Meeting the Challenge in Africa
November 14 th 2012
Dr Mattia Romani
Senior Visiting Fellow Grantham Research Institute
London School of Economics and Political Science and
Director, Green Growth Planning and Implementation
Global Green Growth Institute

Contents
▪
Why infrastructure for Africa? The needs
▪
The gap
▪
The risk profile
▪
Potential solutions
1

Contents
▪
Why infrastructure for Africa? The needs
▪
The gap
▪
The risk profile
▪
Potential solutions
2

Why infrastructure for Africa?
1.
Infrastructure contributed over half of Africa’s improved growth performance (1999-2005). IT contributed significantly more than any other structural policy in the continent.
2.
Africa’s infrastructure lags well behind that of other developing countries , particularly in terms of pave roads and power generation. On the latter, it started from similar levels to South Asia in the 1960s, and is significantly behind now.
3.
Africa’s infrastructure services are twice as expensive as elsewhere . This is true across tariffs for different types of infrastructure. This is particularly severe for power and water, where average tariffs are a multiple of tariffs in South Asia.
4.
Today Africa faces a resource gap of approx $35bn/year.
This includes taking into account the potential for efficiency improvements (as much as $20bn). This gap could double in the coming decade due to growth, as well as limited public funding and lack of private capital.
Source OECD (2012) Romani, Bhattacharya and Stern (2012)
3

Global scale and nature of needs
▪ the incremental investment spending across emerging markets and developing countries is estimated at around $1 trillion a year more than what is currently spent.
▪ This excludes investment in maintenance and upkeep.
Annual Infrastructure Spending in the Developing World ($tr, 2008)
1.8
–2.3
0.2
–0.3
Additional investments for climate mitigation and adaptation
0.8 - 0.9
1.6
–2.0
Estimated current annual spending,
2008
Estimated annual infrastructure spending need,
2020
NOTES: $ trillion per year, (2008 real prices), capital investments only (excl. operation and maintenance costs)
SOURCE: Current spending from Fay et al. (2010), “ Infrastructure and Sustainable Development ” ; Estimated annual infrastructure spending need for 2020 calculated by taking the Fay et al (2010) estimate and assuming a 4% annual growth rate from
2013-20
4

Global scale and nature of needs
▪ East Asia will require up to 50% of the total – in the region of $2tn a year
▪ More than half is required for the power sector, across generation, transmission and distribution; water and land transportation also are very prominent sectors
▪ If maintenance was included, then the transport sector requirements would be much larger
Annual infrastructure spending requirements in the developing world ($tr, 2008)
1.8
–2.3
1.8
–2.3
1.8
–2.3
Transport 15-25%
EAP 35-50%
Telecomms 10-15%
ECA
LAC
MENA
SA
SSA
5-15%
10-15%
5-10%
20 25 %
Electricity 45-60%
Construction 90-95%
5-15%
Split by region
Water 15-30%
Split by sector
Preparation
5-10%
Split by phase
NOTES: $ trillion per year, (2008 real prices), capital investments only (excl. operation and maintenance costs)
SOURCE: the by region, sector, and phase are authors ’ own calculations taking ranges from Yepes (2008), MDB
G20 working group on infrastructure (2011), and Foster and Briceño-Garmendia (2010); note the
$200-300 billion annual requirement for sustainability is assumed split in the same ratio as the other investments across regions, sectors and phases 5

Contents
▪
Why infrastructure for Africa? The needs
▪
The gap
▪
The risk profile
▪
Potential solutions
6

The gap: existing institutions and financial architecture are not adequate to meet the needs
▪ Currently, an estimated $0.8-0.9 trillion is invested annually, mostly financed by public sector budgets, with lesser shares provided by the private sector and foreign countries through development finance
▪ Private sector investment heavily concentrated in the ICT sector
▪ 95% of all private finance is concentrated in middle-income countries (Estache 2010)
▪ Public-Private Investments concentrated in ICT, other sectors investments dried up during the crisis
1,000-1,400
1,800 –2,300
Private sector
Other developing countries ’ financing
Concessional ODA
MDB financing
Government budgets
800 –900
150-250
20-30
20-30
500-600
<20
Estimated split of current annual investment,
2008
Future annual investment needs,
2020
NOTE: Split by sources of finance are approximate ranges only and don
’ t add to exactly to the totals given for that reason
SOURCE: Split of current sources of finance is a G-24 own assessment based on various estimates including
Estache (2010); MDB working group paper on infrastructure (2011); Macquarie (2009).
7

