Thursday, 8 June 2017

The G20 ´Compact with Africa´ is Not for Africa´s Poor: The Finance Framework

A key pillar of the G20 Africa Partnership is the ´Compact with Africa´ (CwA), an initiative within the G20’s finance track, coordinated by the German Federal Ministry of Finance. In its resolution adopted by G20 finance ministers and central bank governors in Baden-Baden, the G20 has acknowledged “its special responsibility to join forces in tackling the challenges facing the poorest countries, especially in Africa”[1]. The ´Compact with Africa´ initiative aims to boost private investment and investment in infrastructure in Africa. To this end, the World Bank, the International Monetary Fund and the African Development Bank have produced a joint report (“The G20 Compact with Africa: A Joint AfDB, IMF, and WBG Report”), which proposes a catalogue of instruments and measures designed to improve macroeconomic, business and financing frameworks as a way to boost investment [2]. The document is a dense, well-argued and documented text, albeit written in fairly technocratic language.
The CwA Financing Framework aims at increasing the availability of financing at reduced costs and risks, with a focus on long-gestation infrastructure projects. It targets in particular pension funds and life insurers. These institutional investors are characterized by the long-term nature of their balance-sheet liabilities, which enables them to invest in infrastructure projects with long gestation periods. They would indeed make a very good fit for funding Africa’s infrastructure. Projected to reach $100 trillion by 2020, institutional investors (pension, funds, life insurers and sovereign wealth funds) would need to invest one percent of their annual new inflows to fund Africa’s infrastructure gap, estimated at $ 50 billion per year [3].
The CwA makes some important ideological presumptions. First, it is solely driven by the Anglo-Saxon financing model with a focus on direct securities (equity and bond) markets rather than bank-based financial intermediation, which has underpinned (Continental) European and East Asian economic and social development.  Second, the CwA Financing Framework is silent on the important role that the public and semi-public sectors may have played in early stages of development via mandatory public pension plans (East Asia) or not-for-profit financial ccoperatives (such as agricultural credit unions).  Third, it is silent on the “financing gap” (also known as the MacMillan gap), which has come to indicate that a sizeable proportion of economically significant SMEs cannot obtain financing from banks, capital markets or other suppliers of finance. The MacMillan gap requires an important role of public development institutions and public policies in tackling underlying market imperfections. Lastly, it seems that the German Ministry of Finance that commissioned the CwA report in the first place has missed a unique chance to bring in the specific German history of bank-based intermediation, of rural credit unions and of public infrastructure push in the context of late industrialization. This would indeed be relevant for the African context.
Instead, the CwA Financing Framework consists of three linked components to tap the global pool of private finance: The first peddles blending instruments and facilities - the use of public or philanthropic funds to attract additional investments from private sector actors into development projects - to lower African country risk to private investors (the new Private Sector Window under the IDA18 replenishment is mentioned explicitely); the second aims at support of domestic debt markets and at a more supportive global regulatory environment; the third aims to promote new public infrastructure investment funds, such as Managed Co-Lending Portfolio Program (MCPP) initiated by The International Finance Corporation (IFC), part of the World Bank Group.
Because most African countries remain poor, they are not considered creditworthy. Even though the African Development Bank (AfDB) has 54 member countries, of which only 17 are not eligible to African Development Fund (AfDF ) funding, most countries have a per capita income below an operational cut off (fiscal year 2015-2016: $1,215). Recent Brookings forecasts project that the number of people living in extreme poverty (the headcount of those falling below $1.90) will rise in 19 African countries by 2030.

Table 1:               Eligibility to access AfDF funding (Number of countries (out of 54 total))
Creditworthiness to sustain AfDB financing
Per capita income
above the AfDF/IDA
operational cut-off

No
Yes
No
30 AfDF-only
3 blend-eligible
Yes
4 AfDF-Gap
3 AfDB-only
Source:http://www.afdb.org/en/about-us/corporate-information/african-development-fund-adf/adf-recipient-countries/

