3. Addressing the Infrastructure Deficit in Sub-Saharan Africa
- International Monetary Fund
- Published Date:
- October 2014
Introduction and Summary
This chapter considers sub-Saharan African countries’ progress in recent years to address the large infrastructure deficit they face, trends in financing of infrastructure, and the challenges ahead.
Addressing the infrastructure bottlenecks evident in many sub-Saharan African countries is important for several reasons.
- First, as elsewhere, this is needed to engender a stronger supply response and raise potential growth (see also the October 2014 World Economic Outlook).
- An added consideration for many low-income developing countries is the importance of improved infrastructure supply to foster economic diversification and structural transformation— for example in the absence of reliable electricity supply, it is difficult for economies to transition from low to high productivity activities.
However, an important element in addressing these infrastructure needs is, at least until recently, the speed with which they can be addressed, which has been highly constrained. With limited implementation capacity, issues related to project design and development are often a major source of significant delay in scaling up infrastructure investment. And once project feasibility has been assessed, mobilizing financing often proves difficult because the domestic revenue base is limited. Nor is outside financing a panacea, for lack of willing lenders at reasonable terms. Finally, weak regulatory environments or inappropriate policies or both (for example, unwillingness to allow investors to charge cost-recovery level user fees) also limit private sector appetite.
Still, things have been changing of late. As the attractiveness of sub-Saharan Africa as an investment destination improves, the financing constraint has started to ease somewhat. Domestic implementation capacity is also improving.
In this context, striking an appropriate balance between scaling up public investment in infrastructure and avoiding an unsustainable buildup of public debt has become one of the main policy challenges facing policymakers. The remainder of the discussion in this chapter considers how best this balance can be struck. It first reviews infrastructure outcomes and sources of financing, and then discusses the pros and cons of different modalities to reduce the large infrastructure deficit that many countries face, including new financing options that have emerged more recently.
The main findings of the chapter are:
- Many countries in sub-Saharan Africa have managed to maintain and improve public infrastructure investment levels and related new sources of financing. In some countries, higher public investment in infrastructure has been associated with improved outcomes, but in many other countries, the link is less clear.
- It is not always obvious that lack of financing is the main binding constraint to scaling up infrastructure investment. In many countries, regulatory and implementation capacity constraints in project development and execution are the main cause of limitation, and addressing these problems has to come first.
- The lion’s share of financing for infrastructure projects in the region comes from domestic resources (including tax and nontax revenues and domestic borrowing) and to a lesser degree budget support provided by development partners. In future, this is also likely to remain the case. Indeed, increasing such revenue collections offers by far the most durable way of financing infrastructure investment. This includes increased mobilization of tax revenues but also fees on the direct beneficiaries of the infrastructure services being provided.
- Provided public debt levels are manageable, it can also make sense to borrow and increase spending on infrastructure for a time-bound period. For most countries, however, the additional room to maneuver that this provides is limited.
- Where the scope to scale up infrastructure investment either from tax revenues or through borrowing is limited, some space can be created by enticing direct private sector investment into projects:
- This includes the use of public private partnerships (PPPs), with appropriate attention to attendant fiscal risks. This requires the adoption of appropriate institutional and legal frameworks to quantify, report, and assess contingent liabilities for the public sector, and ensure that PPPs provide as good a value for money as traditional public investment.
- Purely private investment infrastructure development is another option, possibly exploiting new insurance products and credit enhancement techniques, which are becoming increasingly available for the region. However, the cost of these instruments needs to be carefully assessed. Such purely private investment arrangements also require a stronger institutional and regulatory framework.
- In all cases, public financial management (PFM) considerations are key in implementing a scaling up of infrastructure investment. Countries should seek to upgrade their investment planning and execution capacity by strengthening project appraisal; building up a pipeline of bankable projects; adopting a medium-term budgetary framework with room for infrastructure maintenance; and enhancing the capacity to monitor the implementation of projects to minimize leakages of resources and cost overruns.
Stylized Facts: The Current Status of Sub-Saharan Africa’s Infrastructure
Over the last fifteen years, many sub-Saharan African countries have made progress in improving their infrastructure, but results have been mixed across sectors and country groups. The African Infrastructure Development Index (AIDI)1 shows some overall progress between 2000 and 2010 (Figure 3.1), with the most rapid progress in sub-Saharan African low-income countries, and fragile countries lagging behind. Improvements in the overall index were mostly driven by enhancements in information communications technology (ICT), and to a lesser extent, better access to water and sanitation. By contrast, electricity production stagnated, and transport development has been limited. Three individual high performers are Ghana, Kenya, and Senegal; their noticeable score improvement was mainly driven by better performance in ICT. Some countries that lagged behind in the overall level of infrastructure development, such as Chad, Ethiopia, Madagascar, and Niger, have registered high percentage improvements, albeit from low levels.
Figure 3.1.Sub-Saharan Africa: Levels of Infrastructure Development, 2000 and 2010
Sources: IMF staff calculations based on African Development Bank; Africa’s Infrastructure Development Index, 2013.
