Infrastructure for Development Meeting the Challenge in Africa November 14 th 2012

1. Infrastructure for Development Meeting the Challenge in Africa November 14th 2012 Dr Mattia Romani Senior Visiting Fellow Grantham Research Institute London School of Economics and Political Science and Director, Green Growth Planning and ImplementationGlobal Green Growth Institute

2. Contents • Why infrastructure for Africa? The needs • The gap • The risk profile • Potential solutions

3. Contents • Why infrastructure for Africa? The needs • The gap • The risk profile • Potential solutions

4. Why infrastructure for Africa? • Infrastructure contributed over half of Africa’s improved growth performance (1999-2005). IT contributed significantly more than any other structural policy in the continent. • Africa’s infrastructure lags well behind that of other developing countries, particularly in terms of pave roads and power generation. On the latter, it started from similar levels to South Asia in the 1960s, and is significantly behind now. • Africa’s infrastructure services are twice as expensive as elsewhere. This is true across tariffs for different types of infrastructure. This is particularly severe for power and water, where average tariffs are a multiple of tariffs in South Asia. • Today Africa faces a resource gap of approx $35bn/year. This includes taking into account the potential for efficiency improvements (as much as $20bn). This gap could double in the coming decade due to growth, as well as limited public funding and lack of private capital. 3 Source OECD (2012) Romani, Bhattacharya and Stern (2012)

5. Global scale and nature of needs • the incremental investment spending across emerging markets and developing countries is estimated at around $1 trillion a year more than what is currently spent. • This excludes investment in maintenance and upkeep. Annual Infrastructure Spending in the Developing World ($tr, 2008) 1.8–2.3 Additional investments for climate mitigation and adaptation 0.2–0.3 0.8 - 0.9 1.6–2.0 Estimated current annual spending, 2008 Estimated annual infrastructure spending need, 2020 NOTES: $ trillion per year, (2008 real prices), capital investments only (excl. operation and maintenance costs) SOURCE: Current spending from Fay et al. (2010), “Infrastructure and Sustainable Development”; Estimated annual infrastructure spending need for 2020 calculated by taking the Fay et al (2010) estimate and assuming a 4% annual growth rate from 2013-20 4

6. Global scale and nature of needs • East Asia will require up to 50% of the total – in the region of $2tn a year • More than half is required for the power sector, across generation, transmission and distribution; water and land transportation also are very prominent sectors • If maintenance was included, then the transport sector requirements would be much larger 1.8–2.3 1.8–2.3 1.8–2.3 Transport 15-25% EAP 35-50% Telecomms 10-15% Annual infrastructure spending requirements in the developing world ($tr, 2008) ECA 5-15% Construction 90-95% Electricity 45-60% LAC 10-15% MENA 5-10% SA 20-25% Water 15-30% Preparation SSA 5-15% 5-10% Split by region Split by sector Split by phase NOTES: $ trillion per year, (2008 real prices), capital investments only (excl. operation and maintenance costs) SOURCE: the by region, sector, and phase are authors’ own calculations taking ranges from Yepes (2008), MDB G20 working group on infrastructure (2011), and Foster and Briceño-Garmendia (2010); note the $200-300 billion annual requirement for sustainability is assumed split in the same ratio as the other investments across regions, sectors and phases 5

7. Contents • Why infrastructure for Africa? The needs • The gap • The risk profile • Potential solutions

8. Currently, an estimated $0.8-0.9 trillion is invested annually, mostly financed by public sector budgets, with lesser shares provided by the private sector and foreign countries through development finance Private sector investment heavily concentrated in the ICT sector The gap: existing institutions and financial architecture are not adequate to meet the needs 1,800–2,300 • 95% of all private finance is concentrated in middle-income countries (Estache 2010) • Public-Private Investments concentrated in ICT, other sectors investments dried up during the crisis 1,000-1,400 Private sector 800–900 Other developing countries’ financing 150-250 <20 20-30 20-30 Concessional ODA MDB financing 500-600 Government budgets Estimated split of current annual investment, 2008 Future annual investment needs, 2020 NOTE: Split by sources of finance are approximate ranges only and don’t add to exactly to the totals given for that reason SOURCE: Split of current sources of finance is a G-24 own assessment based on various estimates including Estache (2010); MDB working group paper on infrastructure (2011); Macquarie (2009). 7