Apart from general investment barriers, common project risks for infrastructure investments need to be considered in the African context. These include: completion risks (failure to complete the project on time and on budget); performance risks (the risk that the project fails to perform as expected on completion, maybe due to poor design or adoption of inadequate technology); operation and maintenance risks (relates costs, management and technical components and obligation to provide a specific level of service); financing risk (which may arise from an increase in inflation, interest rate changes etc.); and revenue risks (which relates to the possibility of the project not earning sufficient revenues to service its operating costs and debt and leave adequate return for investors).
Legal, regulatory and institutional challenges of Private-Public Partnerships (PPPs) should not be underestimated in the context of Africa’s low-income countries. Long-term commitments in the infrastructure sector depend on a set of legal, regulatory and institutional frameworks. From the time of project preparation, to bidding and finally operation, the regulation of PPPs requires an independent regulator and the handling of disputes by an independent judiciary. Other institutional prerequisites are property and collateral registries, reliable accounting and reporting procedures, tested and reliable foreclosure mechanisms. The longer the term of contracts and the larger the funding commitments, the more important such ‘basic’ institutional and legal infra­structure becomes. Moreover, fiscal contingencies of PPPs could burden weak public finances in countries where debt tolerance has proven low. In particular when privately financing large infrastructure projects in immature markets, there is a risk that private returns come at the expense of long-term fiscal costs (contingent liabilities).

Table 2: The infrastructure funding escalator
Steps
Step 1
Step 2
Step 3
Step 4
Step 5
Major funding source
Government
Step 1 + Aid
 Grants +
Concessionary
Step 2 + Banks loans + leveraged private funds
Step 3 + Private Equity + Project Bonds
Growing role institutional investors
Source: based on Della Croce, Fuchs, & Witte (2016); see text.


To a large extent long-term funding of infrastructure in Africa is provided circumventing the intermediation process altogether, including via foreign direct investment. As for low-income Africa, the CwA’s focus on an important role for private institutional investors to fund the infrastructure gap lacks realism: Most African countries are at the first two steps of the Infrastructure Funding Escalator, where public investment and concessionary aid remain the major funding sources.
The first component of the CwA Financing Framework pins high hopes on blended finance and leveraged finance via development finance institutions (DFIs). Table 3, however, shows that private funds mobilized by DFIs seem to have shied away from the ‘Bottom Billion’ (to paraphrase Paul Collier). Within the group of countries attracting blended finance investments, LICs generally (not just in Africa) receive much less on a per country basis compared with other developing countries [4]. LICs obtained, on average, US$60 million of private investment per country between 2012 and 2014; the equivalent figures for other developing countries were six times higher – US$352 million for LMICs and US$404 million for UMICs. Little of blended finance and of foreign direct investment (FDI) goes to low-income countries compared to ODA, as both categories of private-sector flows seem to favour middle-income countries. Despite policy efforts to mobilize private finance through official DFIs, they so far have represented a small fraction of the flows directed to low-income Africa.

Table 3:               Allocation of FDI, ODA and DFI mobilized funds per income group in Africa                                (mean percentage shares during 2012-2014 )
Income Group
FDI
ODA
DFI mobilized
Low Income
4
30
5
Lower MIC
22
43
51
Upper MIC
70
47
19
Data for country-allocable investments only; residual went to high-income group


