The risks of foreign denominated debt for Kenya

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Anyone keeping an eye on the economy will have noted the level of public debt being accrued, particularly foreign denominated debt. Total debt stood at KES 2.37 trillion (USD 26.78 billion) after Kenya’s sovereign bond issue in June. The concern with the debt being accrued is that we are getting into larger foreign denominated debt than previously was the case. Kenya is an import economy so by default, in order to service foreign debt, government has to buy dollars. The assumption being made is that the foreign debt will boost the economy primarily through investment in infrastructure which is expected to generate the capital required to service the debt. It is important to note that although there is support for this hypothesis there are also those who question the logic that infrastructure equals growth. In fact, the London School of Economics states that, ‘empirical estimates of the magnitude of infrastructure’s contribution (to growth) display considerable variation across studies. Overall, however, the most recent literature tends to find smaller effects than those reported in the earlier studies’. This article will not debate this point but instead highlight the challenges Kenya will face should this almighty investment in infrastructure not generate the growth expected. How does payment in shillings affect the economy should the foreign denominated debt fail to yield the returns expected of it? How then, will government raise shillings to service this substantial debt?

Debt The first and most obvious option is for government to raise taxes in order to raise shillings that can then be used to service the debt. But Kenya is already a heavily taxed country and one wonders if we have reached a point on the Laffer Curve where raising taxes further will harm profitability and actually lower revenues. Tax rates that are too high effectively penalize people for engaging in economically productive activities; so government risks harming its own revenue if increasing taxation becomes the main strategy used to raise shillings.

The second option is to borrow shillings locally and use this capital to buy dollars and service the debt. The argument has been made that Kenya entered into foreign debt to ease pressure on local credit and interest rates. But if that investment doesn’t yield what is expected then government may have to borrow locally to service the debt anyway. This borrowing obviously crowds out the private sector and reduces private sector access to credit. One consequence of this it that private sector may not be able to implement activity and developments that were to be debt financed. Further, but borrowing locally, government will put pressure on interest rates possibly pushing them up which again, will make credit less available to private sector borrowers. The economic growth of the country may then be muted because private sector and SMEs would not been able to access the credit they needed to become more productive. Further, borrowing locally does not solve the debt problem but merely rolls it over to be dealt with at a later date.

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The third option for government is to implement austerity measures and reduce recurrent expenditure so that more shillings are made available for debt servicing. But in Kenya, this option does not seem feasible. The prevailing climate in the country is one where those being paid by Kenyans always seem to want to increase their salaries not reduce them. This makes it very difficult for government to reduce recurrent expenditure.

The fourth option through which government can ‘raise’ shillings is by printing shillings. Government has done this in the past and this phenomenon is certainly not unique to Kenya. The problem with printing money is that it expands money supply which often drives inflation up. The excess supply of KES can also lead to a further depreciation of the currency making it even more expensive for government to buy dollars and service foreign denominated debt. Therefore if the government prints KES, it will be effectively making the debt more expensive.

Growth

Clearly, none of these four options are attractive and each has consequences that could have economic and perhaps even socio-political implications. These options present the risks Kenya faces as it enters into an era of acquiring and servicing foreign denominated debt on a scale far larger than ever before.

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This is why interest rates will remain high for Kenyan borrowers

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There are myths told to Kenyan consumers on a regular basis. One myth is that if government does not borrow locally, it should lead to lower interest rates because of the ease of pressure on demand for domestic credit. The second myth is that the Kenya Banks Reference Rate (KBRR) will let consumers know how much credit should cost and thus foster competition in the banking industry which will lead to lower rates. Yet since the introduction of the KBRR only one bank has lowered its interest rates. Further, even after announcements by government clearly signalling that it will borrow from outside Kenya, interest rates have not dipped. Why? Why aren’t banks lowering interest rates in any noticeable manner? There are several factors at play that will not only ensure interest rates do not lower but in fact may push interest rates up. The focus here will be on external factors that inform rate setting rather than internal dynamics of banks (such as riskiness of client, required rate of return on funds/capital etc) as these are harder to influence and ascertain.

Growth

The first factor is the cost of borrowing; according to the CBK, during the month of November the interbank lending rate seesawed between 6.39 and 7.6 % but often more long term rates are used and insiders say the real rate can be double this figure. Banks have to on-lend at a rate higher than that at which they borrowed so this borrowing rate is the first rate- hike that hits consumers.

Inflation is another factor that informs rate setting since high inflation devalues the shilling and therefore pushes rates up in order for banks to recover the equivalent value of capital. Calculations on long term inflation demonstrate that the Inflation Rate in Kenya averaged 11.13 % from 2005 until November 2014, well above CBK’s target rate of 2.5-7.5%. Given how unstable Kenya’s inflation rate is year on year, banks would rather err on the side of caution and keep rates up to make sure they get the value of their money back.

Another factor banks have to consider is tax. The Corporate Tax Tate since this obviously eats into profits. Corporate Tax Rates in Kenya currently stand at 30% for residents and 37.5% for non-residents. However, a 2013 report by PriceWaterhouseCoopers found that a company in Kenya on average pays a total tax rate of 44.2%, higher than the global average of 43.1%. Further, it takes a firm operating locally 308 hours to comply with taxes; the global average is 268 hours. These factors lead to a high cost of doing business in Kenya which leads to a higher financial burden in terms of man hours. So it can be understood why some of this financial burden is passed on to consumers in the form of higher interest rates. Additionally, for banks (and any other company) listed on the Nairobi Securities Exchange Withholding Tax on Dividends stands at a rate of 5% for dividends paid to residents of Kenya and on listed shares for citizens of the East African Community; the rate is 10% for other non-residents. To top it all off, the government recently announced the re-introduction of the Capital Gains Tax at 5%. Banks are facing millions of shillings in tax charges on transactions starting January 2015. Such tax burdens increase the cost of funds and puts pressure on banks to find ways to secure profit margins and hiking interest rates is a viable option.

Kenyan-Shillings

There are also non-financial reasons why banks feel no pressure to reduce interest rates: Kenyans do not necessarily choose banks due to their interest rates and Kenyans do not necessarily leave banks if the interest rate goes up. There are other factors that inform how Kenyans choose banking partners or stay with them. A study by Ernst and Young earlier this year indicated that Kenyans, like millions of others across the world, open and close their accounts due to customer experience and this factor is more important than fees, rates, locations, press coverage or convenience. Add to this the reality that Kenya recorded a higher than average increase in confidence in their banks. In fact, while 44% of customers around the world express complete trust in their banks, this figure is 59% in Kenya; the highest level in Africa.

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Given all these factors, why would banks seek to drive down interest rates? It appears as though banks would prefer to reward depositors with higher interest rates and general customers with better services than bring lending rates down. Sadly, no reprieve is in sight for you, Kenyan borrower.

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A version of this article was featured in the Business Daily on December 1, 2014. You can read it here.

The Pros and Cons of Free Trade Areas

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Many Africans are of the opinion that greater economic integration of the continent through Free Trade Areas will be of benefit to the continent’s growth. But is this truly the case?

In October 2014, delegates from 26 countries of three main trading blocs in Africa agreed to launch the continent’s largest free trade area in December 2014. ‘The Tripartite Free Trade Area (FTA), comprising the East African Community (EAC); the Common Market for Eastern and Southern Africa (COMESA) and the Southern African Development Community (SADC), aims to boost intra–regional trade, increase foreign investment and promote the development of cross-regional infrastructure’.[1] This Free Trade Area (FTA), ‘will have a combined population of 625 million people, a Gross Domestic Product (GDP) of USD 1.2 trillion’ and ‘will account for half of the membership of the African Union and 58% of the continent’s GDP’.[2] This trend towards regional integration is well underway as this FTA will be, ‘the launching pad for the establishment of the Continental Free Trade Area (CFTA) in 2017’. The decision to develop a Tripartite FTA occurred in October 2008 where it was agreed that FTA would be guided by the following overarching principles[3]:

  • Duty-Free and Quota-Free Market Access and no quantitative restrictions on goods that meet the Tripartite Rules of Origin.
  • Standstill Provisions and Incremental Liberalisation: Tripartite countries to present national tariffs and declare customs duty rates for all tariff lines at the start of the negotiations and should undertake not to raise customs duties on imports from other Tripartite countries before, during or after the negotiations, and to continuously reduce non-zero customs duties so that they are completely eliminated as part of the Tripartite FTA.
  • Most Favoured National Treatment where Tripartite countries should accord each other Most Favoured Nation (MFN) treatment where there is no prevention by country members from maintaining or concluding preferential or free trade agreements, either separately or together, with third countries provided such agreements do not go against the letter or spirit of the Tripartite Free Trade Agreement.
  • National Treatment: Member countries to accord the same treatment to products manufactured in other Tripartite countries once imported into their territory as that accorded to similar locally manufactured products.

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Further cooperation between member countries will include the harmonisation and coordination of industrial and health standards; combating of unfair trade practices and import surges, relaxation of restrictions on movement of business persons; development of cultural industries in the region and the development of sector strategies to increase productive capacity and link producers to buyers and consumers.[4]

UNECA indicates that there may be a 3 phase process towards the creation of a continental FTA. The on-going COMESA-EAC-SADC FTA is FTA1; The Economic Community of West African States (ECOWAS), Community of Sahel-Saharan States (CEN-SAD) and the Arab Maghreb Union (UMA) would be FTA 2 and finally the Economic Community of Central African States (ECCAS), The Central African Economic and Monetary Community (CEMAC) and possibly the Economic Community of the Great Lakes Countries (CEPGL) as FTA 3.[5] These 3 FTAs would then combine to form a Continental FTA.

This all sounds fine but what one often doesn’t see in Africa is the questioning of the principle of FTAs. Given that we’re hurtling towards FTAs with great momentum, it would be prudent to ask: how good an idea are they?

PROS OF FTAs

1. Enhances intra-regional trade and investment

FTAs encourage member countries to increase trade with each other. Further, it allows projects, particularly in infrastructure, to be designed from a regional perspective allowing for greater efficiencies and cost-sharing between governments. Private sector can also design the development of plants, factories and large industrial facilities more strategically.

2. Increased price competitiveness

The introduction of new players in home markets means expensive goods are replaced with cheaper goods due to competition.[6] This applies to goods made by countries within the FTA as well goods from outside the FTA which may have to cut prices to maintain exports to the region.[7] In a continent where poverty is a reality for many, cheap is better for most.

3. Every country is bound to benefit due to different areas of specialisation

Ideally, each country has a comparative advantage in different areas of production and this allows partner countries to gain as a result of specialisation.[8]

4. Increased performance

Because FTAs engender specialisation in goods and services in which the nation has comparative advantage, ‘countries are able to take advantage of efficiencies generated from economies of scale and increased output’.[9] Further when, ‘firms face increased competition from rivals producing similar goods and services they usually lift their performance to the benefit of consumers in all participating countries’.[10]

5. Variety and Innovation

The FTAs will give African consumers access to a wider variety of goods and increased competition will spur, ‘companies to innovate and develop better products and to bring more of their goods and services to market, keeping prices low and quality high in order to retain or increase their market share’.[11]

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6. Investment efficiency

Fragmented African markets may have engendered the inefficient duplication of plants/ factories/ in different countries. [12] Integration allows for investment, particularly capital intensive investments, to be made in a manner that is most strategic at a continental level.

