15 November 2012

Africa's Infrastructure Boom - Will This Time Be Different?

High inflows to Africa's infrastructure sector bode well for growth. But stubborn obstacles - from procurement to currency denomination choices - now need to be tackled.

From new airports in Kenya, Senegal and Rwanda to the interstate railway project promising to connect Sudan and Chad, Africa is in the throes of an infrastructure boom. Construction industries are flourishing in Angola and Nigeria. In sandy Lamu, a new port could transform the export potential of Kenya, Ethiopia and South Sudan.

Transport corridors along southern Africa promise to strengthen integration, especially between South Africa and Mozambique. Ambitious new financing mechanisms are under debate; most recently, the African Development Bank's infrastructure bond scheme to raise $22bn for ports, railways, roads and energy. China's presence has brought undreamed-of quantities of infrastructure capital, and Western mining companies are drawing up infrastructure proposals to improve the competitiveness of their resource bids.

But this is not the continent's first infrastructure investment frenzy. After independence, governments penned similarly ambitious plans, and European and American financiers piled in. Even Zaire, one of the continent's most chaotic countries, attracted billions of dollars to support copper, manufacturing, steel and energy projects. But for all the transformational rhetoric across the developing world in the post-war era, it was only East Asia that deployed infrastructure spending at the rate and quality necessary to set off sustained high growth. Investment trends were low in Africa. Between 1960 and 1994, the continent invested 9.6 percent of GDP overall, while the proportion of other developing countries was 15.6 percent.

The public investment that was released often served prestige purposes rather than progressive ones. In the 1960s, when Ghanaian hospitals were out of medicines and industries starved of materials, Kwame Nkrumah spent $16m on a gigantic conference hall, with water fountains and banqueting halls, for a single meeting of the Organisation of African Unity. Siaka Stevens copied, spending two thirds of Sierra Leone's budget on buildings for the OAU, while the Togolese government spent half the national budget on a thirty storey hotel in Lomé. More mundane investments like rural road infrastructure and sewage systems often went wanting.

And infrastructure spending for the general good was often undermined by economic policy. Half-finished projects littered the landscape because - while donors lent money - African governments were co-financiers. When budgets were squeezed due to the oil crisis, global recession, and fiscal overstretching, state funds dried up and projects were left incomplete.

Poor economic policy hampered completed projects. "When a country's macroeconomic policies, such as exchange rate, tax and trade policies, are distorted, well-intentioned investment projects can turn out to be unproductive," says Shanta Devarajan, chief economist for Africa at the World Bank. Prior to price liberalisation, Ghana's overvalued exchange rate - reflected in a black market premium of 100 percent - meant farmers had little incentive to sell cocoa through official channels.

In these contexts, "An investment project that built roads to help farmers get more of their produce to market was unlikely to lead to greater output being sold, let alone reduce poverty by increasing farmer incomes," Mr Devarajan argues. Even when there was no black market premium, as in the West African franc zone, governments paid farmers a lower price than the world price for their cocoa and coffee, with an implicit tax rate sometimes reaching 80 percent. Farmers' incentives to produce - even if infrastructure was improved - were limited.

Protected industries were also costing economies in terms of forgone exports and higher domestic prices. Shoe factories, steel plants and car manufacturing plants weighed heavy. "When the protection could no longer be sustained and the tariff barriers came down, these projects failed and did not deliver the intended development dividend," Mr Devarajan concludes.

From the 1980s, donors starting giving project aid on the condition that markets were liberalised and state-run infrastructures privatised. But utilities put up for sale received few bids. Of water contracts signed, most were in distress, or faced early termination. In electricity, private sector engagement in concessions and leases was disappointing, with around a third of contracts signed in distress, or cancelled. "Private enterprise showed a weak appetite for investment in water and electricity in Africa, in part because the region was considered relatively risky but also because of the nature of infrastructure investment," says Kate Bayliss, a privatisation expert at the School of Oriental and African Studies. "These sectors require high up-front costs while returns accrue over a long payback period. The investment is not moveable and these sectors have high political, economic and social significance. Hence, from the perspective of investors, they are potentially subject to political interference which is even more risky in a weak institutional context."

