DEVELOPMENT FINANCE, PRIVATE SECTOR DEVELOPMENT, AND ECONOMIC DEVELOPMENT

We now discuss the various sources of development finance and innovative financing and how these could anchor private sector development.

Private equity and venture capital financing

Private equity is a source of investment capital provided by high-net- worth individuals and high-net-worth institutions with the aim of investing equity in businesses. Private equity firms seek to raise funds and manage these funds in order to generate returns for their investors. Private equity includes buyout, venture capital, growth, turnaround, private equity secondaries, mezzanine finance, private equity fund of funds, angel investments, and other private equity. Venture capital, which is an important aspect of private equity, involves the provision of private equity to innovative businesses that have a high growth potential. Venture capital is regarded as patient capital, since the venture capitalist is usually willing to invest in the enterprise for a longer period before harvesting their investment. Venture capital firms also provide management and technical assistance that can add value to the investee firms. There are, however, some problems associated with venture capital financing. Many SMEs tend to shy away from any form of financing that requires giving up an equity interest and ceding some control over decision-making. Accessing venture capital is often difficult, and the success rate is low in Africa. Although the contribution of private equity firms in financing the private sector is currently limited in Africa, this is gradually picking up over time.

Table 15.1 shows that a total of USD13.6 billion private equity, including venture capital, was raised over the last decade by the top 12 domestic fund manager locations. The bulk of private equity was raised by equity funds located in South Africa (USD6.8 billion), followed by those in Egypt (USD2.7 billion), Mauritius (USD1.1 billion), and Nigeria (USD1.0 billion). The average amount of private equity raised by Africa-focused PEFs per year is USD1.36 billion per annum.

TABLE 15.1 Africa-focused private equity (PE) capital raised in the past ten years by domestic manager location

Domestic manager location

PE capital raised (bn* USD)

Average PE capital raised per year (bn USD)

South Africa

6.8

0.68

Egypt

2.7

0.27

Mauritius

1.1

0.11

Nigeria

1.0

0.10

Tunisia

0.7

0.07

Kenya

0.5

0.05

Morocco

0.4

0.04

Ghana

0.1

0.01

Togo

0.1

0.01

Botswana

0.1

0.01

Senegal

0.1

0.01

Ivory Coast

0.1

0.01

Total

13.6

1.36

Source: Preqin (2016) Note: * bn = billion

Private equity and venture capital can be important sources of enterprise financing. There is ample evidence to suggest that enterprises with venture capital investment tend to perform better than those without venture capital financing (see Dushnitsky & Lenox, 2006; Smolarski & Kut, 2011). However, a lot more needs to be done to increase the capacity of the venture capital and private equity industry to support enterprise development in Africa and other developing regions of the world.

Structured trade finance

Structured trade finance (STF) is an alternative approach to enterprise finance, which focuses on transaction-based lending. It is a cross-border means of finance in emerging markets provided outside the traditional fallback on securities; the focus shifts from the strength of the borrower to the underlying cashflow and structures that enhance safe financing. Each STF deal is tailored to meet the individual borrower's needs. The facility is useful for businesses that do not have strong balance sheets but have an underlying transaction that is self-liquidating. The technique originated from the Latin American financial crisis in the mid 1980s and has since been seen as an innovative means of financing international trade by not relying on balance sheet analysis, government guarantee, and tangible assets as collateral but rather relying on the potential sale of the commodity for payment. STF is particularly beneficial to developing countries, which may not be able to access straight commercial finance; while STF constitutes about 80% of loans to noninvestment-grade borrowers that of investment grade borrowers is 20%-40% (Spratt, 2008).

Examples are the African Export-Import Bank (Afreximbank) based in Egypt and the Ghana EXIM Bank, which provide finance through STF deals. Given the important contributions of Afreximbank in supporting STF in Africa, we provide details of its STF programme in Box 15.1. It would be useful to encourage banks and other lending institutions in Africa and other developing countries to consider STF in addition to traditional methods of balance sheet financing, which excludes most enterprises with viable trade transactions (Abor, Issahaku, & Agbloyor, 2019). This is necessary to facilitate and boost international trade. Lending institutions and banking corporations provide a variety of services to exporters, importers, and trading corporations to carry out trade efficiently, and these services are collectively referred as structured trade finance services (Broer, 2018; Ghent, Torous, & Valkanov, 2017). These services are highly specialized in nature and dedicated to the financing of high-value exports and imports. Trade finance products play a pivotal role in the free flow of commodities and capital goods from one country to another.

