Africa has big development aspirations that call for substantial financial resources, but a key question remains: where is it going to get the money from?
In recent times, there has been a sharp slowdown in the global economy, which has made it even more difficult for Africa to access international financial markets. At the same time, private investors have also been discouraged from investing in the continent in part, because most low-income countries do not have sovereign credit ratings that are up to investment grade, awarded by international rating agencies.
With access to capital becoming tricky, a recent United Nations report on economic development on the continent advised African governments to find new ways to finance development. Between US$600 billion and US$1.2 trillion will be needed each year to achieve the sustainable development goals in Africa, according to the UN Report, subtitled Debt dynamics and development finance in Africa. This equates to about one third of some countries’ gross national income, meaning that public budgetary resources, official development aid and external debt are unlikely to cover those needs. The conclusion? Development partners will need to share the burden.
With serious constraints on public finance both in Africa and in donor countries, development finance institutions (DFIs) therefore are poised to assume a prominent role in terms of financing development and supporting Africa’s infrastructure needs.
According to Professor Nicholas Biekpe, who heads up the newly established Development Finance Centre (DEFIC) at the GSB, national and international DFIs are specialised development banks or subsidiaries set up to support government and some private sector development programmes in developing countries. In essence, DFIs invest in areas where commercial investors or banks would be reluctant to venture.
Local DFIs can play a key role in mobilising resources for underserved segments of the economy, including entrepreneurs and smallholder farmers. From this perspective, they can complement international financial institutions and commercial banks, says Biekpe.
“DFIs … aim to have a developmental impact in the markets in which they invest, alongside the requirement for sustainable returns. They are typically majority-owned by national governments and source their capital from national or international development funds or benefit from government guarantees,” says Biekpe. This, by and large, guarantees their creditworthiness, which makes it possible for them to raise significant amounts of money on international capital markets at low rates and provide financing on very competitive terms. The finance provided by the DFI is also intended to act as a catalyst to attract and mobilise the involvement of other private investors.
Some of the major international DFIs investing in Africa include the World Bank’s International Finance Corporation (IFC) and the European Investment Bank (EIB). There are also several African DFIs, the largest of which is the African Development Bank. The New Development Bank (NDB), also referred to as the BRICS Development Bank, is another prominent and more recent player. Created in 2014 by the BRICS member states (Brazil, Russia, China, India and South Africa), the main objective of the bank is to establish an alternative to the current set of multilateral institutions as a source of development finance for emerging and developing countries.
But while the institutions are well developed and active, Biekpe says that the record of DFIs in stimulating economic growth has not always yielded the desired results in Africa and other developing regions.
In a 2013 working paper for the African Development Bank group, Pietro Calice says that African DFIs have historically played an important developmental role, taking higher-than-average risks to perform their mandates and reducing credit pro-cyclicality. But, notes Calice, the track record of African DFIs is mixed, and their developmental contribution has frequently come with a cost in terms of relatively low efficiency and effectiveness. According to Biekpe, clear and focused mandates, robust corporate governance standards, ‘acceptable’ level of government control, appropriate lending and risk management technologies, and the ability to recruit and retain qualified staff, are some of the key ingredients for an effective DFI that will ultimately contribute to economic and social development.
In the face of the huge developmental needs of the continent, there are strong reasons for African policymakers to continue strengthening and modernising local DFIs, giving them the tools to better fulfil their policy mandates, notes Biekpe.
“Additionally, there is no question that African governments should not continue to depend on the Bretton Woods Institutions – the World Bank and the International Monetary Fund (IMF) – which have their own agenda based on Western interests,” says Biekpe.
He says that the recently launched Development Finance Centre at the Graduate School of Business seeks to address some of these issues within the development finance sector. “Establishing such a centre in Africa is vital for improving the functioning of these institutions which, if managed properly, can be central in the development of the continent. Among other goals, the centre seeks to improve the efficiency of the DFIs, and bolster the production and publication of research related to development finance. Despite a growing literature looking at the impact of individual investments and projects on development, gaps still remain in the research of both the micro and the macro impact of DFIs and indeed their inner workings. What is also lacking is the relevant professional capacity in development finance.” The centre will seek to bring together development finance practitioners from all over the world to encourage knowledge sharing, and promote the public understanding of development finance.
“Very often, development finance institutions have been criticised for being inaccessible to poor communities on the ground, the people most in need of their help. Improving the visibility of DFIs is, therefore, crucial if we are to make sure that they remain useful tools to promote investment and growth in poor countries and communities,” says Biekpe.
The Master of Commerce Degree in Development Finance, hosted by the centre, also plays a key role in terms of honing skills that can help DFIs perform optimally. Furthermore, because many African countries will increasingly become dependent on the DFIs to meet their developmental needs, it is important that they are staffed by people with an in-depth understanding of how these institutions function.
“It will be crucial for the continent’s future to build efficient, sustainable and well-functioning local DFIs that understand the needs of Africa and its people, and that will be able and willing to bridge the financing gap faced by the credit-rationed sectors,” concludes Biekpe.