Private operators did not necessarily prove better than public. One of the best performing water utilities, the National Water and Sewerage Corporation in Uganda, is government-owned, while one British operator, City Water, performed worse than Tanzania's public operator and lost its contract in 2005. "Evaluation of the relative performance of public and private utilities is difficult, because it is not easy to isolate the impact of the private sector when there are other changes going on at the same time," says Ms Bayliss. "Privatisation is often linked to the release of donor funds which will lead to performance improvements which can be mistakenly attributed to privatisation."

The financing of the private sector in the water industry has been "virtually zero" over the past 20 years, she concludes. Private investment in electricity generation meanwhile, on an annual basis, is less than 4 percent of required spending.

Today, while growth rates are higher, the infrastructure deficit yawns. Indeed it is becoming an even bigger problem. "Africa is more chronically short of infrastructure than ever because it is now growing fast, placing a greater strain on a stock that was already inadequate," says Paul Collier at the University of Oxford. The cost of freight on African roads is four times more expensive than other developing territories and travel between African countries is costly and lengthy. Thirteen countries have no operational rail infrastructure. It costs Citadel Capital $25,000 to get a 40 foot container from Mombasa to their agriculture project in South Sudan. Power cuts shave percentage points off growth. Africa has invested just 4 percent of its GDP in infrastructure over the last decade, compared to China's domestic investment ratio of around 14 percent.

One continuing obstacle is the long decision-chains involved in procurement selections on ports, airports, roads and utilities, which increase the likelihood of political meddling. "Sometimes these processes don't survive more than one administration...there is quite a lot of perceived risk, which does deter some companies," says Chris Brown, a lawyer at Norton Rose.

Donors can slow the wheels too. "The World Bank makes its processes so complicated, so drawn out, so difficult to access," says Neil Upton, energy and infrastructure partner at SJ Berwin. "For large scale projects to succeed, they need momentum. It can take you five or six years in a really big project to get there and if you don't have momentum you could have government changing more than once, and when government changes everything gets re-looked at. That delay is substantial on a balance sheet."

Delays increase the risk of dispute. "You set an expectation on price to investors at one point in a cycle. By the time you've sold it internally to stakeholders, 12 months have passed. In that period, things have changed. But if you've dug yourself in and created that expectation, that becomes politically known. Once it becomes politically known, it becomes entrenched," says Mr Upton.

Procedures should not be rushed, he says, but common sense should be applied. "A half decent decision made quickly, and then modified as you're going along, is infinitely more valuable in terms of delivering an outcome, than analysing everything and trying to make something perfect when it can never be."

Mr Collier believes the funding outlook for infrastructure is reasonable. "The new finance will come partly from Africa's natural resource extraction that will provide revenues, side investments by mining companies that need infrastructure such as power and rail, and from the Chinese packages of infrastructure-for-resources," he predicts. "But additionally, much of Africa will be able to borrow commercially at reasonable terms, as did Zambia last month." The country's debut $750m eurobond was oversubscribed by 15 times. "It will also be able to attract private risk capital, which is important because risk capital comes with an involvement in management and maintenance."

One challenge for encouraging investment in buying or building power infrastructure, however, is the energy tariffs. Many governments keep power prices artificially low which is discouraging the private sector from investing, according to Rupert Soames, CEO of temporary power provider Aggreko. Mr Soames believes tariffs must go up to incentivise investment and ultimately bring down the cost of supply.

