Wednesday, December 1, 2021

Infrastructure deficit constrains Africa’s growth and poverty reduction

A 2020 empirical research study conducted by McKinsey & Company that examined Africa’s infrastructure paradox, and its root causes found that “there is need and available funding, together with a large pipeline of potential projects – but not enough money is being spent”.

It is acknowledged by the study that most of Africa lags behind the rest of the world in the coverage of key infrastructure classes, including energy, road and rail transport, and water infrastructure not leaving behind electricity infrastructure as generator-based power in Sub-Saharan Africa (SSA) was found to cost three to six times what grid consumers pay across the world.

McKinsey & Company reckons that closing the infrastructure gap matter greatly for the continent’s economic development, for the quality of life of its people, and for the growth of its business sector.

According to McKinsey, the good news is that “infrastructure investment in Africa has been increasing steadily over the past 15 years, and international investors have both the appetite and the funds to spend much more across the continent. The challenge, however, is that Africa’s track record in moving projects to financial close is poor: 80 percent of infrastructure projects fail at feasibility and business-plan stage. This is Africa’s infrastructure paradox – there is need and availability of funding, but not enough money is being spent”.

Nearly 600 million people in SSA lack access to electricity grid – accounting for over two-thirds of the global population without power. While significant progress is being made to close this gap, Africa still lags behind; for example India connected 100 million people to electricity in 2018, compared to just over 20 million achieved in Africa. McKinsey forecasts that Africa’s demand for electricity will quadruple between 2010 and 2040.

According to McKinsey, there have been concerted efforts to close Africa’s infrastructure gaps. A 2018 report by the Infrastructure Consortium for Africa (ICA) found that between 2013 and 2017, the average annual funding for infrastructure development in Africa was $77 billion – double the annual average in the first six years of this century. Nearly half of the recent activity was in West and East Africa, with 27 and 19 percent of the total respectively. The transport and energy sectors together accounted for nearly three-quarters of the total investment.

According to McKinsey, the rising spend has come principally from African governments, which accounted for 42 percent of total funding in 2017. Chinese investment in particular has grown steadily.

According the same ICA report, Chinese infrastructure commitments grew at an average annual rate of 10 percent from 2013 to 2017 and have supported many of Africa’s most ambitious infrastructure developments in recent years. For example, China’s EXIM Bank financed more than 90 percent of the $3.6 billion Mombasa-Nairobi Standard Gauge Railway in Kenya. Opened in 2017, the railway cut travel time between the cities in half.

However, many more projects are needed. As a share of GDP, infrastructure investment in Africa has remained at around 3.5 percent per year since 2000 – but the McKinsey Global Institute estimated in 2016 “that this will need to rise to 4.5 percent if the continent is to close its infrastructure gaps”.

By way of comparison, China spends about 7.7 percent of GDP on infrastructure, and India 5.2 percent. In absolute terms, this would mean a doubling of annual investment in African infrastructure between 2015 and 2025, to $150 billion by 2025.

Despite debt-to-GDP ratios which are anticipated to constrain Africa’s infrastructure spending in the years ahead, international investors “have considerable appetite for African infrastructure projects. By our estimate, such investors could have as much as $550 billion in assets under management”.

According to McKinsey, the appetite for investment varies across asset classes: some investors are eager for the returns (and risk) associated with Greenfield development, while others are more attracted to the steady performance of the brownfield assets. However, the increase in the number and value of deals in the recent past is a strong  indicator of the region’s potential momentum.  

McKinsey analysis indicates that Africa’s current pipeline of infrastructure projects includes a $2.5 trillion worth of projects estimated to be completed by 2025, across all asset classes.

Not all of these projects will eventually succeed, as over 50 percent of them are still in feasibility stages; nonetheless, this represents an impressive source of future infrastructure activity.

A pertinent question is being asked: Will a critical mass of this project pipeline move from feasibility to completion? The answer will determine whether Africa makes the necessary progress in closing its infrastructure gap.

“Unfortunately our research shows that most infrastructure projects in Africa fail to reach financial close: less than 10 percent of projects achieve this milestone, and 80 percent of projects fail at the feasibility and business-plan stage. This low success rates  represent a significant financial burden for infrastructure developers. For the six largest infrastructure markets in Africa, we estimate that the development costs of just the projects in the feasibility-study phase amounted to $30 billion”, submits McKinsey.

McKinsey terms the situation “Africa’s infrastructure paradox”: there is funding, a large pipeline, and a need for spending, but not enough money is being spent. To better understand the root causes of this paradox – and how they might be tackled – McKinsey investigated a number of case studies spanning important projects across Africa that have been cancelled.

“More than anywhere else on earth, Africa has huge unmet needs for infrastructure, reflecting a long history of underdevelopment. Today the continent has the opportunity to build the infrastructure its people and businesses need – at speed and scale. The funding is available, together with a large pipeline of potential projects.

“To ensure that the money is spent where it is needed, and delivers high-quality infrastructure on time and on budget, governments and private sector players need to step up to prepare, plan, and manage projects with a new level of rigour and robustness”, concludes McKinsey.  

