickly and, with urbanisation, we are also seeing the emergence of an aspiring middle class.

Industries are growing rapidly too, with a raft of new small and medium-sized enterprises bursting into life.

All this creates increased pressure for investment in new and existing infrastructure.

Trade, too, adds to that pressure.

Few countries in sub-Saharan Africa have big enough internal markets to support growth, so developing intra-regional and international trade is essential.

Yet while levels of intra-regional trade have massive potential to grow they are still at very low levels compared with other developing regions in Asia and Latin America. The shaky transport infrastructure – roads, rail and ports – mean that the basic costs of rail freight services and containers are sky high compared with other developed and developing markets.

Understanding the challenges

So what are the main supply side challenges we see, as a development finance institution (DFI) working across Africa for more than 50 years?

One of the first is differing legal frameworks. These vary dramatically across the continent’s 54 nations. Governments also take sharply different approaches to investment. Some are continuing to control all spending centrally; others are beginning to look to the market. It’s clear to us that those governments that are opening the door to private sector involvement in planning and financing projects have much higher chances of success in securing investment.

Political stability is another issue and, here, we’ve seen some significant progress.

While some states, like Somalia for example, remain highly volatile, elsewhere there’s been considerably less upheaval of late. Just look at this year’s election in Nigeria, which saw an opposition leader come to power in free elections for the first time in the country’s history. Recent transitions of power in both Zambia and Ghana have been equally smooth.

Since the state is often the main customer for major infrastructure projects, like power generation, the creditworthiness of governments is obviously an important issue, too. How do investors mitigate that risk? Guarantees from the World Bank and other agencies can help greatly here. But these agencies do not have unlimited capacity to provide insurance. They simply can’t take on each and every project that needs to be done in Africa.

And politics plays an important role in another way too. Essentials of modern life, like power and clean water, are often subsidised to make them affordable. But, at the same time, underinvestment in infrastructure assets means that many economies – even the most advanced – are hostage to regular and often chronic interruptions in supply.

So often governments are wrestling with a very tough dilemma. Outside investors need an incentive to pump money into modernising these industries, but they are unlikely to do so unless governments bite the bullet and allow prices to rise to a level where investorswill choose an African infrastructure project rather than a European, Asian or Latin American project..

Red tape and bureaucracy continue to be a significant issue too, although governments in several countries have made it clear they intend to tackle the issue.

Here inward investment can help by lifting standards. DFIs like CDC and other investors often apply strong environmental, social and governance standards, which will, over time, help to ensure that investment is not only secure but also sustainable. As a company we would never do a deal with a partner that did not follow our own policies, particularly on the issue of business integrity. 

One in five – the early stage funding challenge

Despite some of these challenges, it is clear that many institutional and industrial investors are keen to help tackle the African infrastructure challenge in a way that is both commercially viable and sustainable.

The trouble is, they are often only interested in investing when a project reaches financial close, goes into construction or actually begins operating and delivering a return.

What’s missing is the vital money needed to fund early to mid-stage development. This is the initial and often tricky part of the project – finding the land (and, ensuring it has clean title), negotiating with governments, carrying out environmental studies, lining up equity investors and being prepared to go back to the beginning if the project hits a snag.

The development stage alone could take many years to complete. Indeed, we estimate that for every five projects launched, maybe only one will see the light of day.

Often those taking on early stage development are relatively small local companies, which sometimes fail to realise when they sign an initial memorandum of understanding with government that they may be years away from a bankable project. Often they will walk away.

Our strategy at CDC is to target key sub-sectors – power, ports, railways, roads – and help these local companies navigate their way through development to financial close. In other words, to focus on that point in the infrastructure cycle that is most dysfunctional. To mitigate our own risk, in each case we seek to work with the best-in-class companies in any specific sector or market.

Two recent examples help to explain the stategy. We have taken a 70% stake in Globeleq, for example, working alongside Norfund of Norway, with a 30% stake. We are helping the company with its existing late-stage projects – it has eight working power projects in five countries – but also guiding them through the development of brand new projects. Instead of taking a dividend out of the company, we re-invest revenues from existing projects into new ones in other parts of Africa.

We’re following a similar tack with our investment in Grindrod, the transport and logistics business based in South Africa. With three ports in South Africa and one in Mozambique, it has proved itself to be one of the best port and rail developers in the market, with ambitious but achievable plans for the future. We bring not only money to these ventures, but management skills, market knowledge and a network of contacts built up over many years. CDC is invested in 600 African companies and around 70% of local PE funds. As such, we have much to offer companies like Globeleq and Grindrod.

As a balance sheet investor, CDC has none of the constraints faced by a typical PE fund. You can see why, for example, a hydro project which might take seven to ten years to develop would not appeal to a PE House whose own funds have a lifecycle of about ten to 12 years. They need to return money to their own investors in that time. We don’t have that same concern and that means we can afford to run these investment marathons.

There’s hope here too. Markets that have undergone reform are now attracting investors looking for safe, long-term returns of the sort that infrastructure projects can deliver once past the development and construction stages. Pension funds, for instance, are starting to hunt for safe and secure assets like this in South Africa’s renewable energy market. Now in its fourth round of contracting projects, the programme is now seeing deals being signed on much lower rates of return than when the programme began – an indication of growing investor confidence in the process and the market.

That’s good news. As these funds buy up businesses, they are recycling investment back to the developers, which can then be pumped into the next generation of assets.

Enabling environment

So, however big the funding challenge, there are very positive signs.

Africa is undoubtedly a hot place these days and investors want to put money into it. But to secure that investment, governments need to create the right enabling environment.

South Africa has been successful with renewable energy for precisely that reason – the government has created a programme that is transparent, with proper legal documentation, supported by an open and competitive process for bidding.

We will see more of this, I’m sure. As an African myself, I have very high hopes that things will progress.

But I’m also sure that progress will come at varying speeds in different countries, depending on how quickly governments can create the right environment for investment.

Sameh Shenouda is head of infrastructure at CDC, the world’s longest established development finance institution. 

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