 7. Countries with similar economic structure stand to gain from each other

Integration can facilitate intra-industry trade between economies that produce similar products. In Europe it allowed firms in the same industry (in this case motor industry) to, ‘specialise in parts of a production process that they previously undertook in its entirety, or to concentrate on particular market segments’.[13]

 8. Economic and political reform

FTAs can lock member countries into economic and political reforms particularly if those policies or rules are stipulated within the agreement.[14] This is particularly the case for African countries that want to reassert their commitment to policy reforms and improving the underlying conditions of the economy in order to attract investment.[15]

9. Security

FTAs will enable Africa to not only enhance trade between countries on the content, they may well create a, ‘web of positive interactions and interdependency’ which is, ‘likely to build trust, raise the opportunity cost of war, and hence reduce the risk of conflicts between countries’. FTAs can help countries develop a ‘culture of cooperation’ on common issues in intra-regional security that can be addressed through common defense strategies and mutual military assistance.[16]

 10. Makes Africa economically stronger and more attractive

Africa is currently fragmented into 47 small economies each with its own regulatory structure and each of which present small potential markets. Integration will make Africa a larger more integrated and larger market making it more attractive to investors both within and outside the FTA. Further, FTAs create a platform that increases Africa’s visibility and bargaining power when negotiating agreements giving the continent space to make more lucrative deals.

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CONS OF FTAs

1. Facilitates the flow of illicit trade

It is not a stretch to surmise that as borders come down and the flow of goods, services and people is facilitated across nations, illicit goods can more easily get through the porous borders as well.

2. Increased security threats

While FTAs may allow better coordination between security arms of member governments, the relaxation on borders and free movement of people may allow individuals from terrorist organisations as well as criminals to more easily expand their activity beyond the borders of one country into another.

3. Increase in structural unemployment

Structural unemployment may arise in industries in some member countries that are in, ‘direct competition with other lower-cost trading partners due to a loss of comparative advantage’. [17]

 4. Risk of Trade Diversion

If African countries move to free trade between themselves but, ‘maintain significant tariffs vis-à-vis the rest of the world it may well result in trade diversion and welfare loss’.[18] This is additionally detrimental because FTAs can prevent innovation and creativity from non-member countries entering the FTA zone if tariffs are prohibitive.

diversion5. Can Magnify Inequalities

Africa is varied with regard to the stage at which each country stands in terms of economic development, size and strength. FTAs risk creating a scenario where, ‘more developed countries within the regional integration scheme dominate the market because they may have a head start’.[19] The playing field is not level and this may create momentum that magnifies the discrepancies in economic development on the continent.

 6. Creates difficulties for new industries and sectors

‘Developing or new industries may find it difficult to become established in a competitive environment with no short-term protection policies by government’[20]. Therefore, nascent industries may fail given the access to local markets by economies in which such industries are more developed.

7. Diplomatic tensions

Africa’s FTAs may benefit some member countries more than others and even though these benefits may only accrue in the short term, it risks the development of tension between governments and citizens of countries that are benefitting and those that are not yet seeing benefits. This dynamic will have to be carefully managed.

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 8. Increase in transaction costs

FTAs increase the complexity of the trading system and can raise transaction costs for business; ‘for example, complicated rules of origin are required to prevent third country products entering via the other party’.[21] Thus business may have to spend more time and money ensuring compliance to the introduction of new rules and regulations.

 9. Increased vulnerability to external shocks

A Continental FTA fosters, ‘closer trade links among member countries, and as a result increases the interdependence of their economies. This means that a recession in one country may quickly spread to other countries, which are its trading partners’.[22] Further, as African more intimately links itself to the global economy while also increasing intra-African economic integration, there is a risk that economic downturns in the global economy will spread over Africa more rapidly than would have been the case without regional and continental FTAs.

 10. The interface between Corruption and FTAs

Corruption may well find a new lease of life through FTAs in Africa. Because member countries get preferred access, unscrupulous traders may seek to gain entry into markets by repackaging external goods as those for member countries. This may present a new avenue of collecting illegal dues, particularly by government officials. Corruption remains a monster on the continent and FTAs may present a new and lucrative avenue through which this beast is fed.

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Therefore, it is clear that Africa can both gain and lose from FTAs. It is important that Africans enter this era of economic integration cognizant of these dynamics in order to ensure the process goes as smoothly as possible, that losses are minimised and benefits are maximised.

Endnotes

[1] Samuel Njihia (2014), ‘Africa’s largest free trade area to launch in December’, Business Daily http://www.businessdailyafrica.com/Africa-largest-free-trade-area-launch-December-/-/539546/2500008/-/wd82nr/-/index.html

[2] Samuel Njihia (2014), ‘Africa’s largest free trade area to launch in December’, Business Daily http://www.businessdailyafrica.com/Africa-largest-free-trade-area-launch-December-/-/539546/2500008/-/wd82nr/-/index.html

[3] COMESA-EAC-SADC Tripartite (2009), ‘Focal area 1: The Tripartite Free Trade Area (FTA)’, http://www.comesa-eac-sadc-tripartite.org/intervention/focal_areas/tripartite_fta

[4] COMESA-EAC-SADC Tripartite (2009), ‘Focal area 1: The Tripartite Free Trade Area (FTA)’, http://www.comesa-eac-sadc-tripartite.org/intervention/focal_areas/tripartite_fta

[5] UNECA (2011), ‘Study On The Establishment Of Inter-Recs’ Free Trade Areas In Africa Drawing On Lessons From The COMESA-SADC-EAC FTA experience’, http://www.uneca.org/sites/default/files/uploaded-documents/CTRCI-VII/tripartite_comesa_eac_sadc_fta-study-final-report.pdf

[6] Monash University (2001)‘An Australia-United States Free Trade Agreement – Issues and Implications:FTAs– advantages and disadvantages’, http://www.dfat.gov.au/publications/aus_us_fta_mon/Chapter3.pdf

[7] Lolette Kritzinger-van Niekerk (2005), ‘Regional Integration: Concepts, Advantages, Disadvantages and Lessons of Experience’, http://www.sarpn.org/documents/d0001249/P1416-RI-concepts_May2005.pdf

[8] Monash University (2001)‘An Australia-United States Free Trade Agreement – Issues and Implications:FTAs– advantages and disadvantages’, http://www.dfat.gov.au/publications/aus_us_fta_mon/Chapter3.pdf

[9] Edge, Ken (1999) Free trade and protection: advantages and disadvantages of free trade (), Charles Sturt University, http://www.hsc.csu.edu.au/economics/global_economy/tut7/Tutorial7.html

[10] Monash University (2001)‘An Australia-United States Free Trade Agreement – Issues and Implications:FTAs– advantages and disadvantages’, http://www.dfat.gov.au/publications/aus_us_fta_mon/Chapter3.pdf

[11] Denise H. Froning (2000), ‘The Benefits of Free Trade: A Guide For Policymakers’, Heritage Foundation, http://www.heritage.org/research/reports/2000/08/the-benefits-of-free-trade-a-guide-for-policymakers

[12] Lolette Kritzinger-van Niekerk (2005), ‘Regional Integration: Concepts, Advantages, Disadvantages and Lessons of Experience’, http://www.sarpn.org/documents/d0001249/P1416-RI-concepts_May2005.pdf

[13] Monash University (2001)‘An Australia-United States Free Trade Agreement – Issues and Implications:FTAs– advantages and disadvantages’, http://www.dfat.gov.au/publications/aus_us_fta_mon/Chapter3.pdf

[14] Lolette Kritzinger-van Niekerk (2005), ‘Regional Integration: Concepts, Advantages, Disadvantages and Lessons of Experience’, http://www.sarpn.org/documents/d0001249/P1416-RI-concepts_May2005.pdf

[15] Lolette Kritzinger-van Niekerk (2005), ‘Regional Integration: Concepts, Advantages, Disadvantages and Lessons of Experience’, http://www.sarpn.org/documents/d0001249/P1416-RI-concepts_May2005.pdf

[16] Lolette Kritzinger-van Niekerk (2005), ‘Regional Integration: Concepts, Advantages, Disadvantages and Lessons of Experience’, http://www.sarpn.org/documents/d0001249/P1416-RI-concepts_May2005.pdf

[17] JC Economics, ‘Analyse the impact of FTAs on the Singapore economy and assess the extent to which the impact of FTAs has been positive’, jc-economics-essays.blogspot.com/2012/08/analyse-impact-of-ftas-on-singapore.html

[18] Lolette Kritzinger-van Niekerk (2005), ‘Regional Integration: Concepts, Advantages, Disadvantages and Lessons of Experience’, http://www.sarpn.org/documents/d0001249/P1416-RI-concepts_May2005.pdf

[19] Lolette Kritzinger-van Niekerk (2005), ‘Regional Integration: Concepts, Advantages, Disadvantages and Lessons of Experience’, http://www.sarpn.org/documents/d0001249/P1416-RI-concepts_May2005.pdf

[20] Edge, Ken (1999) Free trade and protection: advantages and disadvantages of free trade (), Charles Sturt University, http://www.hsc.csu.edu.au/economics/global_economy/tut7/Tutorial7.html

[21] Monash University (2001)‘An Australia-United States Free Trade Agreement – Issues and Implications:FTAs– advantages and disadvantages’, http://www.dfat.gov.au/publications/aus_us_fta_mon/Chapter3.pdf

[22] JC Economics, ‘Analyse the impact of FTAs on the Singapore economy and assess the extent to which the impact of FTAs has been positive’, jc-economics-essays.blogspot.com/2012/08/analyse-impact-of-ftas-on-singapore.html

Africa’s Infrastructure Hype: Recommendations

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In last week’s post I discussed the opportunities and risks that Africa faces in what will inevitably be significant and targeted investment in infrastructure from local and foreign investors. The next question is: What can Africa do to make the most of opportunities in a manner that minimises the risks? The suggestions below are not exhaustive but rather seek to highlight key reccomendations:

1. Avoid Legacy Projects

Simple point but difficult to execute given African leader’s predilection for such projects as means of ensuring immortality and eternal adulation. The reality is that in some countries the culture will support legacy projects. In such cases it is imperative that such projects still be vetted for practicality, contributions to productivity and growth and just basic usefulness. As the World Bank states, ‘all investments under political consideration should pass at least a minimum threshold of economic viability’.[1]

2. Match infrastructure projects with specific economic development goals

In order to generate revenues for newly built infrastructure, investment should be concentrated in high potential areas through developmental corridors and primary production centers which promise the greatest economic return such that they become infrastructure hubs with efficient ports and airports to maximize scale. [2] After all, Africa must avoid‘unsustainable infrastructure development that pose a huge financial burden on the host government.’[3]

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3. Secure funds for maintenance spending

While raising investment capital governments should be cognizant of maintenance needs and ensure these are catered for. Further, ‘maintenance offers one of the highest returns to infrastructure spending; it may be more helpful to think of maintenance as a kind of investment in asset preservation’.[4

4. Use infrastructure to catalyse regionalism and African integration

Where possible and pragmatic, African governments should work with other governments in regional and multi-country infrastructure projects to reap benefits such as:

  • Cost effectiveness: For example the West Africa Power Market Development Project could see Nigeria and Cote d’Ivoire reduce their power generation costs from 8-10 US cents per kWh to only 3.5 and 4-4.5 cents per kWh.[5] Other projects include those in Southern and East Africa. This trend should be encouraged.
  • Creates economies of scale: Regional infrastructure not only harnesses regional public goods, it fosters intra-regional trade and global trade.[6] Shared inter-country infrastructure also, ‘addresses the problems of small scale and adverse location by increasing the scale of construction, operation, maintenance and revenue. It reduces costs, pools scarce technical and managerial capacity and creates a larger market’. [7]
  • Peace building: Connected countries foster cultural interaction and provide a platform for the development of collaborative arrangements to deal with peace and security concerns.[8]

5. Foster Public Private Partnerships (PPPs)

The private sector has mainly invested in expanding the ICT footprint on the continent with investment in power plants and container terminals as well. The private sector, particularly the LOCAL private sector, not only can play a role in tackling costly management inefficiencies such as undercollected utility revenues, low labor productivity, or neglected road maintenance, ‘companies have an important role to play in evaluating the social and environmental impacts of their activities’.[9],[10] The private sector role can be expanded by African governments by making PPPs attractive through mechanisms such as [11],[12]:

  • Identifying the contributions that the private sector can make using costs/benefits analysis
  • Create risk-mitigating instruments such as guarantees and co-financing facilities that can help to attract private sector investment
  • Ensure appropriate risk allocation across partners
  • Engage the private sector to formulate their requirements and constraints in order promote mutual understanding and better appropriateness of contracts.
  • Develop appropriate tariff schemes and/or funding mechanisms that allow for proper operation and maintenance of infrastructure and account for the different levels of affordability

Bear in mind that, ‘in countries with well-developed frameworks for PPPs, project preparation costs are generally about 1% as a percentage of total project costs, but for countries without much PPP experience, the project preparation costs run between 3% and 10% of total project costs.’[13] Africa has to get this right.

