Chinese companies now dominate the African construction sector, with a market share larger than those of France, Italy and US combined. This strength of Chinese firms in Africa's construction sector has continued to grow over the past few years despite the global construction market taking a downturn in the aftermath of the credit crunch.
Revenues of construction companies in central and southern Africa grew by 31.7% to US$27.52bn in 2009. North Africa grew 30.8% to US$29.29bn. At the same time, the share of Chinese enterprises in the African market rose significantly from 26.9% in 2007 to 42.4% in 2008 and back to 36.6% in 2009.
China's role in financing Africa's infrastructure projects is fuelling its recent dominance of the construction sector. This has resulted in a perfect match between Africa's infrastructure deficit, China's financial resources and surplus construction capacity following the infrastructure development boom that led up to the 2008 Beijing Olympics. It is worth noting that this is in line with the China "go-out" strategy, driven by the Chinese government, which has a strong influence over both financial institutions and companies.
China Export-Import Bank (China Exim Bank) disburses Chinese government concessional loans. According to World Bank estimates, China Exim Bank has disbursed over US$12.5-billion to support infrastructural projects in sub-Saharan Africa; most of the funds went into Angola, Nigeria, Zimbabwe and Sudan. Often tied to the Chinese loan was the agreement that the public tenders for the construction and civil engineering contracts would be awarded primarily to Chinese state-owned enterprises approved by the Chinese government, furthermore, no less than 50% of the procurement in terms of equipment, materials, technology or services must come from China.
Thus the Chinese state-owned financial institutions such as China Exim Bank and China Development Bank (CDB) have become large-scale lenders in Africa, rivalling the World Bank and the International Monetary Fund in terms of development finance outreach. Chinese funding appears to be tied to Africa's oil resources, with more than 55% of contracts by value accounted for by Angola, Sudan and Nigeria. Chinese funding of infrastructure looks set to continue, with the frequent state visits between China and African countries in recent years an indication of favourable China-Africa foreign policy.
Africa contracts undertaken by Chinese construction firms may be funded through Chinese government loans or other institutions. China-funded projects are restricted to Chinese construction companies, making it impossible for foreign companies to compete. These projects provide a way into a market for the construction company. Once established in the local market, the Chinese construction company will compete for projects financed through international institutions such as the World Bank, African Development Bank and domestic sources, with competitiveness often aided by the low labour costs of Chinese expatriate workers.
Chinese construction companies usually enter the Africa market on government-endorsed contracts, signed between the Chinese head office and the project owner. Most state-owned enterprises (SOEs) are generally engaged in engineering, procurement and construction (EPC) contracts, bringing in their own equipment, materials and some skilled labour from China.
During the initial planning phase much of the focus of a project is on project feasibility, budget and cost-benefit analysis. Chinese companies start the screening process when the project information is available; they look at the country risk, the project type and the source of funding. It is common for a team sent from the head office to a local country to investigate and conduct a feasibility analysis before they decide whether to bid or not.
Once a firm has decided to pursue a project, the company needs to issue a bid bond to support the intent. Compared to local construction companies, Chinese SOEs have the advantage of securing bid bonds, performance guarantees and advance payment guarantees from its head office in China through a Chinese financial institution, while this is a major impediment to local firms.
In most cases, contractors would then sub-contract the various tasks to smaller companies, procurement agents and construction contractors, with the construction company acting as the project coordinator and bringing management skills to the project. Sub-contractors are normally subsidiaries of the same group, sourcing and importing materials and equipment from China due to low costs and tax breaks offered by certain African countries.
This means that relatively little of the project value flows to African suppliers; in our experience, around 70% of the contract value is paid directly to China. By way of example, one client is developing a $500-million housing project that will involve complete prefabrication in China and shipment to Africa of the finished product.
One major concern for Chinese construction companies is the risk of cash being trapped in Africa. In order to mitigate this, contracts are signed with the Chinese parent companies and payment is made in US dollars. The continued deregulation of the Chinese currency, the renminbi (RMB), has made it a viable alternative to the dollar. A number of construction companies are interested in shifting payments to RMB as it gives a natural hedge for supplies from China.
Local currency requirements are either stipulated in contracts as a percentage of total contract value, or may be funded by head offices according to a cash flow forecast. A new account is opened for each project, and the project manager usually makes this decision, selecting the best local bank for the services required.
Companies gradually gain more knowledge of local markets and begin to win more private contracts, often in local currency. At the same time, they develop local alternatives to Chinese suppliers, resulting in deeper integration with domestic economies. Banking requirements then also become more sophisticated with a need for local working capital facilities, cash management services, foreign currency hedging and investment alternatives for surplus cash. Most of the requirements can be met with the right instruments; however, in case of currency risk, Chinese head offices are reluctant to perform currency hedging or use of derivatives.
Most SOEs seek to expand their scope both geographically and in terms of the types of projects they can undertake. A regional approach is popular since the environments, legal systems and business processes of surrounding countries are similar, allowing management of projects with easy access. Chinese companies are also very flexible, both in government projects and private projects. Similarly, subcontractors also seek ways to establish themselves in each country.
Even though Chinese construction companies enjoy many advantages, there are still a number of concerns that need to be addressed - fierce competition between Chinese firms, political and security concerns, fluctuating exchange rates, foreign currency remittance limitations, remote sites and poor infrastructure, poor local productivity and environment, and cultural and language issues. One of the biggest challenges faced by Chinese companies is the language barrier, even though many Chinese have studied English at school, it remains a challenge for them to express themselves correctly and it is a natural inclination to communicate in Mandarin and to do business with other Chinese companies.
It is clear that the China-Africa relationship has gained huge momentum in recent years, supporting construction, infrastructure, health, agriculture and other projects across Africa. Africa has become an important destination in terms of its investment opportunities and ways for China to secure future resources. With infrastructure identified as a priority, we will continue to see a strong demand in the power and infrastructure sectors in Africa, and Chinese construction companies are firmly positioned to take advantage of this coming wave. As such, we see China's construction industry as a key catalyst in Africa's infrastructure development.
Bridgette Liu is senior manager: Transactional Products and Services and Richard Stocken is general manager: Transactional Products and Services, Standard Advisory China at Standard Bank. This article was first published in Standard Bank's Guide to Transactional Banking in Africa 2012 under the headline: The role of China's construction industry in Africa's infrastructure development