Today ’s need for capital expenditure in SSA is in the region of $60bn, likely to increase substantially over the next decade.
SOURCE: WB and AFD (2010). Africa’s infrastructure: a time for transformation
8

The gap in SSA: current capital expenditure is $25bn, gap is $35bn
▪ ICT receives more than 2/3 of total private sector investment in Africa (7 out of 9bn)
▪ The financial crisis reduced substantially the already small amounts going to other sectors
▪ ODA and MDB financing are relatively small (3.8bn), other developing is not insignificant (2.4bn)
Africa ’s infrastructure capital investment, by source of finance (real $bn, 2006)
8.5
7.0
4.7
0.5
1.4
4.6
Private sector
Other developing countries ‘ financing
Concessional ODA
MDB financing
Government budgets
0.2
0.5
0
1.3
0 2.4
4.5
0.3
0.9
0.2
1.1
Information &
Communication
Technology
Power Transport Water, Sanitation,
Sewerage
SOURCE: Adapted from Briceño-Garmendia, Smits, and Foster 2008, splitting ODA financing between 75%
MDB financing and 25% concessional ODA based on Foster and Briceño-Garmendia (2010)
9

In SSA, the unmet need to support infrastructure development is for both debt and equity
Estimated current infrastructure financing need for Sub-Saharan Africa
$ billion per year
ICT
Power
60
7
27
0
25
7
5
9
5
Unmet capital need
Transport 9
WSS
Irrigation
15
3
Annual need
Current spend
35
Total of $ 4-5 billion needed in equity for unmet infrastructure demand
22 22
0
10
3
13
~1
3-4
8-9
Unmet need Unmet need Unmet need Estimated that could be met by public sources 1 that could be met by private sources 1 unmet need for project development equity 2
Estimated unmet need for other equity 2
Estimated unmet need for debt 2
1 ‘Public sources’ includes government financing, ODA, and non-OECD financing (e.g., from China). Public-private split is assumed same as current spending and, as such, may understate the potential private sector contribution
2 Split of equity and debt is approximate, based on 30-40% equity (including c.5-10% of total for project development equity), 60-70% debt
SOURCE: Adapted from Foster and Briceño-Garmendia (2010)
1
0

Can SSA afford its infrastructure?
▪
To meet needs, approximate payment of 0.40 dollars per day in Sub-Saharan Africa
▪
Equal to 35-50% of individual income where a significant proportion of the population lives off less than $1-2 per day
▪
If we add the additional cost of finance on this, the figures look even more worrying
▪
Concessionality , intergenerational transfers of financial burden, cash transfers to enable people to pay fees, ODA to cover fees from donor countries are all potential mechanisms to alleviate this issue
▪
This adds a layer of political uncertainty on the sustainability of user fees which discourages investment : will subsidies be removed or reduced? Will the government have enough liquidity to pay out cash transfers for the foreseeable future?
Source Climate Policy Initiative (2011). The Landscape of Climate Finance.
11

In 2011 private investment in developing country infrastructure fell by more than half due to the financial crisis
PPI in infrastructure, all developing countries, $ billion per year
Others
DAC I & II
180
160
140
120
100
80
60
40
20
0
1990 1995 2000
NOTE: 2011 data has been estimated by doubling H1 data for 2011 in PPI database.
SOURCE: World Bank PPI database
2005 2010
-51%
12

Contents
▪
Why infrastructure for Africa? The needs
▪
The gap
▪
The risk profile
▪
Potential solutions
13

Experience shows that complex infrastructure projects are plagued by risks
▪
Re-financing delayed and costly due to;
–
Governance structure leading to delay in turnaround plans
–
Debt holders did not want to take on more risk
Financing and governance issues
Budget overrun of over 80%
Economic loss >
€10 billion
6 month delay on delivery
Under-estimate of;
▪
Environmental and safety concerns
▪
Construction costs
▪
Capital costs for development 140% higher
▪
Caused partly by design
SPV (MTL) separate from operating SPV
(Eurotunnel)
▪
18 months of unreliable service after opening
▪
Several major issues;
–
Train stuck in tunnel
–
Major Fire in 2008
–
Asylum seekers leading to loss of capacity
▪
Litigation with insurers still in process (> €250 mln)
Unforeseen disasters
Demand forecasts 200% off
▪
Passenger volume forecast at >15 mln in 1 st year, yet 10 mln mark not reached today
▪
Partly underestimated competition from ferries and airlines
SOURCE: CIA Factbook, EIB, UN, National Resources Defense Council, Gates Foundation, WEF, McKinsey
14