Nigeria is trying. In parallel to its power privatisation programme - the largest in Africa's infrastructure sector - the government is pondering a tariff increase to around 17 cents (to date they have increased modestly, from 3 cents per kilowatt hour in 2005 to 7 cents in 2010). The context is the abysmal state of power. Only a third of industrial complexes receive their energy from the national grid and the central bank does not even trust the supply, preferring to use its own. Electricity-intensive industries are migrating to Ghana and Kenya. "If we are talking about being one of the top economies by 2020, we must match this with power development," says Bart Nnaji, the country's former power minister.

But privatisation will only draw interest if energy prices reflect the cost of production, says Dr Cezley Sampson at CPCS, transaction advisors to the government. Might this bring Nigerians, still smarting from the botched removal of the fuel subsidy, back onto the streets? To minimise that risk, the government is introducing a subsidy for the first two years. "The urban poor and rural dwellers will have a tariff reduction," says Mr Nnaji, with industrial, commercial and higher income groups bearing the brunt of the increase.

Supply side financing presents a second obstacle. A stagnant global economy means traditional lending groups are suffering deleveraging, and Basel II and III (international capital frameworks) are having a "significant effect" on banks' ability to lend long-term, says Mr Brown at Norton Rose. International banks are not looking at long-term debt, and there is "no real volume of infrastructure debt available in the marketplace". Project finance from local markets is in short supply. "There is quite a bit of money deposited in Africa in banks that is not being lent on projects because banks don't have large enough teams with the skill sets to do that," says Mr Brown.

One solution involves entities such a Guarantco, an offshore financial institution which acts as a guarantor of local currency loans. Under this model, a local bank lends in a local currency, and the offshore body guarantees the repayment of that debt if the project goes bad, bringing liquidity into the marketplace.

Currency denomination choices also need to be made carefully. Governments negotiating power purchase agreements often insist on payment in local denominated currencies which poses a problem for investors, says Mr Upton at SJ Berwin. "Large-scale projects cost a lot of money and if you are a European or American developer you don't want your money coming back to you in a currency that you think is subject to devaluation or substantial vagaries, and that banks won't accept."

Kenya stands out for its 'complete pragmatism', he says. "What Kenya seems to have done, very sensibly, is to say: 'We don't really care about whether or not this is in Kenyan shillings as long as we're getting what we want for our needs. You can have it dollar denominated, we can even do it in yen if necessary'. That puts them in a completely different place. It drops their unit price of power by about a third, and it tells any developer around the world that these guys are sensible, as a result of which they get a lot of hot competition."

Once a project is financed and launched, a new set of challenges emerge. The list of transformative projects enacting a negative toll on the people they were supposed to help appears endless. Perhaps most famous was the Chad-Cameroon pipeline, a World Bank-funded project with a consortium of investors that became a poster child for how not to fund infrastructure. Revenues raised from the project ended up funding arms deals for the government rather than reducing poverty, and the pipeline leaked and degraded coastal areas.

There are worries that increased investment into Africa encourages lenders to drop standards to compete. "The World Bank is feeling some pressure in terms of their business model. There are a lot of new lenders out there - the Chinese, the Brazilians - so there is a pressure to lower the safeguards to remain relevant," says Petra Kjell, programme manager for the Bretton Woods Project, a watchdog.

Governments are not always sympathetic to civil society complaints about the impact of megaprojects. The recently deceased Meles Zenawi, former leader of Ethiopia, once said: "These people are concerned that butterflies will be disturbed by such projects, and they will not allow the disturbance of butterflies even if this means millions of people have to be subjected to the deadliest killer disease of all: poverty."

Yet while some worry that governments are moving too quickly and recklessly on infrastructure spending, others are concerned about the social consequences of too little spending. This is problematic in countries with resource booms whose governments are under pressure to spend money.

Salvador Namburete, Mozambique's energy minister, says governments must tread carefully. Calls for big spending can incentivise governments to change revenue arrangements to raise more funds. "We do think it's important that we have a better share of what is being produced or extracted from our country, but it has to be on the basis of a negotiation with investors. We cannot change the rules of the game overnight. That's not good for private investment in the country."

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