Sub-Saharan Africa has experienced a revolution in access to ICT. ICT has seen an unprecedented expansion in the past decade, as indicated by the increase in mobile phone subscriptions (Figure 3.2). Cellular phone subscriptions grew at 40 percent per year in the past decade, and about half of the countries moved from under one phone per 100 people in 2000 to more than 50 phone subscriptions a decade later. The liberalization of markets and the emergence of competition, particularly in the mobile phone market, were the main drivers of this success. Regulatory reforms, including successful wholesale tariff setting, and reform of state-owned public enterprises were also instrumental in this transformation.2 Access to water in Africa has also improved, but was uneven, with fragile states and oil exporters lagging behind. However, some low-income countries (Burkina Faso, Ethiopia, Guinea-Bissau, Malawi, Mali, Swaziland, and Uganda) have made substantial progress and increased their population’s access to clean water by more than 20 percentage points since 2000.
Figure 3.2.Sub-Saharan Africa: Sectoral Infrastructure Developments
Sources: African Development Bank, Africa Infrastructure Development Index, 2013; and World Bank, World Development Indicators.
1 Excludes South Africa.
By contrast, progress in the electricity sector has been far more limited. Sub-Saharan Africa remains in the midst of a power crisis characterized by inadequate, unreliable, and costly electricity supply. While the rest of the world improved electricity supply in the last two decades, sub-Saharan Africa’s per capita electricity production remained low and largely stagnant (Figure 3.2). The 48 sub-Saharan African countries, with a population of about 1.1 billion, generate roughly the same power as Spain with a population of 47.27 million (World Bank and African Development Bank, 2013). A few countries managed to double their per capita electricity production over the last decade, albeit mostly from extremely low initial levels.3 Overall, only about 32 percent of the population in sub-Saharan Africa has access to electricity, compared with more than half in South Asia, while sub-Saharan fragile states lag further behind. Most electricity sectors continue to be state dominated with electricity companies operating as monopolies, and highly regulated electricity markets (Alleyne, 2013). This leads to the underrecovery of power costs, as power tariffs are generally set well below the historical costs of supplying electricity (Briceño-Garmendia and Shkaratan, 2011).
Transport infrastructure development has also been limited. The most commonly used indicator to assess road infrastructure—percent of paved roads—suggests that African countries, with few exceptions, have made inadequate progress. Poor road conditions are still a critical issue, as less than one-fourth of total sub-Saharan Africa road network (excluding Mauritius and Seychelles) is paved (Figure 3.2). This results in very high costs, as road transport, the most dominant mode of transport in Africa, accounts for about 80 percent of freight and 90 percent of passenger traffic.4 Railway development has also been limited. Moreover, overall transport and insurance costs represent 30 percent of the value of exports, compared with about 9 percent for other developing countries (United Nations Economic Commission for Africa, 2009); in Africa’s landlocked countries (Chad, Malawi, and Rwanda), these costs may reach about 50 percent of total export values.
Compared with other regions, the overall quality of infrastructure5 in sub-Saharan African countries is broadly in line with the level of economic development, while oil producers seem to lag behind. A broad correlation emerges between the level of GDP per capita and the quality of infrastructure in sub-Saharan African countries and more advanced emerging market countries worldwide (Figure 3.3). Some sub-Saharan African countries stand out and have a relatively high quality of infrastructure, despite being at a lower level in terms of GDP, in particular The Gambia and Rwanda (Figure 3.4). By contrast, relative to their per capita income levels, oil-producing countries such as Angola, Gabon, and Nigeria score lower in terms of the overall quality of their infrastructure.
Figure 3.3.Emerging and Developing Economies: Purchasing Power Parity GDP per Capita versus Quality of Infrastucture, 2013
Sources: World Economic Forum, Global Competitiveness Report; and IMF, World Economic Outlook database.
Note: A larger World Economic Forum score (WEF) indicates a higher quality of infrastructure.
Figure 3.4.Sub-Saharan Africa: Rank of Deviations of World Economic Forum Scores, 2013
Sources: World Economic Forum, Global Competitiveness Report; IMF, World Economic Outlook database.
Note: Positive (negative) residual indicates higher (lower) than predicted World Economic Forum (WEF) scores.
The Financing of Infrastructure in Sub-Saharan Africa: A Broad Overview
Against the background of continued infrastructure deficits, what have been the sources of financing for sub-Saharan Africa infrastructure to date? New instruments, development partners, as well as more fiscal space have boosted public investment in infrastructure, and private investment has also increased. Arrangements between the public and private sectors, such as PPPs, are on the rise.
Most infrastructure investment in sub-Saharan Africa is financed domestically. Unfortunately, direct data on the exact amounts invested in infrastructure and source of financing is scant. But the significant share that domestic resources play can be gleaned by comparing total public spending on infrastructure (approximately US$60 billion in 2012 in the region) with estimates of the total amount of external flows (Figure 3.5) dedicated to infrastructure (about US$22 billion). The former is derived by assuming that three-fourths of public investment is directed to infrastructure,6 while the latter is derived from the range of external financing instruments and sources that the region’s countries have in recent years been relying upon.
Figure 3.5.Sub-Saharan Africa: Public Infrastructure and External Financing Sources, 2007 and 2012
Sources: Bloomberg L.P.; OECD, International Development Statistics; Dealogic; the Infrastructure Consortium for Africa—ICA, 2009; and IMF, 2012.
Note: 75 percent of total public investment is assumed to be allocated to infrastructure each year.
1 Sovereign bonds were issued by sub-Saharan African countries between 2007 and 2012 for financing infrastructure (column 2007 equals the sum of bonds issued by Ghana ‘07 and Senegal ‘09, and column 2012 equals the sum of bonds issued by Senegal ‘11, Namibia ‘11, and Zambia ‘12).