Infrastructure finance underwrites risks along the life of the project
Risks
Demand / revenue
Market
Credit
Enabling environment
Project development
Financing Construction
Early operations
Mature operations
▪
Inaccurate revenue forecasts
▪
Change in environment e.g. customer requirements
▪
Unforeseen competition
▪
Fluctuation in interest and/or exchange rates
▪
Increase in input (e.g. fuel, commodities, labour) costs and availability
▪
High inflation
▪
Financing terms
▪
Availability of financing
▪
Liquidity challenges
▪
Inaccurate revenue forecasts
▪
Change in environment e.g. customer requirements
▪
Unforeseen competition
Regulatory
& legal
▪
Suboptimal regulation
▪
Change in regulation
▪
Contractual conditions/interpretation of contract
▪
Regulatory oversight & (stakeholder) conflict
Operational
Construction
▪
Project-related external (strike, sabotage, theft)
▪
Rise in wages, taxes or labour-related costs
▪
Inefficiencies due to process or organisation
▪
Other counterparty and procurement risks
(e.g., corruption)
▪
Incomplete / optimistic budget
▪
Lack of project / supplier control
▪
EPC quality, technological or equipment issues
▪
Incomplete planning & permitting status
Political & external
▪
Political unrest, war, terrorism, corruption
▪
Natural disaster, outbreak of disease
▪
Nationalisation
▪
Embargoes, supply chain disruption
15

The risk profile: the nature of risk for infrastructure makes it a complex proposition for investment
Description
Main risks
Preparation
▪
Developer/government organizes feasibility studies; models cash flows, finances; organizes contracts with utilities, operators and construction firms
▪
Macroeconomic & political risks
▪
Technical risks to project viability
▪
Environmental and planning risks
Construction
▪
Construction firms build the project to specifications
▪
Macroeconomic & political risks
▪
Construction risks (e.g., of overrun, delay)
Operation
▪
Separate operating company takes over operation and maintenance of the project
▪
Macroeconomic & political risks
▪
Demand / traffic risks
▪
Operating risks
▪
Policy risks (e.g., tariff changes)
Cash flows
(stylized)
Source: AGF Report (2011)
16

The risk profile: the nature of risk for infrastructure makes it a complex proposition for investment
Description
Preparation Construction Operation
Developer/government organizes
▪
Construction firms build the
▪
Separate operating company project to specifications takes over operation and flows, finances; organizes maintenance of the project
Main risks
Technical risks to project viability
▪
Environmental and planning risks
Construction risks (e.g., of overrun, delay)
▪
Macroeconomic & political risks
▪
Demand / traffic risks
▪
Operating risks
▪
Policy risks (e.g., tariff changes)
Cash flows
(stylized)
Financing moments
During project preparation and feasibility studies the developer seeks patient capital or, often, public funds
Once project is ‘ bankable ’ the developer will seek equity investors and debt providers to finance the project
Source: AGF Report (2011)
Once construction is complete and started to operate project can be refinanced to reflect the changing risk profile
17

The upfront investment often relies on a very uncertain future cash flow
Base Case + Volatility
Base case + volatility
5.000.000
4.000.000
3.000.000
2.000.000
1.000.000
-
-1.000.000
-2.000.000
-3.000.000
1 2 3 4 5 6 7 8 9 1 11
SOURCE: McKinsey
18

Most recent and future projects are greenfield
Already today, opportunities are mostly in greenfield…
Projects 2005-10
Average number p.a.
415
29%
And the pipeline is even more skewed towards new construction projects
Projects since 2010
Projected number
61%
Greenfield Mature 1 Greenfield 2 Mature 3
▪
The prospective increase in the scale of ‘greenfield’ investments that are required in developing countries – which typically have higher risks than ‘brownfield’ expansions - means that the risks of a substantial bottleneck where financiers are not ready to invest are greater .
1 Includes Secondary stage and Brownfield 2 Includes Greenfield (112) and Expansion (12)
3 Includes Asset Acquisition, M&A, Brownfield, Privatisation
SOURCE: Preqin, Infrastructure Journal, Public Works Financing, Infrastructure Investor
19

The risk profile: constraints to matching demand of investment with supply of available financial instruments
▪
Infrastructure investment projects in developing countries have high risks across most of the above categories
▪
Macroeconomic and political risk in developing countries compounds with high risks of early phases of investment
▪
This problem is further compounded by the fact that many potential financiers have few if any benchmark projects to serve as comparison for pricing these risks.
Difficult to match project needs and financial archetypes, making investment at scale unfeasible
20

Contents
▪
Why infrastructure for Africa? The needs
▪
The gap
▪
The risk profile
▪
Potential solutions
21

