The role of DFIs in enhancing investments in Africa

Infrastructure is a critical element for the delivery of public services and economic development. Infrastructure contributes to the development of the private sector which, in turn, provides the majority of economic growth through the creation of jobs, and increase in profits leading to an increase in government tax revenues. The higher the growth rates, the better the economic development. Some studies even suggest that an additional 2% GDP growth as well as a 40% increase in productivity in Africa could have been realised if adequate infrastructure had been in place.

According to the World Bank, Africa needs to spend US$93 billion a year until 2020 to close the infrastructure gap, indicating an annual shortfall of roughly 50%.

Though public sector investments are necessary to help support poverty reduction, they are not sufficient. There are, in addition, many constraints on public finances which limit the capability of states to close this gap. Private sector involvement by way of foreign international firms and local companies intervening in projects is, therefore, key.

However, both types of private sector involvement still face challenges: the standards of public corporate governance and the rule of law hamper the involvement and development of international companies for big projects, and access to finance, the creation of an enabling environment, and access to business information and training all act as barriers for the development and involvement of the local private sector.

Given these elements, Development Finance Institutions, commonly referred to as DFIs, can be powerful tools to unlock the barriers for both international companies and local players.

DFIs, be they single government owned ( bilaterals) such as Proparco (French), DEG (German), FMO (Dutch) or multi government owned (multilaterals) such as the International Finance Corporation (IFC), the African Development Bank (ADB) or the European Investment Bank (EIB), generally retain operational independence from their respective governments and benefit from their government credit ratings. This enables them to raise large amounts of money on international capital markets and provide competitive financing terms.

Distinct from aid agencies through their focus on profitable investment and market rule operations, DFIs occupy the space between public aid (which is typically focused on investments through the public and not-for-profit sectors) and private investment.

Their purpose is to provide additionality, such as to provide capital and/or finance in countries where there would otherwise be no access to finance or capital in the private sector, and to invest in sustainable private sector projects with the objective of enhancing socio economic transformation and development, while themselves remaining financially viable.

In practice, development of the local private sector is often undertaken via the improvement of access to finance. This presents a challenge to many companies in developing countries, especially the small and medium enterprises. Generally, big businesses are served by large banks, and micro businesses are served by the micro finance institutions which have mushroomed in the past 10 to 15 years. However, SMEs are often too big for microfinance solutions but are neither big enough nor wealthy enough to interest big banks, for which they are too risky. Further, local banking systems often do not offer loan maturities that are interesting for SMEs and long term debt options are few and costly. As a result, financing for SMEs is often done by way of overdraft and family loans, which hamper their long term development. On a continent where growth relies, in large part, on entrepreneurs, tapping into this underserved market is critical to unlocking the continent's potential.

The African SME sector has strong growth potential, as SMEs currently contribute only 16% of GDP and 18% of employment. By contrast, the figures are between 51% and 57% in high income countries. In addition, demographics are an issue - the proportion of 15 to 24-year-olds has risen from 110 million 10-years-ago to a current 172 million. This number is set to grow to 246 million in 2020. We will need to see the creation of 74 million jobs to avoid a rising unemployment rate. As a result, over 70% of 15 to 24-year-olds are interested in becoming entrepreneurs.

DFIs will intervene in this sector to develop SMEs by acting directly, or via financial intermediaries such as banks or private equity funds. DFIs also use specific financial instruments such as blending, a financial instrument combining grants or concessional loans from DFIs with market finance loans, to reduce the cost of access to credit for businesses most in need.

They will also use risk mitigation instruments which enable the reduction of investment risks. These include credit guarantees that cover losses in case of debt default due to political or commercial reasons, export credits and currency risk coverage. The World Bank's MIGA also provides coverage for non-commercial risks such as currency inconvertibility, transfer restrictions, expropriation, war, terrorism, breach of contract, and non-honouring of sovereign financial obligations. Further, investors teaming up with DFIs will benefit from their environment and social risk assessment and mitigation procedures, guarantees and, when teaming with multilateral institutions such as the IFC, they can also benefit from the institution's preferred creditor's status.

Finally, some DFIs also have specialised project preparation units, such as the Nes Partnership for Africa's Development (NEPAD) and the Development Bank of Southern Africa (DBSA) which support the de-risking of projects and help deliver project concepts to bankability by means of project identification, feasibility assessment, technical assistance, financial structuring, and managing project preparation funds.

DFIs have a higher risk tolerance, look at longer investment horizons in comparison with local banks and, as such, act as catalysts for private sector investment. By supplying long term finance, which is essential but often unavailable in low income countries, mitigating early stage project risks, and leveraging additional finance by improving attractiveness of deals, DFIs help attract and mobilise the involvement of other investors. DFI-backed loans are indeed less risky than pure commercial loans as borrowers are reluctant to default on their obligations as this could harm the relations with the institution or the donor government.

The role that can be played by DFIs in enhancing investment in Africa should not be underestimated.