The role of ECAs in supplementing a flourishing African investment climate
Rick Angiuoni, Director for Africa at US EXIM, discusses the ways in which export credit agencies can help bridge the financing gap for African countries and make Agenda 2063 a reality.
Agenda 2063, the African Union’s strategic framework for inclusive and sustainable development, is driven by several political, economic and social goals, including aspirations for ‘shared prosperity and well-being, for unity and integration, for a continent of free citizens and expanded horizons, where the full potential of women and youth are realised, and with freedom from fear, disease and want.’ In support of Agenda 2063, all stakeholders can collaborate and contribute by providing essential engines for economic growth, such as investment, financing, development aid, and other forms of financial support. While the number and breadth of these stakeholders vary greatly, export credit agencies (ECAs), a key pillar of the international financial architecture, have the potential to mobilise private sector capital and significant sustainable debt critical to bridge Africa’s financing gap and help make Agenda 2063 a reality.
African countries remain among some of the richest markets globally, in terms of resources and human capital. This is illustrated by the fact that the United Nations (UN) projects that the population in Sub-Saharan Africa (SSA) will reach 3.8 billion, representing approximately 35 percent of the world’s population compared with 1.1 billion today. The current financial status quo, however, has been unable to effectively meet present and prospective requirements for sustainable growth, poverty alleviation, and energy transition. Recognising the environmental, social, economic, and political impact of this growth, stakeholders should interpret these dynamics as incentive to use all available funding tools to further support Africa’s sustainable growth.
Sub-Saharan Africa’s large and heterogeneous landscape of economies, risks, and financial systems, many of which are currently in the process of modernising to meet global and domestic demands, as well as industry best practices, have led to the continent’s heavy reliance on external sources of investment and capital. According to the International Monetary Fund (IMF), public debt in sub-Saharan Africa jumped by more than six percentage points to 58% of GDP in 2020, the highest level in almost two decades. The composition of Africa’s debt has somewhat shifted from Paris Club creditors toward commercial and non-Paris Club creditors, most notably Eurobond debt and Chinese financing. Given the current landscape of Africa’s financing and the need to diversify financing sources, International Financial Institutions (IFIs), Development Finance Institutions (DFIs), ECAs – OECD and non-OECD included – have an integral part to play in this shift.
While the shift in the debt mix has provided Africa with new sources of financing, it has also exposed the continent to certain vulnerabilities, namely, rollover risks, volatility of market movements, debt management, and challenging dynamics in dealing with potential debt negotiations and treatment. Moreover, the rise in debt levels has been accompanied by a shift in the cost associated with this debt, making many debt solutions more expensive. So, while the region could greatly benefit from low-cost debt options, many African countries instead face higher risks, higher prices, limited access to credit, and lower capital – Africa’s perennial credit challenges.
Given Africa’s perennial limited access to credit and recognising that Official Development Assistance (which has been a key source of much public sector funding) has been flat or declining, governments across Africa acknowledge that they do not have the capacity to finance the quantum of these investments. Hence, much of this funding will need to come from the private sector, as well as public funds. Since the collaboration from these various institutions is essential to fund projects across Africa, how can these institutions provide more credit and lower borrowing costs in helping to meet Africa’s financing gap?
The role of ECAs
The government-backed status of ECAs makes these institutions critical sources of capital for African countries as guarantors of private investment funds. Due to their capacity to take on country and project risks, they can help unlock commercial investments and institutional investors by addressing these risks to attract more private sector capital. Therefore, ECAs have an unprecedented opportunity to catalyse private sector funding, crowd-in private sector investments, and catalyse additional pools of funds into investments across various economic sectors. This is particularly relevant for clean energy investments, where billions of dollars are being pledged in support of climate investments and energy transition efforts.
In the case of Sub-Saharan Africa, the capacity for taking on risks by the private sector remains limited in many markets, especially for medium and long term credits, large projects, and small and medium sized enterprises. In these circumstances, ECAs can help fill in private sector market gaps by facilitating financing and helping maintain debt sustainability. In response to market gaps and opportunities, the activity of ECAs has evolved and has been significantly conditioned by the environment in which they operate, particularly by government policies and increased competition from non-OECD countries and private insurers.
Over the past decade, ECAs have emerged as active and reliable sources of financial support with respect to global economic development, so much so, that as of 2021, there are almost 90 ECAs in the world. Based on research from the Berne Union, the association’s Member States directly supported $2.6 trillion of global exports of which around 3% goes to transactions in SSA, the majority of it being Medium and Long Term (MLT) export credits which is coming from ECAs.
The prospect of meeting SDGs and the challenges that many African countries face in the 21st century presupposes mobilising private capital to bridge the aforementioned funding gap. As the role and objectives of export credit agencies have been changing, the OECD Arrangement is continually faced with challenges, requiring provisions that allow OECD countries to adapt to the ever-evolving market conditions. In some cases, additional changes are necessary to address the nuances of financing SDGs in Africa. Addressing rules relative to local cost and down payments are all welcome and potential reforms to premiums, and repayments and minimum interest rates can add value to ECAs’ continued competitiveness. These are no substitute for innovation, however. In the end, the competitiveness of ECAs will be driven by their ability to mobilise more private sector investments through creative origination, and collaboration with other institutions through co-financing, risk sharing and the use of de-risking products that utilise blended finance.
