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African Municipal Finance Blog Series - Part 1

08.02.2016Professor Jeremy Gorelick, Managing Director, Affordable Housing Institute

At the annual African Union for Housing Finance conference in Durban, Making Finance Work for Africa spoke with Professor Jeremy Gorelick following his talk, "Positioning Cities for Housing-Related Capital Flows". Based on his professional and academic experiences in supporting sub-sovereign entities to access funds for capital-intensive projects, Prof. Gorelick has been invited to write a series of blog posts about municipal finance across Africa.  The series will discuss substantive current events in the field and feature interviews with politicians, practitioners and other stakeholders.  

 

In an era of increasing decentralization, sovereign governments across Africa are constitutionally shifting more responsibilities to cities than ever before. Along with these new mandates, though, municipal leaders are forced to be more creative in finding money to cover rapidly rising costs associated with such traditionally-central government programs as social housing, underground infrastructure, and solid waste management. Most cities continue to rely on transfers from central governments, while some have additionally opened dialogues with multilateral development finance institutions, like the African Development Bank, or bilateral development finance institutions, like the French Development Agency or the United States Agency for International Development.  Still more have looked for assistance from grant-making bodies like the Rockefeller Foundation or the Bill & Melinda Gates Foundation.  Other cities, like Dakar, have turned to the debt capital markets for assistance through the issuance of municipal bonds. 

The municipal finance gap in Africa is over USD 25 billion per year, in contrast to the current investment capacity of African local governments-approximately USD 10 billion over ten years (according to a 2012 report, Financing Africa's Cities: The Imperative of Local Investment). Despite this pressing need, most African local governments have limited access to capital markets and private sector finance for their infrastructure projects. Essential and impartial supporting capacity - such as rating agencies - are in short supply. In addition to Dakar's attempt, only cities in South Africa (including Johannesburg, Cape Town, Tshwane and Ekurhuleni) have issued municipal bonds not backed by the central government. This can be attributed, in part, to the enabling environment created by South African government's Municipal Finance Management Act. 

Contrast this with the realization that one-third of the world's urban population resides in developing countries, and this portion is growing rapidly. While only about one-tenth of the world's largest urban areas are in least developed countries, thirty of the thirty-five most rapidly growing large cities worldwide are located there.  In other words, the world's fastest-expanding urban agglomerations are now in the Global South.  The magnitude of the urban demographic shift is staggering. Rural-to-urban migration, combined with the effects of urban population growth, could add another 2.5 billion to the world's urban population by 2050.

The growth of cities and towns from urbanization makes functional and fiscal decentralization more viable and more necessary, and in many countries local autonomy is growing. Increasing the capacity of local officials can not only improve urban resilience and quality of life, it empowers cities and towns to contribute in important ways to national, social and economic development goals.

While the responsibilities delegated to local governments by law vary considerably from one country to the next, cities often have constitutional mandates to provide: (i) local basic services and infrastructure, including water, sanitation, public transportation, public lighting, and solid waste management, among others; (ii) resilience building, and climate mitigation and adaptation, including energy efficiency, flood management, and public building retrofitting, among others; and (iii) local social services and infrastructure, including health, education, and childcare facilities, among others.

In the past, most cities would not have had the autonomy, information technology, or knowledge of trends in the urban sector worldwide to embark on significant development projects or to prepare multi-year investment plans. But with the increasing interconnectedness of cities around the world and the growing competition among them, this has changed.

Even so, while needs and aspirations may grow, the financial options available to cities across Africa have not kept pace with the growth and increasing complexity of the cities themselves. Cities are stuck in a vicious cycle of limited resources leading to a constrained response, while the population of the city and the demand for services continue to grow.

Ironically, many local government capital investments have high economic and social returns, and therefore should be prioritized. For instance, transportation signals that reduce congestion free people's time for more productive purposes. Investments in drainage that reduce flooding in commercial areas reduce trading days lost to post-flood recovery. In these cases, domestic private capital should be available to finance municipal investments that cannot be financed through grants.