BOX 15.1 African Export-Import Bank and structured trade finance

The African Export-Import Bank (Afreximbank) was established in Abuja, Nigeria, in October 1993 by African governments, African private and institutional investors, and non-African financial institutions and private investors for the purpose of financing, promoting, and expanding intra-African and extra-African trade. The bank is one of the entities under the African Development Bank Group and is headquartered in Cairo, Egypt.

Afreximbank has various classes of shareholders: class A shareholders consist of African governments, central banks, African regional and subregional institutions, including the African Development Bank; class В shareholders consist of African private investors and financial institutions; class C shareholders are made up of non-African financial institutions, export credit agencies, and private investors; and class D shareholders include other institutions and individuals.

The bank's governance structure includes the general meeting, which consists of shareholders or their representatives and is the highest decision-making organ of the bank. It also has a board of directors, with representations from all classes of shareholders. The president of the bank is assisted by a senior executive vice-president, and executive vice-presidents in the day-to-day management of the bank.

The bank offers a number of products and services, including structured trade finance (STF), factoring, an export development programme, project-related financing programme, and a guarantee programme related to obtaining large contracts.

Afreximbank's STF programme covers both exports and imports and is composed of programmes and facilities designed to address the market and product diversification problems that Africa faces. It is intended to remove bottlenecks to the trading of products already produced or near production and able to enter trade. Facilities under this scheme are organised under dual and non-dual recourse programmes. Programmes under the dual recourse (DR) category are those in which the bank lends to a corporate against the guarantee or aval of an acceptable bank or another creditworthy corporate. This category of programmes helps the bank rely on the nearness of local banks to the underlying borrowers in monitoring the loans it makes and therefore helps mitigate the risk of lending to next-generation exporters that have replaced the dismantled commodity boards and the broader emerging African private sector. It also helps in dealing with the impediments to extending financing to certain countries when problems arise from high documentary taxes and when the bank's special tax-exempt privileges do not apply because they are not nonparticipating states. By using DR structures, the bank extends recourse to all the parties in a deal mitigating the risk of possible impairment of other collateral it may have taken on such a deal. Programmes in the non-dual recourse (NDR) category are operated with direct recourse to one obligor. This involves lines of credit, direct financing, syndications, and special risks programmes. Such deals are done with established corporatons and banks or where the legal regime allows for the proper perfection of securities.

Since Afreximbank's establishment in 1993, it has provided over USD41 billion in credit facilities for African businesses. Most of the loans were STF facilities, funded either directly by the bank or in syndicates. The bank provided about USD15.4 billion through STF deals between 2012 and 2016. Afreximbank plays a significant role in providing capital, facilitating international trade, economic recovery, and stability to the African region.

Source: https://afreximbank.com/

Project finance for infrastructure development

Project finance for infrastructure development is another important development finance tool, given that infrastructure development is critical for enterprise growth. For developing countries to move from being consumer- based economies to investment-driven economies, they need infrastructure. The private sector can thrive in an environment of solid infrastructure in the areas of transportation, water, information and communications technology (ICT), energy, and power. Flowever, in many developing countries, a large and growing infrastructure 'gap' continues to constitute a key constraint to private sector growth. For instance, the World Economic Forum's Global Competitive Index (GCI) 2015-2016 indicates that about 75% of the 20 least competitive countries in the world are found in sub-Saharan Africa, due in large part to the region's deep infrastructure deficit (World Economic Forum, 2015). According to a study by the World Bank (2010), the continent needed USD93 billion per year to plug the infrastructure gap (Ghana alone will require USD1.5 billion per annum over the next decade). Africa's power sector alone has been experiencing a finance shortfall of USD40-45 billion every year since achieving universal access to electricity and requires an investment of about USD55 billion per year until 2030. The fiscal constraints, coupled with underdeveloped capital markets, constitute a major challenge to financing infrastructural development in Africa. As a result, there is a global trend to seek alternative means of financing infrastructural projects that were traditionally financed primarily by governments and banks.

Project finance is therefore necessary in this regard. It is a new financial discipline that has developed rapidly over the past two and half decades. It involves raising long-term finance for major projects through project financial engineering, on the basis of financing against cashflows generated by the project alone. However, not much has been done in this area in Africa. Between 2003 and 2013, the World Bank reported that only 158 project finance deals valued at USD59 billion (representing a mere 3% of the 5,000 deals globally valued at USD2 trillion) have been closed in sub-Saharan Africa. The few deals either have been wrongly priced or have had poor value for money analysis.

