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How to Attract Private Finance to Africa’s Development

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By Catherine Pattillo, Luc Eyraud, and Abebe Aemro Selassie
  • Africa’s economic gains of the last two decades, which have been critical in improving living standards, are in jeopardy due to COVID-19.
  • High public debt levels and an uncertain outlook for international aid, limit the scope for growth through large public investment programs.
  • As a result, the private sector will have to play more of a role in economic development if African countries are to enjoy a strong recovery.
  • Currently public entities, such as national governments and state-owned enterprises, carry out 95% of infrastructure projects.
  • Three experts from the IMF explain how we can change this.

African economies are at a pivotal juncture. The COVID-19 pandemic has brought economic activity to a standstill. Africa’s hard-won economic gains of the last two decades, critical in improving living standards, could be reversed.

High public debt levels and the uncertain outlook for international aid limit the scope for growth through large public investment programs. The private sector will have to play more of a role in economic development if countries are to enjoy a strong recovery and avoid economic stagnation. Heads of state from Africa made this one of their resounding messages during the recent summit on “Financing African Economies” held in Paris in May.

Infrastructure—both physical (roads, electricity) and social (health, education)—is one area where the private sector could be more involved. Africa’s infrastructure development needs are huge—in the order of 20 percent of GDP on average by the end of the decade. How can this be financed? All else equal, the main source of financing would be more tax revenue collections, something that most countries are working towards. But, given the scale of the needs, new financing sources will have to be mobilized from the international community and the private sector.

Africa is a continent that holds immense opportunity for private investors. It has a young and growing population and abundant natural resources. Cities are seeing massive growth. Many countries have launched long-term industrialization and digitalization initiatives. But significant investment and innovation are necessary to unlock the region’s full potential. Recent research published by IMF staff shows that the private sector could, by the end of the decade, bring additional annual financing equivalent to 3 percent of sub-Saharan Africa’s GDP for physical and social infrastructure. This represents about $50 billion per year (using 2020 GDP) and almost a quarter of the average private investment ratio in the region (currently 13 percent of GDP).

What constrains private finance now?

At the moment, the private sector is not involved much in financing and delivering infrastructure in Africa, compared to other regions. Public entities, such as national governments and state-owned enterprises, carry out 95 percent of infrastructure projects. The volume of infrastructure projects with private sector participation has significantly declined in the past decade, following the commodity price bust. The limited role of private investors is also apparent from an international comparison perspective: Africa attracts only 2 percent of global flows of foreign direct investment. And when investment does go to Africa, it is predominantly to natural resources and extractive industries, not health, roads, or water.

To attract private investors and transform the way Africa finances its development, improvements in the business environment seem critical. Our research shows that three key risks dominate international investors’ minds:

  • Project risk. Despite Africa presenting a wealth of business opportunities, the pipeline of projects that are truly “investment-ready” remains limited. These are projects sufficiently developed to appeal to investors that do not want to invest in early-stage concepts or unfamiliar markets. Financial and technical support by donors and development banks can help countries fund feasibility studies, project design and other preparatory activities that expand the pool of bankable projects.
  • Currency risk. Imagine that a project yields a return of 10 percent a year, but the currency depreciates by 5 percent at the same time—this would eliminate half of the profits for foreign investors. No wonder currency risk is a top concern for them. Prudent macroeconomic policy combined with sound foreign exchange reserve management can greatly reduce currency volatility.
  • Exit risk. No investor will enter a country if they don’t have assurances that they can also exit by selling their stakes in a project and recouping their gains. Narrow and underdeveloped financial markets may prevent investors from exiting by issuing shares. Capital controls can slow down or increase the cost of exiting. And, when the legal framework is weak, investors may get bogged down in legal battles to have their rights recognized.

Incentivizing private investment

Improving the business climate is important but not enough. Development sectors have certain structural features that make private sector participation intrinsically complicated, even in the most favorable environments. For instance, infrastructure projects often have large upfront costs, but their returns accrue over long periods of time, which can be difficult for private investors to assess. Private sector growth also thrives on networks and value chains, which may not yet exist in new markets.

When these problems are acute, governments may have to provide extra incentives to make infrastructure projects attractive to private investors. These incentives, which comprise various types of subsidies and guarantees, can be costly and carry fiscal risks. But the truth is, many projects in development sectors won’t happen without them. In East Asia, 90 percent of infrastructure projects with private participation receive government support.

With certain design features, governments can maximize the efficiency and impact of public incentives, while minimizing risks. Support should be targeted, temporary, and granted on the basis of proven market dysfunctions. It should also be transparent, leave sufficient risk to private parties, and display additionality, meaning that incentives should make worthy projects happen that would not happen otherwise. Finally, their size should be well calibrated to avoid overcompensating the private sector.

Given the limited availability of public funds, African countries and development partners could consider reallocating some resources used for public investment towards financing public incentives for private projects. When this reallocation is gradual and supported by sound institutions, transparency and governance, it could increase the amount, range, and quality of services for people in Africa. More innovative thinking can help realize the transformative potential of infrastructure on the continent.


