How to Attract Private Finance to Africa’s Development

IMF Blog, June 14, 2021

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The COVID-19 pandemic has brought economic activity to a standstill and risks reversing Africa’s hard-won gains of the last two decades.
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 for a strong recovery and to avoid economic stagnation.
Heads of state from Africa emphasized private financing at the “Financing African Economies” summit in Paris in May.

Africa’s infrastructure development needs are huge—in the order of 20 percent of GDP on average by the end of the decade.
IMF staff research shows the private sector could bring additional annual financing equivalent to 3 percent of sub-Saharan Africa’s GDP for physical and social infrastructure by the end of the decade.
This 3 percent of GDP 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).

Public entities, such as national governments and state-owned enterprises, carry out 95 percent of infrastructure projects in Africa.
The volume of infrastructure projects with private sector participation has significantly declined in the past decade, following the commodity price bust.
Africa attracts only 2 percent of global flows of foreign direct investment.
When foreign investment does go to Africa, it is predominantly to natural resources and extractive industries, not health, roads, or water.

Project risk:
- The pipeline of projects that are truly “investment-ready” remains limited.
- Investors avoid early-stage concepts or unfamiliar markets; donors and development banks can fund feasibility studies, project design, and preparatory activities to expand bankable projects.
Currency risk:
- Example from the text: a project yielding a return of 10 percent a year could see half of profits eliminated if the currency depreciates by 5 percent at the same time.
- Prudent macroeconomic policy and sound foreign exchange reserve management can greatly reduce currency volatility.
Exit risk:
- Narrow and underdeveloped financial markets, capital controls, and weak legal frameworks increase the difficulty and cost of exiting investments.

Rationale:
- Development sectors often have large upfront costs with returns realized over long periods, making private assessment difficult.
- Private sector growth depends on networks and value chains that may not yet exist.
- Many projects in development sectors may not happen without government-provided incentives (subsidies, guarantees).
- In East Asia, 90 percent of infrastructure projects with private participation receive government support.
Design principles for public incentives:
- Targeted: address specific market failures.
- Temporary: avoid permanent fiscal commitments.
- Based on proven market dysfunctions.
- Transparent: ensure clarity on support and terms.
- Leave sufficient risk with private parties.
- Display additionality: incentives should make worthy projects happen that would not otherwise occur.
- Well calibrated in size to avoid overcompensating the private sector.
Fiscal considerations:
- Incentives can be costly and carry fiscal risks.
- Given limited public funds, countries and development partners could consider reallocating some resources used for public investment toward financing public incentives for private projects.
- When 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.
Innovation:
- More innovative thinking is needed to realize the transformative potential of infrastructure on the continent.

Source: How to Attract Private Finance to Africa’s Development (IMF blog, June 14, 2021).