37549 noTE no. 13 ­ SEpT. 2006GRIDLINES Sharing knowledge, experiences, and innovations in public-private partnerships in infrastructure Financing infrastructure in Africa How the region can attract more project finance Robert Sheppard, Stephan von Klaudy, and Geeta Kumar S ub-Saharan Africa receives only a small finance in capital markets through project bonds. share of private investment in infrastruc- And most of this bond financing was raised for ture. One reason for this is its difficulties South African projects through local currency in getting project finance--difficulties that stem issues in that country's capital markets. from the low creditworthiness of most African countries, the limits of local financial markets, Three related sets of factors limit Africa's ability and the risk profiles typical of infrastructure to tap both foreign and local currency markets to projects. Whether the region can attract more raise private finance for infrastructure, especially private foreign currency funding for infrastruc- long-term debt finance. ture will depend in part on the ability to reduce First, most African countries have low or nonex- foreign exchange risks. But in some countries istent sovereign credit ratings. Only 16 of 48 local currency sources, especially local capital countries have foreign currency debt ratings, and markets, also offer good potential. only 4 of these have ratings of BB­ or higher, Sub-Saharan Africa has attracted only a small which provide relatively broad access to financial share of the private investment in infrastruc- markets. The countries that have obtained (or ture in developing countries, and that share has have an estimated) foreign currency debt rating been heavily tilted toward telecommunications of at least BB­ represent only 43 percent of (Leigland and Butterfield 2006). This sector regional gross national income (GNI)--and this claimed 64 percent of investment flows to the share is dominated by South Africa. In all other region's infrastructure sectors in 1990­2004--a developing regions the share would be more than far larger share than the 47 percent in the rest of two-thirds of regional GNI, and in East Asia and the developing world.1 Many factors have influ- Pacific, close to 100 percent.2 enced these patterns. But Africa's limited access For most African countries foreign commercial to project finance has been an important one. lending is therefore difficult to access and typi- cally limited to short-term transactions. The Key constraints on project finance ability of infrastructure projects to tap long-term Infrastructure projects with private participa- foreign currency lending has depended on a mix tion are often financed with a mix of equity and of factors that mitigate risk. These include the nonrecourse debt (debt contracted by the project ability to generate foreign currency revenues and company without recourse to the sponsors, also strong support by official (bilateral or multilat- called project finance). Limited access to such eral) agencies. Economic links to South Africa debt can severely damage an economy's ability (through exports or through ownership by South to attract private investment in infrastructure. Project sponsors will rarely finance infrastructure projects with equity only, or take the project debt Robert Sheppard is a consultant. Stephan von Klaudy fully on their balance sheets. is a lead infrastructure specialist, and Geeta Kumar a consultant, in the World Bank's Infrastructure Economics Africa has attracted less nonrecourse bank debt and Finance Department. This note is a product of the relative to private investment in infrastructure PUBLIC-PRIVATE INFRASTRUCTURE ADVISORY FACILITY Private Participation in Infrastructure (PPI) Project Database, than other developing regions (Figure 1). It a joint initiative of PPIAF and the World Bank's Infrastructure has been even less successful in raising project Economics and Finance Department. Helping to eliminate poverty and achieve sustainable development through public-private partnerships in infrastructure PUBLIC-PRIVATE INFRASTRUCTURE ADVISORY FACILITY fIgure 1 Africa attracts little project finance Sub-Saharan Africa's share of project finance and private infrastructure investment flows to developing countries, 1997­2004 (percent) Source: Project Finance International; World Bank and PPIAF, PPI Project Database. Note: The data on project loans and bonds (both foreign and local currency debt) are reported voluntarily by financial institutions and so may be incomplete, especially for smaller transactions. The data include all sectors but are representative of trends for infra- structure, which has accounted for two-thirds of project finance on average. The data on PPI investment represent total investment in infrastructure projects with private participation. Infrastructure African investors) also usually help, because they private participation in Africa: The projects have create opportunities to tap that country's sophis- typically been small relative to those in other projects in ticated financial markets. regions, and many have been financed entirely Africa are with equity. Projects with economics permitting Second, most local financial markets have limited faster payback and shorter-term debt (such as typically small,capacity to finance infrastructure projects. Only telecommunications) have tended to be favored South