The Currency of Infrastructure
Very late in 2018 (nearly exactly one year ago), two of my colleagues at AFC successfully led their respective heavy industry and syndications teams to secure more than half a billion Euros in long-term project financing from international and regional financiers, for the major petroleum refinery in Cote d’Ivoire. The funds were secured in both CFA Francs and Euros, at highly attractive interest rates for the borrower. The conclusion of this important financing followed a long, tortuous syndication process; and the final transaction was very finely calibrated to meet the specific needs of financial investors and credit insurers, a landmark achievement for the teams.
Painstaking structuring aside, there was one critical factor upon which this highly complex transaction depended for its success: the currency of Cote d’Ivoire. Put simply, the same innovative structure and highly favorable financing terms would likely have been entirely impossible if the country did not have its local currency pegged to the Euro.
For good or ill, African infrastructure is primarily financed in hard, convertible, globally traded currencies. The reasons for this are too complex to cover in a short article, but in summary: the critical factors of production for the typical long-term infrastructure asset are all sourced internationally and are therefore priced in hard currency. These include low cost debt financing, technical expertise, equity capital, construction equipment, intellectual property, key hardware components, software, high-value parts and even steel supplies. For three reasons, this would normally not be anything to be concerned about.
Firstly, Africa is itself an exporter and earner of hard currency internationally, the proceeds of which can be utilized to pay for infrastructure. Secondly, well-managed African currencies would normally stay sufficiently stable over time to comfortably repay hard currency borrowings. And thirdly, improvements in regional and domestic financial markets capabilities will ultimately create hedging solutions and local currency options to mitigate hard currency financing risks.
In reality, most African countries face an infrastructure financing challenge that stems from the failure (to varying degrees) of each of the three preceding assumptions. As of December 2019, there are fourteen west and central African countries that have procured a unique solution to this challenge, and Cote d’Ivoire is one of them. But this admittedly imperfect and historically controversial solution is now under great political pressure across the so-called Francophone African countries.
Specifically, a popular movement appears to be afoot (and gaining momentum) towards the removal of the link between both of the CFA Francs and the Euro, a connection that has been in place (originally to the French Franc) for the entire modern history of these countries. Much of the rationale for the agitation is political rather than economic (the relationship is considered colonial, patriarchal and exploitative). In fact, the economic arguments for and against the arrangement are far less prosaic, and worthy of deeper consideration. These arguments have been repeatedly extensively elsewhere and need not detain us now, but essentially the debate boils down to a face-off between the certainty of monetary stability and the potential of fundamental macroeconomic restructuring.
In simpler terms, any of the fourteen countries electing to withdraw from the controversial connection would almost certainly face significant uncertainty in relation to future inflation, interest rates, capital inflows, and consequently foreign currency exchange rates. At the same time, such an exiting country might also then possess greater flexibility in relation to fundamentally altering its economic structure to focus on non-commodity export-led growth (but this is a challenging path by itself, dependent on several other politically difficult structural adjustments). Overall, a case-by-case analysis would need to be undertaken, to determine which countries might be better off outside the CFA zone, as there is no generic answer applicable to all, given their different trade and economic profiles.
For now, one simple fact is eminently evident: infrastructure is easier and cheaper to develop, operate, finance and maintain in countries that maintain a hard currency peg. The single most important reason for this of course is inflation, an unfortunately under-rated African macroeconomic demon. Inflation translates directly to financing and operational costs, and infrastructure projects are extremely sensitive to such variation in prices. To use one basic illustration, consumers of electricity, users of a tolled road or buyers of refined petroleum would absolutely not tolerate an 11.3% annual increase in their usage tariffs; versus, say 1.0%. The former rate (11.3%) is the 2019 IMF forecast consumer price inflation in Nigeria, and the latter (1.0%) is the exact same statistic for Cote d’Ivoire. Financiers of infrastructure are no different from consumers; and their hard currency return expectations are also set with a careful eye on the present value of future cash flows. Again, high inflation rates are destructive to future values, making projects harder to do in countries suffering from this affliction. In summary, much of the fundamental basis for any modern human development at all is monetary stability; and thus sacrificing some degree of political control over monetary policy might not be a terrible trade-off relative to this all important benefit.
Perhaps the more important point is that currency pegs, however well-intentioned are “spit-and-glue” solutions which detract from addressing the underlying issue: domestic institutional capacity to manage and maintain monetary discipline through appropriately independent and counter-cyclical policy making. Without a doubt, the first prize for every African country should and must be the development of strong domestic institutions that can withstand political pressure in relation to currency management (the most unassailable raison d’etre for the CFA zones).
Ultimately, local currency financing solutions are the holy grail of African infrastructure; which is why several other colleagues and I at Africa Finance Corporation are very focused on this area of work. One of the many ongoing outcomes of that work (in Nigeria) is the amazing progress of InfraCredit (a company AFC has invested in), which has begun to successfully catalyze long-term domestic pension fund liabilities into infrastructure investments. Long may this continue! Several other initiatives are underway (stay tuned!), and we look forward to a future when the most important African infrastructure projects will be financed predominantly in local African currencies.