Africa’s infrastructure needs are staggering.
Of the region’s population of 1.2 billion people, more than half lack access to electricity, a quarter have no close source of clean drinking water and roughly 700 million are without decent sanitation, according to the OECD. A fifth of companies operate in the formal economy, but of those, only 40% or so enjoy a regular electricity supply.
“Africa has an urgent infrastructure challenge,” says Bolaji Balogun, chief executive of Chapel Hill Denham (CHD), an independent investment bank in Nigeria. “The region’s economy is mostly agrarian, but farmers are unable to move up the value chain without electricity for processing and for preserving produce or access to good roads and railways to take their produce to markets. How do small and medium-sized enterprises survive without electricity or broadband in today’s world?”
Building new infrastructure would give a welcome lift to economic growth in sub-Saharan Africa, estimated by the World Bank at 2.6% in 2017 and forecast to reach 3.1% this year and 3.6% next year. The African Development Bank (AfDB) and other agencies estimate that ailing or inadequate infrastructure in the power sector knocks as much as two percentage points off GDP growth.
Nigeria alone needs to invest between $30 billion and $40 billion in infrastructure, Lagos-based CHD estimates, yet the national infrastructure budget has never surpassed $2 billion. The country’s problems are made worse by the rapid growth of its population, which is expected to jump from its current level of 186 million to 400 million by 2050.
|Bolaji Balogun,Chapel Hill Denham|
Between 2004 and 2013, African states closed just 158 financing deals for infrastructure or industrial projects, valued at $59 billion, or just 5% of the total needed, according to the New Partnership for Africa’s Development, an economic development programme of the African Union.
To make matters more difficult, sluggish economic growth has put constraints on African government budgets while the Basel III rules make it harder for banks to free up capital for infrastructure lending. That has made it all the more imperative to explore alternative sources of finance, whether by tapping Africa’s domestic pension fund industry, as is happening in Nigeria, or soliciting investments from international insurance firms to join the existing line-up of multilateral agencies, development finance institutions (DFIs), government agencies and private-sector firms.
One of the biggest issues relating to African infrastructure is currency risk, says CHD’s Balogun. The only infrastructure projects in Africa that have dollar-denominated income streams are linked to airports or ports, whereas the revenues from toll roads or electricity generation are denominated in local currency, so there is a mismatch with the financing of the projects, which tends to be in dollars.
“For an infrastructure project’s debt side, financiers and investors have tended to lend in US dollars,” he says. “But dollars create a problem. In Nigeria, following the privatization in the electricity sector, most operators took out debt in dollars but consumers or industrial users pay their utility bills in Nigerian naira. When the local currency was devalued significantly, these sponsors were not able to increase their tariffs denominated in naira and so are struggling to pay back their debt.”
Africa has an urgent infrastructure challenge... How do small and medium-sized enterprises survive without electricity or broadband in today’s world?- Bolaji Balogun, Chapel Hill Denham
To get around this problem, CHD launched a N200 billion ($550 million) Nigeria infrastructure debt fund in July 2017. The closed-end fund, denominated in naira, is the first fund of its kind to list on the FMDQ OTC Securities Exchange, the country’s debt capital, foreign exchange and derivatives over-the-counter securities exchange.
While the fund’s investors include the Nigeria Sovereign Investment Authority, it mainly targets Nigerian pension funds, which have $22 billion in assets but which only allocate 0.01% of their holdings to infrastructure.
The fund provides loans over 10 to 15 years to infrastructure developers, especially in the captive power market. Within the first week of closing, CHD had written loans for 80% of the first fund raised. It is helping to finance the development of 5-megawatt to 10MW plants for industrial users, fired by natural gas. One client provides captive power to a Coca Cola bottling plant.
“These small power plants are much better for the natural environment than using diesel generators,” says Balogun. “There has been a lot of emphasis on the national grid, but perhaps developing mini-grids is better for Africa.”
Many experts see African institutional money as a largely untapped resource that can drive infrastructure projects.
According to PricewaterhouseCoopers, assets under management in the pensions industry in 12 of Africa’s leading economies – South Africa, Morocco, Mauritius, Namibia, Egypt, Kenya, Botswana, Ghana, Nigeria, Angola, Algeria and Tunisia – will add up to $1.1 trillion by 2020.
Local institutional investors are seen as an important source of private financing in other African countries. For example, Volt Resources, a natural resources company based in Perth and listed on the Australian stock market, is developing the Bunyu graphite project in Tanzania. It plans to invest up to $40 million during the first stage, when annual production is expected to reach 23,000 tonnes of graphite. By the second stage, in late 2020, production is forecast to hit 170,000 tonnes, making it one of the biggest graphite mines in the world, with an internal rate of return of up to 87%.