Mobilizing resources to finance investments and improve services at the municipal level is one of the most challenging aspects of local development, especially if the goal is to provide resources on market-like conditions in a sustainable manner, for instance from loans or bonds.  Even when government transfers are predictable and generous (which is the exception), they are rarely adequate to finance major infrastructure improvements in growing cities. The capital investment financing that is available to local governments is often provided by national agencies whose own access to capital is highly constrained. Winning funding allocations from national budgets requires local governments to compete with line ministries and other priorities of the government in power.

As a result of these conditions, cities are realizing the importance of diversifying their resource base to meet tremendous population growth coupled with an increased list of constitutional responsibilities.  Along with providing a crystallization of the current state of municipal finance across Africa, a critical purpose of this blog series will be to highlight best practices and provide a roadmap for municipal leaders eager to leave a positive legacy on their respective cities.

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About the Author

Since 2011, Professor Jeremy Gorelick has served as the Lead Technical and Financial Advisor for the City of Dakar's Dakar Municipal Finance Program. He has previously worked in structuring public debt obligations at BNP Paribas and Dresdner Kleinwort Wasserstein, and has taught classes on finance, international development and business analytics at the Johns Hopkins University since 2010. For more information on Professor Gorelick, contact him at LinkedIn.

Upcoming events:  

African Municipal Bond Forum - Dakar, Senegal 

Innovative Domestic Resource Mobilization in Africa

25.01.2016John Mbu, Financial Economist, African Development Bank

On 25 September 2015, world leaders adopted the Sustainable Development Goals (SDGs) at the United Nations Headquarters in New York. The 17 SDGs will serve as an economic development blueprint for the developing nations for the next decade and half. Developing countries, particularly those in Africa, now have the herculean task of mobilizing the required finances to fund their economic transformation. Although private capital now forms a significant proportion of development finance, the main "take home message" from the three major development finance conferences (Monterrey in 2002, Doha in 2008 and Addis Ababa in 2015), is that there should be a significant boost in domestic resource mobilization. In addition to tax revenues in Africa, which stand at about $550billion per annum, financial institutions particularly banks, sit on huge financial resources.

It is interesting to note that even with the "not-so-rosy" global economic reality, with economic slowdown in China and other emerging markets, plunges in commodities prices, the Greek debt crisis, Europe's migrant problems, the crises in Ukraine, Syria, Libya, Iraq and Yemen, financial institutions in Africa have been boosted by rising assets. Africa's 200 biggest banks have total assets worth $1.5trillion - almost half of the entire continent's GDP. Their total loans rose by 5% from $749billion in 2011 to over $789billion in 2015, whereas the total deposits rose from $1.012trillion to $1.019 over the same period, as can be seen in the figure below.

Source: The Africa Report October-December 2015 Edition

Worthy of note is the fact that the assets of the 23 biggest banks ($965billion) represent over 65% of the total assets of the 200 biggest banks as can be seen in the figure below. Standard Bank Group of South Africa, Africa's largest bank has assets worth $169billion, about half of South Africa's GDP.

African countries will have to find new ways to mobilize its domestic resource. For example, the Government of the Federal Republic of Ethiopia in 2011 passed a law obliging commercial banks to allocate 27% of their loan portfolio for the purchases of treasury bills. Proceeds from these are then sent to private entities that are engaged in manufacturing and investing, and particularly for large infrastructure projects such as the $4billion 6000MW Grand Renaissance Dam Project. If Africa's 200 biggest banks, which constitute between 60-70% of the total number of banks in the continent, were mandated to allocate 27% of their loan portfolios to fund economic development initiatives, as is the case in Ethiopia, about $213billion will be raised just in 2015 - almost twice Africa's annual infrastructure needs, estimated to be about $100billion.

However, although such a model is commendable, proponents of "free market economics" may argue that this could cause distortions in the market, as the allocation of resources should be based entirely on market forces. Whilst the argument is justifiable, it is also true that moral suasion is a long standing phenomenon in economics - this is simply a situation where a monetary/financial authority pressures (though not by force) market participants to act in a certain way in order to achieve a particular objective or objectives. A good example is the United States Federal Reserve's $85billion monthly bond purchases program (referred to as Quantitative Easing) that was initiated in response to the 2008/2009 financial crises. The bond purchases were used in combination with near-zero interest rates to boost investment and stimulate the US economy that was in reels after the credit and financial crisis of 2008/2009.