2 Commitments reported by the ICA from 2008 to 2012. Members of the Arab-Coordination Group: Arab Fund for Economic and Social Development, Islamic Development Bank, Kuwait Fund for Arab Economic Development, Abu Dhabi Fund for Development, OPEC Fund for International Development, Arab Bank for Economic Development in Africa, and Saudi Fund for Development.
3 Estimated disbursement based on the annual share of the commitments for economic infrastructure and services.
4 75 percent of total public investment is assumed to be allocated to infrastructure each year.
New external partners to support the authorities’ investment effort
Within this context, the external sources of financing for infrastructure in sub-Saharan Africa have changed, and new partners have emerged. Public investment in infrastructure doubled between 2007 and 2012 (Figure 3.5), financed by a combination of domestic public resources, loans or grants from multilateral institutions and bilateral creditors, private financing, and sovereign bond issues, which also more than doubled. Infrastructure financing in the form of syndicated loans to the government became more prominent as an instrument over the same period. China’s infrastructure financing in sub-Saharan Africa tripled over the same period, and now accounts for about half of the external funding, mirroring the sharply increased commercial activity between China and Africa.
This sustained investment was also facilitated by more domestic fiscal space through debt relief, revenue collection, and gains from the commodity price boom. Debt relief under the HIPC/MDRI initiatives in the first half of the 2000s contributed to create fiscal space, while domestic revenue mobilization also improved, reflecting policy reforms and an upward trend in economic growth in the region since late 1990s. Finally, the sustained boom in most commodity prices over the last decade also helped resource-rich countries boost their revenue and finance higher public investment levels.
Emerging direct private sector involvement in sub-Saharan Africa’s infrastructure investment
In the last fifteen years, privately funded infrastructure investment in sub-Saharan Africa increased. The modalities and forms of this private participation and investment in infrastructure are a continuum, and range from concessions and PPPs to equity investment, syndicated loans, and infrastructure bonds.
Arrangements between the public and private sectors in the form of PPPs and related setups became more prominent between 1995 and 2012. Private participation in infrastructure (PPIs) refers to contractual arrangements and modalities—management contracts, leasing, investment concessions, divestiture, and new entry and build-operate-transfer (BOT) schemes—that allow for private sector involvement in building infrastructure assets and supplying services. PPI indicators show that sub-Saharan Africa’s infrastructure sectors have become attractive for such arrangements, even though the overall volume declined after the global financial crisis (Figure 3.6).7 This development was facilitated by enhanced regulations for the private sector’s involvement in key infrastructure sectors. However, there is a clear concentration of this private participation in the telecommunications sector, mirroring the extreme dynamism of ICT growth. By contrast, in many countries, government regulations are not conducive to private sector involvement in the power, water, and railway sectors (Foster and Briceño-Garmendia, 2010).
Figure 3.6.Sub-Saharan Africa: Private Participation in Infrastructure Investment by Country, 1995–2012
Source: World Bank, Private Participation in Infrastructure.
PPPs are characterized by very diverse forms in sub-Saharan Africa, spanning across a variety of sectors. A number of low-income countries such as Benin, Burkina Faso, Mali, Niger, Rwanda, and Senegal have used PPPs in the water sector, including in rural areas. These arrangements have successfully used small piped water schemes to serve communities, as an alternative to community-based water management, and are often small in terms of project value. At the other end of the PPP spectrum are large transnational infrastructure projects, such as the New Limpopo Bridge across the Limpopo River, connecting Zimbabwe and South Africa. A private company constructed the bridge in 1994, using one of the first BOT schemes on the continent. The investor recovered his costs by tolls charged to users, and upon the expiry of the 20-year BOT agreement, the government took ownership of the bridge in mid-2014. Along this spectrum, PPPs have been used in many countries in sub-Saharan Africa, and large transnational projects are in the pipeline, spanning across the transport, water, and energy sectors (see Box 3.1).
While declining in volume terms after the financial crisis, syndicated loans have gained prominence again, with a more diversified structure and a change in the origin of flows. Traditional European investors from France, Germany, and the United Kingdom have scaled back their participation in new syndicates and large bilateral loans, mainly as a result of deleveraging and the introduction of stricter international regulatory requirements that indirectly penalize cross-border lending. However, domestic banks have stepped in to fill the gap. Moreover, increasingly focusing on sectors other than telecommunications, African banks, in particular the larger institutions from Southern and Western Africa, are becoming the lead arrangers of syndicates (Figure 3.7). Most of the syndicated financing operations outside South Africa are directed toward sub-Saharan African frontier markets.
Figure 3.7.Sub-Saharan Africa: New Syndicated and Large Bilateral Loans for Infrastructure by Lender Nationality, 2006–13
Sources: Dealogic Analytics; and IMF staff calculations.
The tenor of syndicated loans has increased over time (Figure 3.8). This also reflects the shift toward projects in the energy/water sectors that usually are large in size and have a long economic life. Projects in basic infrastructure and energy/water sectors are usually cofinanced by development institutions and export credit agencies. The presence of these institutions in the syndicate provides valuable comfort to private lenders, allowing them to provide the longer tenor loans that are essential for large-scale projects. New models that allow larger entities with in-house teams to invest in larger projects, spreading the risk among stakeholders, are also gaining prominence. Although strong macroeconomic fundamentals are a major driver of private lending to finance infrastructure, not surprisingly, oil- and gas-rich countries are a primary destination of credit flows. Apart from Nigeria and South Africa, some frontier markets and middle-income countries with transparent business environments were able to attract significant lending flows.