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6. Strengthen line ministries

Ministries related to infrastructure have to be engaged and strengthened since they, ‘take the lead in sector planning, participate in the formulation of the public budgets, and execute investments.’[14] One approach to strengthening line ministries is through, ‘creating engineering universities within line ministries to support infrastructure development’, as China did.[15] This means there needs to be a conversation between the line ministries and the ministry of education to ensure the universities teach the skills the ministry needs. Other strategies include[16]:

  • Strengthening sector planning such that the construction of critical new assets begins early enough to come on stream when needed
  • The development of sound technical methodologies for identifying and selecting infrastructure projects
  • More rigorous project screening such that infrastructure investments are selected according to their expected returns and are appropriately sequenced and synchronized with one another and broader development plans
  • Another key element of strengthening line ministries is improving the budgetary process such that the process is medium-term, link sector objectives and resource allocations and are underpinned by clear sector plans that go down to specific activities and their associated costs

7. Address the land issue

Crucial to infrastructure projects is ensuring the lands on which the projects are built are not beleaguered in conflicting claims and acrimony. There are examples of strategies to address this. For example in Burkina Faso, Rwanda and Sierra Leone the Investment Climate Facility for Africa automated land registration processes which led to facilitating access to credit and prevented land disputes.[17]

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8. Foster Harmonisation [18]

Given the multitude of actors that will be involved in African infrastructure projects, there should be coordination between different bodies where possible. This could be done via pan African bodies such as the AfDB due what some consider as its robust financial management systems and firm commitment by all stakeholders. Such coordination would also allow for common reporting and joint monitoring and evaluation processes. Investors and implementers can also organise informational exchange meetings on infrastructure activities at national or regional levels. Further, division of labour among investors such that each administer small portions of the total investment for Africa’s infrastructure can be considered.

9. Create an enabling environment

Bear in mind that, ‘the enabling environment cannot be dissociated from broader governance reforms—for instance, anti-corruption measures or a developed financial sector’.[19] African governments have to prove they have the capacity to manage the incoming investment, deliver on projects and ensure deadlines are met efficiently. This means eliminating issues such as poor policy planning and weak operational performance or poor municipality/county functioning crucial to project implementation.[20] These key elements, also addressed in points 5,6 and 8, are crucial to fostering confidence for continued investment in infrastructure.

10. Remember affordability

Infrastructure development, particularly basics such as roads, water and electricity, cannot afford to leave out the poor. This is a challenge because in the case of water and sanitation ‘an estimated 60 percent of the African population cannot afford to pay full cost-recovery tariffs or extend consumption beyond the absolute minimum subsistence level’.[21] African governments and investors have to find a means through which access to infrastructure such as water, energy will be affordable where affordability is, ‘measured by the share of infrastructure spending in the total household budget and whether it exceeds a set threshold.’[22] African governments therefore must take the time to consider affordability needs at the public finance level. If households, ‘cannot afford to pay cost-recovery tariffs, the move toward universal access will create burgeoning liabilities for the state, which must bridge the gap between the tariffs the public can afford to pay and the real cost of service provision’.[23] Therefore governments must assess how, when and, ‘whether subsidizing services to reach universal coverage is an affordable strategy at the country level.’[24]

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[1] Vivien Foster and Cecilia Briceño-Garmendia (2011), ‘Africa’s Infrastructure: A Time For Transformation’, Agence Française de Développement and the World Bank,, http://infrastructureafrica.org/library/doc/552/africa%E2%80%99s-infrastructure-time-transformation

[2] Tanya Konidaris and Clare Allenson (2011), ‘Africa’s Infrastructure Regional Challenges And Opportunities, Johns Hopkins University-Sais, http://www.wilsoncenter.org/sites/default/files/Infrastructure%20Discussion%20Paper.pdf

[3] OECD (2012), ‘ Mapping Support for Africa’s Infrastructure Investment’, http://www.oecd.org/daf/inv/investment-policy/MappingReportWeb.pdf

[4] Vivien Foster and Cecilia Briceño-Garmendia (2011), ‘Africa’s Infrastructure: A Time For Transformation’, Agence Française de Développement and the World Bank,, http://infrastructureafrica.org/library/doc/552/africa%E2%80%99s-infrastructure-time-transformation

[5] Benno Ndulu, Lolette Kritzinger-van Niekerk and Ritva Reinikka (2005), ‘Infrastructure, Regional Integration and Growth in Sub-Saharan Africa’, Africa in the World Economy – The National, Regional and International Challenges, http://www.fondad.org/uploaded/Africa%20in%20the%20World%20Economy/Fondad-AfricaWorld-Chapter9.pdf

[6] Tanya Konidaris and Clare Allenson (2011), ‘Africa’s Infrastructure Regional Challenges And Opportunities, Johns Hopkins University-Sais, http://www.wilsoncenter.org/sites/default/files/Infrastructure%20Discussion%20Paper.pdf

[7] Benno Ndulu, Lolette Kritzinger-van Niekerk and Ritva Reinikka (2005), ‘Infrastructure, Regional Integration and Growth in Sub-Saharan Africa’, Africa in the World Economy – The National, Regional and International Challenges, http://www.fondad.org/uploaded/Africa%20in%20the%20World%20Economy/Fondad-AfricaWorld-Chapter9.pdf

[8] Benno Ndulu, Lolette Kritzinger-van Niekerk and Ritva Reinikka (2005), ‘Infrastructure, Regional Integration and Growth in Sub-Saharan Africa’, Africa in the World Economy – The National, Regional and International Challenges, http://www.fondad.org/uploaded/Africa%20in%20the%20World%20Economy/Fondad-AfricaWorld-Chapter9.pdf

[9] Vivien Foster and Cecilia Briceño-Garmendia (2011), ‘Africa’s Infrastructure: A Time For Transformation’, Agence Française de Développement and the World Bank,, http://infrastructureafrica.org/library/doc/552/africa%E2%80%99s-infrastructure-time-transformation

[10] Céline Kauffmann(2008), ‘ Engaging the Private Sector in African Infrastructure’, NEPAD and OECD, http://www.oecd.org/investment/investmentfordevelopment/41775965.pdf

[11] Céline Kauffmann(2008), ‘ Engaging the Private Sector in African Infrastructure’, NEPAD and OECD, http://www.oecd.org/investment/investmentfordevelopment/41775965.pdf

[12] Tanya Konidaris and Clare Allenson (2011), ‘Africa’s Infrastructure Regional Challenges And Opportunities, Johns Hopkins University-Sais, http://www.wilsoncenter.org/sites/default/files/Infrastructure%20Discussion%20Paper.pdf

[13] OECD (2012), ‘ Mapping Support for Africa’s Infrastructure Investment’, http://www.oecd.org/daf/inv/investment-policy/MappingReportWeb.pdf

[14] Vivien Foster and Cecilia Briceño-Garmendia (2011), ‘Africa’s Infrastructure: A Time For Transformation’, Agence Française de Développement and the World Bank,, http://infrastructureafrica.org/library/doc/552/africa%E2%80%99s-infrastructure-time-transformation

[15] Calestous Juma (2012), ‘Poor Infrastructure Is Africa’s Soft Underbelly’, Forbes, http://www.forbes.com/sites/mfonobongnsehe/2012/10/25/poor-infrastructure-is-africas-soft-underbelly/

[16] Vivien Foster and Cecilia Briceño-Garmendia (2011), ‘Africa’s Infrastructure: A Time For Transformation’, Agence Française de Développement and the World Bank,, http://infrastructureafrica.org/library/doc/552/africa%E2%80%99s-infrastructure-time-transformation

[17] Omari Issa (2013), ‘Africa Infrastructure Investment Report 2013’, Commonwealth Business Council http://www.cbcglobal.org/images/uploads/docs/The_CBC_Africa_Infrastructure_Investment_Report_2013.pdf

[18] OECD (2012), ‘ Mapping Support for Africa’s Infrastructure Investment’, http://www.oecd.org/daf/inv/investment-policy/MappingReportWeb.pdf

[19] OECD (2012), ‘ Mapping Support for Africa’s Infrastructure Investment’, http://www.oecd.org/daf/inv/investment-policy/MappingReportWeb.pdf

[20] OECD (2012), ‘ Mapping Support for Africa’s Infrastructure Investment’, http://www.oecd.org/daf/inv/investment-policy/MappingReportWeb.pdf

[21] Sudeshna Ghosh Banerjee and Elvira Morella (2011), ‘Africa’s Water and Sanitation

Infrastructure: Access, Affordability, and Alternatives’, World Bank http://www.oecd.org/daf/inv/investment-policy/MappingReportWeb.pdf

[22] Sudeshna Ghosh Banerjee and Elvira Morella (2011), ‘Africa’s Water and Sanitation

Infrastructure: Access, Affordability, and Alternatives’, World Bank http://www.oecd.org/daf/inv/investment-policy/MappingReportWeb.pdf

[23] Sudeshna Ghosh Banerjee and Elvira Morella (2011), ‘Africa’s Water and Sanitation

Infrastructure: Access, Affordability, and Alternatives’, World Bank http://www.oecd.org/daf/inv/investment-policy/MappingReportWeb.pdf

[24] Sudeshna Ghosh Banerjee and Elvira Morella (2011), ‘Africa’s Water and Sanitation

Infrastructure: Access, Affordability, and Alternatives’, World Bank http://www.oecd.org/daf/inv/investment-policy/MappingReportWeb.pdf

Africa’s Infrastructure Hype: The Opportunities and Risks

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Earlier this month over 40 African Heads of State gathered in Washington DC at the inaugural US-Africa Leaders’ Summit. This is the first ever initiative of this scale initiated by an American President specifically targeted towards Africa and with a core focus on infrastructure. 90 U.S. companies participated in the forum including Chevron Corp , Citigroup Inc, Ford Motor Co, Lockheed Martin Corp and Morgan Stanley.[1] We in Africa understand that the world is beginning to wake up to the potential and capabilities of the continent but this summit was still important in order to garner the type of international attention required to continue to drive investments of significant scale on the continent by the North which has been losing ground to the East in recent times. This summit is also important because it has allowed African leaders to articulate their commitment to moving away from a relationship of “aid donor and aid recipient” to one of investment and trade.[2]

 According to the White House, US companies pledged investments totalling more than $33 billion to Africa.[3] US and African companies as well as the World Bank pledged new investment in construction, energy, water and information technology projects in Africa. This article will focus on infrastructure deals as these were where key pledges were made, where Africa’s needs are dire and where the scale of investment will be significant. The key deals in the summit include:[4],[5],[6],[7],[8]

  • General Electric Co: $2 billion to boost infrastructure, worker skills and access to energy
  • Power Africa: $12 billion in new commitments from US private sector partners, the World Bank and the government of Sweden
  • Beyond the Grid program: US Private sector commitments of more than $1 billion, including new investments in off-grid and small-scale energy solutions to rural communities.
  • IBM: $2 billion into the region over seven years
  • $5billion partnership between private-equity firm Blackstone and Carlyle, and Aliko Dangote (Africa’s richest businessman) for energy infrastructure projects.
  • Coca Cola: $5 billion for projects including safe water access programs

 GROUP4

How does the USA compare with China?