The SDGs, which are a motley of economic development goals have to be funded. Financial and monetary authorities in Africa therefore have a huge task ahead of them and "innovative finance" is a statement that they will have to get used to. If moral suasion can be used for Africa's highly liquid banks to allocate 25%+ of their loan portfolios to fund economic development and economic transformation, finance officials may not have to worry so much about the plunges in commodities prices.

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About the Author

John Mbu is a financial economist and is presently an economic and policy analyst in the Office of the First Vice President & Chief Operating Officer at the African Development Bank(AfDB) in Abidjan, Côte d'Ivoire. Prior to this, he spent two years as an economic analyst in the Evaluation Department of the African Development Bank, focusing on private sector evaluations as well as regional integration evaluations. Before joining the AfDB, John worked as a management consultant for Pricewaterhouse Coopers in Douala, Cameroon and in Lagos, Nigeria. John holds two Masters Degrees, in Development Finance from the University of Cape Town, South Africa, and in International Finance from Durham University in the UK.

Growing Africa’s Economies through Residential Investment

20.10.2015Kecia Rust, Executive Director, Centre for Affordable Housing in Africa

* An edited version of this piece originally appeared in the Autumn edition of Housing Finance International, the journal of the International Union for Housing Finance.

The African Union for Housing Finance's (AUHF) conference, which will take place on October 26 -28 in Durban, South Africa, promises to focus on making housing finance markets work in Africa. The line-up is impressive, with speakers from across the continent and the globe, focusing on financing the housing value chain, growing the capacity of housing microfinance, and responding to demand. The keynote address will be offered by the African Development Bank, and will set out the findings from their recent study into housing market dynamics across the continent. Following this, the African Union's Housing and Urban Development (HUD) Coordinating Committee will make a presentation on the Draft Africa Common Position - Africa's input into the Habitat III process which will culminate in Ecuador in April, next year. The AUHF conference will produce a "Durban Declaration", a statement on housing finance in Africa and the key issues that practitioners in the private sector will commit themselves to in the coming years.

The African Development Bank's work into housing markets is important, because it signals the institution's interest in focusing on housing and working with both governments and the private sector to develop and implement solutions to address the various problems undermining functioning housing markets in the continent. It comes at a good time, offering recommendations into the Habitat III process, which hopefully will pull together the public and private sectors into a coordinated effort. Of course, a key set of constraints sits at the macro-economic level: average mortgage interest rates across the continent range from 9.25% in South Africa through to 42% in Madagascar. This is what makes the participation of the AU at the AUHF meeting so significant, as that body offers the opportunity to engage with governments through the AU structures.

A further component of the AUHF conference is the Housing Finance Marketplace, a combined effort by the AUHF and the Making Finance Work for Africa Partnership (MFW4A) that aims to increase access to assistance for housing projects. As many stakeholders are unaware of how funding and technical assistance from investors can be tapped for projects, the Marketplace creates a platform that not only fills this information gap between stakeholders and investors, but also increases the ease of accessing assistance for specific projects. The Marketplace will launch at the AUHF, and will allow for one-on-one meetings between investors, DFIs and housing practitioners - projects, programmes and initiatives - towards sealing new deals to promote investment in affordable housing across the continent.

In its recent directory of investors, the Global Impact Investment Network identified a number of investors already active in housing across Africa, including Rockefeller Foundation, Echoing Green, Credit Suisse, LoK Capital, Ludin Foundation, Oikocredit, CDC Group, Blue Haven, MicroVest, Acumen, TH Investments LLC, AdobeCapital, AlphaMundi Group, Cordaid Investments. Just within East Africa, twenty-three impact investors were identified as having an interest in housing. Among them, just fewer than ten deals involving collectively about US$150 million worth of investment in housing were identified. Interest notwithstanding, housing was low on the list of priorities, trailing investments in other sectors, namely financial services and agriculture, and the number of deals realized was fewer than the number of interested investors. Why is this? Clearly there are factors in the housing sector in Africa that are stopping the market from working as effectively as it could. This is one of the issues that the AUHF conference will address.