Another research study titled “Investment and market Opportunities in Africa 2021 – 22 by the India Infrastructure Research acknowledges that Africa is seen as one of the world’s fastest growing regions and infrastructure development will help to catalyze the growth.

“The continent’s vast infrastructure deficit is a constraint on its growth, but also an opportunity to leapfrog to new, more efficient business models and technologies”, states the research paper which further reckons that “infrastructure development plays a major role in promoting growth and reducing poverty in Africa”.   

According to the African Development Bank (AfDB), Africa’s infrastructure needs have increased overtime, reaching $130 – 170 billion a year by 2018, with a deficit of $68 – 108 billion.

Energy infrastructure seems to be the most in need of financing in Africa, followed by water and sanitation. Transport infrastructure comes a close third in funding needs. However, Africa is reportedly performing much better in telecommunications than in any infrastructure sector.

The report notes that on the global scale, the African countries still have a long way to go. Nonetheless, a host of countries across the continent have started the Africa rising narrative. The African countries make 17 of the bottom of the bottom 20 countries in the Global Competitiveness Index 2019. Mauritius and South Africa are among the few bright spots, being the only two countries in the top half of the index.

It is also reckoned by the report that in the decades ahead, Africa can become a major contributor to and driver of global growth, just as Asia has been. However, for this to be true, Africa’s industrialization would have to be underpinned by a robust infrastructure financing programme. This requires a global financing pact among advanced and developing countries, a shift in strategic approaches, and new models of financing.

However, political instability remains one of the key challenges in the growth path of Africa. The policy landscape, especially that related to infrastructure is still at a nascent stage. Besides, the PPP is still evolving and fraught with several challenges.

As per industry experts, inadequate availability of funds for project development and preparation renders projects unviable. Across African countries, the Covid-19 pandemic has highlighted “structural gaps in national health care systems, corruption risks associated with public procurement and the misappropriation of emergency funds”.

In a 2015 research paper titled “Spanning Africa’s Infrastructure Gap” sponsored by Baker & McKenzie, it is quoted that in 2009 World Bank estimates indicated that over $900 billion was required in SSA alone, a figure likely to have increased in the six years that have passed since then.

The paper also acknowledges that the private sector actors’ “funding contribution in Africa is not nearly enough, and, importantly, sourcing the required funding is only part of the challenge”.

Addressing the infrastructure deficit in power, communications and transport, water and sanitation, and other sectors, requires the technical capacity to manage the physical build and on-going maintenance, as well as establishing a conducive or “bankable” environment to support large, and at times, complex projects. These resources, unfortunately, are lacking in many African jurisdictions”.

The study undertaken over a six year period from 2009 to 2014 on 22 African focus countries found that the challenge of addressing the infrastructure gap “in Africa is too big for any one actor to address on its own. Billions of dollars are required to pay for the physical infrastructure, but, beyond the build-related finance, funding and assistance are required to plan, manage and develop bankable projects”.

According to the research study, many African countries face the conundrum of not being able to take on additional debt, while lacking the technical and other capacities to manage infrastructure-related projects successfully. In this context, the role of development finance institutions (DFIs) have played the role of being there “through cycles”, and helping to create an enabling environment that supports infrastructure development, has been indispensable.

“Clearly, not all DFIs operate on an altruistic basis. Some DFIs, the bilateral one in particular, are guided primarily by a nationalist agenda in support of their own export base, which may or may not distribute the benefits of their funding initiatives equitably. However, without the contributions of the DFIs, bridging the infrastructure gap would be all the more difficult”, states the paper.

Africa-based development-capital providers may see their ability to raise and extend funding at competitive rates negatively impacted by the credit ratings of their shareholding countries.

This is particularly the case with the Development Bank of Southern Africa (DBSA), whose rating is dictated by the credit rating of South Africa, which is a country acutely exposed to international capital flows, and which depends on commodity exports for over 50 percent of its foreign-exchange earnings.

This notwithstanding, the involvement of development funders from other regions is expected to remain constant. Of note, China-based sources of development funding and investment in Africa have increased drastically over the last 14 years, and, if the narrative coming from the Chinese officials is to be believed, “China will remain by far the biggest source of finance to assist in addressing Africa’s infrastructure deficit for the foreseeable future”.

The report further notes that the development-capital sector and its funding participants will continue to occupy an important space in creating and supporting bankable projects.  DFIs, having already approved hundreds of billions of dollars into Africa-based infrastructure projects in the last few years alone, over the next decade are likely to allocate well over $1 trillion in new funding, combining the contributions from China, focus DFIs and other institutions, such as BRICS Development Bank.

In developed markets, DFI funded projects act as multipliers, bringing in tens of dollars for every one dollar in funding allocated. Africa is not necessarily achieving that level of capital leverage, but the signs, for example with South Africa’s REIPPP or Uganda’s GET Fit programme point encouragingly in this direction.

The report concludes that development capital is certainly catalyzing private sector investment in Africa-based infrastructure projects, but not yet on the scale needed. However, as investors become more comfortable, perhaps the multiplier effect will increase to a greater extent, if that happens, “billions of dollars will rapidly become trillions, and Africa will acquire the platform of infrastructure necessary to fully realize its potential”.

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