MIL OSI Translation. Government of the Republic of France statements from French to English –
Source: IMF in French
How to attract private funds to finance the development of Africa?
Abebe Aemro Selassie, Luc Eyraud and Catherine Pattillo
June 14, 2021
The countries of Africa are at a crossroads. The COVID-19 pandemic has crippled activity. The continent’s hard-won economic progress over the past two decades, which is essential to raising living standards, is in danger of being undone.
High levels of public debt and the uncertainty surrounding international aid limit the possibilities of encouraging growth through large public investment programs. For these countries to achieve a solid recovery and avoid economic stagnation, the private sector will need to contribute more to economic development. African heads of state hammered home this message at the “summit on financing African economies”, held in Paris in May.
Infrastructure, both physical (roads and electricity) and social (health and education), is an area in which the private sector could become more involved. The infrastructure development needs are immense in Africa: on the order of 20% of GDP on average by the end of the decade. How to finance them? All other things being equal, resources would come primarily from increased tax revenues, which most countries are already working on. But considering the extent of the needsNew sources of funding will have to be mobilized from the international community and the private sector.
The African continent is full of opportunities for private investors. Its population is young and growing, natural resources abound, its cities are experiencing massive growth, and many countries have launched long-term initiatives for their industrialization and digital transformation. However, considerable investment and innovation will be needed to unlock the region’s full potential. According to recent work published by IMF staff, by the end of the decade, the private sector could provide additional financing for physical and social infrastructure each year equivalent to 3% of GDP in sub-Saharan Africa. This is about $ 50 billion per year (based on 2020 GDP) and nearly a quarter of the region’s average private investment rate, which today stands at 13% of GDP.
What are the current obstacles to private financing?
Compared to other regions, the private sector is currently little involved in financing and providing infrastructure in Africa. Public entities, such as national administrations and public enterprises, execute 95% of infrastructure projects. The volume of infrastructure projects involving the private sector has declined markedly over the past decade, following the collapse in commodity prices. The limited role of private investors in Africa is also evident internationally: the continent attracts only 2% of global foreign direct investment flows. In addition, these scarce investments focus on natural resources and extractive industries, not on health, roads or water.
It appears essential that Africa improve the business climate in order to attract private investors and transform the way it is financed for its development. From our analysis, international investors are primarily concerned with three risks:
The risk inherent in the project. Although Africa presents many opportunities for doing business, the number of projects that are truly “investment ready” remains low. These are projects that are at a sufficiently advanced stage of conception to be of interest to investors who do not wish to invest in projects under development or in unfamiliar markets. Financial and technical support from donors and development banks can help countries finance feasibility studies, project design and other preparatory activities that will expand the pool of bankable projects.
The monetary risk. Imagine that a project has an annual return of 10%, but the currency depreciates by 5% over the same period, wiping out half of the profits for foreign investors: no wonder they are particularly wary of the monetary risk. Prudent macroeconomic policies, combined with sound management of foreign exchange reserves, can greatly reduce currency instability.
The risk of exit. No investor will venture into a country if he does not have the guarantee that he will also be able to get out by selling his stakes in a project and recovering his earnings. Small and underdeveloped financial markets can prevent investors from opting out by issuing shares. Control of capital movements can slow the outflow or increase its cost. And in countries where the legal framework is fragile, investors risk getting bogged down in legal proceedings to assert their rights.
Encourage private investment
Improving the business climate is important, but it is not enough. Development sectors have certain structural features that make private sector participation inherently complicated, even in the most enabling environments. Infrastructure projects, for example, often have high initial costs, but their profitability is spread over long periods of time, which can be difficult to assess for private investors. Private sector growth also relies on networks and value chains, which may still be lacking in new markets.
When these problems are serious, governments may need to offer additional incentives to make infrastructure projects attractive to private investors. These incentives, which take the form of various types of grants and guarantees, can be costly and pose fiscal risks, but in reality many projects in development sectors cannot happen without them. In East Asia, 90% of infrastructure projects involving private companies receive public support.
With certain design features, governments can maximize the efficiency and effect of public incentives, while reducing risks as much as possible. Support must be targeted, temporary and granted on the basis of proven market failures. It must also be transparent, leave enough risk to the private parties and add value, that is to say, to ensure that worthwhile projects that would not have been realized otherwise can come to fruition. Finally, these incentives must be well calibrated to avoid overcompensating the private sector.
Given the limited availability of public funds, African countries and development partners might consider reallocating some resources from public investment to financing incentives for private projects. If this reallocation is gradual and supported by strong institutions, transparency and governance, it could increase the quantity, variety and quality of services offered to African populations. More innovative thinking can help realize the transformational potential of infrastructure on the continent.
Abebe Aemro Selassie is the Director of the IMF’s Africa Department. He was previously its deputy director. He led the staff teams responsible for relations with Portugal and South Africa, as well as the production of Regional Economic Outlook for Sub-Saharan Africa. He has also worked on Thailand, Turkey and Poland, as well as on policy issues. Between 2006 and 2009, he was IMF Resident Representative in Uganda. Before joining the IMF, Mr. Selassie worked for the Ethiopian government.
Luc Eyraud is Advisor and Head of Mission in the Africa Department of the IMF. He leads the annual Article IV consultations with regional authorities in WAEMU. Prior to that, Mr. Eyraud was Head of Mission for Benin and, previously, Team Leader in charge of the Public Finance Monitor in the Public Finance Department. Much of his research focuses on fiscal policy, including fiscal institutions, fiscal multipliers, and wealth taxation. More recently, he supervised several projects on financing for developing countries. Before joining the IMF, he was a French Treasury official.
Catherine Pattillo is Deputy Director of the Africa Department of the IMF. There, she oversees a range of country monitoring programs and activities, and leads activities related to capacity development, climate change and private sector finance, as well as research and analysis. After holding a post at Oxford University, she worked in the IMF’s Research Department, the Fiscal Affairs Department, where she headed the Fiscal Monitor Division, and on countries in Africa and Caribbean, as well as in the Department of Strategy, Policy and Evaluation, where she focused her work on low-income countries and emerging issues, such as gender, inequalities and climate change. She has published numerous studies in these fields.
EDITOR’S NOTE: This article is a translation. Apologies should the grammar and / or sentence structure not be perfect.