Most of us have heard of, read, or structured blended finance transactions. International Finance Corporation defines blended finance as the use of relatively small amounts of concessional donor funds to mitigate specific investment risks. OECD defines it as the strategic use of development finance for the mobilisation of additional finance towards sustainable development in developing countries.
Africa requires high investments, but high-country risks and high-risk premiums required by investors have limited the amount of capital available in current markets. This higher risk-higher returns dynamic has the potential to perpetuate a vicious cycle of even higher risk-higher returns and paradoxically lower investments.
How can this cycle be disrupted?
Per AfDB, “Going forward, strengthening the links between debt financing and growth returns would play an important role in ensuring debt sustainability on the continent.” Whether it is financing for infrastructure or for the green energy transition, low-cost financing is critical for debt sustainability. Given that the cost of capital is high across the region, efforts to reduce the costs of borrowing are critically important to Africa’s infrastructure gap and climate agenda. Since the challenge of lowering cost of capital is complex and an enabling environment that can attract and retain capital is essential, the focus of current thinking is on financial de-risking. To this end, the use of ‘blended financing’ has received increased attention with Sub-Saharan Africa as the most attractive region for blended financing transactions.
Recognising that investing in infrastructure is essentially a problem of risk analysis and risk mitigation, the objective of ‘financial de-risking’ is to reduce the risks involved with investments in order to lower the perceived risks and required returns, and, thus, reduce investment costs. Project risks can be mitigated through blended finance instruments, such as counter guarantees, first loss, grants, concessional loans, interest rate reductions, longer tenors, and subordination structures, for both debt and equity. However, in the end, most of this funding is premised on bankability of projects based on solid financial, economic, environmental, legal, and technical conditions and allocation of risks among the various parties participating in these projects.
In short, the utilisation of a blended finance structure allows for the potential use of two types of different instruments: i) funded and/or ii) unfunded. For example, funded options could include any form of co-investment with the private sector. These options could be in the form of loans and donor funding. The co-investment can also take the form of equity, subordinated/mezzanine debt or a debt contribution provided directly to the infrastructure directly or indirectly via investment vehicles for infrastructure. Other funded options may include technical assistance by way of grants to reduce the costs of projects that require enormous initial capital expenditures. These mechanisms have exemplified the potential that blended finance possesses with respect to garnering increased investment and capital mobilisation in African countries.
Unfunded instruments are represented by public guarantees, or back-up liquidity facilities, that can be provided to creditors. These credit enhancements, such as World Bank Partial Risk Guarantees, guarantees from ECAs, and insurance from ATI, are provided to improve the attractiveness of the project for private investors and creditors.
The landscape of institutions from private and public sector intermediaries and guarantors active in supporting finance in Africa with unfunded and unfunded instruments and risk-sharing structures is quite diverse. Ultimately, the objective is for stakeholders to collaborate in partnership on projects that create value. This allows them to ensure that pools of funds and resources are strategically and optimally allocated, serving as catalysts to attract greater capital on investments necessary to generate future growth. To this end, a platform for dialogue, through entities such as the Berne Union, with appropriate control measures, should be created to enable greater communication in sharing information on risk mitigation instruments to increase the ratios of public to private capital mobilisation.
While Africa faces many challenges, it is encouraging that many initiatives from Europe, America, the Middle East, Africa, and Asia seek to provide solutions for them. Yet, a new challenge is to find ways for the various stakeholders to collaborate in mobilising capital so that their initiatives will have a greater and more successful impact. Considering the complexities of Africa and of the international financial architecture, the required changes and initiatives to fill in the financing gap are not an easy task, but in the end, it’s a worthy task to undertake for the realisation of Agenda 2063.
In writing this brief article, I am reminded of the Berne Union’s foundational principles of cooperation and stability and the words of Walter Wriston, former chairman and CEO of Citibank, “Capital goes where it is welcome and it stays where it is well treated.” Agenda 2063 can be a reality if built on these principles.
- “Agenda 2063”. African Union Website available at https://www.africaunionfoundation.org/agenda-2063/ (last accessed Aug 15, 2022). ↑
- “World Population 2019”. United Nations Department of Economic and Social Affairs website available at https://population.un.org/wpp/Publications/Files/WPP2019-Wallchart.pdf (last accessed Aug 15, 2022). ↑
- https://www.imf.org/en/News/Articles/2021/06/23/sp062321-the-road-ahead-for-africa-fighting-the-pandemic-and-dealing-with-debt (last accessed Aug 24, 2022). ↑
- The OECD Arrangement is a ‘gentleman’s agreement’ among several OECD countries that aims to level the playing field and encourage competition among exporters by placing limitations on the financing terms, conditions and use of tied aid when countries provides officially supported export credits to exporters. ↑
- African Economic Forecast 2021. African Development Bank website available at https://www.afdb.org/sites/default/files/2021/03/09/aeo_2021_-_chap2_-_en.pdf (last accessed Aug 15, 2022). ↑