9. Today’s need for capital expenditure in SSA is in the region of $60bn, likely to increase substantially over the next decade. SOURCE: WB and AFD (2010). Africa’s infrastructure: a time for transformation 8

10. The gap in SSA: current capital expenditure is $25bn, gap is $35bn • ICT receives more than 2/3 of total private sector investment in Africa (7 out of 9bn) • The financial crisis reduced substantially the already small amounts going to other sectors • ODA and MDB financing are relatively small (3.8bn), other developing is not insignificant (2.4bn) 8.5 Africa’s infrastructure capital investment, by source of finance (real $bn, 2006) 7.0 Private sector 0.5 Other developing countries ‘ financing 1.4 4.7 4.6 Concessional ODA MDB financing 0.2 Government budgets 0.5 0.2 4.5 0.3 0.9 0 0 2.4 1.3 1.1 Information & Communication Technology Power Transport Water, Sanitation, Sewerage SOURCE: Adapted from Briceño-Garmendia, Smits, and Foster 2008, splitting ODA financing between 75% MDB financing and 25% concessional ODA based on Foster and Briceño-Garmendia (2010) 9

11. Unmet need that could be met by private sources1 ~1 Irrigation WSS Transport Power ICT Estimated unmet need fordebt2 8-9 Estimated unmet need for other equity2 3-4 Estimated unmet need for project develop-ment equity2 0 22 Unmet need 10 3 Total of $ 4-5 billion needed in equity for unmet infrastructure demand 15 Unmet need that could be met by public sources1 60 3 5 0 25 Current spend Annual need In SSA, the unmet need to support infrastructure development is for both debt and equity Estimated current infrastructure financing need for Sub-Saharan Africa $ billion per year Unmet capital need 1 ‘Public sources’ includes government financing, ODA, and non-OECD financing (e.g., from China). Public-private split is assumed same as current spending and, as such, may understate the potential private sector contribution 2 Split of equity and debt is approximate, based on 30-40% equity (including c.5-10% of total for project development equity), 60-70% debt SOURCE: Adapted from Foster and Briceño-Garmendia (2010)

12. To meet needs, approximate payment of 0.40 dollars per day in Sub-Saharan Africa Equal to 35-50% of individual income where a significant proportion of the population lives off less than $1-2 per day If we add the additional cost of finance on this, the figures look even more worrying Can SSA afford its infrastructure? • Concessionality, intergenerational transfers of financial burden, cash transfers to enable people to pay fees, ODA to cover fees from donor countries are all potential mechanisms to alleviate this issue • This adds a layer of political uncertainty on the sustainability of user fees which discourages investment: will subsidies be removed or reduced? Will the government have enough liquidity to pay out cash transfers for the foreseeable future? 11 Source Climate Policy Initiative (2011). The Landscape of Climate Finance.

13. -51% 2010 2005 2000 1995 1990 DAC I & II Others In 2011 private investment in developing country infrastructure fell by more than half due to the financial crisis PPI in infrastructure, all developing countries, $ billion per year NOTE: 2011 data has been estimated by doubling H1 data for 2011 in PPI database. SOURCE: World Bank PPI database

14. Contents • Why infrastructure for Africa? The needs • The gap • The risk profile • Potential solutions

15. Under-estimate of; Environmental and safety concerns Construction costs Capital costs for development 140% higher Experience shows that complex infrastructure projects are plagued by risks Caused partly by design SPV (MTL) separate from operating SPV (Eurotunnel) 18 months of unreliable service after opening Passenger volume forecast at >15 mln in 1st year, yet 10 mln mark not reached today Partly underestimated competition from ferries and airlines Several major issues; Train stuck in tunnel Major Fire in 2008 Asylum seekers leading to loss of capacity Litigation with insurers still in process (> €250 mln) Re-financing delayed and costly due to; Governance structure leading to delay in turnaround plans Debt holders did not want to take on more risk Budget overrun of over 80% 6 month delay on delivery Financing and governance issues Economic loss > €10 billion Unforeseen disasters Demand forecasts 200% off SOURCE: CIA Factbook, EIB, UN, National Resources Defense Council, Gates Foundation, WEF, McKinsey