The shift in wealth has implications for asset allocations:
Most emerging market investors have very low allocations to equities
Asset allocation by investor, 2010
%; $ trillion, 2010 exchange rates
Other
Cash and deposits
100% =
Fixed income
Traditional investors Emerging investors
43.6
6
19
28.3
5
4.3
6
15
3.6
0
39
54
29
29
23
13
Equities 45
34
52
32
2.7
3
65
14
18
US pensions and private investors
Western
Europe pensions and private investors
Sovereign wealth funds
Developed
Asian private investors
MENA private investors
3.5
8
54
6.5
9
74
24
14
5
12
Latin
American private investors
Chinese private investors
Compound annual growth rate, 2000
–10
%
4 3 15 9 23 16 16
1.8
76
13
11
Emerging
Asian private investors
14
1 Includes Singapore, Hong Kong, Korea, and Taiwan. Excludes Japan, where private investors have 10% in equities
5.9
10
90
Emerging market central banks
22
22

The BRICS are now playing a larger role in infrastructure financing and are taking a new approach
China is now a larger contributor to infrastructure financing in Africa than the World Bank
Infrastructure financing in Africa
$ billion
World Bank Group
1.9
1.3
3.3
2.5
8.1
China
9.0
▪
China and Gulf countries offer cheap capital and turnkey solutions conditional to geo political objectives rather economics
▪
Chinese commitments are
15% of total African infrastructure investment
▪
Chinese commitments including non-infrastructure sectors are even higher at
$15.9bn in 2010
▪
Two-thirds of Chinese infrastructure financing is in energy and transport
2004 2007 2010
SOURCE: Infrastructure Consortium for Africa 2010 annual report; ICA 2010 annual report; World Bank, “Building bridges: China
’s growing role as infrastructure financier for sub-Saharan Africa” (2008); World Bank Group,
Infrastructure Strategy Update paper (2011)
23

Potential solutions: reforming IFIs and need for new institutions
① Innovative public finance instruments (project preparation funds, political risk guarantees, etc)
② Complementing private finance instruments
(both debt and equity)
③ Financial solutions that combine these public and private instruments effectively at low transactional cost
④ Large data-banks providing benchmark for assessing risk-return of projects
⑤ Governance of public money that allows a more efficient use of scarce public finance resources
⑥ Project preparation facilities that support countries in creating a healthy pipeline of investable projects
⑦ Mechanisms to guarantee revenues from user fees at the end of the investment cycle
⑧ Excellent data rooms on projects to facilitate assessments of risk and returns for private investors
Current IFIs :
• ensure that current money made available by members is leveraged more efficiently
•
Change governance to reflect both new geopolitics and current risk frameworks
New institution(s):
•
Institutions that reflect in their governance, capital and instruments the new economic and financial reality of the world and use resources from emerging and developing countries efficiently
24

Rationale for a new a bank fit for purpose: modern in its mandate, instruments and ownership o Resolving the infrastructure challenge for the next 2 decades means laying the foundations for global growth.
o Most greenfield infrastructure projects in developing and emerging markets face upfront risks that current market players are unable to take on. A new institution could have the scale of capital, the portfolio of projects and the instruments required to take on this risk and unlock private investment. o Public finances under pressure and domestic financial systems relatively young. New bank can help deepen domestic financial markets, channel savings to profitable investment and reduce exposure to currency risk, particularly with respect to $US/Euro o BRICS keen to expand their commercial and strategic links with resource rich countries, mostly pursuing this through bilateral deals. A new bank could help achieve such objective with less financial and political exposure with a multi-lateral approach o Existing IFIs not in a position to take on scale (due to institutional limits and governance) and nature (long term financing, large proportion of equity) although can be good partners o Project preparation is not happening at the scale and quality required which results in a poor pipeline of bankable projects. A successful new institution needs to develop world-class, global project preparation facilities over time
Source Romani and Stern (2011)
25

Proposed G24-GGGI work program in collaboration with other partners
1.
Deepening the assessment of infrastructure investment needs – by region, country, sector
2.
Risk analysis framework: assessing the risk return profiles of projects across regions, sectors, phases
3.
Evaluating experience on existing financial instruments: what works and what doesn’t
4.
Assessing the constraints on the development of a strong pipeline of investable projects across different sectors, countries, regions; explore experience on project preparation facilities and technical assistance
5.
Assessing the existing financial architecture and its delivery:
1.
Public finance (budgets)
2.
MDBs and RDBs
3.
National Development Banks
4.
Private finance
6.
Considerations and implications on developing new institutional arrangements: range of functions, instruments, membership, governance, capitalization, etc
Source Romani and Stern (2011)
26