Three commitments addressed to partner countries are derived from the first component: support ongoing de-risking initiatives; support various de-risking instruments (IDA18 Private Sector Window, AfDB´s PSF; support the further refinement of a commonly accepted set of principles for ´blended finance´. This is more of a self-promotion of the World Bank and the AfDB than a helpful commitment for low-income Africa. In reality, new AfDB initiatives have had a low uptake, especially in low-income Africa. A study finds that the growing complexity and fragmentation of private-sector mobilization initiatives created my multilateral development banks seems confronted with “little awareness or understanding of these private sector mechanisms and initiatives” on the ground [5].
The second component of the CwA Financing Framework calls for domestic debt market development, as already exist in Egypt, Nigeria and South Africa. The CwA document is well aware (in some paragraphs, at least) of capacity constraints that impede Africa´s securities market development. To be sure, there has been limited progress in developing markets for long-term finance on the continent. Except for South Africa the depth of equity and bond markets falls far short of the capitalization and liquidity of financial markets in other developing regions, despite recent issuance of Eurobonds and local currency bonds in some places. The largest and most important segment across financial sectors in Africa is the banking system, not an ideal source of intermediation for long-term finance, given the maturity transformation of banks’ short-term liabilities and consequent risks.
To avoid currency mismatches in private and public balance sheets, local currency bond market development is primordial. Most poor countries do not borrow in their own currency, which has time and again triggered debt crises as a result of strong currency depreciation (as currently observed in African commodity exporting countries).  Substituting external, foreign currency debt with domestic, local currency debt may increase rollover and interest rate risks because of shorter maturities of the latter; this implies it will have to be refinanced more frequently and possibly at a higher rate. Ghana is an example of the risks involved: In the recent decade, Ghana had issued three Eurobonds with tenors between 10 and 12 years, whereas the average tenor of its local currency bonds at issuance was about two years only; moreover, their yields stood at no less than 23% in 2014.
Four commitments addressed to partner countries are derived from the second component: introduce an appropriate regulatory and supervisory framework; establish over-the-counter trading as well as custody and settlement mechanisms to minimise costs and risks for debt securities; support the development of pensions funds, life insurance companies and mutual funds to develop a domestic institutional investor base; implement ´sound´ debt management policies. I have major doubts whether scarce African government resources are really best employed by facilitating an Anglo-Saxon system of direct securities markets, and what the risks are in terms of fraud and gambling.
The CwA finance framework tries to put the cart before the horse, especially for LICs in Africa, by trying to appeal to institutional long-term finance. It ignores the financing model of successful development that has been largely based on public infrastructure preceding industrial development, corporate savings via retained earning, rural credit associations and bank-based finance. It also ignores the risk of debt sustainability linked to blended finance, especially as multilateral development banks are reducing the share of concessionary finance, including to African countries with a long default history.
Low domestic savings levels, weak government finances and a low debt tolerance militate against forcing foreign private debt and contingent fiscal liabilities upon countries where infrastructure deficits are most blatant. The risk of lasting current account deficits, which are mostly financed privately, is that they tend to end with balance-of-payments crises. Many African countries have benefited from comprehensive debt restructuring and relief efforts in recent decades, but since 2010 countries have accumulated foreign debt again as raw material prices weakened, growth slowed and concessional debt was replaced.  Both investors and Africa’s governments should consult the Joint World Bank-IMF Debt Sustainability Framework for Low-Income Countries before raising the finance they need to meet the SDGs, including through grants when the ability to service debt is limited.




[1] http://www.bundesfinanzministerium.de/Content/EN/Standardartikel/Topics/Featured/G20/2017-03-30-g20-compact-with-africa.html
[2] The report benefited from contributions by Professor Paul Collier (Oxford University), Richard Manning (Oxford University), and Ulrich Bartsch (German Ministry of Finance).  
[3] Kappel, Pfeiffer & Reisen (2017), https://www.die-gdi.de/discussion-paper/article/compact-with-africa-fostering-private-long-term-investment-in-africa/. GDI Discussion Paper 13/2017.  
[4] Tew & Caio (2016), Blended finance: Understanding its potential for Agenda 2030. London: Development Initiatives.  http://devinit.org/wp-content/uploads/2016/11/ Blended-finance-Understanding-its-potential-for-Agenda-2030.pdf.
[5] Bertelsmann-Scott, Markowitz & Parshotam (2016). Mapping current trends infrastructure financing in low-income countries in Africa within the context of the African Development Fund. SAIIA, Johannesburg.

Tuesday, 9 May 2017

Multilateral Development Banks: Policy Options for the Next German Government

This post first was published early May in German on request of Stephan Klingebiel for the German Development Institute: 
http://blogs.die-gdi.de/2017/05/02/die-zukunft-der-multilateralen-entwicklungsbanken/

2015 was the year of important summit promises made by the UN and heads of states that yielded some of the most ambitious global commitments ever made:
1.       The 3rd Conference on Financing for Development in Addis Ababa;
2.       The Summit in New York on Sustainable Development Goals (SDGs); and
3.       The 21st Climate Change Conference in Paris.
2016 followed to witness the delivery promise by ten multilateral development banks (MDBs) and the IMF:  We stand ready to support the realization of these ambitious UN summit promises into reality[1]. Table 1 presents those MDBs that committed to the delivery promise through their presidents´ signatures. The Table will help the next German government to monitor these institutions for the implementation of their promise and to take them to task. Talk is cheap, especially at UN summits, but implementation is critical to improving lives and protecting the planet.