16. Political & external Operational Risks Incomplete / optimistic budget Lack of project / supplier control EPC quality, technological or equipment issues Incomplete planning & permitting status Construction Political unrest, war, terrorism, corruption Natural disaster, outbreak of disease Nationalisation Embargoes, supply chain disruption Regulatory & legal Suboptimal regulation Change in regulation Contractual conditions/interpretation of contract Regulatory oversight & (stakeholder) conflict Project-related external (strike, sabotage, theft) Rise in wages, taxes or labour-related costs Inefficiencies due to process or organisation Other counterparty and procurement risks (e.g., corruption) Financing terms Availability of financing Liquidity challenges Demand / revenue Inaccurate revenue forecasts Change in environment e.g. customer requirements Unforeseen competition Inaccurate revenue forecasts Change in environment e.g. customer requirements Unforeseen competition Market Fluctuation in interest and/or exchange rates Increase in input (e.g. fuel, commodities, labour) costs and availability High inflation Credit Infrastructure finance underwrites risks along the life of the project Enabling environment Project development Financing Construction Early operations Mature operations

17. The risk profile: the nature of risk for infrastructure makes it a complex proposition for investment Preparation Construction Operation Description • Developer/government organizes feasibility studies; models cash flows, finances; organizes contracts with utilities, operators and construction firms • Construction firms build the project to specifications • Separate operating company takes over operation and maintenance of the project Main risks • Macroeconomic & political risks • Technical risks to project viability • Environmental and planning risks • Macroeconomic & political risks • Construction risks (e.g., of overrun, delay) • Macroeconomic & political risks • Demand / traffic risks • Operating risks • Policy risks (e.g., tariff changes) Cash flows (stylized) 16 Source: AGF Report (2011)

18. The risk profile: the nature of risk for infrastructure makes it a complex proposition for investment Preparation Construction Operation investors in the early phases (greenfield) need to consider all risks across the different stages of the project- since a return on their investment will only be possible if the return profile of the later stages of the project life are sufficiently attractive to make up for the early stage risks Description • Developer/government organizes feasibility studies; models cash flows, finances; organizes contracts with utilities, operators and construction firms • Construction firms build the project to specifications • Separate operating company takes over operation and maintenance of the project Main risks • Macroeconomic & political risks • Technical risks to project viability • Environmental and planning risks • Macroeconomic & political risks • Construction risks (e.g., of overrun, delay) • Macroeconomic & political risks • Demand / traffic risks • Operating risks • Policy risks (e.g., tariff changes) Cash flows (stylized) During project preparation and feasibility studies the developer seeks patient capital or, often, public funds Once project is ‘bankable’ the developer will seek equity investors and debt providers to finance the project Financing moments Once construction is complete and started to operate project can be refinanced to reflect the changing risk profile 17 Source: AGF Report (2011)

19. The upfront investment often relies on a very uncertain future cash flow Base Case + Volatility SOURCE: McKinsey

20. Most recent and future projects are greenfield And the pipeline is even more skewed towards new construction projects Already today, opportunities are mostly in greenfield… Projects 2005-10 Average number p.a. Projects since 2010 Projected number 415 29% 61% Greenfield Mature1 Greenfield2 Mature3 • The prospective increase in the scale of ‘greenfield’ investments that are required in developing countries – which typically have higher risks than ‘brownfield’ expansions - means that the risks of a substantial bottleneck where financiers are not ready to invest are greater. 1 Includes Secondary stage and Brownfield 2 IncludesGreenfield (112) and Expansion (12) 3 Includes Asset Acquisition, M&A, Brownfield, Privatisation SOURCE: Preqin, Infrastructure Journal, Public Works Financing, Infrastructure Investor

21. The risk profile: constraints to matching demand of investment with supply of available financial instruments • Infrastructure investment projects in developing countries have high risks across most of the above categories • Macroeconomic and political risk in developing countries compounds with high risks of early phases of investment • This problem is further compounded by the fact that many potential financiers have few if any benchmark projects to serve as comparison for pricing these risks. • Difficult to match project needs and financial archetypes, making investment at scale unfeasible 20