Africa has domestic banks and a local short term, over those with long payback periods and requir- capital market capable of consistently provid- ing long-term financing to offer services at an and dependent ing local currency financing for infrastructure affordable price (such as toll roads). And projects projects on suitable terms and in significant on official have often depended crucially on support by offi- amounts. In virtually all other African countries cial agencies. support local long-term financing has been limited, and infrastructure projects have needed substantial credit enhancement (for example, through guar- How to increase foreign financing? antees), provided mostly by official agencies, to As the financial crises of the late 1990s made clear, attract local currency debt. exchange rate volatility poses a big risk for foreign currency financing of infrastructure projects that Third, features typical of infrastructure projects earn mainly local currency revenues. Mechanisms raise the risk of investments. Compared with proj- used in the 1990s to mitigate this risk, such as ects in many other sectors, those in infrastructure exchange rate­indexed contracts, often proved tend to have longer payback and build-out peri- ineffective under macroeconomic instability. And ods and to be more susceptible to political and in many cases they triggered adverse regulatory regulatory interference, which increases the regu- changes, such as arbitrary tariff reductions that latory risk such investments may be facing. made projects financially unsustainable. Moreover, nothing can insure against the risk of devalua- Together, these factors have helped shape the tion, and targeted mitigation instruments, such as characteristics of infrastructure projects with contingent loans, are rarely available. Financing infrastructure in Africa Extreme fluctuations in exchange rates have affected private infrastructure investment in BOx 1 Africa less than in other regions. One reason is the region's limited ability to raise debt in inter- Local currency financing emerges in national markets in the first place. Another is Sub-Saharan Africa its bias toward projects with limited regulatory Some infrastructure projects in Africa, mostly intervention (such as mobile telephony) or with in telecommunications, have been able to tap U.S. dollar revenues (such as export-oriented the market for long-term local currency fund- ports, railways, and gas pipelines). ing. But like foreign lenders, local currency debt How to Still, mitigating regulatory risk related to changes providers have often required risk mitigation in exchange rates could help improve access to from official agencies. recent local currency increase foreign financing for projects that earn mainly financings outside South Africa include these project local currency revenues and are subject to tariff transactions for telecommunications projects: regulation (such as electricity projects). Mitigat- finance? · The Afghanistan reconstruction Trust fund, ing such risk means protecting projects against enhance risk arbitrary interference by regulatory agencies that administered by the World Bank, supported would prevent tariff adjustments commensurate efforts to rehabilitate the satellite earth station mitigation with cost increases caused by exchange rate in Kabul, expand and improve transmission and reform movements. The partial risk guarantee against links to neighboring countries, and improve the regulatory default that the World Bank granted billing system. local capital for the concession of Uganda's electricity distri- · Kenya, Safaricom, 2001. Five-year floating markets bution company, for example, played a key part rate notes 75 percent guaranteed by Belgium's in attracting private investors (see Mazhar 2005 export credit agency (US$51.1 million). and Nyirinkinda 2005). · uganda MTN, 2001. Eight-year bond guaran- And how to increase local financing? teed by the Swedish International Development Africa has escaped currency crises like those that Cooperation Agency (SIDA) for three years have hit many developing regions. But African (US$7 million). currencies have nonetheless seen exchange rate · Orange Cameroon, 2002. Bank loan with partial shifts large enough to harm a project's ability to guarantee by the International Finance Corpo- service foreign currency debt and meet equity ration (IFC) and Proparco (US$41 million). investors' expectations on rates of return. So in Africa, as in other regions, project sponsors have · uganda Telecom, 2003. Five-year bond (US$27 in recent years sought to increase local financial million). markets' contributions to the debt funding of · MTN Nigeria, 2003. Bank loans (US$250 infrastructure projects that generate mostly local million), including loans covered by South currency revenues. These efforts have led to some Africa's export credit agency (US$40 million); local currency loans and bonds, mainly for tele- and loans from the Netherlands Development communications projects (box 1). Finance Company (FMO), the German Invest- But a larger share of local currency financing ment and Development Company (DEG), and would be desirable. Progress in financial sector IFC (US$105 million). reform could make this feasible, as local banks Source: Project finance International, various issues; and build capacity for project finance and capital local press articles. markets become