OBG Event

10 Nov 2011

Robert Tashima

Delivered at the Vodafone African Business Leaders Forum

Accra, Ghana
November 2012

I grew up in California. Those of you familiar with recent events in the land of Hollywood and Silicon Valley no doubt know that it is in rough shape now, with a huge deficit, massive debt and political stagnation. 

But California, once upon a time, was truly the Golden State – thanks largely to a series of massive infrastructure projects in the 1960s. 

There was a brand new system of aqueducts, transporting fresh water down to what would become one of the largest conurbations in the world. There was a vast and extensive new network of six-lane motorways. And there were the several publicly-funded university campuses that would compete against the likes of Harvard and Oxford.

These targeted investments built the foundations for what would eventually be the 5th largest economy in the world. But that was then. 

Since the 1990s, California’s spending on infrastructure has dropped significantly, and it shows. Potholes are everywhere. Transit times have doubled or tripled. Brownouts are common during the hot summer months and universities are selling buildings to stave off budget cuts.

Now, we’re not to here today to talk about California’s economic growth but the point of this eulogy is to highlight the fact that infrastructure, as any investor knows, is crucial for a market’s business climate –regardless of the level of development.

THE ENGINE AND THE FUEL: Infrastructure defines the limits of an economy’s growth potential. So too does financial capacity: the performance of the capital markets and banking industry set the pace for GDP growth. In a sense, infrastructure is like the engine of an economy, and the financial sector is the fuel that propels it. The two go hand-in-hand. Without one, or the other, or both an economy will underperform.

Africa ably demonstrates this. Thanks to crumbling roads and high credit risk, operating costs in Africa go up and productivity goes down – ask any business owner in Nigeria, where blackouts can add up to 30% more in annual spending. Or talk to traders who pay $300 more to ship a container between ECOWAS countries than to export abroad. Or SMEs in Ghana who face interest rates above 20%.

SPOTTY REPUTATION BUT KEY FOR GROWTH: Emerging markets in Africa suffers from a spotty reputation amongst foreign investors in regards to the quality of local infrastructure and the capacity of local financial institutions. However, in spite of the poor maintenance and undersupply that plagues transport and energy networks, and the opacity and low penetration in the financial sectors, both are key to unlocking rampant growth – and recent reforms show that governments have realized this.

Before we begin to look at how the two sectors are being revamped for the betterment of the continent’s economic performance as a whole, let’s take a realistic look first at the shortcomings both sectors struggle to deal with.

BROAD CHALLENGES: Obviously the advantages and disadvantages faced by Africa’s economies are amazingly diverse – not every country grapples with the same issues –but there are a few broader themes that apply to many of the continent’s emerging markets.

Infrastructural maintenance is one such issue. Road density across the continent is less than one third that of the global average, yet a drive down Lekki peninsula in Lagos reveals more potholes than pavement. In Ghana, dedicated revenues cover only 60% of total maintenance costs for roads. In some of the neighbouring ECOWAS countries, bribes can add up to $14 per 100km.

A lack of capacity is also a significant challenge. Africa’s population is the fastest-growing of any continent – virtually doubling over the next forty years. Yet while demands on existing networks are increasing rapidly, supply is not. In Nigeria, one of the world’s largest oil producers, generation covers only a quarter of total demand, and the nicknames given to the national utilities – Never Expect Power Again for the old Nigerian Electric Power Authority, and Please Hold Candle Near for the Power Holding Company of Nigeria – capture the problem of undersupply in a nutshell. The blackouts shave an estimated $130bn off GDP annually. 

Still, at least the costs of infrastructural problems are clear and easy to asses. When it comes to talking about the challenges of Africa’s financial sectors, the impact of inefficiency is harder to gauge, coming more in the form of lost opportunity costs and unrealised gains. 

One of the greatest challenges banks, investors, auditors, and analysts grapple with in Africa is a lack of transparency, which has a direct impact on credit expansion and stock activity. One of the reasons interest rates are high in Ghana is due in part to the elevated level of credit risk. Until last year, there were no effective clearinghouses for information on borrower records or collateral, and while that has changed, the results will take time to emerge. 