22. Contents • Why infrastructure for Africa? The needs • The gap • The risk profile • Potential solutions

23. Western Europe pensions and private investors Traditional investors Fixed income Cash and deposits Emerging market central banks Equities 90 Emerging Asian private investors 14 11 Emerging investors Chinese private investors 5 Latin American private investors 14 24 0 MENA private investors 3.5 13 32 12 18 Other Developed Asian private investors 6.5 52 29 6 100% = 3 34 23 5 Sovereign wealth funds US pensions and private investors 1.8 29 6 2.7 4.3 28.3 45 43.6 3.6 13 5.9 The shift in wealth has implications for asset allocations: Most emerging market investors have very low allocations to equities Asset allocation by investor, 2010 %; $ trillion, 2010 exchange rates Compound annual growth rate, 2000–10 % 4 3 15 9 23 16 16 14 22 1 Includes Singapore, Hong Kong, Korea, and Taiwan. Excludes Japan, where private investors have 10% in equities

24. 2004 2010 2007 World Bank Group China China and Gulf countries offer cheap capital and turn-key solutions conditional to geo political objectives rather economics Chinese commitments are 15% of total African infrastructure investment Chinese commitments including non-infrastructure sectors are even higher at $15.9bn in 2010 Two-thirds of Chinese infra-structure financing is in energy and transport The BRICS are now playing a larger role in infrastructure financing and are taking a new approach China is now a larger contributor to infrastructure financing in Africa than the World Bank Infrastructure financing in Africa $ billion SOURCE: Infrastructure Consortium for Africa 2010 annual report; ICA 2010 annual report; World Bank, “Building bridges: China’s growing role as infrastructure financier for sub-Saharan Africa” (2008); World Bank Group, Infrastructure Strategy Update paper (2011)

25. Innovative public finance instruments (project preparation funds, political risk guarantees, etc) Complementing private finance instruments (both debt and equity) Financial solutions that combine these public and private instruments effectively at low transactional cost Large data-banks providing benchmark for assessing risk-return of projects Governance of public money that allows a more efficient use of scarce public finance resources Project preparation facilities that support countries in creating a healthy pipeline of investable projects Mechanisms to guarantee revenues from user fees at the end of the investment cycle Excellent data rooms on projects to facilitate assessments of risk and returns for private investors Potential solutions: reforming IFIs and need for new institutions • Current IFIs : • ensure that current money made available by members is leveraged more efficiently • Change governance to reflect both new geopolitics and current risk frameworks • New institution(s): • Institutionsthat reflect in their governance, capital and instruments the new economic and financial reality of the world and use resources from emerging and developing countries efficiently FINANCE PROJECTS 24

26. Resolving the infrastructure challenge for the next 2 decades means laying the foundations for global growth. Most greenfield infrastructure projects in developing and emerging markets face upfront risks that current market players are unable to take on. A new institution could have the scale of capital, the portfolio of projects and the instruments required to take on this risk and unlock private investment. Public finances under pressure and domestic financial systems relatively young. New bank can help deepen domestic financial markets, channel savings to profitable investment and reduce exposure to currency risk, particularly with respect to $US/Euro BRICS keen to expand their commercial and strategic links with resource rich countries, mostly pursuing this through bilateral deals. A new bank could help achieve such objective with less financial and political exposure with a multi-lateral approach Existing IFIs not in a position to take on scale (due to institutional limits and governance) and nature (long term financing, large proportion of equity) although can be good partners Project preparation is not happening at the scale and quality required which results in a poor pipeline of bankable projects. A successful new institution needs to develop world-class, global project preparation facilities over time Rationale for a new a bank fit for purpose: modern in its mandate, instruments and ownership 25 Source Romani and Stern (2011)

27. Deepening the assessment of infrastructure investment needs – by region, country, sector Risk analysis framework: assessing the risk return profiles of projects across regions, sectors, phases Evaluating experience on existing financial instruments: what works and what doesn’t Assessing the constraints on the development of a strong pipeline of investable projects across different sectors, countries, regions; explore experience on project preparation facilities and technical assistance Assessing the existing financial architecture and its delivery: Public finance (budgets) MDBs and RDBs National Development Banks Private finance Considerations and implications on developing new institutional arrangements: range of functions, instruments, membership, governance, capitalization, etc Proposed G24-GGGI work program in collaboration with other partners 26 Source Romani and Stern (2011)