Plugging Africa’s Infrastructure gap through Public Private Partnerships

LAGOS, Nigeria, Capital Markets in Africa: Africa is widely acknowledged as being the ‘preeminent emerging markets investment destination’ attracting global investors across all sectors. Investors seeking relatively higher risk-adjusted returns are appraising opportunities across the consumer sector, services and Infrastructure.

However, one of the key constraints to economic growth in Africa is the lack of adequate and well-maintained infrastructure. Various studies on the infrastructure deficit have been carried out by multi-lateral agencies most notably a World Bank study which revealed that the annual financial requirement for infrastructure in Sub-Saharan Africa (SSA) is about US$93 billion a year for both capital expenditures and maintenance. To finance this, only US$45 billion is being mobilized, two-thirds paid for by African governments and citizens, 8% by multilateral and bilateral donors and the rest by the private sector in emerging economies. There is therefore an estimated funding gap of US$50 billion a year.

Financing the infrastructure deficit across Africa will involve collective innovation both across the public and the private sectors. Traditional funding sources such as government budgets and donors will no longer suffice but rather coopting in the private sector will provide the necessary platform on which to accelerate infrastructure growth.

Prior to 2008, the banking community was engaged in providing long-term capital to the private sector sponsors undertaking public infrastructure projects. However, following the global financial crisis and the subsequent collapse of Lehman Brothers, long-term financing became harder to get and the debate quickly focused on where the necessary infrastructure investment will come from. At the height of the credit boom, long-term financing was available for bankable projects at about 100bps above LIBOR but after the crisis, a prominent UK highways bankable project reached financial close with margins rising up to 350bps above LIBOR. This erroneously led to many conclusions that a lack of financing was the key constraint to infrastructure development, but to the contrary, financing was actually available but at what cost? Across Africa, currently, projects lucky enough to make it across the financial close line are seeing margins anywhere between 400 to 700 bps above benchmark rates.

Financing costs aside, the Un-invested Capital Ratio (UCR) across Africa ranges from 50 to 60% implying that for the right infrastructure projects, there is an over subscription and or commitment of private capital in excess of requirements by about 50-60%. Clearly when someone asks ‘Can you show me the money?’ The money will be shown but why is it not being invested to plug the infrastructure gap?

Answering the million dollar question of why money is not flowing into African infra at a quicker rate, one has got to examine and understand the dynamics and success drivers for the three key principals that stand to benefit if additional resources are mobilized for African infrastructure. The three principals in no particular order of priority are:

1. The Government: Many governments across Africa have ambitious visions to turn their countries into middle-income countries within the next 20 or so years. To achieve these visions and deliver infrastructure to their electorates, governments need to involve the private sector. Success from a government’s perspective is measured through delivering priority infrastructure.
2. The Citizens: Africa is averaging economic growth at about 5% and population growth about 1-2%. Affluence growth and population pressures demand that infrastructure is delivered to expectations. Citizens who pay taxes will, therefore, be looking to the government to deliver infrastructure that accelerates their growth ambitions.
3. The Private Sector: International private players from developed economies who have seen their return expectations at home shrink (Nominal Internal Rates of Return less than 10%) are pursuing emerging markets like Africa for higher risk-adjusted returns. National private players in African countries are also looking to tap into this opportunity and grow their businesses and they too need to be involved. Success from the private sector’s perspective will hinge on the right balance between risk and reward.

Public Private Partnerships (PPP) which are gaining traction lately with governments are in their basic form a procurement method that seeks to utilize the private sector to deliver a service that has traditionally been delivered by the public sector. But for the PPP to work, the partnership must not forget the end users who typically are the citizens because when the service is delivered, the key issue that remains is the ability to pay for the service that the infrastructure is providing. Government financing is challenging, especially in fiscally constrained environments, end-user financing is a politically sensitive issue depending on the ability and willingness of the general public to pay for new infrastructure investment. The private sector that is being relied upon to plug this financing gap is not entirely charitable and at the macro level, for the PPP to work, a country needs to demonstrate that the following are present in-country: Political stability; a continuous pipeline of bankable projects; transparent and efficient procurement; enforceability of contracts; equitable sharing of risks with the public sector; and certainty of the envisaged future cash flows.