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BUSINESS & ECONOMY

Inquiry on General Babangida’s Involvement in Conventional Banking despite Introduction of Islamic Finance in Nigeria

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Dear Editor,

I hope this letter finds you well. I am writing to express my curiosity and seek clarification on a matter that has caught my attention, specifically pertaining to General Babangida’s involvement in the conventional banking industry despite his role in introducing Islamic finance during the financial reforms of his military government in Nigeria. Vide your special article commemorating his 81st Birthday published in your esteemed news website: https://focus.afrief.org/trending/a-salutary-tribute-to-general-ibrahim-badamasi-babangida-architect-of-islamic-finance-in-nigeria/

It is indeed noteworthy that General Ibrahim Babangida played a pivotal role in shaping the economic landscape of Nigeria by introducing Islamic finance principles. It is fascinating to witness the implementation of Islamic finance in Nigeria, as it promotes principles that align with religious and ethical values. General Babangida’s efforts to introduce this form of finance were undoubtedly commendable, reflecting his commitment to establishing an alternative financial system that adheres to Islamic principles.

However, recent observations suggest his active participation in the conventional banking sector in Nigeria. Certainly, it is intriguing to see General Babangida’s continued involvement in the conventional banking industry, which operates under different principles. While some may argue that his involvement in both sectors is simply a matter of personal choice, it raises questions about the compatibility of his actions with the ideals and principles of Islamic finance. While the former is interest driven, the latter prohibits interest related transactions completely.

I wonder if General Babangida has ever publicly addressed this matter or explained his reasoning behind being active in both sectors. It would be enlightening to hear his perspective on how he reconciles his involvement in conventional banking with his efforts towards promoting Islamic finance. This has raised questions in my mind and perhaps in the minds of others as well.

I am keen to understand the rationale behind General Babangida’s dual engagement in both Islamic finance and conventional banking. Does this reflect a strategic approach to diversify Nigeria’s financial sector, or are there specific reasons behind his involvement in conventional banking despite advocating for Islamic finance principles?

Additionally, it would be interesting to explore the potential impact of his dual involvement on the perception and growth of Islamic finance in Nigeria. Does his presence in the conventional banking industry hinder the progress of Islamic finance, or does it have the potential to bridge the gap between the two sectors?

I believe that delving into these questions could provide valuable insights and generate constructive discussions within the Islamic finance community in Nigeria. By shedding light on General Babangida’s dual involvement and the potential implications, we can further enhance our understanding of the challenges and opportunities faced by the Islamic economy in our country.

Thank you for considering my questions, and I look forward to reading more about this topic in your esteemed Focus on Islamic Economy.

Sincerely,

 

Abba Musa Mamman Lagos

Kaduna


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BUSINESS & ECONOMY

10 Megatrends Shaping the World in 2024

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The report, “Navigating Megatrends Shaping Our Future in 2024”, was launched during the first day of the World Governments Summit (WGS) 2024, being held under the theme “Shaping Future Governments” from 12th-14th February in Dubai. The report examines the indicators that shape these megatrends, supported by evidence from today as well as future expectations. These trends inform decision-makers and foresight experts about various sectors and the potential opportunities in each.

Khalfan Belhoul, CEO of Dubai Future Foundation, said, “This report has been launched in line with DFF’s efforts to identify and communicate those trends with the most potential to shape opportunities and strengthen local and international partnerships to overcome current and future challenges.”

“The challenges that face us on our journey to the future require that we are agile enough to be able to adapt to rapid change. It is vital we pay attention to the signals we detect – only then can we be prepared to overcome challenges and seize opportunities. The World Governments Summit provides a platform for discussing these challenges and exploring the opportunities.”

Materials revolution

New types of materials will create a shift in the industry, with solutions based on artificial intelligence (AI) such as biopolymers, biorefineries, and chemical recycling paving the way. These solutions will facilitate the development of new biological and novel materials that could rival plastics.

Boundless Multidimensional Data

Enabled by developments such as 5G and 6G in addition to advanced connectivity, the availability of raw data will vastly increase. The Internet of Things (IoT) will continue being deployed in healthcare, agriculture, and smart cities, especially in the Middle East.

Technological Vulnerabilities

The cybersecurity sector will boom amid a sharp rise in smart home devices and wearable tech. According to a report by Allianz, the annual cost of ransomware is projected to reach around $265 billion by 2031. Meanwhile, the debate on the future of decentralised finance will continue.

Energy Boundaries

Advances in tech and the growing demand for energy will drive the pursuit of alternative sources of energy. Novel materials and machine intelligence will enhance current sources of energy, including their distribution around the world – and in space.

Saving Ecosystems

Approaches to conservation will be more interdisciplinary and future-focused, taking into account both societal and environmental factors. Driven by resource scarcity, climate change, and shifts in social values, environmental impact management will become increasingly holistic.