In terms of how this investment fits into the trend in energy and investment, $33 billion sounds massive but pales in comparison to what China has been putting into Africa, in infrastructure alone, over the past few years. China, invested more than $13 billion in infrastructure in Africa in 2012 alone. [9] But that’s not all, let’s take a handful of recent deals; in May 2014 China committed US 20 billion in loans for infrastructure development to Nigeria alone.[10] In terms of East Africa, 2013 saw Kenya sign deals worth $5 billion with China for the construction of a railway line and an energy project.[11] Earlier this year, China announced that it will finance a $1.2 billion gas pipeline project in Tanzania from Mtwara to Dar es Salaam as well a railway network at Bagamoyo with investment of more than $10 billion.[12] Uganda is not far behind where China is financing 85% of two hydroelectric projects worth $1.4 billion and $556 billion respectively. Also in Uganda 2013 saw the China National Offshore Oil Corporation win the right to develop Uganda’s Kingfisher field with investments worth $2 billion. You get the picture; the USA has a lot of catching up to do.

Other major foreign players in African infrastructure are Brazil, India and South Korea in addition to a significant increase in commitments from the Arab Coordination Group, totalling $5.15bn in 2012.[13] 

Africa’s Infrastructure Needs

One may wonder if Africa truly needs all these billions in targeted at infrastructure. According to the Africa Infrastructure Country Diagnostic, the continent’s infrastructure spending needs stand at about $93 billion per year.[14] Over 40 % of the expenditure needed is in the power sector; 20 % the for the transport sector to achieve a reasonable level of regional, national, rural, and urban connectivity and slightly more than 20 percent is for water supply and sanitation.[15] The main element of the infrastructure puzzle that Africa is getting right is the increase in penetration of telecommunications; but this sector can and must be further developed.

 131217110359-kenya-chinese-railway-1-horizontal-gallery

 

Why is Infrastructure Important?[16]

  • Electricity: Supply creates benefits for health because vaccines and medications can be safely stored in hospitals and food can be preserved at home. Electricity also improves literacy and primary school completion rates because students can read and study after sundown. Access to electricity lowers costs for businesses and increases investment and driving economic growth.
  • Transport: Enables isolated rural communities to move into commercial agriculture, thereby increasing their income, and to use health and education services some distance away. By reducing the time and money it takes to move goods, better transportation improves competitiveness, helping create more jobs and boost incomes.
  • Water and Sanitation: Prevents serious illnesses transmitted through unsafe water and better water and sanitation service is associated with less malnutrition and stunting. Waterborne illnesses can be a substantial economic burden, affecting both adult productivity and children’s overall health and education. Sufficient water also reduces the substantial opportunity cost in travel time when women in particular have to fetch water.
  • ICT: Expansion of ICT networks democratizes access to information. It can be particularly critical for rural populations otherwise cut off from important technological know-how or critical information about market prices. telecommunication improvements also reduce transportation spending by allowing people to avoid fruitless journeys or to perform transactions remotely

 So dire is the negative effect of poor infrastructure on economic growth that for most of Africa that power deficiencies alone reduce per capita growth by 0.11-0.2 percentage points. For many countries, such as Ethiopia, Malawi, and Senegal, the negative effect of deficient infrastructure is at least as large as that of crime, red tape, corruption, and lack of financing.

 Kenya is the number one choice in Africa for investors in infrastructure[17]

According to the African Development Bank, Kenya is considered the most attractive infrastructure investment destination in Africa,; South came second. When respondents to the Survey of Private Sector Investors (in infrastructure) were asked why Kenya, the following was stated:

  • Transparent operating environment.
  • Growing economy and emerging sector in ICT and low rate of criminality and corruption
  • The Kenyan government is very pragmatic in its approach when dealing with private investors
  • Institutional capacity and its clear and fit-for-purpose regulatory framework, which ensured projects are run relatively efficiently

 

 Opportunities in investment in Infrastructure

So what opportunities does investment in infrastructure offer the continent now?

Firstly, Africa’s energy needs are dire. In fact, ‘Africa will need to install 7 gigawatts of new power generation per year’ to meet energy needs. This means that the African market is still underserved therefore opportunities for investments exist in a context where Africa is tabling robust growth. In a continent where, ‘power costs 14 US cents per kilowatt-hour against 5– 10 US cents elsewhere’, investment presents attractive opportunities that ensure, ‘returns to investors are high’. [18] This creates an environment where investors want to invest in infrastructure in Africa at a time when Africa needs it the most. Win-win.

 

Secondly, a massive opportunity lies in the fact that Africa’s infrastructure needs are going to be met at a time when high-tech, clean and efficient energy options are available. Renewable energy is seen as an ideal fit for Africa across the board. In a report on investment and trends in Africa’s clean energy sector that surveyed 140 senior executives and industry stakeholders from around the world, respondents stated that, ‘Africa’s strong wind and solar resources as a strong driver for renewables deployment’ and that, ‘wind, solar, hydro and biomass projects will play a major role in meeting Africa’s growing power needs’. Added to this Africa can focus on building clean coal capacity as well. Africa stands to become the continent with cleanest energy infrastructure in the world.[19]

 RES-Southern-Africa

Linked to the point above Africa stands to gain more bang for the buck as,’ Renewable energy is relatively quick and cheap to deploy on a small scale compared with fossil fuels’.[20] This affordability for Africa is enhanced by the fact that there is competition in the sector for energy, ‘Japanese trading houses and industrial corporations, the big five Chinese power companies and Chinese wind and solar equipment manufacturers’ are keen to get a slice of the pie in addition to Northern partner. Africa has the solid opportunity to get clean energy affordably.[21]

 

Thirdly investment in infrastructure, specifically the transport sector, has multiplier effects by not only linking people, goods, services, knowledge and markets but also by more creating a more attractive environment for foreign investors.[22]

 

Fourthly, investment in infrastructure will help Africa develop economically; indeed, infrastructure could, ‘add 2% to Africa’s GDP growth rate and improve productivity by 40%’.[23] Infrastructure will also enhance intra-African trade and take an important step towards broader regional integration.[24] Indeed, ‘regional infrastructure will create scale economies, harness regional public goods, increase intra-regional trade and global trade, and improve competitiveness’.[25] Africa can use this opportunity to drive intra-African trade and make use of economies of scale.

 

Fifthly, investment in infrastructure will help Africa meet development and poverty reduction goals. The MDG Africa Steering Group which consists of representatives of the UN, AfDB, AU, EC,IMF, OECD and the World Bank Group, argues that, ‘investments in transformational energy generation projects, including large-scale hydropower, and transmission net­works need to be increased substantially if the continent is to meet the MDGs’. [26] The visual below from the UN-Africa Working Group (2007) illustrates the power that improving infrastructure can have on African development by meeting 7 of the 8 MDGs:

Role of infrastructure in the MDGs [27]

 

Energy

ICT

Transport

Water and Sanitation

MDG 1: Eradicate extreme poverty

Energy increases productivity of firms

ICT increases productivity of firms

Transport facilitates trade of goods

Enables greater workforce participation

MDG 2:   Achieve universal primary education

Lighting facilities for reading and studying at home

Improved access to educational material

Ensure access to educational facilities

Reduces burden of domestic work on children

MDG 3: Promote gender equity and empower women

Energy facilitates domestic work

   

Reduces burden of domestic work

MDG 4: Reduce child mortality

Modern energy reduces respiratory illness

Improved access to public health messages

Ensures access to health facilities

Improved water and sanitation reduced the risk of waterborne diseases

MDG 5: Improve maternal health

Energy improves quality of health care

Improved access to public health messages

Ensures access to health facilities

Improved water and sanitation reduced the risk of waterborne diseases

MDF 6: Combat HIV/AIDS, malaria and other diseases

Modern energy reduces respiratory illness

Improved access to public health messages

Ensures access to health facilities

Clean water, sanitation and hygiene are significant elements of health programs including HIV/AIDS. Proper drainage contributes to control of malaria and other waterborne diseases.

MDG 7: Ensure environmental sustainability

Use of modern energy reduced the pressure on deforestation

   

Access to improved water and sanitation is one of the targets of this MDG

 

Another opportunity for Africa is that these incoming projects offer, ‘substantial short-term employment to counteract otherwise rising unemployment’.[28]

 

Additionally, this focus on infrastructure is happening in a context where there is a push for efficiency and organisation from infrastructure investors who, ‘do not want to be involved in projects where there are no clear implementation timelines or where the timelines, are repeatedly moved out. Infrastructure investors want to be involved in projects that are high priority for governments and thus are likely to come to a conclusion’. [29]This emphasis will serve the interest of African citizens many of whom are interested in ensuring projects are not only completed in a timely and efficient manner but also meet their needs.

 

Finally, infrastructure has a role to play in securing peace on the continent, ‘a national system of highways and railroads can provide opportunities for the types of cultural exchanges (e.g., between ethnic communities) that will greatly enhance national integration and minimize destructive ethnic and religious conflict’.[30]

 peace

It is clear there is ample room for Africa to benefit from the infrastructure hype but what are the risks?

 What are the risks?

Firstly there is the issue of malinvestment and the potential creation of ghost towns and bridges to nowhere. Here malinvestment means mistaken investment in infrastructure, ‘which inevitably leads to wasted capital and economic losses, subsequently requiring the reallocation of resources to more productive uses. “Wrong” in this sense means incorrect or mistaken from the point of view of the real long-term needs and demands of the economy’.[31] This becomes a risk particularly when there are numerous lines of credit and plenty of liquidity. Africa’s risks with regards to malinvestment do not lie in central bank policies setting artificially low interest rates or aggressive stimulatory policies as has been the case elsewhere, in Africa’s case, ‘infrastructure projects and their large scale require different types of financiers, including private sector, bilateral and multilateral partners’.[32] Thus given the number of players on the field, some with very deep pockets (from Africa’s point of view), there is a risk of money being thrown at infrastructure projects of poor merit. Lessons can be learnt from China’s Kongbashi District with, ‘sky high apartments, gleaming infrastructure and modern townhouses. Nearly empty of residents, it has been dubbed China’s ‘Ghost Town’.’[33] Africa simply cannot afford to indulge in projects that do not support or lead to economic activity. As Nderi, an investment analyst states, ‘in short we have to ensure that the infrastructure will grow businesses that will support and pay for the infrastructure. Imagine a road that links two towns but with no production to support it’.[34] Also bear in mind that African politicians have a penchant for, ‘”prestige projects” or “white elephants”- infrastructure projects that generate significant benefits for governing elites but provide very little or even negative social value’.[35] This should be a prescient warning that malinvestment will likely have a different face in Africa.[36] So while it is clear Africa needs infrastructure, each project should be rigorously analysed on its own merit so that Africa is not lured into investing in projects that build bridges to nowhere.

 bridge-to-nowhere

Secondly, there are uniquely high costs for infrastructure development in Africa. In fact, ‘Africa’s infrastructure services are twice as expensive as elsewhere, reflecting both diseconomies of scale in production and high profit margins caused by lack of competition.’[37] Further, ‘whether for power, water, road freight, mobile telephones, or Internet services, the tariffs paid in Africa are several multiples of those paid in other parts of the developing world’.[38] This is an issue for Africans because a number of infrastructure projects will be co-financed by government making the poorest continent in the world pay the steepest prices to meet basic infrastructure needs.

 

Linked to the point above is the risk that the new projects will be a sight to behold when completed but will fall into disrepair due to poor maintenance of new structures. Nderi alludes to the new Thika road in Kenya, ‘whose maintenance cost is proving to be a drain…it is possible to develop infrastructure that a country may not be able to afford’.[39]

 

Africa is already grappling with this next risk which is a failure to use projects to create local employment opportunities and ensure skills transfer to the local workforce. Just this month in Kenya, ‘at least 5,000 foreign workers will be shipped into the country from China to undertake the construction of the 609km standard gauge railway from Mombasa to Nairobi.’ [40] Although there will be a local workforce of 30,000, experience with China indicate that Africans employed on construction sites are often as cheap and poorly skilled labour, and even this isn’t guaranteed as China has been known bring in unskilled labour. Such patterns cannot continue as they not only keep Africa from reaping the benefits of the creation of jobs, they also condemn Africa to being eternally reliant on foreigners to build infrastructure and prevent Africa from developing the capacities required to maintain the new structures.

