Taking the presidency of the G20 in December, Germany has been vocal in its intention to shake up the development agenda. Taking centre stage is the proposed ‘G20 Africa Partnership’ and crucially, as of the March summit in Baden-Baden, the ‘Compact with Africa’.
The Compact is Germany’s attempt to do away with aid-based development initiatives — which have paved the way for more than $1 trillion in aid over the last fifty years to limited success — and replace them with demand-driven private sector investment. It is also Merkel’s electoral ticket to demonstrating she is attempting to stem an ongoing migrant crisis.
Through ‘enhanced investment contracts’ between participating African states — currently the so-called C-5 (Côte d’Ivoire, Morocco, Rwanda, Senegal and Tunisia) plus Ghana and Ethiopia — Western powers are expected to use their financial and political muscle to channel private investment, with beneficiaries agreeing to a range of private sector-enabling reforms. The World Bank, IMF and African Development Bank (AfDB) have even produced a handy joint catalogue of reforms, ‘The G20 Compact with Africa: A Joint AfDB, IMF, and WBG Report’, for perusal of World leaders.
With the ball barely rolling, what can investors expect as the initiative gains traction?
Not without reason, the architects of the Compact have highlighted infrastructure as the key locus toward which capital should flow. Indeed, with a continental infrastructure gap of $90 billion each year the benefit to the African continent is patent. Investors stand to gain from an essentially endless flow of prospective ventures — particularly where projects pay off — however this is not without its risks.
Depending on the financing model and chosen contractors, investors could expose themselves to the costs of projects overrunning in completion horizon and budget, reputational risks (say, if a project is poorly executed by external contractors), and of course revenue risks where a project does not generate enough revenue to service operating costs or generate an adequate ROI. It is important to acknowledge that these risks persist for projects anywhere in the World, however it is equally worthwhile mentioning that they are particularly poignant in an African context where inefficiency, a deficit of technical expertise and misuse of resources are notoriously pervasive. How much of an issue this really is will depend on parameters of the agreements and the destination country.
Investors are not alone in facing risks. African states could face scenarios where investor returns on major projects come at the expense of long-term fiscal costs for the host government. Foreign private partners could benefit to an unsustainable degree for local partners.
It is also worth highlighting that looking beyond infrastructure could prove a smart move for both investors and host governments, particularly where SMEs enter the equation. Research by the World Bank reveals that 40% of African SMEs highlight financing as a key constraint on borrowing, while the McKinsey Global Institute has pointed out that the average return on investment for African SMEs in terms of growth and revenue far outpaces that of Western counterparts. This is particularly the case for telecommunications, wholesale & retail, and healthcare sectors which all come in well above World averages for growth and profitability. Infrastructure projects are long-term enablers for the private sector and short-term sources of employment. Sustained growth in private sector enterprises, however, offers more.
A central facet of the Compact’s approach is the luring of investors by Western countries to African opportunities, with a particular nod to reducing risks of investing in sovereign debt instruments. By guaranteeing African bonds, for example, contingent upon structural changes on the Continent, Western actors can enhance financial channels for African governments (and potentially make them cheaper) while neutralising the high investor risk associated with certain African assets. Both camps would gain access to new markets.
This is particularly useful in an African context where even the African Development Bank (AfDB) considers much of the continent to be uncreditworthy. Of the AfDB’s 54 members, only 17 are eligible for direct AfDB lending, with the remaining 37 relying on the limited scope of the African Development Fund.
Seemingly a win-win, the extent to which Western powers will act is unclear. The Compact primarily highlights subsidies and guarantees as risk-mitigators, however if even the AfDB has considered some of its members uncreditworthy it is unclear how willing Western powers will be to backup formerly untenable investments. It will therefore be key that African governments demonstrate sufficient commitment to the conditionalities of Compact support to inspire adequate confidence as a first step. Whether or not previously flagged debtors can repay newfound commitments is another question for all parties given mismatch between debt maturities and timelines for reforms to take hold.
A key question for investors then is whether or not the Compact can be expected to open up new markets and, as a result, new streams of returns. For example, the Compact calls for a renewed push with respect to public-private partnerships (PPPs), but to what extent will the Continent’s performers be able to fulfil their obligations to such PPPs? Similarly, as before, how willing will guarantors be willing to support assets from markets such as Chad, Eritrea, Mauritania, and so on?
It seems likely that what we will see is enhanced engagement between Western actors and the obvious suspects. Indeed, the C-5 Group consists entirely of names bandied around as ‘markets to watch,’ not ‘hidden gems’. The opportunity for investors may therefore fall short of expectations.
At the time of writing no signed compacts have been unveiled and, as such, the extent to which the initiative’s shortcomings and assets hold true remain to be seen. As the first country-specific compacts roll out we will have a clearer idea of whether investors and their African partners should take Merkel’s rhetoric seriously.