Figure 3.8.Sub-Saharan Africa: Tenor of New Syndicated and Large Bilateral Loans
Sources: Dealogic Analytics; and IMF staff calculations.
Moreover, in a few countries, local currency bond financing for infrastructure is rapidly expanding. Infrastructure project bonds are instruments to raise capital for specific projects, and typically repaid through resources generated by the project. Since February 2009, Kenya has successfully issued three infrastructure bonds to finance roads, water, and energy projects. These public bonds have also paved the way for corporate bonds issues for the same purpose, by either private or state-owned companies (for example, the electricity utility KenGen and the mobile phone company Safaricom). Kenya has used a number of incentives to make infrastructure bonds attractive, such as allowing use of the bonds as collateral and providing tax exemptions on interest income.
Infrastructure outcomes not yet commensurate to the sustained investment effort
Comparing the average levels of public investment in infrastructure with the changes in the quality of infrastructure over the same period does not point to a generally strong association (Figure 3.9). Some countries do look to have made substantial progress in developing their infrastructure, but many others have little quality improvement to show for similar or higher public investment levels. In part, the absence of correlation may have to do with the inevitable lags between outlays and projects being completed. But it may also point to difficulties in executing investment budgets effectively, particularly in countries with limited institutional capacity.
Figure 3.9.Sub-Saharan Africa: Average Public Investment versus Change in Quality of Infrastructure Score, 2006–13
Source: IMF staff calculations.
Note: 75 percent of total public investment is assumed to be allocated to infrastructure each year.
A Public Investment Management Index constructed by Dabla-Norris and others (2010) confirms that investment efficiency in sub-Saharan Africa lags behind other emerging markets and developing countries. Major shortcomings affect the appraisal, evaluation, and implementation of projects. Remedies to reduce the infrastructure funding gap and increase absorptive capacity in public infrastructure include (i) strengthening sectoral planning and the capacity to appraise and monitor infrastructure projects, and (ii) applying a medium-term budgetary perspective through a medium-term expenditure framework.
The Way Forward: Policies to Reduce the Infrastructure Deficit
This section discusses the pros and cons of different modalities to reduce the remaining infrastructure deficit in sub-Saharan Africa in the future. These modalities include public investment, PPPs, and pure private involvement in infrastructure projects. There is no easy answer, and all of these have different implications for the overall resource envelope and present different forms of fiscal risks. As such, their impact on debt sustainability should be examined carefully.
The analytical framework: Choosing from the menu of financing modalities
In the years ahead, policymakers face three broad options for infrastructure financing—public investment, PPPs, and purely private investment. Public investment is likely to continue to play the dominant role in infrastructure investment in many sub-Saharan African countries. This in turn is likely to be financed mainly from internal resources, supplemented at the margin by borrowing including through new financing instruments such as infrastructure bonds. But there is also ample scope to entice private investors to finance joint public-private or even purely private projects.
Each of these options has its advantages and disadvantages (Table 3.1). For instance, using limited near-term borrowing capacity to finance infrastructure projects would reduce the policy buffers available to deal with exogenous shocks. As policymakers complement public investment efforts financed by taxation and debt instruments with support for more private participation in infrastructure, the potential resource envelope increases, as do the institutional capacity requirements needed to mitigate potential fiscal risks. Public investment financed by domestic revenue may have lower financing costs, but leaves execution risks to the public sector. PPPs can be a vehicle to transfer some risks to the private sector, but they typically have high transaction and financing costs, need to be underpinned by an appropriate legal and institutional framework, and require monitoring on the side of the authorities. Full private investment could in principle address the entire infrastructure deficit, but governments would reduce their control of infrastructure assets. The following sections discuss these issues in more detail.
|Increased resource envelope with greater institutional capacity requirements|
|Public Investment/Taxation||Public Investment/Debt Financing||PPPs||Private Financing|
|Pros||More control of the asset||Imposes market discipline||Efficiency gains through private sector’s capacity||High resource envelope|
|Limited debt creation||Some liabilities transferred to private|
|Cons||Lower resource envelope||Proceeds could be diverted to other uses||Contingent liabilities from government guarantees||Limited control of assets|
|Absence of market signals on project viability||Political interference||Risk of off-budget spending||High costs due to high risk premium|
|Political interference||Limited execution capacity||High transaction costs||High transaction costs|
|Limited execution capacity||Fiscal sustainability risks||Government might have to step in||Not available for small projects|
|Government might have to step in|
|Key policy measures||Debt Sustainability Analysis (DSA)||Adapt legal and institutional framework||Mitigate risks|
|Ensure adequate fiscal and accounting reporting|
|Address regulatory shortcomings||Address regulatory shortcomings||Address regulatory shortcomings||Address regulatory shortcomings|
|Upgrade investment capacity||Upgrade investment capacity||Upgrade institutional and investment assessment capacity||Upgrade institutional and investment assessment capacity|
Any scaling up in infrastructure should go hand in hand with “investing in investment.” Line ministries, often the key players in planning and executing infrastructure projects, should ensure that infrastructure projects are underpinned by a clear strategic vision for the whole sector. Moreover, multiyear public infrastructure investment should be carried out in the context of a rolling medium-term expenditure framework (MTEF), allowing for a planning perspective beyond the actual budget cycle. In some other regions, such as Latin America, a “bottom-up” approach has proven useful, in which line ministries propose projects, while a central agency such as the Ministry of Finance prioritizes and aligns them with the MTEF. An effective project appraisal procedure subjects infrastructure projects to a cost-benefit analysis to assess their economic and social returns, complemented by an assessment of whether the government has the capacity to collect any envisaged user charges. As project execution starts, close monitoring and coordination between the Ministry of Finance and line ministries is crucial.