Volt wants to tap local investors in Tanzania to help fund the project. It plans to issue a $40 million, seven-year bond with a coupon of 14.5% on the Dar es Salaam Stock Exchange; the bond will make a dollar payout converted into Tanzanian shillings at the spot rate every six months. Volt says it has received strong interest from investors in Tanzania, Uganda and Kenya, including local pension funds.
Exotix Capital, the London-based independent investment bank, is advising on the deal and Orbit Securities, a Tanzanian stockbroker, is the sponsor broker.
Even though it is a mining project, Bunyu would involve a big investment in infrastructure that would benefit the local community. An existing seven-kilometre-long dirt road would be upgraded to an all-weather road and the project would lead to better telecommunications in the area, including the provision of internet services. It would also improve the local area’s access to electricity and water.
“Issuing a bond locally is certainly a novel way of raising capital in Africa,” says Trevor Matthews, Volt’s chief executive. “The authorities have been helpful, but changes in legislation show how difficult it can be to advance projects in Africa.”
In July 2017, Tanzania’s congress passed legislation giving the national government 16% of the equity of all existing and future mining projects. It held out the prospect of raising that proportion to 50%. It also increased the royalties from gold, copper, silver and platinum exports to 6% from 4%. Volt decided to go ahead with its project because of the expected high IRR but many other mining projects have been put on hold. The drastic change in the legal framework underlines the risk of doing business in many African markets.
But is not just domestic institutions that are being lured into African infrastructure investments. In April this year, Investec Asset Management’s Emerging Africa Infrastructure Fund (EAIF) completed a $385 million fund-raising of new long-term debt capital to invest in infrastructure projects, mostly in Africa.
The lending group includes the AfDB; KFW, the German development bank; FMO, the Dutch development finance institution; and Standard Chartered Bank. In addition, Allianz, the German insurance firm, became the first large commercial institutional investor to join the group. It will provide loans of €75 million and $25 million, both over a 12-year period.
“The EAIF investment provides an attractive risk-return profile for Allianz insurance customers and fits well into our global investment strategy,” says Sebastian Schroff, global head of private debt at Allianz Investment Management.
Allianz points out that the universe of listed emerging market debt is smaller than in developed markets, so the EAIF transaction is attractive in terms of accessing a risk-return profile that it cannot reach via the capital markets.
An additional benefit is that Allianz is lending in dollars and euros as opposed to paying for sovereign bonds in local currency.
“In this transaction, as in any other non-listed transaction, we assess whether there is a compensation for the additional complexity, illiquidity,” says Schroff. “If we don’t have a direct comparable (as here where there is no clear benchmark), we work with proxies, such as similar transactions, corporate bond indices.”
Since its foundation in 2001, EAIF has invested around $1.3 billion, which has been instrumental in attracting more than $10.9 billion of private capital investment to more than 70 projects in 22 sub-Saharan countries.
In general, private finance only plays a small role in meeting the region’s infrastructure financing needs. According to the Infrastructure Consortium for Africa, or ICA – a G8-backed platform to increase infrastructure financing backed and whose members include the world’s main development finance institutions – the region’s total infrastructure funding amounted to $62.5 billion in 2016. African national governments made up around 42% of the total; ICA members, 29.8%; the Arab Co-ordination Group, 8.8%; China, 10.3%; other multi-lateral organizations, 5%; and the private sector only 4.1%.
Many national governments put a lot of emphasis on big projects such as the proposed $80 billion Grand Inga Dam in the Democratic Republic of Congo, but the reality is that much smaller private initiatives are more likely to get off the ground, especially in renewable energy. That said, national governments must provide the right conditions so that this kind of project is viable.
A good example of a recent startup is Jaza Energy in Tanzania, which was founded by two Canadians, Jeff Schnurr and Sebastian Manchester. In 2015, Jaza started building a network of solar energy hubs in communities beyond the electric grid. A central hub provides power to charge portable battery packs. These are brought home and used to power lights, phones and other direct-current loads. One hub can provide affordable and reliable access to electricity in up to 100 households.
Jaza, a ‘last mile’ energy company, raised $750,000 in venture capital funding in January from New Brunswick Innovation Foundation, a Canadian VC investor in innovation-based growth companies and applied research. As these are very early days for this startup, Jaza has not yet made any payments to investors.
However, most international interest in big infrastructure projects depends on whether or not these projects deliver an export revenue stream.
“Infrastructure around mining projects is a prime example of this,” says Aadil Cajee, head of project finance at Standard Bank. “The commodity can be exported.”
But such projects are fraught with difficulties.
“Many national governments suffer from a lack of capacity,” Cajee says. “The planning stage is not up to scratch and it can be a drawn-out process to try to get a project off the board. The enabling environment is not good enough or the regulatory framework has not been fully developed.”