Table 1: Multilateral Development Banks with SDG Delivery Commitments
Multilateral Development Banks
Accronym
African Development Bank
AfDB
Asian Development Bank
AsDB
Asian Infrastructure Investment Bank
AIIB
European Bank for Reconstruction and Develoment
EBRD
Europen Investment Bank
EIB
Inter-American Development Bank
IADB
International Finance Corporation
IFC
Islamic Development Bank
IsDB
New Development Bank (BRICS)
NDB
World Bank
IBRD/IDA

The MDB bosses declared that the can translate the SDGs into meaningful country-level targets, policies, programs, and projects needed to achieve them. They would provide not only the necessary financing—either directly or by helping to “unlock” and catalyze additional public and private resources—but also policy advice and technical assistance supporting countries to build domestic capacity and to identify needed priority investments with the right standards.  At the same time, the IMF and the World Bank would strengthen their debt sustainability assessment tools to ensure that investment scaling-up in the wake of the summit promises  do not threaten the sustainability of public finances. So much for self-promotion.
With respect to the summit and delivery promises and the MDBs, three central strategic questions will confront the next German government:
·         Which share of the aid budget is to be spent via multilateral rather than bilateral channels?
·         How to allocate German budget contributions across the MDBs?
·         Which priority will be given to poverty reduction in the poorest countries relative to financing global public goods?

Aid allocation: Bilateral or multilateral delivery channels?
Budget allocation between bilateral and multilateral delivery channels can be guided by two important criteria: 1) Who has the comparative advantage to deliver on specific SDGs effectively and efficiently? 2) Which channel helps better promote the priorities of partner country and donor country?
Usually, multilateral are preferred over bilateral agencies for some genuine advantages: Know How (to fight poverty and pandemics), basic research (for example on agricultural seeds), to combat global climate change, global terror, financial crises and shortages of water, food and energy. These are classic global public goods that constitute the case for the necessity of multilateral organizations also for aid delivery.
Where – unlike in Germany – national agencies of aid delivery are hardly present, a hard decision is often avoided via cherry picking multilateral organizations for earmarked (´bilateral`) purposes. By contrast, German contributions to multilateral institutions are mostly contributions to their core budget. The high share of core budget payments in German contributions to multilateral organizations is welcome and should not be reduced. Many international organizations, especially at the UN, suffer from eroded core budgets that leads either to their effective ´privatization´ (example: the World Health Organization budget financed by the Gates Foundation) or to mission creep, mandate encroachment and fund shopping by management. This leads to aid fragmentation, costly for poor countries with thin administrative capacities.
To be sure, the risk of aid fragmentation is much higher when aid is delivered via bilateral channels, given the multitude and competition of bilateral aid agencies and of private donors. However, the bilateral channel is tempting for an export oriented country such as Germany as it will serve as a door opener for good bilateral relations, which imply stronger trade relations.

Assigning Mandates across the MDB Space
In the past, the bulk of multilateral lending has been provided by institutions created and ruled by the west. The pressure for the BRICS to ‘exit’ had risen with past, present and expected failure for ‘voice’ reform in the established international financial institutions (IFIs). With the Asian Infrastructure Investment Bank (AIIB) and the New Development Bank (NDB), two multilateral banks created in 2014 outside the established Bretton Woods system, choice has increased for borrowers and capital donors alike as the new institutions led by China and the other BRICS help rebalance multilateral development finance away from western dominance[2]
To avoid the administrative burden on developing partners that may arise through fragmented MDB lending, it remains important to avoid mandate duplication and overlap, to reduce mission creep and to arrest multilateral fragmentation[3]. The fragmentation of multilateral development cooperation is not just a problem for developing countries, but equally for sponsors in donor countries. They have so far often fulfilled the task to direct and control the management of multilateral development banks by benign neglect.
A clear role assignment and coordination of the multilaterals will help reduce mandate shopping and hopefully raise their efficiency and effectiveness. This requires first and foremost to find out comparative advantage across the MDB space in supporting specific SDG goals (of which there are 17 with 169 targets between them). Because of ministerial patronage and conflict of interest the mapping of comparative advantage cannot be trusted upon specific ministries, let alone upon international organizations (nor upon academics that depend on them). The most promising procedure is to have the heads of states to entrust national audit agencies with mapping comparative advantages in the MDB space[4].