 

Another risk is government; there are, ‘concerns about governance and slow project approvals by the government…Clearances from various ministries and departments add to the delay. Since there is no single-window mechanism, considerable time is wasted addressing the protocols of multiple agencies. This complex clearance mechanism delays many projects… The pre-tendering process can extend for almost a year.’[41] Even the casual African observer would likely agree that government can be a slow and lethargic animal that can make one pull one’s hair out.

 

Fourthly, in Africa multiple agencies will be working on infrastructure projects which means various approvals required across the different stages of the project cycle. Multiple players will invariably mean conflict rooted in differing viewpoints and expectations, potentially making implementation of projects hard. Trinity International LLP, a law firm that advises on power, energy/renewable energy, resources and infrastructure in sub Saharan Africa shares experiences where, ‘public sector’s expectations as to the risks it should bear are different from the expectations of the developer and, the banks’ and thus ‘the developer continues to push the public sector in a direction it is unwilling to go, thereby (further) delaying the negotiation process.’[42] Although this delay also affects financiers and developers, Africans waiting for roads to be built will be affected by the fact that big deals may be mired in conflict thereby delaying urgently needed work.

 pump

Another risk that should make one shudder is the beast called land. There may be agreement across the board that Africa needs infrastructure, but issues such as land acquisition on which the structures will be built are not always adequately dealt with. In, ‘sub-Saharan Africa where land ownership is complex and legally uncertain, third party claims to land can often arise on an unregulated basis, free from planning constraints. This results in houses, businesses and often informal utilities connections being located illegally on areas of land ear-marked for the project’.[43] From the citizens’ point of view, there is the risk of being forced to relocate and leave ancestral land without necessarily being compensated adequately, if at all. And of course for African governments the risk is creating acrimony and political difficulties. Land use issues must be sensitively managed as a failure to do so may create pockets of instability on the continent.

 

Another risk is the environment and herein lays a conundrum; while Africa stands to benefit from becoming the cleanest energy producer in the world, ‘there is a dark side to infrastructural investments: they often lead to environmental degradation. Fossil fuel energy generation and transportation create emissions that contribute to acid rain locally and global warming. Hydropower and irrigation can lead to flooding, water pollution, and disruption of communities. Roads can lead to erosion, deforestation, and biodiversity loss. These environmental costs have been estimated to each four to eight percent of GDP for some developing countries, with most of the effects falling on the poor.’[44]

 

Asymmetrical investment is a risk for Africa as well because often, ‘the territories most in need of development are generally those that are in the direst of circumstances and therefore the least attractive to investors’.[45] As a result, investment may leave marginalized communities out of the loop as projects in remote areas are not viable. However, while the centrality of prudent investment should remain, Africa cannot afford to continue to neglect communities that have been left out of development projects for decades. This is a difficult risk to grapple with but it must be addressed.

 

Another important risk is that of overleveraging, particularly if Africa’s infrastructure will be financed by shadow banking which Standard and Poor’s define as, ‘the system of finance that exists outside regulated depositories, commercial banks, and publicly traded bonds. Shadow banking participants include pension funds, insurers, sovereign wealth funds, and export credit agencies, alongside finance companies, private investment funds, business development corporations, asset managers, hedge funds, and sponsored intermediaries such as money-market funds’. In 2013 S&P anticipated that for infrastructure projects around the world, Africa included, ‘up to $25 billion of project finance debt will sourced from the shadow banking sector’.[46] Such trends complicate what will be an already complicated financing structure for projects in Africa. Is there going to be a central point through which all projects will be monitored and managed? Will progress and financial transactions be communicated to the public? If not, it creates an overleveraging risk because if, ‘loans and private placements from institutions do not trade through a central exchange, there is no place to observe the activity. This leaves the potential for a build-up of debt to be largely overlooked’.[47]

 

Finally, government mismanagement of funds perhaps is the largest risk of all. Look at Ghana which not only, ‘anticipated too much revenue from its recently found oil reserves’ but also ‘frittered it away paying higher salaries to civil servants’ rather than using the funds for infrastructure projects.[48] When high infrastructure costs (which make it difficult to ascertain if budgets are inflated) are coupled with high liquidity and interfaced with corruption, it is a recipe for disaster. And it is the African people who will pay if their governments engage in financial misbehaviour.

 anti c

So what is Africa to do given that there are juicy opportunities yet worrisome risks associated with infrastructure investment? Find out next week where recommendations that address the risks and optimise the opportunities will be discussed.

 Anzetse Were is a Development Economist

anzetsew@gmail.com

 

Endnotes

 

[1] Reuters (2014), ‘UPDATE 4-U.S.-Africa summit garners over $17 bln in investment pledges’,

http://www.reuters.com/article/2014/08/05/africa-summit-idUSL2N0QB0MW20140805

[2] Reuters (2014), ‘UPDATE 4-U.S.-Africa summit garners over $17 bln in investment pledges’,

http://www.reuters.com/article/2014/08/05/africa-summit-idUSL2N0QB0MW20140805

[3] White House (2014), ‘President Obama Engages with African Leaders on Final Day of the U.S.-Africa Leaders Summit’,

http://www.whitehouse.gov/blog/2014/08/06/president-obama-engages-african-leaders-final-day-us-africa-leaders-summit

[4] Reuters (2014), ‘UPDATE 4-U.S.-Africa summit garners over $17 bln in investment pledges’,

http://www.reuters.com/article/2014/08/05/africa-summit-idUSL2N0QB0MW20140805

[5] Mipe Okunseinde (2014), ‘U.S. Companies Prove Eager To Take the Lead in Investing in Africa’, http://www.covafrica.com/

[6] BBC(2014), ‘US-Africa Summit: US firms to invest $14bn in Africa’, http://www.bbc.com/news/business-28668533

[7] White House Office of the Press Secretary (2014), ‘FACT SHEET: Powering Africa: Increasing Access to Power in Sub-Saharan Africa’

http://www.whitehouse.gov/the-press-office/2014/08/05/fact-sheet-powering-africa-increasing-access-power-sub-saharan-africa

[8] The White House Office of the Press Secretary (2014), ‘FACT SHEET: The Doing Business in Africa Campaign’. http://www.whitehouse.gov/the-press-office/2014/08/05/fact-sheet-doing-business-africa-campaign

[9] Rene Vollgraaff and David Malingha Doya (2014), ‘African Development Bank Raises Funding as China Boosts Role’, Bloomberg, http://www.bloomberg.com/news/2014-05-18/african-development-bank-steps-up-funding-as-china-boosts-role.html

[10] Patrick Atuanya (2014), ‘Nigeria to benefit from $12bn Chinese Africa infrastructure fund’,

http://businessdayonline.com/2014/05/china-promises-africa-robust-infrastructure-transformation/#.U-NYRKNasdU

[11] Reuters (2013), ‘Kenya signs infrastructure, energy deals worth $5 bln with China’, http://www.reuters.com/article/2013/08/19/kenya-china-idUSL6N0GK2MT20130819

[12] Henry Lyimo (2014), ‘Tanzania’s Economy On Right Track – – Chinese Ambassador’, Tanzania Daily News, http://allafrica.com/stories/201402261451.html

[13] African Development Bank (2013), ‘Infrastructure Financing Trends In Africa: Ica Annual Report 2012’, http://www.icafrica.org/fileadmin/documents/Annual_Reports/ICA%20_AnnualReport%202012.pdf

[14] Amadou Sy (2013), Financing Africa’s Infrastructure Gap

Brookings Institute, http://www.brookings.edu/blogs/up-front/posts/2013/10/09-financing-africa-infrastructure-gap-sy

[15] Vivien Foster and Cecilia Briceño-Garmendia (2011), ‘Africa’s Infrastructure: A Time For Transformation’, African Development Bank Group, http://infrastructureafrica.org/library/doc/552/africa%E2%80%99s-infrastructure-time-transformation

[16] Vivien Foster and Cecilia Briceño-Garmendia (2011), Africa’s Infrastructure: A Time For Transformation

[17] African Development Bank Infrastructure Financing Trends In Africa: Ica Annual Report 2012

[18] Albert Mafusire, John Anyanwu et al (2010), ‘ Infrastructure Deficit and Opportunities in Africa, The African Development Bank Group, http://www.afdb.org/fileadmin/uploads/afdb/Documents/Publications/ECON%20Brief_Infrastructure%20Deficit%20and%20Opportunities%20in%20Africa_Vol%201%20Issue%202.pdf

[19] Baker & McKenzie (2013), ‘The Future for Clean Energy in Africa’, http://www.bakermckenzie.com/files/upload/The%20future%20for%20clean%20energy%20in%20Africa%20%28Final%29.pdf

[20] Baker & McKenzie (2013), ‘The Future for Clean Energy in Africa’, http://www.bakermckenzie.com/files/upload/The%20future%20for%20clean%20energy%20in%20Africa%20%28Final%29.pdf

[21] Baker & McKenzie (2013), ‘The Future for Clean Energy in Africa’, http://www.bakermckenzie.com/files/upload/The%20future%20for%20clean%20energy%20in%20Africa%20%28Final%29.pdf

[22] Oxford Business Group (2014), ‘ The multiplier effect: Public-private partnerships should provide a boost to infrastructure development’, http://www.oxfordbusinessgroup.com/news/multiplier-effect-public-private-partnerships-should-provide-boost-infrastructure-devel

[23] Tanya Konidaris and Clare Allenson (2011), ‘Africa’s Infrastructure Regional Challenges And Opportunities, Johns Hopkins University-Sais, http://www.wilsoncenter.org/sites/default/files/Infrastructure%20Discussion%20Paper.pdf

[24] Tanya Konidaris and Clare Allenson (2011), ‘Africa’s Infrastructure Regional Challenges And Opportunities, Johns Hopkins University-Sais, http://www.wilsoncenter.org/sites/default/files/Infrastructure%20Discussion%20Paper.pdf

[25] Tanya Konidaris and Clare Allenson (2011), ‘Africa’s Infrastructure Regional Challenges And Opportunities, Johns Hopkins University-Sais, http://www.wilsoncenter.org/sites/default/files/Infrastructure%20Discussion%20Paper.pdf

[26] MDG Africa Steering Group (2008), ‘Achieving the Millennium Development Goals in Africa: Recommendations of the MDG Africa Steering Group’, http://www.mdgafrica.org/pdf/MDG%20Africa%20Steering%20Group%20Recommendations%20-%20English%20-%20HighRes.pdf

[27] UN-Africa Working Group (2007) Infrastructure and Millennium Development Goals, http://www.icafrica.org/en/topics-programmes/focal-points/infrastructure-and-millennium-development-goals/

[28] IFC, (2009)Infrastructure: Crisis & Response, Energy Week 2009, http://siteresources.worldbank.org/INTENERGY/Resources/335544-1232567547944/5755469-1239633250635/Bernard_Sheahan.pdf

[29] Milla SA’s Infrastructure Division (2013), ‘The Africa Infrastructure Rollout Conference 2013’, http://assets-production-webvanta-com.s3-us-west-2.amazonaws.com/000000/23/58/original/The%20Africa%20Infrastructure%20Rollout%20Conference%202013%20-%20v5.pdf

[30] John Mukum Mbaku (2013), ‘Building Opportunities: Addressing Africa’s Lack Of Infrastructure’. The Brookings Institution, http://www.brookings.edu/~/media/research/files/reports/2013/01/foresight%20africa/foresight_mbaku_2013.pdf

[31] Ludwig Von Mises Insitute (2014), ‘Malinvestment’, http://wiki.mises.org/wiki/Malinvestment

[32] Amadou Sy (2013), Financing Africa’s Infrastructure Gap

Brookings Institute, http://www.brookings.edu/blogs/up-front/posts/2013/10/09-financing-africa-infrastructure-gap-sy

[33] Lin Henry (2013), ‘China’s Biggest ‘Ghost Town’: A Microeconomic Perspective, http://economicstudents.com/2013/02/microeconomic-factors-keeping-chinese-modern-city-a-ghost-town/