Sustaining public investment without compromising debt sustainability
Public investment financed by taxation and debt allows the government to exert the highest control over the infrastructure asset or service. This is often an important consideration, as many large infrastructure projects constitute public goods of strategic importance. Public investment provides governments with the highest degree of control over the infrastructure asset, from the planning, design, and execution process during the construction phase, to operation and maintenance during the later phases of its life cycle.
Financing public investment with tax revenue limits debt creation. However, tax collection in sub-Saharan African low-income countries, while having increased over recent years, is still relatively low (Figure 3.10), constraining the overall resource envelope for this policy option. Durable increases in available resources—and thus greater fiscal space—could be achieved through reforms that broaden the tax base, raise the efficiency of tax collection, and reduce tax evasion. However, when infrastructure projects are financed fully through tax revenue, there are no signals regarding the financial viability of individual projects, which could lead to losses and inefficiencies.
Figure 3.10.Sub-Saharan Africa: Low-Income Countries: Median General Government Revenue, 1990–2013
Source: IMF, World Economic Outlook database.
Public investment financed by bonds and other forms of debt increases the resource envelope. Traditionally, syndicated loans have been used for the early and more risky stages of infrastructure project development. However, owing to more sophisticated credit enhancement techniques and completion guarantees, the use of bonds for precompletion projects has become more prominent. Moreover, compared with syndicated loans, bonds are more standardized and therefore more liquid instruments, which might, all else equal, increase the pool of investors. Because bonds can also be tied to the proceeds of a particular project, such as user fees, they might be self financing, at least partially. Bond financing could thus be less expensive than other modalities, and better match the long time horizon of infrastructure projects’ life cycles. As proceeds from debt financing are in principle fungible, however, they might be diverted to other uses, including current expenditure, which might undermine the sustainability of public finances over time. Debt-financed infrastructure investment, however, might entail the need to increase taxes over time, thereby crowding out the private sector.
Any scaling up of public spending on infrastructure, however, should be conducted without compromising debt sustainability. Governments need to calibrate their infrastructure investment with a view to safeguarding a sustainable debt-to-GDP position over the medium term. Funding options need to be commensurate with debt vulnerability and debt management capacity. Countries with higher risk of debt distress or lower institutional capacity should seek to rely more on concessional financing. In contrast, countries with low debt vulnerabilities and higher capacity can consider relying more on nonconcessional financing for infrastructure projects.
Making the most of PPPs
Well-structured PPPs present clear benefits and increase the available resource envelope, compared with public investment. By teaming up with the private sector, PPPs allow to harness higher project execution and innovation capacity. PPPs can offer better value for money, compared with traditional public investment, to the extent that partners assumes the risk they are better placed to manage. However, as investment projects, PPPs are characterized by a broad range of risks: construction risks (such as cost overruns), financial risks, future demand risks (such as lower traffic volumes), political risks, and risks of natural disasters. If PPPs are poorly designed, they can give rise to contingent liabilities, in particular through government guarantees to private partners.8 A key measure for mitigating these risks is to assess and disclose such contingent liabilities and budget for them accordingly.
In future, the following principles can help strengthen the institutional and legal frameworks for making the most of PPPs, which might prove challenging, in particular for fragile states:
- Investment planning and institutional setup. PPP projects should be part of the government overall investment strategy and of medium-term fiscal and expenditure frameworks. Many countries have found it useful to establish a centralized PPP unit within the government to act as a focal point overseeing all PPP agreements, act as a contact point for public and private operators, and develop the specific expertise required to monitor and quantify fiscal risks arising from PPPs.9
- Public sector comparator. PPPs should be pursued only if they offer more value for money than traditional publicly procured projects. This can be assessed through a public sector comparator (PSC), a detailed estimate of the cost of the project if the public sector was the unique provider. A project should be carried out as a PPP only if it generates lower costs for the government over time than the PSC.
- Legal framework. A comprehensive legal framework for PPPs10 assigns clear roles and responsibilities for PPPs, and draws up transparent procurement rules; basic elements for the renegotiation and termination of PPP contracts; financial management and audit procedures; and reporting requirements. In the same vein, a single PPP framework law has emerged as international best practice.
Private infrastructure investment
Private investment has the potential to reduce sub-Saharan Africa’s infrastructure deficit in some sectors, provided that the right conditions are in place to involve private investors. By their nature, infrastructure assets are illiquid, upfront capital requirements are large, and the revenue stream may be subject to long delays. Therefore, investing in infrastructure entails significant risks for private investors, including higher-than-projected costs; shortfalls in projected revenues, exchange rate risks; force majeure; and, most importantly, regulatory and political risks.
Several instruments and characteristics of financial contracts could help to diversify these risks and make infrastructure investments in sub-Saharan African countries more attractive for private investors. The following new instruments and techniques stand out:
- Insurance. Multilateral institutions and donors, such as the Multilateral Guarantee Investment Agency (MIGA),11 and the Private Investment Development Group (PIDG),12 recently strengthened their insurance options against political and regulatory risks. International financial institutions such as the African Development Bank (AfDB) provide guarantees that cover private lenders against the risk of a government failing to meet its obligations.