Which Role should MDBs have for the Bottom Billion?
The Communiqué released by G20 Finance Ministers and Central Bank Governors at their meeting in Baden-Baden over March 17-18, contained the following, less noted, declaration:
“Given scarce public resources and the key role of the private sector for sustainable economic development, we welcome the work by Multilateral Development Banks (MDBs) on mobilising private capital. We call on MDBs to finalise Joint Principles by our next meeting and develop Ambitions on Crowding-in Private Finance by the Leaders Summit in July 2017. We look forward to the joint MDBs’ reports on the implementation of the MDBs Balance Sheet Optimisation Action Plan…”
Following a decision made in 2015, The AsDB has become a pioneer of merging concessional and non-concessional balance sheets in order to raise leverage on MDB capital. Since the AsDB merger, the assets of the concessional loan window, named the Asian Development Fund (AsDF), have been treated as equity and brought onto the bank’s core balance sheet. The inclusion of AsDF equity, comprised of $30.8 billion in loans outstanding and $7.2 billion in liquidity/receivables, effectively tripled AsDB capital to $53 billion. The Washington-based Centre for Global Development (2016) estimates that the move increased the AsDB lending capacity by 50%. The new regulations for the AsDF were released by the AsDB on 1st January 2017.
Reforms are also ongoing in other international financial Institutions. The IDA, following its 18th Replenishment, plans to leverage its capital for non-concessional loans through a private-sector set-aside window. The African Development Bank (AfDB) is opening its non-concessional window to the poorest countries. Also IFAD – an MDB and a specialized UN agency – is exploring options for changing the financial architecture, so as to increase the size of the programme of loans and grants.
The AsDB merger has been described as “win-win-win”: AsDF countries see expanded access to lending; AsDB countries also see expanded access (on non-concessional terms); and AsDF donors see a 50 percent reduction in their contributions to the grant fund as a result of a smaller pool of eligible countries. Is this too good to be true – a free lunch?
We need to consult MDB balance sheets to see when the MDB windows merger will bring the advertised results:
  • On the liability side, the ratio of concessional to non-concessional equity determines lending potential of merged windows. The more concessional equity can be merged into non-concessional equity, the more bang for the buck can be expected.
  • On the asset side, composition of borrowers—those requiring concessional lending terms and their size relative to non-concessional borrowers – will define the leverage ratio as non-concessional lending raises the leverage ratio while concessional lending will reduce it toward 1.
Table 2: MDB Balance Sheet Ratios
MDB
AfDB
AsDB
IADB
IBRD
Equity ratio 
4.16
2.24
0.07
4.38
Leverage ratio
2.49
3.79
3.26
4.13
Sources: Moody´s; CDG (2016); MDB annual reports; own calculations.

The net result of window mergers on MDB lending capacity will depend on how much additional finance the balance-sheet reform produces, and how much of the additional resources is absorbed by a higher concentration of fragile and conflict affected countries in the remaining pool of IDA countries. The World Bank balance sheet lends itself to the optimization proposed by the G20: Both the equity ratio and the leverage are comparatively high, so that lending capacity can be increased significantly by the window merger. In contrast, the room for manoeuvre is quite limited for the AfDB. This kind of redirection of investment priorities away from social investments toward hard infrastructure investments could be fatal in Africa where fragile and conflict affected countries are plentiful, and where the majority of countries are still dependant on concessional lending[5]



[1] http://www.worldbank.org/en/news/press-release/2016/10/09/delivering-on-the-2030-agenda-statement
[2] Helmut Reisen (2015), “Will the AIIB and the NDB Help Reform Multilateral Development Banking?”, Global Policy, Vol. 6,  Issue 3, September, pp. 297–304.
[4] To entrust the national audit authority on evaluating engagement with multilaterals was pioneered in the UK. See National Audit Office (2005), Department for International Development: Engaging with Multilaterals, London: NAO.
[5] See more detail in Helmut Reisen (2017), On the G20 call for MDB Balance-Sheet ´Optimization´, T20 Germany Blog, German Development Institute, 11 April.