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The Longer Term Finance and Investment For Africa: The Funding Gaps and Investment Opportunities

The Longer Term Finance and Investment For Africa: The Funding Gaps and Investment Opportunities. December 9, 2014. Presentation by Prof. Njuguna Ndung’u Governor, Central Bank of Kenya at the Workshop on Longer-Term Finance in Africa Bonn, Germany. Outline. Background

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The Longer Term Finance and Investment For Africa: The Funding Gaps and Investment Opportunities

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  1. The Longer Term Finance and Investment For Africa: The Funding Gaps and Investment Opportunities December 9, 2014 Presentation by Prof. Njuguna Ndung’u Governor, Central Bank of Kenya at the Workshop on Longer-Term Finance in Africa Bonn, Germany

  2. Outline Background The Growth Potential for Africa Challenges for Long-Term Finance in Africa Financing Trends in Africa – Domestic and External Sources Kenya’s Experience

  3. 1. Background • Africa has diversity in its countries: coastal, resource-rich; land-locked, resource-rich; coastal resource-poor; and, land-locked, resource-poor • The urban population in Africa was estimated at 37% of the total in 2013 which was below the world average of 53% (World Bank) • The African middle class is growing fast – now estimated at 380 million – a large market is thus developing. • The macroeconomic environment in Sub-Saharan Africa (SSA) has improved: inflation moderated from 9.3% in 2012 to less than 6.6% in 2013. Growth is resilient at 4.4% to 5.1% (IMF Regional Economic Outlook-2014) • But Africa needs rapid and sustained growth to achieve poverty reduction and create employment for the rising population of the youth – World Bank estimates show that 46.8% of SSA population live on less than USD1.25 a day against a global average of 14.5% (World Bank) • Long-term finance is essential to meet the long-term physical investment needs especially on enablers for growth such as Infrastructure, Real Estate, Research and Development, and New Ventures • However, thin and shallow financial markets in Africa remain the main constraint to long-term finance • But even with finance in some sectors infrastructural gaps has encouraged potential investors to adopt a awaiting option. Heavy infusion of public investment and availability of long term finance in infrastructure will dislodge the market from this waiting option

  4. 1. Background…Infrastructure Development and Investment Creates Capacity for Future Growth • Transport infrastructure development in Africa is limited while road transport accounts for 80% of freight and 90% of passenger traffic – less than a quarter of the total SSA road network is paved (IMF Regional Economic Outlook for SSA-2014) • Transport and insurance costs in SSA are equivalent to 30% of export value – this is much higher than the 9% in other developing countries (IMF) • Infrastructure projects are necessary to address the binding constraints – they reduce transaction costs and enhance private sector investments’ profitability • Public investments in infrastructure are complementary to private investments – enhances productivity of private investment • Regional infrastructure projects like Lamu Port Southern Sudan-Ethiopia Transport (LAPSSET) Corridor in Kenya, Ethiopia and South Sudan will enhance trade and encourage private sector investments – LAPSSET is expected to generate at least 3% of Kenya’s GDP – but also an opportunity for long term investments.

  5. 2. The Growth Potential for Africa Africa has potential and is a large market for the world: (a) Africa’s GDP in PPP terms is above USD4 trillion which places it as the fifth block after the USA, China, India and Japan; and, (b) Africa’s middle class stands at over 380 million which is considerably higher than the entire USA population and provides potential for consumption, innovation and consequential investment opportunities Financial Institutions are diversifying, growing and deepening across Africa Widespread institutional reforms supported by changes in legal and regulatory frameworks have improved the business environment – as an example, the devolved government structure under the new Constitution in Kenya provides new opportunities for inclusive growth Macroeconomic stability in most SSA countries has enhanced investor confidence and domestic policy (monetary and fiscal) to support economic activity.

  6. 2.The Growth Potential for Africa… Adequate room for inclusive growth through reforms to promote economic diversification and employment, deepen financial sectors, and tackle infrastructural gaps – to make markets accessible Recent discoveries of oil and other mineral deposits in Eastern and Southern African countries could provide new impetus for growth by enhancing both the productive capacities of economies and finance public investment The diversification of trading partners has increased prospects for increased trade opportunities and development cooperation Public-Private-Partnerships should will supplement the skills of the public and endoginize risk in the long-term public investments projects.

  7. 3. Challenges for Long-Term Finance in Africa • The level of capital markets development, with limited tradable securities such as debt and corporate equity. The securities markets act as catalysts of long-term finance. But this potential has scarcely been realized in Africa – domestic credit provided by the financial sector stands at 66.4% of GDP in SSA which is way below the world average of 171.4% (World Bank) • Limited range of long-term instruments, weak risk management and diversification, including few transparent price discovery channels • Minimal bond issues in African Stock Exchanges and lack of trading activity limit the ability of most of these markets to provide a platform for price discovery and for benchmarking long-term assets

  8. 3. Challenges for Long-Term Finance in Africa… • The mismatch especially between demand and supply of infrastructure finance is due to lack of a pipeline of properly structured projects • Infrastructure investments entail complex legal and financial arrangements, requiring a lot of expertise, which is costly. Investors need sufficient and predictable pipelines of infrastructure investment opportunities • Need for solid legal framework as infrastructure projects are long-term, and political risks loom large for investors • Various Development Finance Institutions established across Africa to provide long-term finance needs for housing, industrial development and agriculture suffer from Governance Issues, Political patronage and above all, low levels of funding.