Within this environment, one area that has been receiving increasing attention by investors, DFIs, financiers, as well as local banks and developers, is rental housing. In June, Shelter Afrique hosted a symposium in Ghana, on developing affordable housing for rent. This followed a conference on rental housing held by Shelter Afrique in December 2014, and supported by the Agence française de développement (AFD). Over the course of these events, key motivations for investing in the sector were highlighted: (i) given urbanization rates and demographics, demand for rental housing was clearly evident and growing; (ii) with a regular cash flow and increasing rentals, the sector offered strong synergies with pension fund liabilities, and opportunities for diversification and hedging; and (iii) the growing track record of the sector showed impressive yields. As with the broader housing sector, key factors undermining investment had to do with institutional and regulatory capacity[1].

Clearly, investment in these broader, macro-level issues is required if investor interest is to be translated into effective deals. A number of recommendations towards supporting the rental sector were offered. As a first priority, it was noted that governments at all spheres, from the national to the local level, should identify and support, in both policy and administrative terms, the opportunities to be found in the "build-to-let" market. This could be achieved, in part, through the release of public sector land for rental housing. A further recommendation emphasized the importance of scale interventions and the need for new business models (possibly the establishment of public sector supported funds to gear private sector investment) to entice investor participation in the market. The establishment of a body of best practice was also necessary, both to demonstrate successes and create a framework for on-going learning. Shelter Afrique has promised in this regard to publish a Rental Housing Development Manual, setting out rental housing transaction structures, financial modelling options, management experience and best practice, design standards, model leases, and so on. Pilot initiatives to demonstrate viability would also be identified and pursued.

Certainly, the rental-housing sector offers opportunities for a wider array of practitioners to participate in Africa's housing challenge. Through this, investors may also become more familiar with the dynamics of residential investment, while local authorities become familiar with addressing the implications of scale. The emergence of REIT-friendly legislation in many countries was offering opportunities to build this broader capacity. All of these issues will be considered at the upcoming AUHF conference. The "Durban Declaration", arising from the conference, will offer opportunities for all role players to play their part and participate in the exciting growth of African cities.


[1] For a very useful summary of the issues surrounding rental housing in Africa, see the White Paper produced for the December 2014 conference: http://www.shelterafrique.org/wp-content/uploads/2014/12/Rental-Housing-Conference_White-Paper_ENGLISH-FINAL.pdf

Kecia Rust is the Executive Director and founder of the Centre for Affordable Housing Finance in Africa (CAHF). She is a housing policy specialist and has provided strategic support to governments in South Africa in the development of national, provincial and local housing policy for the past 20 years. She was the Housing Finance Coordinator at the FinMark Trust from 2003-2014, from where CAHF was established. Under her direction, CAHF was appointed as the Secretariat to the African Union for Housing Finance, an association of about 40 mortgage banks, building societies, housing corporations and other organisations involved in the mobilisation of funds for shelter and housing across Africa. CAHF's work is represented on its website: www.housingfinanceafrica.org 

Private Equity for Africa’s Transformation: What Governments Can Do

07.09.2015Excerpt from Innovative Financing for the Economic Transformation of Africa*

African Governments have a key role to play in promoting private equity as one of the major potential sources of investments for enhancing growth and development in their countries. Areas for government intervention include the following:

Improving the legal and regulatory environment: The private-equity industry needs policies and regulatory frameworks that foster its growth. Policymakers need to have deeper understanding of the industry in order to develop these policies. Most private-equity funds on the continent are registered in countries with good regulations, and flexibility in the free flow of funds. No player wants to set up a holding company in a country with fund transfer restrictions.

Building the talent pool: Private equity is effective only when managers are prudent in using capital to grow businesses in a sustainable manner. In Africa, however, the industry is still new and the continent lacks adequate skilled and experienced fund managers. Governments should create the enabling environment for Africa to attract and retain more talent in the form of skilled and experienced managers, specifically with operational experience, in order to make the industry grow.