Cajee explains that partial guarantees provided by a DFI or an export credit agency can go a long way in helping a project to get off the drawing board. Often commercial banks can only lend for up to seven or eight years, but infrastructure projects require 15 years of financing. If a DFI can step in and provide a loan for the whole period, it makes it easier for a commercial bank to provide credit for the first seven or eight years.
ECAs recently helped to finance one of sub-Saharan Africa’s biggest infrastructure projects, the $5 billion Nacala corridor rail and port project in Mozambique. Brazilian miner Vale operates an opencast coalmine in Tete province in the west of the country. In March 2017, Mitsui & Co, the Japanese general trading company, purchased 15% of Vale’s 95% stake in the mine (the remaining 5% is owned by the Mozambican state). Mitsui also bought half of Vale’s share of the Nacala rail and port project, with an initial payment of $733 million for the two investments.
Many national governments suffer from a lack of capacity... The enabling environment is not good enough or the regulatory framework has not been fully developed- Aadil Cajee, Standard Bank
In November 2017, Vale and Mitsui signed a $2.73 billion project finance deal to develop the Nacala corridor. It is backed by a loan of $1.03 billion from the Japan Bank for International Cooperation and another $1 billion from a syndicate of financial institutions. The AfDB, which was the project’s co-lead arranger, also provided a $300 million loan for the project. Nippon Export and Investment Insurance – a Japanese state-owned company that provides Japanese companies with various types of insurance to cover political and commercial risks – and the Export Credit Insurance Corporation of South Africa also backed the project.
It will lead to an upgrade of the 912-kilometre-long rail line from Tete province to the Nacala port on the eastern coast of the country, passing through Malawi. It also includes the construction of a deep-sea port and associated terminal infrastructure at Nacala. The amount of coal that can be transported will increase to 22 million tonnes a year from six million tonnes today.
Around two thirds of the investment is destined to be in Mozambique and the remainder in Malawi.
“Export credit agencies can act as a big enabler in mining and infrastructure projects,” says Cajee. “Not only do they provide credit-risk guarantees – which often mean that commercial banks can get involved in a project – but they bring a key government-to-government link. If a major project starts to go a bit wobbly in some way, the governments can talk to one another and try to solve a problem, without the private sector becoming involved.”
Cajee believes DFIs can help national governments at a project’s design and procurement stage.
“A degree of hand holding is necessary,” he says. “A DFI can help a national government undertake a proper feasibility study of a project and take it to the bankable stage.”
Laurent Bouchilloux, co-head of infrastructure finance at Société Générale’s investment banking arm, agrees.
“Many national governments do not take into account the social and environmental impact of a project early enough,” he says. “This becomes a big problem when the private sector is asked to resolve this kind of issue properly. It is also an issue for private banks, as they cannot do this kind of preparatory work. The public authorities must do so if they want a project to get off the ground, even if that means taking on external advisers prior to tendering it.”
Bankers say that more than enough liquidity exists from commercial banks, institutional investors and DFIs to finance big African infrastructure projects, but that a big issue is still affordability: it is not always clear if these projects will be commercially viable because the state or the state-owned utility company must pay the developer a tariff and they may not be able to afford those tariffs.
To avoid this problem, the government can provide a guarantee in the form of payment and liquidity support, which enables lenders to take out political risk insurance. For example, the national government can guarantee the six-monthly debt payment obligations of a power utility. This guarantee is then supported by a World Bank partial risk guarantee, which reduces short-term liquidity risk for lenders. Political risk insurance is normally contracted with a multilateral insurer and would kick in in the event of non-payment by the government.
“Whether the loan comes in the form of direct procurement or through a public-private partnership (PPP), ultimately the utility must be able to afford it,” says Alan Sproule, executive principal in project and export finance at Standard Chartered. “This is always an issue, but it can be overcome by the government providing guarantees against which lenders can procure political risk insurance.
“ECAs are also very valuable for raising liquidity for large projects. Agencies from Japan, South Korea, South Africa, Canada and European countries are helping to mitigate credit risk in Africa. Once one of these backs a project, banks from the ECA country – including Standard Chartered – are in a much stronger position to commit financing to a project.”
There are around 15 African countries – including Botswana, Zambia, Mozambique, Kenya, Uganda and Nigeria – that allow ECAs to be used to back infrastructure projects.
But Sproule also makes the point that one of the issues in African infrastructure is currency risk.
“Big infrastructure projects require dollar financing, but revenues come in the form of the local currency,” he says.
Local banks in Kenya, for example, will only provide loans of up to the equivalent of $100 million for up to seven years, while in Tanzania the maximum is the equivalent of $30 million for a similar tenor. Only international banks will provide loans of up to $1 billion for between 10 and 20 years.
