The Important Role of Private Capital in Africa’s Economic Development

Private capital is emerging as a crucial force in unlocking Africa’s economic growth potential.

Newstimehub

Newstimehub

11 Jun, 2024

Private capital is emerging as a crucial force in unlocking Africa’s economic growth potential.

Partnerships between governments, private investors and multilateral institutions are instrumental in mobilizing capital for large-scale projects.

Government must create an enabling environment for the private sector to thrive and establish policy frameworks to support private enterprise.

Private capital is emerging as a crucial force in unlocking Africa’s economic growth potential. Investing in Africa will address urgent development needs and provide lucrative opportunities for investors. Following projected population growth on the continent, demand for infrastructure, food and services will increase, creating a vast market for investors to tap into. Africa is also home to abundant natural resources, offering attractive prospects for the energy, mining and agriculture industries.

As Africa continues on its path of economic stability and development, the critical need for finance is becoming increasingly evident. From transportation networks to energy systems, the continent is full of opportunities for improvement and expansion. However, financing these projects remains a significant challenge.

Unlocking private capital for African development projects, however, requires a favorable investment climate. Governments play a fundamental role in creating an attractive environment for investors, including by implementing transparent regulatory frameworks, ensuring political stability and mitigating investment risks.

In addition, partnerships between governments, private investors and multilateral institutions are instrumental in mobilizing capital for large-scale projects. Collaborative initiatives facilitate knowledge sharing, risk mitigation and project structuring, maximizing the impact of private capital on Africa’s development agenda.

Scaling up to mobilize private capital

According to a World Bank report, the global financial landscape consists of about $500 trillion in financial assets. However, development finance needs, especially in Africa, face an ever-increasing financing gap.

The Bank is uniquely positioned to meet this challenge. It provides policy, knowledge and technical support to clients, builds institutions and markets, addresses market failures and supports macroeconomic fundamentals that facilitate private capital flows. However, as it strengthens the private sector enabling lens, it should help narrow the risk-return gap that inhibits private capital.

One promising approach from clients’ perspective is risk absorption through governments using bank funds to remove risk and crowd out the private sector.

Investments, even in risk-absorbing capital, can generate better returns than simply spending on development activities. Market perceptions of project risk tend to overestimate the actual risk, which for World Bank projects is mitigated by technical knowledge and project preparation. The provision of risk-capital creates multiples of private capital, thus ‘stretching’ World Bank project dollars more efficiently. Being a joint venture brings efficiency gains and returns to crowd them in, even if government returns are pegged at lower levels than in the private sector. This approach is in line with the Bank’s objective of bringing in private capital while maintaining financial sustainability.

Bridging demand and supply for private investment capital

Capital demand for large-capitalization opportunities in Africa is outstripping supply. At the same time, small and medium-sized companies across the continent are underfinanced. This leaves development projects across the continent in need of continuous financing, which is not available.

The government should create an enabling environment for the private sector to thrive and establish policy frameworks to support private initiatives to narrow the gap between the supply and demand for development capital from private entities.

A stable social and macroeconomic environment must be created to attract investors to inject capital into infrastructure, agribusiness, technology development and education.

The value created by private capital investments

Private equity (PE) firms thrive on their ability to acquire and build great businesses, even in challenging times. They are skilled at creating value quickly and adapting their plans as conditions change. Their differentiated approach has always given them an advantage, and their intrusive nature is key to generating returns in a competitive market.

In terms of their impact, PE investments are undeniably the best. The businesses they invest in thrive compared to other companies, mainly due to the hands-on engagement leadership style exhibited by most PE investors.

In addition to generating returns for its investors, private equity also impacts the broader socio-economic environment of a country. PE investments inject international capital into African economies, boosting their stability and growth.

Risks and challenges for private equity firms and investors

Despite the value that the PE sector brings to the African continent, some key challenges threaten investor confidence in the region. Currency risks, particularly foreign currency shortages and exchange rate fluctuations, are emerging as a key challenge facing private equity investors in Africa.

In addition, while there is capital available for investments, there needs to be better quality ventures, as the policies and structures of most African companies are geared towards ownership stakes in their businesses. For this reason, African companies prefer to borrow rather than sell majority stakes in their companies.

Moreover, PE investors in Africa often face the same challenges, as most intermediaries source investment deals only from their limited geographical and professional networks.

Political risks and macroeconomic instability are other factors affecting PE investments in the African region. For example, the halt of PE investment in the Rift Valley Railways concession by the governments of Kenya and Uganda in 2017 failed due to the company’s alleged failure to meet the conditions under the concession agreement as a result of political risk related to a national project.

Promises and opportunities through private equity investments

Over the last few years, there has been a notable increase in private equity investments and venture capital, particularly in areas such as real estate, technology, infrastructure, hospitality and tourism, healthcare, renewable energy and consumer goods. In addition, impact investing is on the rise, with many players becoming more socially minded and willing to give back.

Despite the challenges, there are many promising investment opportunities. A report published by the Economic Intelligence Unit in December 2023 predicted that Africa will develop at the second fastest rate among major global regions in 2024, thanks to its service sector.

Private capital is a key enabler and catalyst for unlocking Africa’s economic growth potential. By harnessing the power and resources of the private sector, African countries can accelerate the pace of development, promote sustainable economic growth and improve the quality of life for millions of people across the continent.

Expanding financial and capital market development, enabling policy reforms, supporting strong pipeline development and knowledge sharing, staff training and sensitization to attract private capital will be critical to sustaining these efforts.

Financing risk, capital risk sharing, first loss and credit enhancing lending projects will deliver results and promise to leverage more private capital for development and better optimize public financing.