Creating awareness among key private-equity players: There is limited knowledge about the industry in a number of countries, as well as very little or no engagement between private equity industry players and regulators, resulting in communication gaps between them. Policymakers need to understand the issues affecting the industry, including political risk. There is, therefore, a need for greater engagement between policymakers and private-equity actors.

Improving availability of funds for the private equity industry: Finding adequate financial resources for the private-equity industry remains one of the major challenges in many African countries. This calls for an urgent need to explore how Governments could facilitate the flow of capital into private equity. Normally pension funds are restricted in what they can invest in for reasons of prudence, including even restrictions in investing in companies that are listed on stock markets. African Governments should find a way to ensure that these pension funds are invested in private equity, albeit wisely and responsibly. They are also encouraged to explore co-financing and co-sharing opportunities with other private-equity investors, in sectors such as infrastructure financing (for example energy, telecommunications and water). The Ghana Venture Capital Trust Fund is a good example of such a public-private partnership initiative, partly financed by the Ministry of Finance and Economic Planning.

Encouraging investment of local African capital into private equity: Building up private equity in Africa entails accelerating development of the ecosystem and sourcing investments from local capital markets and funds. There is a need to improve the knowledge of local African investors through education, better understanding of the asset class, incentives and the regulatory framework. Significant sources of local capital (pension funds, family offices, sovereign funds, high net worth individuals, diaspora) can be tapped both for investing and exiting private equity assets.

Encouraging more impact investments: Adequate consideration should be given to investing in sectors that could positively change the lives of many people, while making decent returns for the investors. In this regard, Governments should provide special incentives for private equity firms to put their money into sectors such as agriculture, where the majority of the poor are actively involved.

Other enabling measures to enhance the role of Governments

Enabling measures need to be specific to each country. Private equity is not exclusively driven by the size of an economy or opportunity. Some countries have policies that are friendlier to private equity-friendly than other countries. Governments need to maintain policies that allow them to foster growth. The macro, political and socioeconomic situations are the driver for an enabling environment.

Governments should therefore make the effort to implement and sustain strong macroeconomic reforms. Governments should strengthen the bond and equity markets by introducing securities-lending, encouraging new listing requirements and supporting companies for listing and post-listing, especially as there are not many companies listed in sectors such as agriculture and oil and gas. Governments are also urged to open sectors such as telecommunications, banking and insurance services for investment, as these provide key opportunities for private equity investors.

African investors cannot move around as easily as foreign investors. This deters local investment. Governments should enact policies that encourage local investors and foreign investors alike. In this regard, implementing protocols on the free movement of people and capital across the continent will be very beneficial.

Furthermore, efforts to accelerate the achievement of the objectives of Africa's regional integration in areas such as trade facilitation and infrastructure networks can greatly boost the ecosystem for private equity and for investments in general.

 

*If you find value in this excerpt, you may enjoy reading the full book, Innovative Financing for the Economic Transformation of Africa, a publication of the Economic Commission for Africa (ECA).

Gravatar: Enrique Gelbard, Mumtaz Hussain, Rodolfo Maino, Yibin Mu, and Etienne B. Yehoue

Status and Development of Islamic Finance in Sub-Saharan Africa

09.03.2015Enrique Gelbard, Mumtaz Hussain, Rodolfo Maino, Yibin Mu, and Etienne B. Yehoue

The Islamic finance industry has been growing rapidly in various regions, and its banking segment has become systemic in some countries, with implications for macroeconomic and financial stability. While not yet significant in Sub-Saharan Africa (SSA), several features make Islamic finance instruments relevant to the region, in particular the ability to foster SMEs and micro-credit activities. In a recent paper, we provide a survey on Islamic Finance in SSA where on-going activities include Islamic banking, sukuk issuances (to finance infrastructure projects), Takaful (insurance), and microfinance. Should they wish to develop the market, policy makers could introduce Islamic financing windows within the conventional system and facilitate sukuk issuance to tap foreign investors. The entrance of full-fledged Islamic banks would require addressing systemic issues and adapting crisis management and resolution frameworks.

The financial sector in SSA has been growing rapidly in the past two decades. New products have been introduced and financial institutions are playing an increasing role in financial intermediation, including cross-border financial intermediation.