Project finance through a public-private partnership (PPP) can help deal with the issues of pricing and with issues from risk sharing and rewards between the public and private partners in a manner that is mutually acceptable. For example, countries like Brazil, Colombia, Chile, Mexico, China, and India have made huge progress on infrastructure development, mainly through PPP deals. African countries can consider such a financing model for major infrastructure development in order to support private sector growth, but this should require the proper regulation and governance of these arrangements.

External capital inflows

External capital inflows in the form of foreign direct investment (FDI), debt inflows, foreign portfolio investment, and remittances are considered important sources of economic growth in many countries. While financing flows often proved volatile and prone to recurrent misallocation, FDI, for instance, is sought by many countries because of the large positive externalities they are expected to carry with them (Asiedu, 2002; Alfaro, Chanda, Kalemli-Ozcan, & Sayek, 2004; Abor, Adjasi, & Hayford, 2008; Abor & Harvey, 2008). Remittances have also become a preferred source of development finance due to their countercyclical nature and the fact that they do not constitute debt to the host economy (Issahaku, Abor, & Amidu, 2016, Issahaku, Abor, & Harvey, 2017).

Figure 15.1 shows FDI inflows among top recipient countries in Africa. In 2015, out of the USD764.67 billion FDI inflows into all developing countries, Africa received only 7% (USD54.08 billion), with Ghana (USD3.19 billion), Angola (USD8.68 billion), Egypt (USD6.89 billion), Mozambique (USD3.71 billion), and Morocco (USD3.16 billion) as the top five FDI recipients in Africa. Total FDI inflows into Africa in 2014 were USD53.9 billion, with South Africa, the Congo (Democratic Republic), Mozambique, Egypt, and Nigeria as the top five FDI recipients (UNCTAD, 2015, 2016).

FIGURE 15.1 Top recipients of FDI flows in Africa (billions of dollars), 2014-2015

Source: UNCTAD (2015, 2016)

Although the importance of FDI is recognised, a key issue that requires serious policy attention is whether FDI necessarily leads to growth at both the micro level and the macro level. Recent empirical studies recognise that the effects of FDI on growth may depend on the size of FDI, the absorptive capacity of domestic firms, and the role of the local financial market (Abor, 2010; Adjasi, Abor, Osei, & Nyavor-Foli, 2012). That is, countries have to achieve a certain minimum level of human development, financial market development, trade openness, macroeconomic stability, institutional quality, and infrastructural development to benefit from FDI.

The contribution of remittances to economic development in developing countries is becoming apparent. World Bank (2018) estimates show that remittance flows to low- and middle-income countries reached a new high of USD466 billion in 2017, a growth of about 8% from the 2016 figure of USD429 billion. In absolute dollar terms, the top six remittance recipients in 2017 were India, China, Philippines, Mexico, Nigeria, and Egypt. In terms of share of remittances in total GDP, the top six recipients in 2017 were the Kyrgyz Republic, Tonga, Tajikistan, Haiti, Nepal, and Liberia. Remittances now exceed three times the size of foreign aid, and with the exception of China, remittances exceed FDI inflows to low- and middle-income countries.

Formal remittances to the sub-Saharan Africa (SSA) region reached USD34 billion in 2016 and rose to USD38 billion in 2017. These understate the number of remittances received in Africa, since a significant number of remittances are sent through informal channels. Nigeria, the largest remittance recipient in dollar terms, received USD22 billion in 2017. Senegal and Ghana, which are next to Nigeria, each received only USD2.2 billion in 2017. In terms of the size of remittances relative to the size of the economy, Liberia is the most remittent-dependent country in the region, with remittances as a percentage of GDP reached 27.1 in 2017 (see Figure 15.2). Comoros and Gambia follow, with remittances as a share of GDP exceeding 20%.

FIGURE 15.2 Remittances dependent countries in SSA, 201 7

Source: World Development Indicators (2018)

Other innovative sources of financing

Other innovative sources of financing private sector development could be explored, including crowdfunding, green bonds, and leasing and factoring.

CROWDFUNDING

Crowdfunding entails raising money to start a business venture or to support an existing venture or charity through an online platform, particularly social media. The issuer taps into a network of social media users who offer their contributions in support of the business idea in exchange for a promised return. Examples of crowdfunding applications include Crowdfunder, Indiegogo, and Kickstarter. The platform allows the fundraiser to set up and launch a public campaign to solicit funds from the general public. This campaign will give details of the business venture for which funding is needed, the amount required, any promised return, and the duration of the fundraising campaign. Crowdfunding offers an opportunity for the entrepreneur to raise external funds from a large cross-section of individuals (a 'crowd') instead of relying on a single financing source or a small group of complicated investors.