more liquid. Nigeria's financial sector reforms, for example, could greatly increase local term finance for infrastructure. infrastructure projects is their difficulty in reli- Local banks ably funding themselves over the long term. But In recent years local banks in Africa have shown as experience in such countries as Cameroon, interest in providing local currency loans to infra- Nigeria, and Tanzania shows, macroeconomic structure projects. But these loans have required and institutional changes and financial sector significant risk mitigation (see box 1). The biggest reforms can increase longer-term local currency constraint on the ability of African banks (except financing for banks and thus slowly increase local those in South Africa) to increase funding for bank financing for infrastructure projects. Local capital markets Institutional investors in these countries and Long-term local currency financing, often avail- across Africa may initially require that local able only in local capital markets, is well suited bond issues to finance infrastructure projects for infrastructure projects. But only a few devel- carry full or almost full guarantees by govern- oping countries have local capital markets that ments, official agencies, commercial banks, or can provide such financing consistently and in other private sector institutions. But in time significant amounts. These countries have larger local capital markets could potentially finance economies than almost all African countries. 10­20 percent of new infrastructure needs with Moreover, they have sovereign credit ratings and declining requirements for risk mitigation (see financial markets sophisticated enough to provide Sheppard 2006). currency forwards and interest rate swaps. Notes Even so, African capital markets can offer a grow- 1. The data are from the Private Participation in Infrastructure ing source of long-term funding for infrastructure (PPI) Project Database (http://ppi.worldbank.org). They include investment flows to greenfield projects, concessions, and projects. Pension reforms under way in several management and lease contracts. Divestitures are excluded because countries could increase long-term savings and they have been relatively unimportant in Sub-Saharan Africa and are based on different financing approaches. transform them into investment funds for infra- 2. The analysis is based on countries that are rated BB­ (or Ba3) or structure. higher by one of the three major international rating agencies or, if unrated, have an estimated credit rating of at least BB. Estimated credit ratings are based on a recent analysis provided confidentially Some countries already have the beginnings by a major U.S. financial institution (see Sheppard 2006). of a contractual savings industry, often in the References form of government-initiated pension funds, and Leigland, James, and William Butterfield. 2006. "Reform, Private their governments have successfully issued long- Capital Needed to Develop Infrastructure in Africa: Problems and term fixed rate debt--two of the key elements Prospects for Private Participation." Gridlines series, no. 8. PPIAF, Washington, D.C. for providing long-term local currency financ- Mazhar, Farida. 2005. "Privatization Guarantees for Regulatory ing. Kenya has pension fund assets estimated at Systems for Power Distribution in Uganda and Romania." Paper US$4 billion, around 26 percent of 2004 GDP. presented at World Bank Energy Week, Washington, D.C., March 14­16. World Bank, Infrastructure Economics and Finance Tanzania's are estimated at only US$1 billion, Department, Washington, D.C. about 9 percent of 2004 GDP, but its pension Nyirinkinda, Emmanuel. 2005. "The Uganda Distribution funds and insurance companies hold almost as Concession." Paper presented at World Bank Energy Week, Washington, D.C., March 14­16. Uganda Ministry of Finance, large a share of government securities as those in Planning, and Economic Development, Utility Reform Unit, Kenya. Equally significant, its government has Kampala. been able to issue 10-year securities, indicating Project Finance International. Various issues. Project Finance. http:// www.pfie.com/. progress in developing local markets. Sheppard, Robert. 2006. "Financing of Private Infrastructure in Sub-Saharan Africa." Draft report prepared for World Bank, Infrastructure Economics and Finance Department; and PPIAF, Washington, D.C. GRIDLINES Gridlines share emerging knowledge on PPP and give an overview of a wide selection of projects from various regions of the world. Past notes can be found at www.ppiaf.org/gridlines. Gridlines are a publication of PPIAF (Public-Private PUBLIC-PRIVATE INFRASTRUCTURE ADVISORY FACILITY Infrastructure Advisory Facility), a multidonor technical assistance facility. Through technical assistance and knowledge dissemination PPIAF supports the efforts of policymakers, nongovernmental organizations, research institutions, and others in designing and implementing strategies to tap the full c/o The World Bank, 1818 H St., N.W., Washington, DC 20433, USA potential of private involvement in infrastructure. The PHONe (+1) 202 458 5588 fAx (+1) 202 522 7466 views are those of the author(s) and do not necessarily geNerAL eMAIL ppiaf@ppiaf.org WeB www.ppiaf.org reflect the views or the policy of PPIAF, PUBLIC-PRIVATE INFRASTRUCTURE ADVISORY FACILITY the World Bank, or any other affiliated organization.