[34] Nderi Johnson (2014), personal interview

[35] John Mukum Mbaku (2013), ‘Building Opportunities: Addressing Africa’s Lack Of Infrastructure’. The Brookings Institution, http://www.brookings.edu/~/media/research/files/reports/2013/01/foresight%20africa/foresight_mbaku_2013.pdf

[36] John Mukum Mbaku (2013), ‘Building Opportunities: Addressing Africa’s Lack Of Infrastructure’. The Brookings Institution, http://www.brookings.edu/~/media/research/files/reports/2013/01/foresight%20africa/foresight_mbaku_2013.pdf

[37] Vivien Foster and Cecilia Briceño-Garmendia (Ed) (2010), ‘Africa’s Infrastructure: A Time for Transformation’, Agence Française de Développement and the World Bank, http://siteresources.worldbank.org/INTAFRICA/Resources/aicd_overview_english_no-embargo.pdf

[38] Vivien Foster and Cecilia Briceño-Garmendia (Ed) (2010), ‘Africa’s Infrastructure: A Time for Transformation’, Agence Française de Développement and the World Bank, http://siteresources.worldbank.org/INTAFRICA/Resources/aicd_overview_english_no-embargo.pdf

[39] Nderi Johnson (2014), personal interview

[40] Kiarie Njoroge (2014), ‘5,000 Chinese workers expected for railway project, http://www.businessdailyafrica.com/5000-Chinese-workers-set-for-railway-project—/-/539546/2409994/-/4kq0l9/-/index.html

[41] Milla SA’s Infrastructure Division (2013), ‘The Africa Infrastructure Rollout Conference 2013’, http://assets-production-webvanta-com.s3-us-west-2.amazonaws.com/000000/23/58/original/The%20Africa%20Infrastructure%20Rollout%20Conference%202013%20-%20v5.pdf

[42] Trinity International LLP (2010), ‘Are We There Yet? Sub-Saharan Africa Transport Projects, http://www.trinityllp.com/are-we-there-yet-sub-saharan-africa-transport-projects/

[43] Trinity International LLP (2010), ‘Are We There Yet? Sub-Saharan Africa Transport Projects, http://www.trinityllp.com/are-we-there-yet-sub-saharan-africa-transport-projects/

[44] African Development Bank, Asian Development Bank, European Bank for

Reconstruction and Development, European Investment Bank, Inter-American

Development Bank, International Monetary Fund, and the World Bank Group (2007) ‘ The Nexus Between

Infrastructure and Environment: From the Evaluation Cooperation Group of the International Financial’, Institutions, http://siteresources.worldbank.org/INTOED/Resources/infrastructure_environment.pdf

[45] Trinity International LLP (2010), ‘Are We There Yet? Sub-Saharan Africa Transport Projects, http://www.trinityllp.com/are-we-there-yet-sub-saharan-africa-transport-projects/)

[46] Mike Wilkins (2013), ‘Out Of The Shadows: The Rise Of Alternative Financing In Infrastructure’, http://www.infrastructureviews.com/2013/02/01/out-of-the-shadows-the-rise-of-alternative-financing-in-infrastructure/#sthash.KDaxEdLZ.dpuf

[47] Mike Wilkins (2013), ‘Out Of The Shadows: The Rise Of Alternative Financing In Infrastructure’, http://www.infrastructureviews.com/2013/02/01/out-of-the-shadows-the-rise-of-alternative-financing-in-infrastructure/#sthash.KDaxEdLZ.dpuf

[48] Financial Times (2014), Ghana tarnishes ‘Africa rising’ story, FT Editorial, http://www.ft.com/cms/s/0/d9c39f02-1c8c-11e4-88c3-00144feabdc0.html

 

What’s With All The International Sovereign Bonds Being Issued By African Governments? (Part 2): The Dangers Of Eurobonding

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In my previous post I looked at 1) Why international sovereign bonds have become so attractive to African governments and 2) Why these bonds are so well received in global markets.

Clearly, Eurobonding[1] is fashionable, but is it wise? It can’t all be roses and butterflies….

3. What Are the Risks and Challenges for African Governments in Issuing International Sovereign Bonds?

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 a. Danger Lurks In Current Conditions

African governments are issuing international bonds in an environment where there are, ‘record-low interest rates that prevail in the United States’ and more developed markets in general.[2] Yield hunting has brought investors to Africa’s door but, ‘when global interest rates increase and concerns about the global financial crisis abate, governments in sub-Saharan Africa will have to compete with other issuers for funding’.[3] African governments seem to be cognizant of this which may lead to over-issuing in order to seize the conditions of the moment. Further, there is an air of optimism around Africa and the world is beginning to look at the continent as a truly viable member of the global economy. It seems as though African government are courting this new found attention and perhaps entering into more agreements than advisable. Eurobonding certainly seems to be trendy on the continent with one commentator stating that, ‘Eurobonds have become like stock exchanges, private jets and presidential palaces. Every African leader wants to have one’.[4] I therefore echo Stiglitz’s concerns about Africa’s Eurobond spree when he asks, ‘are shortsighted financial markets, working with shortsighted governments, laying the groundwork for the world’s next debt crisis?’[5] If so, Africa will be impacted far more significantly this time around not least due to the manner in which Eurobonds are integrating African economies into the global financial system. The current conditions spiral into several other risks such as…

b. Over Leveraging Risk

The current environment may cause Africa to over borrow because it’s relatively easy to get the money. However, the IMF is of the opinion that, ‘the rates at which sub-Saharan African countries are borrowing on the international markets are not sustainable.’[6] The rates African governments are getting are,’ sometimes below what many euro area countries are paying’. This rate of borrowing is probably ‘unsustainable in the long run unless these countries are able to generate high and sustainable economic growth and further reduce macroeconomic volatility.­’[7] Africa risks becoming overleveraged.

c. Debt Sustainability

Linked to points a) and b) is debt sustainability or rather the lack thereof. Prior to the Eurobond issue (as of March 2014) Kenya’s GDP to debt ratio stood at 52.2%.[8] Kenya has gone ahead with the issue despite the fact that in the same month of March, the IMF and World Bank ‘raised the red flag over Kenya’s debt’ specifically suggesting that, ‘the debt ratio be kept at not more than 50 per cent of the GDP’.[9] The Eurobond issue exacerbates Kenya’s debt burden and heightens concerns over sustainability. This is a mantra being sung about Africa in general because after a spate of debt forgiveness, ‘many countries’ debt levels are creeping up again, which could undermine the region’s growth boom’.[10] For example, if Ghana, Uganda, Mozambique, Senegal, Niger, Malawi and Benin, ‘continue to borrow at current rates their debt indicators could be back to pre-(debt) relief levels within a decade’[11]. Eurobonding is risky behaviour with grim prognoses.

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d. Defaulting

The scale of funds that African governments are accessing via Eurobonds, which have more stringent conditions that concessional loans, are actually predicated on robust growth of the borrowing economies in order to raise the capital required to meet maturity deadlines. No one can guarantee robust growth and thus defaulting is a real risk. In fact, African countries have already defaulted on Eurobonds, ‘The Seychelles defaulted on a $230 million Eurobond in October 2008…Following election disputes, Côte d’Ivoire missed a $29 million interest payment, which led to a default in 2011 on a bond that was issued in 2010’ and ‘Ghana and Gabon are struggling to find money for a $750 million and $1 billion bond, respectively, on 10-year Eurobonds that will reach maturity in 2017’. [12], [13] In some cases the default has led to government spending cuts, which is problematic (more on this in h.). ­

 e. Poorly Project Selection

Infrastructure projects have usually been a key element of the activities to be funded by Eurobonds due to their multiplier effects on the economy and the fact that African infrastructure needs are dire. However, there is no guarantee that the specific projects selected are the best candidates for such finances. Indeed, the IMF argues that due to factors such as limited administrative capacity, low efficiency of public investment expenditure and governance issues, ‘there is a risk that increased public spending or investment projects financed by bond issuance may be poorly selected or executed and therefore would not render value for money’.[14] Anyone familiar with the African political scene knows that sometimes flagship projects are selected based on their political currency rather than economic or developmental return. Some projects are selected due to the prestige enhancement and legacy effect they will confer African leaders rather than the prudence and pragmatism of the suggested projects. Are African governments choosing the Eurobond-financed projects wisely?

f. Poor Implementation

Poor implementation of the projects for which the funds have been planned is a serious risk because, ‘there are carry costs for not using proceeds and these are greatest when there are delays in projects’.[15] This thought makes one shudder given the ongoing debacle in the Kenyan government’s management of the standard gauge railway project which, if well managed, could have been a clear indication and proof of competent management of funds for infrastructure development. It seems to be proving the opposite. Sadly this project does not stand alone; in fact in response to the Kenya 2014/15 budget in which the Eurobond was incorporated, PWC stated the projects planned by government have inherent risks that, ‘relate to time and cost overruns, which will require a significant upgrade in technical, legal and institutional frameworks to manage and control the delivery of the investments’. [16] If governments do not address such concerns, projects will be implemented poorly which may cause the bonds to mature before the projects are completed, in which case governments may have to rollover the debt.

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g. Rollover Risk

Given the implementation risk and the possibility that planned projects may develop significant delays, roll over risk is very real. Roll over risk is, ‘A risk associated with the refinancing of debt commonly faced by countries (and companies) when their debt is about to mature and needs to be rolled over into new debt. If interest rates rise adversely, they would have to refinance their debt at a higher rate and incur more interest charges in the future’.[17] Bear in mind that in case of Kenya’s Eurobond, the 5 year tranche matures in 2019 and the 10 year one in 2024.[18] These are tight deadlines given the delays current infrastructure projects are experiencing. Please remember that Kenya’s railway gauge project was due to start in November 2013; yet no work has begun to date. That is an 8-month delay with no resolution in sight. Rollover risk is real.

h. Rollovers Are Not Guaranteed due to Perception Risk

Rollovers happen if investors are of the opinion that the borrower is capable of meeting the new terms and deadlines. Africa doesn’t have this luxury. Although currently there is immense optimism about the continent, the reality is that Africa is still a poorly understood market. Further, Africa is still considered a high risk venture and is therefore vulnerable to negative hype that can push the continent back to being the world’s investment pariah. Africa’s perception risk is of particular concern given that, ‘negative or inaccurate international market perceptions about a sovereign issuer’s economy may develop due to a lack of comprehensive and timely information on the pursuit of appropriate policies, fears of instability stemming from political developments and unfavorable interpretations of economic or political pronouncements.’[19] There is already evidence that when African economies suffer from internal political instability or terrorist attacks these are prominently covered and sensationalized in local and global media and create negative global perceptions of Africa. This then undermines Africa’s, ‘ability to secure access to international capital markets on a sustained basis, thus significantly increasing refinancing risk.’ Also, if Africa’s economies begin to weaken significantly as more developed markets recover, international markets may not be inclined to refinance thereby forcing Africa to service the debt by cutting government spending in areas such as health, education and agriculture. With a debt the scale of the Eurobond, how much spending will have to be cut? Shudder.

i. Currency Depreciation Risk

Obvious point; debt secured in foreign denominations may have to be paid when the sovereign’s currency is weaker. This is of particular concern with bullet maturities.

j. Currency Appreciation Risk

Interestingly, the opposite scenario is also a risk because like, ‘other forms of capital flows, international bond financing has potential repercussions for exchange rate policy’ because a shift to larger foreign financing, ‘potentially implies appreciation pressure for the domestic currency (depending on the import content of the associated spending)’.[20] This may harm export competitiveness which is of particular concern for African countries which need healthy exports in order to service all the debt issued in foreign currencies.