This touches upon another major issue: a lack of financial penetration. This is a problem that afflicts all emerging markets, and not just in Africa, but even in countries like Ghana and Nigeria, that benefit from a fairly extensive universe of financial agents, the unbanked population is upwards of 80%.

BUT CHANGE IS ON THE CARDS: These issues – undermaintenance and undersupply, and opacity and shallow penetration – dampen economic activity in both the short and long term. They are visible, both at the micro and macro level. And until they are resolved, African economies will underperform. But while these sorts of problems cannot be magicked away overnight, they are being tackled by some of the continent’s more aggressive reformers – which bodes well for future performance. 

This starts with roads. In fact, every dollar spent on preventative maintenance, according to the AfDB, saves four dollars worth of liabilities in the broader economy. This is crucial given the centrality of ground transport in Africa. 

As a result, countries like Ghana have embarked on ambitious development programmes, and increased the role of the private sector in maintenance. Toll roads are an increasingly common feature across the continent – from Dakar to Cape Town – bringing in dedicated revenues for operational budgets. By the same token, the number of deep-sea ports under private concession has risen dramatically, with clear results in performance and equipment.

Reforms in the energy sector are particularly important, especially since many African nations are too small to cost-effectively generate their own power. To alleviate this, initiatives like the ECOWAS West African Power Pool are laying the foundations for improving transmission sharing schemes. 

Domestically, countries like Nigeria have introduced Power Sector Reform roadmaps to privatise elements of generation and grid management while boosting IPP capacity. Cost-recovery is key to this and several countries have begun to raise usage tariffs to ensure the financial viability of oil refineries and generating plants.

FINANCING IS STILL AN ISSUE: Financing all these infrastructure projects is still an issue of course. The AfDB estimates the total cost of addressing the continent’s infrastructure needs at $93bn, only around half of which is currently covered.  Some of the additional $48bn can be captured through reduced inefficiencies, such as better targeted spending and implementation, but more funds will need to be sourced elsewhere.

This is where the domestic financial sector comes into play.

Only one-tenth of the continent’s currently outstanding bank loans are for infrastructure projects, which means there is extensive room for growth. And while opacity and lack of penetration have hindered lending and equity trading, a slew of recent reforms look sent to unleash the financial industry’s potential – with encouraging consequences for the continent’s overall performance.

Although currently underutilised, Africa’s capital markets can also serve as a significant funding source for infrastructure, offering potential in both the medium- and long-term through either bonds or institutional investment. South Africa is one of the most aggressive proponents of this strategy but increasingly, others are following their lead. The port of Dakar, for example, recently floated a series of bonds on the regional bourse to finance expansion.

Improving financial transparency is key to making this happen, however – spurring many governments to improve regulatory enforcement accordingly. In Nigeria, the crackdown on reporting and governance standards that followed the domestic banking crisis in 2009, combined with the establishment of the bad debt bank, has been of immense benefit for a sector that is in many ways a sleeping giant. After all, in spite of the size of Nigeria’s larger banks – many of which have a regional presence and strong balance sheets – most have hitherto played limited roles in the country’s capital-intensive energy sector. 

Greater financial penetration is also required to boost local debt trading and credit capacity – but that may be easier than expected. Ghana presents a particularly adept case study in this regard, given that the country has what would otherwise appear to be an unappealing set of characteristics: a small banking system, a limited client base, and market fragmentation. 

Yet the financial universe here boasts a lengthy list of players, from banks to microfinance firms to savings and loans houses, and there is extensive usage of informal financial services, such as susu collectors. These sorts of traits pave the way for a rapid deepening of the penetration rate. Furthermore, the country boasts a healthy credit rating and has a developed bond market, both of which bode well for securities trading and infrastructure debt.

CONCLUSION: The situation in Ghana could be an example for the broader situation of Africa as a whole. Ultimately, in spite of the numerous obstacles African economies face, they are in fact ideally situated to see explosive growth. There are some intractable problems, but there are also bountiful advantages, such as demographic booms and resource wealth.

To profit from these, however, requires robust banks, well-paved roads, reliable electricity and active bond markets. And while the measures currently being taken are encouraging, governments need to ensure that their strategies are sustainable.

California, with its $40bn deficit and stagnant growth rate, ably demonstrates what can happen if this does not happen.