However, Islamic finance remains small, although it has potential given the region's demographic structure and potential for further financial deepening. As of end-2012, about 38 Islamic finance institutions-comprising commercial banks, investment banks, and takaful (insurance) operators-were operating in Africa. Out of this, 21 operated in North Africa, Mauritania and Sudan, and 17 in Sub-Saharan Africa.

Botswana, Kenya, Gambia, Guinea, Liberia, Niger, Nigeria, South Africa, Mauritius, Senegal and Tanzania have Islamic banking activities. There is also scope for development in Zambia, Uganda, Malawi, Ghana and Ethiopia, as all but Zambia has relatively large Muslim populations-Zambia is interested in using Islamic finance instruments to fund investment in the mining sector. In Uganda, the central bank has started the process of amending its banking regulations to allow for the establishment of Islamic banks and three Islamic banks have applied for a license.

Islamic finance is still at a nascent stage of development in SSA. The share of Islamic banks is small, and Islamic capital markets are virtually non-existent (there were small Sukuk issuances in Gambia and Nigeria). At the same time, the demand for Islamic finance products is likely to increase in coming years. At present, about half of the region's total population remains to be banked. Furthermore, the SSA Muslim population, currently at nearly 250 million people, is projected to reach 386 million in 2030 and financial activities are expected to rise as a share of GDP. Many countries are expected to introduce Islamic finance activities side-by-side conventional banking. Opportunities for the development of Islamic finance are expected to comprise retail products to small and medium-sized enterprises. The sub-continent's growing middle class, combined with its young population is an opportunity for Islamic finance to expand its services. SSA's large infrastructure needs will also provide an opportunity for Sukuk issuance to channel funds from the Middle-East, Malaysia, and Indonesia. For example, recent issuance of a Shari'ah-compliant bond by Osun state in Nigeria and South Africa could start a trend in favour of sukuk, especially if planned sukuk by Senegal.

Developing Islamic Finance in Sub-Saharan Africa

The development of Islamic Finance could increase the depth and breadth of intermediation, extending the reach of the system (e.g. extension of maturities and facilitation of hedging and risk diversification). At the same time, the much larger non-Muslim population could find Islamic financial instruments attractive in broadening the range of available options, particularly for SMEs and micro-credit. Moreover, financial deepening and inclusion could be further enhanced if new instruments are inspired from Islamic finance, but without necessarily being Shari'ah certified. The development of partial risk guarantees, as in Mauritius, could be seen as an example.

In addition, SSA countries could tap into growing Islamic financial markets to meet infrastructure financing needs. By opening doors to Islamic finance, SSA can seek to attract capital from Muslim countries whose savings rates are high and projected to grow. In particular, sukuk financing, which is expanding in other countries, could be a useful tool to finance infrastructure investments.

Lastly, Islamic financing can help develop small and medium enterprises and microfinance activities, given those African households and firms have less access to credit from conventional banks compared to other developing regions. Islamic banks can tap a segment of depositors that do not participate in interest-based banking. They can also promote SMEs' access to credit through expanding acceptable collaterals by extending funds on a participatory basis in which collateral is either not necessary or includes intangible assets.

Through its different forms-windows, full-fledged banking, investment banking, and Insurance-Islamic finance activities ensure appropriate leverage and help limit speculation and moral hazard. It should be noted, however, that they are also subject to constraints and risks, most notably the difficulties and costs involved in supervising and monitoring and the reputational risk implicit in some products that are not properly certified as compliant with Islamic principles.

For countries that want to develop Islamic finance in their jurisdictions, a strategy could contemplate the following steps: launching a public awareness campaign, providing the needed infrastructure (i.e. amending as needed laws and accounting and prudential frameworks), building capacity at the central bank (especially on supervision), and considering the need to set up an appropriate liquidity management framework and introduce adequate monetary operations instruments.

This blogpost is based on the academic study "Islamic Finance in Sub-Saharan Africa: Status and Prospects", prepared by Enrique Gelbard, Mumtaz Hussain, Rodolfo Maino, Yibin Mu and Etienne B. Yehoue.

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