Thursday, 16 February 2017

Compact with Africa or Deal for Allianz AG?

The renowned development economist Paul Collier has recently suggested[1] funding Africa´s infrastructure by deploying a part of the huge asset base of pension funds and life insurance companies. The idea sounds great but is all but new[2]. And Collier´s suggestion may downplay the barriers to private co-financing of infrastructure precisely in those countries where demographic trends will generate the highest migration pressures: in low-income Africa such as the Sahel Zone countries.
Nonetheless, Collier´s suggestion has been picked up with enthusiasm by Germany´s finance minister Schäuble. Unsurprisingly, as the often fatal privatization of basic public services and the balance-sheet contraction of the public sector are central guidelines of the Lord of the ´Black Zero´.
Prima facie, the idea to engage institutional investors in co-funding Africa´s infrastructure is quite beguiling. Pension funds, life insurers and also sovereign wealth funds can be patient investors, as their balance-sheet liabilities reflect long-term savings for old age or future generations. Patient investors are a good fit for infrastructure projects, which tend to have a long gestation period. Moreover, as infrastructure returns correlate little with returns from other assets, they can contribute to higher risk-adjusted returns of institutional portfolios.
According to the World Bank´s Africa Infrastructure Country Diagnostic (AICD), the infrastructure need of Sub-Saharan Africa exceeds US $93 billion annually over the next 10 years[3]. To date less than half that amount is being provided (mainly from domestic and foreign official sources, with about half from China), thus leaving an annual financing gap of more than US $50 billion to fill.

Table 1: Global Assets Managed by Long-Term Institutional Investors
Assets, $ trillion/Year
Pension funds
Insurance companies
Sovereign wealth funds
Total, long term institutions
Source: PwC Asset Management 2020: A Brave New World, New York 2016

Ignoring valuation changes, the rise projected for the three groups of institutional investors translates into annual asset additions worth $4.78 trillion per year on average. To fill Africa´s annual infrastructure funding gap of $50 billion, one percent of new institutional investment by pension funds, life insurance companies and sovereign wealth funds would need to be invested in Africa´s infrastructure every year[4]. These numbers suit wonderfully the Bella Figura that the German G20 Presidency wants play with respect to Africa.
Skepticism seems warranted, though:  Despite the longstanding policy focus of G8/20 leaders, private long-term investment in Africa´s infrastructure has remained deficient. As Africa´s infrastructure gap became officially recognized, the Infrastructure Consortium for Africa (ICA) was established in July 2005 as a recommendation to the G8 Summit in Gleneagles (UK) by the Commission for Africa. Subsequently, G20 leaders highlighted the importance of private long-term financing to foster long-term growth[5], in particular since 2012. The G20 Summit 2013 in Moscow saw the creation of a permanent working group to identify and remove barriers to private investment in African infrastructure.  G-20-OECD High-Level Principles of Long-Term Investment Financing by Institutional Investors were agreed. All these efforts have achieved little:
·         The index of Africa´s infrastructure (AIDI) stagnates since 2010, after rising for a decade thanks to Chinese cooperation.
·         Private finance still plays a minority role in funding Africa´s infrastructure. Its share recently dropped to 15% (2015) from 23% (2012).
·         In capital imports to low-income Africa (<$1.045/head/year), the share of blended finance (mobilized by development finance institutions) has remained at a one-digit percentage level.
The rational for private investment in Africa by long-term institutional is high, but so are the barriers.
On the supply side, regulatory supply-side barriers and past decent returns for life insurers and pension funds explain why they mostly have stayed in the comfort zone of liquid bond and equity markets. Despite widespread whining about low or negative interest rates (particularly in Germany´s conservative media), OECD surveys on pension funds and life insurers report annual average returns of 3-5% for recent years. Rising bond and equity markets have allowed long-term investors to leave assets in their comfort zone of highly liquid securities markets.  Ultimately, encouraging long-term investment of pension funds and life insurers in infrastructure - including in Africa - will need the G20 to engage in a coordinated dialogue with regulatory authorities (such as EIOPA, the European Insurance and Occupational Pensions Authority) and the Financial Stability Board (FSB)—the international body of finance ministers, central bankers, and other agencies established in 2009 after the global financial crisis.
On the demand side, African countries remain poor, have immature domestic financial markets, and have recently featured deteriorating scores of safety and rule of law. This holds particularly in those low-income countries, such as in the Sahel Zone, where present demographic and future migration pressures remain extremely high. Common infrastructure project risks (completion, performance, revenue, financing, maintenance and operation risks) weigh also particularly in low-income Africa. In low-income Africa, a prominent role of private institutional investors should be envisaged only once the discussed host-country barriers have been largely removed.
Despite policy efforts to mobilize private finance through official development finance interventions, they so far have represented a small fraction of the flows directed to low-income Africa. The central dilemma: Low domestic savings, weak government finances and a low debt tolerance militate against forcing foreign private debt and contingent fiscal liabilities upon low-income African countries where infrastructure deficits are most blatant. Grants, remittances and FDI equity finance should be preferred over debt-creating finance as IMF debt sustainability assessments have deteriorated in a number of Africa´s countries, not least due to public infrastructure commitments[6].
Despite those warnings and limited absorption capacities, development banks around the world have an incentive to do business. The International Finance Corporation (IFC), part of the World Bank Group, is showing particular ingenuity. Thanks to its Managed Co-Lending Portfolio Program (MCPP), the Allianz AG has now invested $500 million in emerging-country infrastructure[7]. The Allianz engagement carries relatively little risk as IFC (joint with SIDA, the Swedish aid agency) assumes the first-loss in the joint infrastructure fund. In turn, Allianz is guaranteed a return of 4-4.5% above LIBOR. Not a bad deal for Allianz AG. But who will pay for the implicit subsidy?

[1] Paul Collier, Afrika kann sich nur selbst retten, Die Zeit, 27.10.2016.
[2] I myself helped popularise the idea in several papers in the early 1990s. Find them in Helmut Reisen (2000), Pensions, Savings and Capital Flows: From Ageing to Emerging Markets, Edward Elgar Publishing Ltd in association with the OECD, Cheltenham (UK).
[3] Vivien  Foster and Cecilia Briceno-Garmendia (Eds.) 2009, Africa’s Infrastructure: A Time for Transformation, World Bank, Washington DC: 2009.
[4] R. Kappel, B. Pfeiffer & H. Reisen (2017), „ Compact with Africa: Fostering Private long-Term Capital“, forthcoming, DIE-GDI Discussion Paper.
[6] IMF (2016), Regional Economic Outlook: Sub-Saharan Africa, IMF: Washington DC, April.