- Credit tranching and bundling. An important credit enhancement technique is to slice the project financing instrument into tranches that match the different appetite for risk of different investors. Similarly, multiple projects can be rebundled into a portfolio to mitigate risk for investors with low risk appetite, such as pension funds (see Box 3.2).
- Cofinancing initiatives. Sub-Saharan African countries could leverage international experience relating to (i) securitization and (ii) publicly provided commitment technologies. Shallow domestic capital markets limit substantially securitization as a means of financing infrastructure, unlike the success recorded in other emerging markets. In this regard, investment funds cofinanced by development financial institutions,13 which pledge their “goodwill” by participating in an infrastructure project, can help catalyze funding from a broader pool of investors (see Box 3.3). A number of multilateral development banks—including the International Finance Corporation (IFC), the African Development Bank (AfDB), and the European Investment Bank (EIB)—offer partial credit guarantee (PCG) products for debt instruments.14 New cofinancing initiatives are also being developed (see Box 3.4).
Shortcomings of private financing for infrastructure assets include significantly reduced control of the government vis-à-vis the private investor. Entirely private infrastructure investment might also involve higher transaction costs, owing to complicated financial engineering, or higher costs associated with private sector borrowing. Moreover, private investment might not be available for smaller projects. Finally, this financing option also involves some moral hazard, in case the government has to step in and assume financial and social welfare losses if a project fails.
Strengthening the regulatory environment and performance of public utility companies
Crosscutting along these financing modalities is the need to address regulatory shortcomings in key infrastructure sectors. Lack of financing resources has surely been an important barrier to addressing the infrastructure deficit; however, regulatory constraints, policy uncertainty, and pricing of infrastructure services are also important barriers. In particular, the attractiveness of the regulatory environment is an important factor for the private sector’s choice of which country to invest in (OECD-AfDB, 2014). Similarly, PPPs operating in regulated sectors would benefit from overhauling the regulatory environment.
- Infrastructure sectors such as electricity and transport are typically dominated by state-owned utility companies operating as monopolies. Independent and high-capacity regulation is crucial to determine the charges levied on users, and set adequate standards for operators in the sector. Improving the reporting and monitoring of public utility company operations and costs would also help to ensure their financial sustainability and minimize fiscal risks.
- Utility pricing schemes should be well targeted, with crossubsidization among users as a tool to achieve greater progressivity. Tariffs should also be set in a way that allows public enterprises to recover their costs, carry out new investments and maintenance operations, and reduce the strain on government budgets.
Similarly, strengthening the performance of public utility companies is also warranted to enhance infrastructure investment. Many sub-Saharan Africa state-owned utility companies are characterized by financial difficulties reflecting shortcomings in management, distribution losses, undercollection of revenues, and overstaffing. Services are frequently underpriced, implicitly subsidizing large industrial customers.
Governance reforms such as establishing performance contracts and external auditing procedures, addressing distribution losses, and monitoring the financial performance of public enterprises in a more systematic way are thus called for. Such measures would lay the groundwork for higher public and private investment in public utility companies.
Progress with developing sub-Saharan African infrastructure in the last two decades has been uneven across countries and sectors, despite sustained investment levels, and points to inefficiencies of the investment process. Although data show that public investment efforts have improved the overall infrastructure stock, the infrastructure deficit remains important, particularly in the energy and transportation sectors. Overall, the quality of sub-Saharan African infrastructure is broadly in line with the continent’s development level, but oil producers and fragile states lag behind.
There is new momentum aimed at reducing the remaining infrastructure deficit. New sources and instruments of financing have already emerged in sub-Saharan Africa, but no single financing modality constitutes an easy answer. In future, it will be important to make the most of the new available financing from international investors and relatively new instruments such as PPPs, while maintaining debt sustainability and mitigating the risks involved. To enhance the quality of infrastructure outcomes, it will also be crucial to increase absorptive capacity. Against this background, the following policy measures will be important:
- Build up capacity for complex projects, and make effective use of new instruments and options to diversify and mitigate risks. Governments should seek to build up a pipeline of bankable projects, and adopt clear standards in the bidding and procurement processes. Characteristics of financial contracts such as credit enhancements can serve to mitigate risks and make investment in sub-Saharan Africa more attractive for private investors. Insurance by multilateral institutions can also help mitigate the political and regulatory risks for private investors. On the domestic side, governments should seek to develop capacity to structure, negotiate, and execute complex infrastructure projects.
- Adapt the legal and institutional frameworks for PPPs. A single PPP framework law should, among other elements, clearly spell out the roles and responsibilities of the partners involved, and provide guidance on concluding, renegotiating, and terminating PPP contracts. For the institutional setup, a gateway process in which the Ministry of Finance can veto PPP projects that might compromise debt sustainability has proven useful in several countries. More broadly, infrastructure investment projects should be carried out as a PPP only if such arrangement can provide value for money. A centralized PPP unit is useful for minimizing the fiscal risks involved. Contingent liabilities from PPPs should be quantified and reported as part of the budgetary reporting framework.
- Strengthen the performance of public utility enterprises, and overhaul regulatory agencies and policies. Independent and transparent regulation, including cost-recovering tariff setting, is important both to put public enterprises on a sustainable footing and to catalyze higher private investment, in particular from international sources.