Generally, PPP projects would be financed using project finance where lenders and investors rely mainly on the future cash flows of the project. Such arrangements if well-structured would ensure that project debt doesn’t sit on the government’s balance sheet thereby providing an opportunity for the government to meet its other core obligations with the limited budget resources.

Attractive as it may seem, PPPs are certainly not for all projects, sectors or indeed countries. The upstream work required to enable a long lasting successful PPP is often underestimated by governments and in so doing, the projects never reach financial close. The procurement and preparation of a PPP project is expensive and time-consuming (particularly for first time projects in a country). Based on my personal experiences of structuring projects in Africa, for a project to make it across the line, it is essential that the following fall into place at the right time:

1. A credible pipeline of projects– mobilizing for PPP projects from a private sector perspective is quite expensive both at the procurement and implementation stage. For key players to invest the time and resources there has to be a credible and consistent pipeline within a country to justify costs and also refine key contractual provisions in subsequent projects.
2. Real demand for the service– if the end users are going to directly pay for the service, then the demand and willingness to pay for the service must be real and not perceived. If however the government is the payer, then the contracts must not be ambiguous in addition to an actual demand being there for the service because if the demand is false, it won’t be long before the government gets ‘bored and tired of paying the private sector for a service with no demand’.
3. Environmental & Social considerations– responsible and sustainable investing is a consideration that has gained priority amongst many international investors and quite rightly so because we all have an obligation to preserve the environment for future generations. Many projects have stalled because of a halfhearted attempt at mitigating Environmental & Social issues. As a good start, governments should review and incorporate key provisions of the Equator Principles within their national environmental and social guidelines.
4. Multilateral Development Bank Involvements– quite often, the affordability and bankability of projects is difficult and multilateral development agencies often play a critical role in providing viability gap funds, political/credit guarantees and a very unquantifiable confidence boost to crowd in capital from private investors.
5. Currency fluctuations- the majority of projects in the energy and transport sector have a currency mismatch brought about by loans & their repayment being in hard currency whilst project revenues and government revenues/taxes being in local currency. Over the life of projects, local currencies typically depreciate against the hard currencies and very quickly, this along with other factors will lead to African projects defaulting leading into termination. Strong consideration must be given to local currency financing, service/off take payments in local currency and the inclusion of local capital markets (e.g. pension funds, insurance funds) that are highly liquid and looking for long term assets to match their long-term liabilities.
6. Local content– across many African countries, governments/private sector and the public are increasingly pushing for local companies to be supported into building their requisite capacity to handle the infrastructure drive across Africa. Though this must certainly be considered, the challenge is always in how you prescribe local content and the right proportion of it into projects. Done wrongly, it only promotes the interests of a few savvy investors but done rightly, it builds a nation’s capacity to compete globally.

As governments continue their pursuits of visions to become middle-income countries, it is clear that the funding of infrastructure remains the greatest constraint and this only increases the need to diversify the sources of funding available and considerable local capital markets. Within funding, the role of the citizens who are the end users must be recognized and the cost of infrastructure should be shared with the end user. Governments must be clear in articulating the benefits of infrastructure investment to citizens who will finance a large part of it. Through PPPs which certainly will help, governments should put in place an enabling environment for private capital to flourish in the market.

Contributor Profile
Chris Olobo is an infrastructure financing professional with over 12 years of progressive, substantial and relevant experience in analyzing projects, developing commercial solutions and building partnerships that have successfully delivered projects in Europe and Sub-Sahara Africa. Having started his career as a civil engineer with Mott MacDonald in the UK before moving into project finance with PwC London and finally to the IFC in Nairobi, Chris offers insights into project financing from both technical and financial perspectives. Currently working with the IFC in Nairobi, Chris is supporting regional governments to develop and deliver bankable and value for money PPP projects. Chris holds a Bachelor and Masters in Engineering from the University of Southampton, UK.

This article was featured in the INTO AFRICA August edition, with focuses on Infrastructure Finance in Africa.