On a daily basis, I see projects that are no more than a concept or an idea. One of the nuts to crack is how to support and help governments at the design and procurement stage- Yasser Charafi, IFC
Gad Cohen, chief executive at eleQtra, a developer of green-field infrastructure projects mostly in the power sector in Africa, believes that one of the biggest issues is the risk-averseness of the development finance institutions.
“A lot of projects do not get off the ground because of the very high standards of bankability that DFIs impose on them,” he says. “DFIs play a crucial role because it becomes a lot easier to get other private investors once these institutions are backing a project. But they really set the market terms and have a low tolerance for risk due to the public taxpayer source of their ownership and funding.”
Development finance institutions normally take an equity stake in a project for a five- to 10-year period and provide a loan at a preferential interest rate. After this period, they will sell their stake on to a private investor and take a profit. It is one of the main routes by which private investors are introduced into a project.
James Doree, managing director at Lion’s Head, a London-based independent investment advisory firm, agrees.
“DFI standards drive the market,” he says. “Many DFIs operating in Africa only want to complete two or three deals a year. They are only prepared to take a very low level of risk, consistent with their business model.”
Industry players say they would like DFIs to change their remit and play a much bigger role at the earlier stages. What the infrastructure industry really needs is venture capital money, they say.
“The project development stage is riskier, so it is more difficult to raise capital,” says Oliver Griffith, communications adviser at Africa50. “It becomes easier once financial close has been reached.”
A private toll road in Senegal is a good example of where a DFI played a key role in getting a vital infrastructure project off the ground. International Finance Corporation, the private-sector arm of the World Bank, acted as the lead arranger and global coordinator for the PPP portion of the €225 million toll road that connects Dakar to peripheral neighbourhoods. The 24-kilometre-long, six-lane road was developed by Senac, a concession company set up by Eiffage, the French construction company, and became operational in August 2013. It replaced a two-lane road that could only handle a fraction of the capital’s traffic.
IFC provided €60 million in debt of a 14- to 15-year tenure and a mezzanine, subordinated debt tranche of €10 million. It also helped arrange loans from the AfDB and the West African Development Bank. The toll road is now used by 40,000 vehicles a day and is profitable. As the first PPP in west Africa, it is widely seen as a flagship project for the country and the surrounding region.
“The toll road creates a very interesting model that can be applied to many other places in Africa,” says Yasser Charafi, principal investment officer for the sub-Saharan region at IFC. “Most big African cities suffer from congestion. An urban motorway eases access into and out of the city. The project was well thought through and people were prepared to pay the toll to use it.”
The toll road was so successful that, in January 2015, the IFC and Senac signed a financing agreement to extend it by 17 kilometres to a new international airport. These plans required a further investment of €130 million.
“It is vital to distinguish, on the one hand, between infrastructure projects that are essential to the national economy but that are not commercially viable and those on the other hand – such as ports, airports, and toll roads – that are viable,” says Amadou Oumarou, director of the infrastructure, cities and urban development department at the AfDB.
“In the first case, the national government must fill the gap, but it can provide grants to the private sector so that it can get involved.”
Dakar’s toll road provides a good example of a commercially viable project that sets an example for others to follow.
The AfDB is one of the most important multilateral organizations operating in Africa. It provided loans valued at $8.5 billion in the infrastructure, agriculture and education sectors in 2017, compared with $10 billion in 2016. Around two thirds of its funding is destined for national governments and one third goes to the private sector. It has helped many infrastructure projects come to fruition, including a $680 million, 300MW wind farm near Lake Turkana in Kenya, the biggest wind farm project in Africa. The last turbine was built in March 2017 and four months later, 310MW of capacity was ready for full commercial operation.
The total project cost includes the planned 428-kilometre-long transmission line from Lake Turkana to the Suswa sub-station near Nairobi, as well as the upgrade of 200 kilometres of roads and various bridges. The project will be financed through equity (25%), mezzanine debt (5%) and senior debt (70%). As the mandated lead arranger and senior co-lender, AfDB will provide a long-term senior loan of $150 million.
The deal had a unique public-private aspect in terms of generation: a private consortium led by KP&P Africa, a Dutch investment group, and Aldwych International, a British energy company, will develop the wind farm but the transmission line is being procured and delivered by the public sector.
The AfDB is providing a €20 million partial risk guarantee for the transmission line to mitigate any delay risk (this is also covered by delay payment obligations from the Kenyan government to the project company and its lenders).
The AfDB used its B-Loan structure, allowing participant banks to benefit from its preferred creditor status. The European Investment Bank is providing €200 million of debt, after receiving guarantee structures from the Danish Export Credit Agency and from Standard Bank and Nedbank. Deca will provide political and commercial cover while the two banks provide commercial cover.