Borderless World – Fluid Economies

The world is witnessing a rise in unmediated transactions in finance, health, education, trade, services, and even space, which are blurring boundaries and creating more cross-border communities. Advances in communications, computing, and advanced machine intelligence will accelerate the creation of a borderless world that will change the way we work, live, and connect.

Digital Realities

The spread of 5G and 6G networks will enhance the applications of autonomous technologies and IoT. As quantum technologies become scalable and reliable, immersive experiences will become even more realistic.

Living with Autonomous Robots and Automation

Robotics and automation will increasingly be deployed across industries beyond automotive, manufacturing and supply chain logistics. This will provide opportunities for efficiency and innovation, although there will also be ethical challenges to address.

Future Humanity

New workplace norms will emerge, with people needing to adapt to non-traditional skill sets in areas such as digital literacy, communications, culture and sustainability.

Advanced Health and Nutrition

Accelerated progress in advanced machine intelligence, nano- and biotechnology, additive manufacturing, and IoT will transform health and nutrition, improving health and wellbeing for people of all ages. Technology will reduce, if not eradicate, some communicable and non-communicable diseases and enhance the sustainable use of and access to water and food.


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BUSINESS & ECONOMY

Africa’s New Online Foreign Exchange System will Enable Cross-border Payments in Local Currencies – what you need to know

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The high cost of making cross border payments on the African continent has driven governments on the continent to seek options of settling trade and other transactions in local currencies. This has given birth to the Pan-African Payment and Settlement System which was formally launched in Accra, Ghana, in January 2022.  Development economist Christopher Adam, who has studied the exchange rate policies of African countries, answers some key questions.

Why are African countries exposed in the international currency market?

Three main reasons. First, African economies are small and as such are highly dependent on trade with the rest of the world. Their exports are dominated by primary commodities including oil and gas, minerals and cash crop agriculture. On the import side, they purchase a whole range of goods – from essential commodities not produced at home such as fooddrugs and medicines, to capital goods and energy. A large proportion of these are sourced from China and other major economies of the global north. But because African countries are small relative to their trading partners they rarely have the power to determine the prices of imports and exports. They are “price takers” in world markets. And with world prices being set in the major reserve currencies of the world (the US dollar, euro, yen and renminbi), African countries are exposed to movements in these world prices. Second, “intra-African” trade is still a relatively small proportion of the total trade of African countries.

Finally, since African countries’ currencies mostly can’t be directly exchanged in international transactions, the dollar remains the most widely used currency in trade, even between African countries.

What’s required for the system to get off the ground?

The basic idea of the system is to be able to settle trade between African countries without having to use the US dollar.  There are two major challenges with that. First, intra-African trade accounts for less than 15% of Africa’s exports at present (although supporters of the African Continental Free Trade Area expect this to grow significantly over the coming decades). The African payment system therefore does not eliminate the role of the dollar (or other foreign currencies) in trade settlement entirely.

The second issue is that trade is not balanced between African countries. For example, Kenya exports goods of higher total value to Ethiopia than it imports from Ethiopia. If Ethiopia paid in its own currency, Kenya would end up with Ethiopian currency that it didn’t need. Some form of settlement currency that is acceptable to all is required – most likely the US dollar.

What are the challenges and potential risks?

Since trade rarely occurs instantaneously, some institution in the trade financing chain carries the exchange rate risk. Because of the gap between placing an order for imports and receiving them to sell in the local economy, there is a risk that the value of local currency will change relative to the currency in which the import is denominated.

In the “old” system, this risk is borne by the trader because everything is priced in dollars. The local currency value of the income from exports or the local currency cost of imports will change with movements between the local currency and the dollar, but the banks and those counterparts pricing in the dollar are protected.

Under the new system the same allocation of risk will remain in “external trade”. This currency risk is also present for intra-African trade.

An important question for the new African payment system is: who bears the exchange risk if one African currency depreciates relative to another? Should the importer carry the risk, or the exporter? Can and should the African payment system bear this risk of exchange rate movements itself? Where both currencies are volatile, traders might still prefer the relative stability of settlement through the US dollar.

The success of this system also depends on scale. The more trade settlement is routed through it, the easier it will be to settle in local currencies. Large currency imbalances will be less common. But until the system achieves this scale, the African payment system will need a strong balance sheet so that traders and participants can have confidence that settlement will be swift and risk free. It is unclear at the moment how this is to be achieved.

What is the best case scenario?

If the system can address the trade imbalance problem, provide clarity on risk management and reach scale, it could be very successful. But this is all going to be driven by underlying economic performance. Improved settlement will help but what is really driving this is the structure of trade. The more the economies of Africa can develop intra-African trade and the less dependent they are on extra-African trade, the less will be dollar dependence in trade. This growth in trade depends to some degree on trade settlement and trade financing but much more on production, consumption, trade policy and fiscal policy.

Christopher Adam is a Professor of Development Economics, University of Oxford


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