For three days last week, June 1 to 3, 2021, the African Development Bank (AFDB) and the Association of African Development Finance Institutions (AADFI) held a webinar aimed at enlightening stakeholders on the challenges and opportunities facing development finance across Africa. Some of the issues discussed include foreign direct investment, blended finance, as well as an increase in grants and the need for more development finance institutions (DFIs) to start considering more blended finance solutions in place of existing solutions.
Development financing in general terms is the funding of development projects in developing countries usually by foreign investors and even governments of nations through DFIs. They are oftentimes aligned with specific goals and objectives of the host country. In this case, discussions at the webinar focused on developments that mitigate the impact of climate change on countries. As a result, a lot of the projects are geared towards renewable energy and sustainable projects. Primarily Solar energy for irrigation and solar-powered cold storage plants across Africa.
General trends in development financing
One of the trends in recent years has been the shrinking of funds available to developing countries. Funding available to Africa has shrunk to $45 billion in 2020, down 10 per cent from 2019 according to the World Investment Report 2020. This is projected to drop even further owing to the impact of the COVID-19 pandemic on businesses globally.
Most capital available is driven towards green financing and ESG activities. Key among these is sustainability and economic resilience. Most commercial activities and development generally involve some degree of environmental degradation, which sustainability aims to resolve.
Environmental resilience on the other hand stems from the deployment of technologies and business models that promote a reduced impact on the environment and climate of a region allowing the said region to achieve or sustain similar levels of output while limiting negative impact on the climate. This is primarily achieved through the use of technologies such as renewable energy, recycling and other green initiatives.
With most of the financing on the continent in need of replacement or nearing the end of their viability, one of the major concerns is how to attract additional funding. These are challenges the AFDB and AADFI are uniquely poised to proffer solutions to.
Much as the world has shown a shift towards sustainability. The funding of these projects has been a source of concern to stakeholders. Policymakers have shown concern regarding the need to replace the funding available to partner organizations. These projects seek to enable food security, providing agricultural inputs such as renewable energy – primarily solar grids, irrigation projects and cold storage facilities.
One of the challenges limiting foreign direct investment is the perceived lack of equity contribution by local players who seem insistent on pitching these projects primarily on the grounds of being able to access development funds. To combat this, most DFIs have aligned their strategies towards backing projects that align with SDGs and are seen as bankable while representing an equity contribution from the proposing organisations and tying into the development agenda of the sponsoring agency.
Restructuring the finance component
Interestingly, one major challenge in the funding arena has to do with how the funds are structured or composed. Usually, development financing is a combination of grants, loans, guarantees and foreign direct investment. The challenge stems from a reduction in philanthropic contributions. The WIR 2020 (World Investment Report) also reinforces that philanthropic donations or contributions alone cannot sustain development across target communities.
Addressing this, Stanislaus Deh of ACFA, mentioned the following factors as being responsible for the failure to attract funding:
- Presenting projects outside the operational scope of the DFIs.
- Recommending technology that is unproven or lacking the technical know-how and expertise to manage technologies intended to be deployed for projects.
- Not following approval guidelines.
- Not securing buy-in from the destination government and domestic partner organisations.
- Not securing equity contributions from local investors and philanthropic organizations.
Admittedly, these challenges reinforce the position of most DFIs, particularly considering the drop in FDI in recent years. According to the WIR 2020, this trend should reverse after 2021 and rise in 2022.
The case for blended finance
Blended finance is the use of catalytic capital from public or philanthropic sources to increase private sector investment in sustainable development. This sort of funding structure allows investors to de-risk and effectively lower the cost of projects while ensuring returns on investment for all parties involved. The structure of such deals also allows for concessions to be given, enabling access to funding at lower than market rates, ensuring that all parties can commit to funding the specified objectives and meet either their interest or impact goals. This also ties in with SDG 13 centred on mitigating the impact of climate change.
The ability of such a structure to de-risk the investment being made inherently makes it more attractive to foreign investors who partner with local players, philanthropic organizations, and development banks such as the AFDB to ensure that these projects are adequately capitalized and indexed. As such, there have been efforts to measure and track these developments over time.
Africa currently receives less than Asia in terms of funding but it remains one region where a lot of development focus has been placed. Most of these efforts are geared towards renewable energy, climate change and environmental resilience.
Written by Ogodilieze Osaji-Ugo