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k. Revenue Risk

This is a risk that has apparently been acknowledged by the Kenyan government. According to the Business Daily, in one of the Eurobond pitch documents, ‘the Treasury stated, as a key risk, that the informal economy is not recorded and is only partially taxed, resulting in a lack of revenue for the government, ineffective regulation, unreliability of statistical information and inability to monitor or otherwise regulate a large portion of the economy’.[21] So government has handicapped revenue generation capacity linked to widespread economic informalisation (a long term problem), yet the international sovereign bond will mature well before the revenue issue is resolved. This is a simple illustration of how even acknowledged weaknesses in the economic infrastructure of African governments still carry very real risks.

l. Reduced Access To Concessional Funding

The willingness of African government to accept debt at higher rates than in other financing packages may reduce access to low interest vehicles such as concessional deals particularly if the Eurobonds, ‘generate new macrofinancial and debt vulnerabilities’.[22]

m. Corruption And Questionable Public Financial Management

Please bear in mind that all the risks raised hereto exist even if the funds raised are used responsibly. Yes there may be delays in projects and low levels of competence but the assumption is that no one is trying to steal the money and engage in corruption. Yet the monstrosity called corruption is a trademark of African governments and, ‘competent public debt management is not yet in place in many SSA countries’.[23] Transparency International’s Corruption Perceptions Index ranks countries and territories based on how corrupt their public sector is perceived to be on a scale from 0 (highly corrupt) to 100 (very clean). 90% of African countries scored below 50 and of the bottom 20, 9 were African.[24] This is self-sabotage by African governments at its best and both African citizens and the international community are yet to find truly effective strategies to reign in corruption. Corruption is one of the most onerous risks on the list because if the money is siphoned to personal accounts, there is zero hope that the projected activities will occur and generate the requisite economic growth.

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So there are real and present dangers to Africa’s love affair with Eurobonds. The natural question then becomes how African governments can manage all these risks and opinions will vary on how to mitigate each of these risks. Additionally, some may argue that many of the risks are unavoidable and part and parcel of getting into Eurobond deals. However, I posit that the risk that is most needless is corruption. Interestingly, although corruption is the risk that could most seriously sabotage the positive power of Eurobonds, it is also the risk most readily addressed via Eurobonding itself! How? Well…

4. Can International Sovereign Bonds Change The Way African Governments Manage Public Funds And Stem/End Corruption?

The answer is yes and no.

The YES side exists with the following contributors:

a. Eurobond Issues Are Predicated On Disclosure and Transparency

‘The prospectus or offering memorandum of a bond issue requires disclosure of a substantial amount of data, allowing investors a close look at the current economic situation of the issuing country and a better assessment of the country’s prospects for successfully meeting its debt service payments’.[25] Although there may be an asymmetry in information, it is in the interest of African countries to fully cooperate in the disclosure and put all the cards on the table and acknowledge weaknesses and risks, including corruption. This disclosure ought to come with commitments on risk mitigation with clear strategies on how to address them. It is therefore possible that Eurobond issues have forced African governments to look at how they manage funds and put clear structures in place that assures investors that corruption will not compromise management of the bond and related activities.

b. Scrutiny

‘Accessing international markets through a sovereign bond can strengthen macroeconomic discipline and move forward transparency and structural reforms as a result of increased scrutiny by international market participants. For instance, Nigeria’s fiscal and monetary discipline to date has continued to strengthen following its increased presence in international markets in recent years.’[26] Indeed, ‘any country that borrows in the Eurobond market, by definition, exposes itself to rigorous analysis and questioning’. The world is watching African sovereign issuers; they better be corruption free.[27]

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c. International Reputation

The manner in which African governments manage debut issues informs access to future issues. If bonds are beleaguered with corruption, African governments will soon find themselves as investment exiles unable to access international financial markets. Easy global financial conditions will end and African governments will soon find themselves competing for money on global markets with everyone else. Therefore, developing a reputation of transparency, competence and efficiency is in the interest of African governments if future issues are to be successful.

d. Debt Will Not Be Forgiven

African governments know that if ‘money disappears’ they will still have to pay the debt. Governments forgive debt, private investors do not. As one commentator stated with reference to African Eurobonds, ‘Investors are cold blooded, rational people. They want to be assured they will be paid back.’[28] This fact becomes particularly potent if the issuing government also has to service the debt; which is possible in the case of 5 year maturities. If the government responsible for the issue fails to pay up, due to issues such as corruption, they will meet hostile sentiment from both investors and citizens. A government in power over the period of both issue and servicing will face hard questions and perhaps legal action if they can’t pay because funds were mismanaged. A new government can always say the previous government stole the money. This does not hold if the same government is in power throughout as any corruption would have happened under their docket. Therefore, it is in the interest of African governments to tame corruption as a failure to do so will lead to a world of trouble with which no government would like to contend.

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However, the NO side exists with the following to consider:

a. Change In Government= Change In Accountability

If the government that issued the bond is not the one responsible for paying up, this creates serious problems. A change in government can easily lead to a blame game with the incoming cadre accusing the former government of mismanagement of funds, and the predecessor denying the same. Bloody nightmare.

b. No guaranteed trickle effect

All the factors mentioned in the ‘YES’ section provide impetus to end corruption…in managing the Eurobond alone. There is no guarantee that discipline in this area will trickle into the management of public funds in general.

 So there you have it, the pros and cons of Eurobonding.

I think there are more reasons to smile than frown because, as stated in the previous post, there are solid reasons for African governments to pursue Eurobonds and now we see that these bonds open doors for: 1) African issuers to better manage public funds, and 2) For African citizens and the international community to use the Eurobonds as vehicles to better monitor public financial management and push for better management of public funds.

Therefore, I offer that yes, Eurobonding may be dangerous…but even roses have thorns. All that African citizens and interested parties can do is to make the effort to increase the likelihood that this shopping spree will be used to the continent’s advantage.

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Sources

[1]A term I coined.

[2] Amadou N.R. Sy (2013), ‘ First Borrow’. IMF, http://www.imf.org/external/pubs/ft/fandd/2013/06/sy.htm

[3] Amadou N.R. Sy (2013), ‘ First Borrow’. IMF, http://www.imf.org/external/pubs/ft/fandd/2013/06/sy.htm

[4] Tosin Sulaiman (2014), ‘Analysis: Decade after debt relief, Africa’s rush to borrow stirs concern’, Reuters, http://www.reuters.com/article/2014/03/18/us-africa-debt-sustainability-analysis-idUSBREA2H08B20140318

[5] Joseph Stiglitz (2013), ‘Sub-Saharan Africa’s Eurobond borrowing spree gathers pace’, The Guardian, http://www.theguardian.com/business/economics-blog/2013/jun/26/subsaharan-africa-eurobond-borrowing-debt

[6] Rintoul, Fiona (2013), ‘Sub-Saharan market: High yields fire appetite for African eurobonds’, http://www.ft.com/cms/s/0/d7c5c5d8-3810-11e3-8668-00144feab7de.html#axzz354cr4weH

[7] Amadou N.R. Sy (2013), ‘ First Borrow’. IMF, http://www.imf.org/external/pubs/ft/fandd/2013/06/sy.htm

[8] Mohamed Wehliye (2014), ‘The National Debt. Are we about to go bust?’, http://www.capitalfm.co.ke/eblog/2014/06/09/the-national-debt-are-we-about-to-go-bust/?wpmp_switcher=mobile&wpmp_tp=1

[9] Geoffrey Irungu (2014), ‘IMF, World Bank raise the red flag over Kenya’s debt’, Business Daily, http://www.businessdailyafrica.com/IMF-and-World-Bank-raise-the-red-flag-over-Kenya-debt/-/539546/2252232/-/68mp65/-/index.html

[10] Tosin Sulaiman (2014), ‘Analysis: Decade after debt relief, Africa’s rush to borrow stirs concern’, Reuters, http://www.reuters.com/article/2014/03/18/us-africa-debt-sustainability-analysis-idUSBREA2H08B20140318

[11] Tosin Sulaiman (2014), ‘Analysis: Decade after debt relief, Africa’s rush to borrow stirs concern’, Reuters, http://www.reuters.com/article/2014/03/18/us-africa-debt-sustainability-analysis-idUSBREA2H08B20140318, parenthesis mine.

[12] Amadou N.R. Sy (2013), ‘ First Borrow’. IMF, http://www.imf.org/external/pubs/ft/fandd/2013/06/sy.htm

[13] Jocelyne Sambira (2014), ‘Hunting for Eurobonds’, http://www.un.org/africarenewal/magazine/april-2014/hunting-eurobonds#sthash.tzl64sec.dpuf

[14] Mauro Mecagni, Jorge Ivan Canales Kriljenko et al (2014), Issuing International Sovereign Bonds: Opportunities and Challenges for Sub-Saharan Africa, IMF, http://www.imf.org/external/pubs/ft/dp/2014/afr1402.pdf

[15] Willem te Velde, Dirk (2014), ‘ Sovereign bonds in sub-Saharan Africa: Good for growth or ahead of time?’, ODI, http://www.odi.org/sites/odi.org.uk/files/odi-assets/publications-opinion-files/8883.pdf

[16]All Africa (2014), ‘Kenya: Understanding Kenya’s 2014-2015 National Budget – PWC’, http://allafrica.com/stories/201406131050.html

[17] Investopedia (2014), http://www.investopedia.com/terms/r/rollover-risk.asp

[18]Author interview with expert, June 2014

[19] Udaibir S. Das, Michael G. Papaioannou and Magdalena Polan (2008), ‘Strategic Considerations for First-Time

Sovereign Bond Issuers’, IMF, http://www.imf.org/external/pubs/ft/wp/2008/wp08261.pdf

[20] Mauro Mecagni, Jorge Ivan Canales Kriljenko et al (2014), Issuing International Sovereign Bonds: Opportunities and Challenges for Sub-Saharan Africa, IMF, http://www.imf.org/external/pubs/ft/dp/2014/afr1402.pdf

[21] Bodo, George (2014), ‘Eurobond faces structural risks despite flying start’, Business Daily, http://www.businessdailyafrica.com/Opinion-and-Analysis/Eurobond-faces-structural-risks-despite-flying-start-/-/539548/2354496/-/ypyeyb/-/index.html

[22] Mauro Mecagni, Jorge Ivan Canales Kriljenko et al (2014), Issuing International Sovereign Bonds: Opportunities and Challenges for Sub-Saharan Africa, IMF, http://www.imf.org/external/pubs/ft/dp/2014/afr1402.pdf

[23] Deutsche Bank (2013), ‘ Capital markets in Sub-Saharan Africa, http://www.dbresearch.com/PROD/DBR_INTERNET_EN-PROD/PROD0000000000321468/Capital+markets+in+Sub-Saharan+Africa.pdf

[24] Transparency International (2013), ‘Corruption Perceptions Index 2013’ http://cpi.transparency.org/cpi2013/results/#myAnchor1

[25] Udaibir S. Das, Michael G. Papaioannou and Magdalena Polan (2008), ‘Strategic Considerations for First-Time

Sovereign Bond Issuers’, IMF, http://www.imf.org/external/pubs/ft/wp/2008/wp08261.pdf

[26] Mauro Mecagni, Jorge Ivan Canales Kriljenko et al (2014), Issuing International Sovereign Bonds: Opportunities and Challenges for Sub-Saharan Africa, IMF, http://www.imf.org/external/pubs/ft/dp/2014/afr1402.pdf

[27]Author interview with expert, June 2014

[28]Author interview with expert, June 2014

What’s With All The International Sovereign Bonds Being Issued By African Governments? (Part 1)

Posted on Updated on

The Kenyan government successfully launched its debut Eurobond this month and ‘secured bids worth $8 billion (Sh702.4 billion); Treasury will accept $2 billion (Sh175.6 billion)’ [1]. The Kenyan Eurobond is a big deal for Africa because it is the largest ever debut for an African country. However, international sovereign bonds have been gaining popularity amongst African countries and, ‘Sub-Saharan Africa (SSA) issued a record $4.6 billion in 2013 in sovereign bonds (5% of developing country sovereign-bond issues), up from zero in 2010 (and around $1 billion in 2001).’[2]  Thirteen other SSA countries have issued Eurobonds so far: South Africa, Seychelles, Republic of Congo, Côte d’Ivoire, Ghana, Gabon, Senegal, Nigeria, Namibia, Zambia, Tanzania, Rwanda and Mozambique. [3]

But there are four core questions to ask here:

1. Why are international sovereign bonds becoming so attractive to African governments?
2. Why are international bonds floated by African governments so well received in global markets?
3. What are the risks and challenges?
4. Can international sovereign bonds change the way African governments manage public funds?