  9. 4. Financing Trends in Africa:Domestic Sources of long-Term FinanceBanks in most SSA Countries are traditionally the Key Players in the Financial System, just like in Kenya • The insurance and pension penetration remains low in most African countries. In Kenya, the insurance and pension industry accounted for 8.9 percent and 17.0 percent, respectively of financial sector assets in 2013 • But pension funds in Africa often have sizeable and growing funds that should be invested long-term given the available investment opportunities. Source: Kenya Financial Stability Report, 2013

  10. 4. Financing Trends in Africa:Domestic Sources of Long-Term Finance…Most Insurance Companies and Pension Funds have invested mainly in Real Estate, Government Securities, and Bank Deposits and comparably little in Traded Equities. This in some cases is due to Investment Restrictions imposed by Prudential Regulations, as well as the Risk Appetite Kenya Pension Industry Investment Portfolio, 2013 (%) Kenya Insurance Industry Investment Portfolio, 2013 (%) • Source: Kenya Financial Stability Report, 2013 • Large investments in deposits and risk free government securities should • be seen as a waiting option by potential investors in fixed irreversible investments

  11. 4. Financing Trends in Africa:Foreign Source of Long-Term Finance… Foreign Direct Investment (FDI) Remained the Main Source of External Finance in Africa driven mainly by Infrastructure Investment. But FDI flows to SSA are much lower than those in other Developing Economies Source: IMF Regional Economic Outlook, 2014

  12. 4. Financing Trends in Africa:Foreign Source of Long-Term Finance… Sovereign Bonds has become an additional source of external long-term finance in Africa supported by improved credit ratings and macroeconomic management. Sovereign Bond inflows in SSA stood at USD5.0 billion in 2013 which was equivalent to 20% of Aid to SSA and 12% of Foreign Direct Investment flows (ODI, April 2014). Recent Sovereign Bond Issues in Sub-Saharan Africa Source: Kenya: IMF 2014 Article IV Consultation – Staff Report

  13. 5. Kenya’s Experience • Central Bank of Kenya in collaboration with stakeholders in the financial sector initiated domestic debt market development programs • Lengthening of Debt Maturity Profile • Prior to 2002, the Government domestic debt market was dominated by short term debt instruments with the debt portfolio ratio of 70:30 (T/Bills:Bonds) and an average debt maturity profile of 0.7 years • There has been a notable success in the transformation of debt composition and maturity profile. As at October 2014, the average time to maturity of Government debt was 5 years and 7 months while that for bonds alone was 7 years and 7 months • In 2008, CBK issued the first long-dated paper of 20-years to maturity. This was followed by successful issuance of a 25-year Bond in 2010 and a debut 30-year Savings Development Bond in 2011

  14. 5. Kenya’s Experience… 2. Infrastructure Bond (IB) Issuance • A major milestone - Infrastructure Bond first issued in 2009, with the debut IB successfully raising Ksh.18.5bn (USD231.25mn) • A total of six Infrastructure Bonds have been issued successfully since 2009 with the largest single IB of USD395mn issued in August 2010 • This has seen even corporate institutions venture into the Infrastructure Bonds avenue- But they are still limited in number

  15. 5. Kenya’s Experience…Infrastructure Bond Targeted Projects/Sectors • Unlike conventional bonds, IB proceeds target specific projects, with potential for sustaining reliable income streams and great economic value • There is transparency as the targeted projects are factored in the annual Budget of the Government under development expenditure • Spatial distribution of the projects around the country very important for regional equity • Enhance success rate of the bond • Transport Sector – e.g. construction of new roads and rehabilitation of old ones • Water, Sewerage and Irrigation – e.g. construction of water supply and sewerage systems, water reservoir dams, boreholes and irrigation schemes around the country • Energy – e.g. drilling of Electricity Generating Steam Wells (Geothermal), upgrading the National Grid System with New Transmission Lines and expanding the Rural Electrification Project

  16. 5. Kenya’s Experience…Bond Trading Market Performance has continued to improve

  17. 5. Kenya’s Experience…The Sovereign Bond… • Kenya issued A Sovereign Bond of USD2 billion in June 2014 to enhance the capacity for a faster rollout of public investments in infrastructure – under Vision 2030 • The Bond was massively oversubscribed at 440 percent. The realised yields of 5.875% for the 5-year and 6.875% for the 10-year were comparably lower relative to those on recent issues of similar bonds in the region and on domestic Government securities • The Bond has helped to benchmark the country’s credit and facilitate access to international capital markets by corporate entities thereby enhancing investment • The Sovereign Bond has also dampened pressure on both Government domestic borrowing and interest rates Given these successes in Kenya, it shows it is ready for long-term investments – it is not a risky environment to invest in long-term

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