Box 3.1.Regional Infrastructure
There has been a growing focus on the regional dimension of Africa’s infrastructure development. The African Union Assembly of State and Government adopted in July 2012 the Programme for Infrastructure Development in Africa (PIDA). This program is a blueprint for continental infrastructure transformation from 2012–14. It is also the basis for the implementation of priority projects to transform Africa and the inspiration for the construction of modern infrastructure based on PIDA Priority Action Plan (PAP) projects. Regional infrastructure projects are important as they can bring more economies of scale and improved efficiency.
Weak legal, regulatory, policy, and underdeveloped financing instruments have so far hindered infrastructure development. Over recent years, however, increased cooperation between regional bodies have ushered the road to regional infrastructure development. Accordingly a recent regional study (NEPAD-ECA Study for Mobilizing Domestic Financing) laid out the way to engineer domestic resources for national and regional projects. At the same time, with a contribution of up to US$100 million from the African Development Bank, significant progress has been noted in implementing Africa50 aimed at promoting regional and transformational infrastructure projects as well as accelerating the pace of projects’ execution. Also the recent summit held in Dakar on June 15, 2014 sets off innovative synergies between the public and the private sector toward mobilizing pan-African and global financial investments for infrastructure development in the continent.
As regulatory reforms are advancing and financing becomes more available for regional projects, more projects are being envisaged. Sixteen projects have already been identified as pilot to accelerate regional infrastructure.1 One regional project worth noting is the backbone project to be implemented in a PPP framework. With planned investment of about US$4 billion, the project includes three key components: (i) rehabilitation and extension of a railway from Cotonou to Parakou, Dosso, and Niamey, including a dry port at Parakou in Benin; (ii) a new deep-water port at Seme-Podji on the Benin-Nigeria border; and (iii) a new airport on the border. It is an indigenous African-driven initiative that could bring transformative impact on Benin, Niger, and the subregion. Other projects are the Botswana-Namibia railway and Standard Gauge Railway designed to boost coal export outlook and for passengers and freight, opening Northern Kenya for exploitation of standard resources, respectively.1 The sixteen projects comprise: 1) Ruzizi III hydropower; 2) Dar es Salaam port expansion; 3) Serenge-Nakonde road (T2); 4) Nigeria-Algeria gas pipeline; 5) Modernization of Dakar-Bamako rail line; 6) Sambangalou hydropower; 7) Abidjan-Lagos coastal corridor; 8) Lusaka-Lilongwe ICT terrestrial fibre optic; 9) Zambia-Tanzania-Kenya transmission line; 10) North Africa transmission corridor; 11) Abidjan Ouagadougou railroad; 12) Douala Bangui Ndjamena corridor railroad; 13) Kampala Jinja road upgrading; 14) Juba Torit Kapoeta Nadapal Eldoret railroad; 15) Batoka Gorge hydropower; and 16) Brazzaville Kinshasa railroad, bridge, and the Kinshasa Illebo railways.
Box 3.2.Financial Contracts to Facilitate Infrastructure Investments
Despite growing interest among investors for infrastructure assets, there has been limited issuance of sub-Saharan Africa project finance debt. This reflects mainly the inability of issuers to design debt instruments with a risk-return profile suitable for investment grade rating. This, in turn, prevents issuers from gaining access to institutional investors’ capital, given that in many countries, regulations limit the capacity of pension funds and insurers to invest in assets rated below investment grade or sanctions these investments with high capital charges.
Traditionally, achieving the threshold investment grade rating for sub-Saharan Africa’s infrastructure debt has been difficult, as rating agencies tend to cap the rating of project finance transactions in developing countries at the level of the domestic sovereign’s rating unless there are strong mitigating factors.1 Recently, however, issuers have started to put in place innovative finance structures to make project debt issues more attractive to investors. These structures include a number of elements aimed at enhancing the credit quality of debt instruments, such as credit-enhancement, blending of funding sources, and other contractual safeguards.
Credit enhancement refers to a type of financial engineering technique that changes the structural details of the debt obligation to increase its credit quality by allocating more risk to one or more of the other parties involved in the transaction (debt holders with lower seniority, equity investors, the government, multilateral development banks). Credit enhancement tools can also be combined in order to bridge the gap between the credit worthiness of the underlying asset (the infrastructure project) and the desired credit rating for the debt obligation.
- Credit tranching and subordination. This is the most common form of credit enhancement. The key goal of the tranching process is to create debt instruments whose rating is higher than the average rating of the underlying asset (the infrastructure project). For this purpose, the debt obligation is sliced into tranches with different levels of credit risk protection (senior, mezzanine, junior). In this structure, the subordinated lenders (junior and mezzanine) act as credit enhancers for the senior lenders that would incur in losses only if the losses exceed the amount of the subordinated tranches (Figure 3.2.1). In this way it is possible to create securities with different risk-return profiles suitable to different types of investors. Senior tranches would be more appropriate for institutional investors, characterized by a more conservative business and regulation limitation, while mezzanine tranches would fit better investment banks, willing to accept a greater risk in return for the possibility of obtaining a greater yield. The junior tranche would generally be retained by the sponsoring entity or bought by a multilateral development institution (MDI).
- Spread account. This is the simplest form of credit enhancement. To set up a spread account, the debt obligation is designed in a way that the expected project’s cash flows exceed the total costs of issuing the obligation (interest and principal payments, servicing fees). This “excess spread” is deposited in an account that normally bears the first loss.