The first two questions will be answered in this post and the rest in part 2.

Sovereign bonds carry significantly higher borrowing costs than concessional debt does so the question is:

1. Why Are International Sovereign Bonds Becoming So Attractive To African Governments?

Image(Source: Moody’s)

Consider the following:

a. Governments Need The Money
Africa’s development needs are huge and need money to address them. Africa has significant infrastructure requirements such as, ‘electricity generation and distribution, roads, airports, ports, and railroads’.[4] Funds raised through Eurobonds are an effective means of financing such infrastructure projects which often, ‘require resources that exceed aid flows and domestic savings’.[5]

b. Gives Government More Autonomy
Foreign aid and funding from multilateral institutions as well as development financing institutions come with conditions as do funds from unilateral agreements with other governments. International sovereign bonds give African governments more choice and negotiation power to define how the funds will be used.

c. Allows Government To Restructure Debt
African governments are using international sovereign bonds to restructure their debt by, ‘exchanging an outstanding sovereign debt instrument for new debt instruments’ thereby ‘allowing debt rescheduling or reduction’. [6] The Kenyan government seems to be among those employing this strategy since part of the Eurobond will be used to ‘retire a $600 million (Sh52.2 billion) syndicated loan’. [7] Kenya is not alone; four other African countries (Seychelles, Gabon, Republic of Congo and Côte d’Ivoire) issued international bonds in the context of debt restructuring. [8]

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d. Reduces Pressure for Credit In Domestic Markets
Successful international bond issues reduce pressure for credit in domestic markets. In Kenya, a failure with the issue may not have augured well for domestic borrowers as government appetite may have crowded out borrowing from individual and corporate consumers. Thus in issuing Eurobonds, African governments leave the credit space more open which allows more businesses and individuals to access this credit and in doing so, ‘support domestic investment and growth, and help develop the local capital market’. [9]

e. Diversifies/ Broadens Sources of Investment Finance
International bond issues broaden the country’s investor base as, ‘governments diversify sources of capital and reduce reliance on bank financing from abroad and official financing.’ [10] They also allow governments to reduce budgetary deficits in an environment in which donors are not willing to increase their overseas development assistance. [11]

f. Reduced Sovereign Debt
The Highly Indebted Poor Countries (HIPC) Initiative and Multilateral Debt Relief Initiative (MDRI) significantly reduced the debt of African countries. In fact, multilateral creditors, bilateral aid organizations, export credit agencies, and private creditors have delivered about $100 billion of debt relief to African economies since 2000. [12] This has allowed African governments to, ‘borrow in international markets without straining their ability to repay’. [13]

g. The Conditions Are Right
Africa is operating in a context of easy global financial conditions due to, ‘record low interest rates in developed markets and ample liquidity’. [14] As a result, sub-Saharan African countries have been able to borrow at ‘historically low yields’ sometimes even lower than those of Eurozone crisis countries. [15]

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h. Benchmarking
International sovereign bonds give African governments the opportunity to develop a benchmark for pricing other government and corporate bond markets in international markets.[16] Ergo, African governments can use insights gained in international bond issues to develop subnational (e.g. parastatal) and corporate bonds thereby enhancing African access to international capital markets. [17]

i. Signals Support for Planned Activities
In many ways, ‘the successful issue of an international bond gives a signal of approval of current and planned economic policies’. [18] This provides grounds on which African governments can rationalize economic and development plans to both local and international parties.

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So it is clear that there African governments have solid reasons to issue international sovereign bonds, but…

2. Why Are International Bonds Floated By African Governments Being So Well Received In Global Markets?

a. High Yields
Investors looking for high bond yields are increasingly buying African sovereign debt because the, ‘debt sales offer exposure to growing economies, with a better return than they would receive in more-developed markets’. [19]

b. Strong Economic Growth in Africa
The world is looking at Africa and becoming increasingly interested in investing in the continent partly because of Africa’s robust GDP growth rates and, ‘considerable resilience to financial shock’. [20] Africa grew at an estimated growth of 4.0% in 2013 and is expected to grow at 4.7% in 2014. [21] This is compared to 2.5% for the USA, 1.5% for Western Europe, 3% for Brazil and 2.9% for Russia. [22] These figures strengthen investors’ appetites for African offerings.

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c. Improved Availability Of Credit Information
The number of African countries rated by either Moody’s, Fitch or Standard & Poor’s increased to 21 from only 10 in 2003. [23], [24] Credit ratings are important for African governments as they make it easier to sell the country and related offerings due to several effects : [25], [26]

– Signal effect – increased credibility
– Information effect – especially for smaller countries that might otherwise be overlooked
– Advertising effect- the rating works as a kind of advert to investors, showing that the country is open to foreign capital
– Identifying country risk
– Economic policy effect – countries don’t want to lose ratings, and will adjust economic policy accordingly.

All these work together to foster confidence in investors, raising their inclination to favourably respond to African bond issues.

d. Africa’s limited exposure to international capital markets
Most of sub- Saharan Africa is not well exposed to international capital markets, providing ample opportunity for investors to make deals on the continent through instruments like international sovereign bonds that carry relatively low risk. Indeed, Moody’s predicts, ‘significant potential in Africa for increasing the use of international capital markets’. [27] There are possibilities for healthy profits to be made by increasing African exposure to capital markets and foreign investors are aware of this (risks notwithstanding).

So it looks like it’s smiles all around for African international sovereign bond issues…but behind the shine, does real danger lurk? Find out in the next post.

 Sources

[1] Gachiri, John (2014), ‘Eurobond attracts Sh702bn bids, shows investor confidence in Kenya’, http://www.businessdailyafrica.com/Eurobond-attracts-Sh702bn-bids-investor-confidence-in-Kenya/-/539546/2352268/-/14p1riw/-/index.html

[2]Willem te Velde, Dirk (2014), ‘ Sovereign bonds in sub-Saharan Africa: Good for growth or ahead of time?’, ODI http://www.odi.org/sites/odi.org.uk/files/odi-assets/publications-opinion-files/8883.pdf

[3]Deutsche Bank (2013), ‘Capital markets in Sub-Saharan Africa, http://www.dbresearch.com/PROD/DBR_INTERNET_EN-PROD/PROD0000000000321468/Capital+markets+in+Sub-Saharan+Africa.pdf

[4]Amadou N.R. Sy (2013), ‘First Borrow’, IMF, http://www.imf.org/external/pubs/ft/fandd/2013/06/sy.htm

[5] Amadou N.R. Sy (2013), ‘First Borrow’, IMF, http://www.imf.org/external/pubs/ft/fandd/2013/06/sy.htm

[6]Udaibir S. Das, Michael G. Papaioannou and Christoph Trebesch (2012), ‘Restructuring Sovereign Debt: Lessons from Recent History’, http://www.imf.org/external/np/seminars/eng/2012/fincrises/pdf/ch19.pdf

[7]Gachiri, John (2014), ‘Eurobond attracts Sh702bn bids, shows investor confidence in Kenya’, Business Daily, http://www.businessdailyafrica.com/Eurobond-attracts-Sh702bn-bids-investor-confidence-in-Kenya/-/539546/2352268/-/14p1riw/-/index.html

[8] IMF (2013), ‘Regional Economic Outlook: Sub-Saharan Africa Building Momentum in a Multi-Speed World’, http://www.imf.org/external/pubs/ft/reo/2013/afr/eng/sreo0513.pdf

[9] Udaibir S. Das, Michael G. Papaioannou and Magdalena Polan (2008), ‘Strategic Considerations for First-Time

Sovereign Bond Issuers’, IMF, http://www.imf.org/external/pubs/ft/wp/2008/wp08261.pdf

[10]Udaibir S. Das, Michael G. Papaioannou and Magdalena Polan (2008), ‘Strategic Considerations for First-Time

Sovereign Bond Issuers’, IMF, http://www.imf.org/external/pubs/ft/wp/2008/wp08261.pdf

[11] Sambira, Jocelyne( 2014), ‘ Hunting for Eurobonds’, http://www.un.org/africarenewal/magazine/april-2014/hunting-eurobonds#sthash.FyAGjNqr.dpuf

[12] Mark Roland Thomas (2012), ‘African Debt since Debt Relief: How Clean is the Slate?’, World Bank, http://blogs.worldbank.org/africacan/african-debt-since-debt-relief-how-clean-is-the-slate

[13] Amadou N.R. Sy (2013), ‘First Borrow’, IMF, http://www.imf.org/external/pubs/ft/fandd/2013/06/sy.htm

[14]Deutsche Bank (2013), ‘Capital markets in Sub-Saharan Africa, http://www.dbresearch.com/PROD/DBR_INTERNET_EN-PROD/PROD0000000000321468/Capital+markets+in+Sub-Saharan+Africa.pdf

[15]Amadou N.R. Sy (2013), ‘First Borrow’, IMF, http://www.imf.org/external/pubs/ft/fandd/2013/06/sy.htm

[16] IMF (2013), ‘Regional Economic Outlook: Sub-Saharan Africa Building Momentum in a Multi-Speed World’, http://www.imf.org/external/pubs/ft/reo/2013/afr/eng/sreo0513.pdf

[17] IMF (2013), ‘Regional Economic Outlook: Sub-Saharan Africa Building Momentum in a Multi-Speed World’, http://www.imf.org/external/pubs/ft/reo/2013/afr/eng/sreo0513.pdf

[18] Udaibir S. Das, Michael G. Papaioannou and Magdalena Polan (2008), ‘Strategic Considerations for First-Time

Sovereign Bond Issuers’, IMF, http://www.imf.org/external/pubs/ft/wp/2008/wp08261.pdf

[19]Sarka Halas (2013), ‘Hunt for Higher Bond Yields Leads to Africa’, Wall Street Journal, http://online.wsj.com/news/articles/SB10001424127887323646604578402033262468070

[20] Javier Blas (2013), ‘Africa bond issues soar to record sums’, Financial Times, http://www.ft.com/cms/s/0/7f11fab8-2f61-11e3-ae87-00144feab7de.html#axzz35ATQX9Pu

[21] UN Department for Economic and Social Affairs (2013), ‘World Economic Situation and Prospects 2014: Global economic outlook’, http://www.un.org/en/development/desa/publications/wesp2014-firstchapter.html

[22] UN Department for Economic and Social Affairs (2013), ‘World Economic Situation and Prospects 2014: Global economic outlook’, http://www.un.org/en/development/desa/publications/wesp2014-firstchapter.html

[23] Minto, Rob (2013), ‘What use is a credit rating? For Africa, it means FDI’, http://blogs.ft.com/beyond-brics/2013/02/28/what-use-is-a-credit-rating-for-africa-it-means-fdi/

[24]Deutsche Bank (2013), ‘Capital markets in Sub-Saharan Africa, http://www.dbresearch.com/PROD/DBR_INTERNET_EN-PROD/PROD0000000000321468/Capital+markets+in+Sub-Saharan+Africa.pdf

[25] Minto, Rob (2013), ‘What use is a credit rating? For Africa, it means FDI’, Financial Times, http://blogs.ft.com/beyond-brics/2013/02/28/what-use-is-a-credit-rating-for-africa-it-means-fdi/

[26]Reuters (2013), Ratings more than a piece of paper for Africa’, http://blogs.reuters.com/globalinvesting/2013/02/28/ratings-more-than-a-piece-of-paper-for-africa/

[27] Javier Blas (2013), ‘Africa bond issues soar to record sums’, Financial Times, http://www.ft.com/cms/s/0/7f11fab8-2f61-11e3-ae87-00144feab7de.html#axzz35ATQX9Pu