Africa’s new free trade area – streamlining trade and infrastructure development in Africa

Increasing intra-African trade is essential for the growth and development of  the continent and so the recent signing of the African Continental Free Trade Area (AfCFTA), set to be the first continent-wide African trade agreement, is good news in terms of its potential to facilitate and harmonise trade and infrastructure development in Africa.

In March this year, most member states of the African Union signed the text of the AfCFTA agreement. Once it is ratified by 22 member states, it will come into force, possibly within a year. AfCFTA includes protocols, rules and procedures on trade, simplified customs procedures as well as dispute resolution mechanisms – all aimed at creating a single legal framework for the continent. South Africa is supportive of the agreement, with President Cyril Ramaphosa recently saying that it would present major trade and investment opportunities for the country.

In 2015, when announcing the creation of AfCFTA, the United Nations Conference on Trade and Development, (UNCTAD) noted that intra-regional trade in Africa needed to be contextualised in a broader developmental framework that would provide benefits in terms of realising Agenda 2063 of the African Union and the 2030 Agenda for Sustainable Development of the United Nations. The African Union’s Agenda 2063 is a strategic framework for the socio-economic transformation of the continent over the next 50 years. It sets as a target the doubling of intra-African trade by 2022 and emphasizes the need to connect Africa to the rest of the world through world-class infrastructure.

According to the African Development Bank, poor infrastructure has cost the continent a cumulative 25% in forgone growth in the last two decades alone, equivalent to the growth rate achieved in the past ten years. This productivity gap between Africa and the rest of the world continues to grow, with the World Bank estimating that the continent requires more than USD 90 million per year to begin bridging the infrastructure gap.

Despite emerging markets long being known as key drivers of economic growth in the global economy, maintenance of this status requires extensive development and infrastructure finance. Investments in infrastructure however are often big ticket, long term commitments with fixed locations and structures, which require substantial financial buy-in.

According to research by the IMF – Corporate Investment in Emerging Markets: Financing vs Real Options, the risks and potential for stranded costs in infrastructure investments in emerging markets are further exacerbated by the effect of volatility on emerging markets (being the first to suffer in times of uncertainty, given their higher public debt, lower foreign reserves and shallow financial markets), lack of political will/support and inadequate legal and regulatory frameworks.

In the midst of this prolonged volatility, coupled with low credit ratings and a lack of exposure to private investors, emerging markets, and Africa in particular, require innovative financing solutions to bridge the gap between public and private investment. This is where the Development Finance Institutions (DFIs)  play a pivotal role.

Africa is not crippled by a lack of infrastructure investment capital, but by a lack of bankable projects. Apart from general investment barriers, infrastructure projects are coupled with completion risks (regulatory or policy uncertainty), performance risks (both during and post construction) and revenue risks (ensuring that the project not only repays its debts, but also provides an adequate return for investors), which effects the project’s overall “bankability”.

In this regard, DFIs are vital in ensuring such projects are bankable, by bringing capital, technical expertise and capacity where private sector players were unable, ill equipped or unwilling to do so on their own.

The key role that DFIs have to play in making a project bankable include being able to provide a broad range of financing products, the ability to act as a loss absorber on both greenfield as well as brownfield projects, having  developmental mandate which goes beyond pure funding, active engagement in creating enabling environments to address regulatory and institutional challenges, and risk mitigation.

The 2016 McKinsey Bridging Global Infrastructure Gaps Report found that during the period 2012 to 2015, DFIs, multilateral and bilateral banks and their development partners provided 47% of the financing for African infrastructure.

As one of Africa’s largest trading partners, China also plays an important role in infrastructure investment in Africa. As such, it has prioritised its Belt and Road Initiative as part of its development strategy. Baker McKenzie’s recent report Rising Tension: Assessing China’s FDI drop in Europe and North America<> shows that in 2017, China’s global outbound investment dropped for the first time in more than a decade as policy changes in China and host economies cooled M&A activity and created a shift in the industries and geographies targeted by Chinese investors. According to the report, the Chinese government has begun placing greater restrictions on outbound investment in late 2016, with missions focusing on advancing China’s development strategies such as the Belt and Road Initiative (BRI).

A further report by Baker McKenzie and Silk Road Associates; Belt & Road: Opportunities & Risks. The prospects and perils of building China’s New Silk Road<> details how key opportunities in Africa with regards to BRI will be transactions related to major projects in the power and infrastructure sector and related financing. China’s construction of power plants and transmission lines in East Africa is expected to be a game changer for local industry.

While infrastructure development has been the primary driver of BRI activity to date, this new report also identifies sectors including technology and telecommunications, manufacturing and eventually consumer goods and retail as all starting to play a larger role in BRI over the next five years and beyond.

Improved infrastructure on the continent in all sectors, but particularly in transport, energy and telecommunications, is a necessity for greater African integration. AfCFTA is expected to play a vital role in ensuring the harmonising of laws and trade rules across the continent that will streamline this infrastructure development.

AUTHOR: Kieran Whyte, Head of Energy, Mining and Infrastructure, and Jen Stolp, Partner in the Banking & Finance Practice at Baker McKenzie in Johannesburg

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