- Bundling projects with different risk/return profiles. Sponsors can bundle multiple projects into a single portfolio. Although typically not classified as a credit-enhancement technique, bundling can significantly reduce credit risk by enhancing diversification, particularly if the bundled projects belong to different geographical areas and different sectors. Assigning a rating to a bundled project portfolio can be, however, challenging as the default rate analysis is complicated by limited data. Correlations in particular can be difficult to determine.
- Unbundling and rebundling projects. Project sponsors can also slice (unbundle) the project into components with different risk/return profiles (project development, construction, operation) and allocate the financing of the different components to investors with different risk tolerance (banks, sovereign wealth funds, institutional investors, private equity). It is also possible to pool the same component (for example, operation) of multiple projects into a single portfolio (rebundling) to further reduce risk. In this way, investors with a low risk threshold would be able to contribute to the financing without taking on the full risk of the project (Collier and Mayer, 2014).
Figure 3.2.1.Subordination Structure and Credit Enhancement
Source: IMF staff calculations.
Note: Tranching can be structured so as to achieve a particular rating for the senior tranche: the “thicker” are the subordinated tranches compared with the senior tranche, the higher is the credit enhancement and, consequently, the rating of the senior tranche. The figure above illustrates two possible subordination structures for a debt obligation issue of US$100 million. In this example, the senior tranche of structure 2 will obtain a higher credit rating than the senior tranche of structure 1, because it has a higher level of credit enhancement measured as subordinated debt (US$75 million against US$50 million).
Box 3.3.Role of Multidonor Budget Support and Donors in Leveraging Private Capital
Multidonor budget (MDB) support and donors may play a critical role in promoting project financing, particularly when stand-alone financial engineering techniques are not sufficient to enhance the creditworthiness of debt obligations to a level sufficient to access financial markets. MDBs and donors’ support for project financing has traditionally taken two forms: i) provision of credit guarantee products (also defined as external or third-party credit enhancement) and ii) participation in the financing of the project.
- Provision of credit guarantee products. Credit guarantees cover losses in the event of a debt service default with no differentiation of the source of the risks that caused the default.1 There are two types of credit guarantees: i) partial credit guarantees (PCGs), which cover the payment of principal and/or interest up to a predetermined amount and ii) full credit guarantees or wrap guarantees, which cover the entire amount of the debt service in the event of a default. A number of MDBs—including the International Finance Corporation (IFC), the African Development Bank (AfDB), and the European Invest Bank—offer PCG products for debt instruments. By covering part of debt services, PCGs improve the terms of commercial debt by extending maturity, lowering interest rate costs, increasing issue amount and/or enabling access to financial markets. The guaranteed coverage level may be structured so as to achieve a particular bond rating or to enable commercial bank lenders to participate in project financing. Wrap guarantees were mainly provided by private financial operators, the monoline insurers, which underwent severe stress during the financial crisis and whose transaction volume has contracted significantly since.
- Participation in the financing of the project. Participation in the financing can take many forms, but support during the project development and construction phases is likely the most potent vehicle to leverage private capital investment in infrastructure.2 By committing funds to the initial phases of the project, MDBs and donors can indeed reduce investors’ construction risk concerns.
Among the initiatives financed by donors, an interesting product is offered by GuarantCo. This is an entity established by the Private Infrastructure Development Group (PIDG)3 to support the placement of local currency debt instruments in domestic credit and capital markets to finance infrastructure in low-income countries. In countries defined by the OECD as “fragile and conflict-affected states,” the company may also support the placement of U.S. dollar or euro debt instruments. In 2011, GuarantCo used its local AAA in Nigeria to credit enhance a 7-year naira-denominated bond issued by a local aluminum company for the construction of a new factory. With GuarantCo enhancement, the bond was able to secure a local A rating, required to be able to access national pension funds.1 PCGs cover investments against credit risk and differ from political risk insurance products (such as MIGA), which cover investments against adverse government actions or war, civil strife, and terrorism.2 Standard & Poor’s “How Europe’s New Credit Enhancements for Project Finance Bonds Could Affect Ratings,” November 13, 2012.3 See Chapter 3, footnote 12, on page 51 of this publication.
Box 3.4.New Infrastructure Financing Initiatives
Multidonor budget support has recently launched a number of initiatives that try to take a holistic approach to the issue of unlocking private sector participation in infrastructure. This is the philosophy that inspired the Africa50 Fund. Launched by the African Development Bank and Made in Africa Foundation in September 2013, the Africa50 Fund is a new vehicle aimed at mobilizing private financing for infrastructure in Africa. To begin operations, Africa50 targeted raising US$3 billion in equity capital. The equity base is expected to reach US$10 billion at full capacity, and to attract up to US$100 billion of local and global capital. Africa50 Fund will operate in two segments: one that will support project development and another that will support project financing. The project financing segment will focus on delivering credit enhancement and other risk mitigation measures geared to attract funders such as institutional investors.
The G20 under the Australian Presidency launched a Global Infrastructure Initiative to ensure continuity of its multiyear agenda to promote increased levels of quality investment in infrastructure. The initiatives include making operational voluntary best practices in project prioritization and preparation, and working to address key data gaps that matter to investors, especially the lack of information on performance of infrastructure investments and information on project pipelines. Participation in these efforts is open to interested non-G20 members, including in sub-Saharan Africa.