Unlocking Private Finance For African Infrastructure
Paul Collier explores the potential of private finance to support African development.
Africa needs more infrastructure than its governments or donors can afford. However, while needs are too large for existing funding sources, they are trivial relative for world capital markets. Infrastructure is not an intrinsically risky investment, but Africa has not been able to tap these markets. Investment in electricity generation within the OECD is classified as a safe utility. But if the electricity generation is in Africa it is reclassified as a frontier investment. Matching investors to opportunities would be mutually beneficial, and the G8 committed to investigate the scope for catalytic public action. What impediments need fixing?
InfraCoAfrica, an entity funded by development agencies, recently promoted a Ghanaian electricity project: it took eight years to prepare. That it took so long is an indication of the multiple political veto points that must be negotiated in order for a project to be authorized. Because African infrastructure projects are mostly small and idiosyncratic, they are not only costly to prepare, they are hard to value. Idiosyncrasy is a killer for markets because it inflates the information cost of transactions. The generic solution is standardization. Purchasers need only a single effort to understand a whole class of projects. Markets are bad at self-generating standardization. Even simple standards such as weights and measures have invariably been supplied by governments as public goods.
The riskiness of African infrastructure projects is predominantly political: governments have exceptionally strong opportunities for hold-up. Faced with these exceptional political risks, one approach is to reduce them through commitment technologies. An acceptable form of commitment technology is implicit in the political risk insurance provided by agencies such as the World Bank’s MIGA. It is able to offer political risk insurance cheaply because, through the implied power of the World Bank, it is able to recover from governments most of what it pays out. In effect, by permitting investors to insure with MIGA, governments are subjecting themselves to a publicly provided commitment technology in which the implicit threat of deteriorating relations provides credibility. But MIGA is small. Its operations in Africa need to be scaled up and so it needs more capital. Aid could also be used to pay MIGAs’ insurance premium on strategic infrastructure investments.
To the extent that they cannot be reduced or insured, risks can be re-bundled so that investors with a low risk threshold are able to accept only the low-risk component of a project. Over the lifetime of a project the risks and costs change considerably. The catalytic design stage is risky but small-money and might be funded by private venture capital. The project construction phase, during which large irreversible investment is committed, is high-risk and big-money and so requires public risk capital. The project operation phase, which may last for decades, is low-risk, big-money and should be appropriate for OECD pension funds.
Having un-bundled individual infrastructure projects according to their phasing, a further step in de-risking would be to re-bundle them into a fund which would hold them together with other infrastructure projects from emerging market and OECD contexts. This would both diversify individual country risk and dilute the high-risk projects. Such a bundling approach has already been demonstrated to work by the Bank for International Settlements in respect of East Asian sovereign debt. A good way of getting such a fund started would be for the public agencies to divest their existing portfolio of completed, operational infrastructure projects. Not only would this enable a fund to hold a range of projects from the start, but it would inject liquidity into agencies such as IFC and FMO needed for the construction phase.
The operational risks of a project depend primarily upon how it is run. The OECD now has some reputable specialist private operators. They have been wary of Africa and could usefully forge links with aid agencies that have the local knowledge.
The final hurdle facing the private financing of African infrastructure is the culture and regulation of pension funds. Pension funds equate safety with liquidity, but since they have well-defined obligations, liquidity is less important than yield. Funds are in crisis because the yield on assets has substantially declined. Some Canadian funds have recognized the potential of African assets, but culture and regulation have precluded it in Europe. Regulations currently give legal force to the unaccountable assessments of commercial risk-rating agencies. A rule adopted by the rating agencies is that African projects cannot be rated more highly than the sovereign debt of the country. The rating agencies do not adopt such a rule for OECD countries and the rationale appears questionable. For example, when the government of Cote d’Ivoire suspended its debt service, projects maintained payments. The rule frustrates the design of low-risk projects in high-risk countries.
These multiple impediments to private finance for African infrastructure create interdependence between distinct missing classes of actor. This is a killer for privately driven solutions. Only coordinated public action on multiple fronts can unlock the potential. America’s political gridlock has slashed its public funding even for its own infrastructure. Realistically, Africa’s urgent infrastructure needs will be met either by European public action to catalyze private finance, or by China.
This post first appeared on Social Europe Journal.