After evaluating a sample of 48,500 crowdfunded projects with a combined value of USD 237 million, Mollick (2013) found that the success of crowdfunding depends on the fundraiser's network and the quality of the underlying project. The study further found that the majority of fundraisers fulfil their obligations to funders, though about 75% of fundraisers delay in the delivery of their products. Lack of awareness, inadequate technological infrastructure, lack of regulatory framework, and other constraints have hindered the adoption of crowdfunding in developing countries. The

Crowdfunding Centre (2014) reports that the best-performing countries in terms of successful projects include advanced countries like the US, the UK, Canada, Germany, France, Australia, and Italy. Developing countries must build a strong internet backbone and a robust regulatory framework and launch a spirited public campaign in order to popularise the adoption and use of crowdfunding as a means of reducing the financing constraints of their funding-starved private sector.

GREEN, SOCIAL, AND SUSTAINABILITY BONDS (GSSBS)

Globally, there is a rising cadre of investors who have a high level of environmental and societal consciousness. Such investors screen projects and select projects that optimise the use of resources in a sustainable manner. The private sector can take advantage of this intergenerational and social consciousness to issue GSSBs. GSSBs are debt securities issued with the proceeds applied solely to environmental or social projects. Worldwide, there is a rising concern about the devastating consequences of climate change and the sustainability of resources. The private sector can seize the opportunity to raise funds to apply them in projects that satisfy the triple bottom line (profit, people, and planet). The green bond principles (GBPs) and social bond principles (SBPs) and the sustainability bond guidelines (SBGs), generally called the principles have become the leading framework for GSSBs. The International Capital Market Association (ICMA) is the secretariat for providing guidance and governance of the principles. The principles are aimed at ensuring integrity of the GSSBs market by providing guidelines that ensure transparency, disclosure, and accurate reporting. Each of these principles has four components (ICMA, 2018a):

  • 1 Use of proceeds.
  • 2 Process for project evaluation and selection.
  • 3 Management of proceeds.
  • 4 Reporting.

Green bonds are debt instruments where the funds/proceeds are applied solely to finance or refinance either in full or in part a new project or an existing project that has environmental benefits (ICMA, 2018a). Some eligible green bond project categories include renewable energy, energy efficiency, the prevention and control of pollution, the environmentally sustainable management of living natural resources and land use, biodiversity conservation, clean transportation, sustainable water and wastewater management, climate change adaptation, and green buildings.

Social bonds are debt securities where the funds/proceeds are applied solely to finance or refinance either in full or in part a new project or an existing project that has social benefits (ICMA, 2018b). Some eligible projects that can be financed through the issuance of social bonds include projects that promote or provide affordable basic infrastructure (clean water, sewage, sanitation, health, and energy), affordable housing, food security, and employment generation and those targeted at alleviating the suffering of people below the poverty line, the unemployed, and the vulnerable in general (ICMA, 2018b).

Sustainability bonds are debt securities where the funds/proceeds are applied solely to finance or refinance either in full or in part a mix of green and social projects (ICMA, 2018c). Thus, sustainability bonds finance or refinance projects with social cobenefits and environmental cobenefits. Some social projects may have environmental cobenefits while some green projects may have social cobenefits. Whether a bond is classified as green or social or sustainability depends on the underlying objectives of the project.

GSSBs are sometimes linked to the UN Sustainable Development Goals (SDGs) in which case they are SDG-themed bonds. The private sector can innovatively raise finance by aligning their business models with the SDGs.

LEASING AND FACTORING

Leasing as a financing option involves a contractual arrangement, in which one party (lessor) gives the right to use an asset for a given period to another party (lessee). Lease financing is considered a form of debt financing where the lessee makes periodic lease payments for the use of the asset. Efficient leasing can help firms acquire the needed machinery and equipment to enhance production. Factoring, however, entails a firm's handing over its debt collection responsibility to a specialist institution - the factor or factoring house. The factor or factoring house provides financing by means of advances and uses the firm's accounts receivable balances as security. Factoring provides the means by which firms can outsource their sales function, smooth cashflows, and enhance financial planning. Lease financing and factoring can make significant contributions to financing private sector development in Africa.

 
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