Balancing risk between local and hard currency infrastructure financing

In conversation with Martijn Proos and Roland Janssens, both Directors at the Emerging Africa Infrastructure Fund’s (EAIF) manager, Ninety One, we discussed the opportunities and challenges of supporting credit solutions to finance infrastructure projects in local currency across Africa.

Typically, EAIF provides hard currency (USD and EUR) credit solutions, predominantly senior debt loans. It lends between USD 10 million and USD 65 million to infrastructure projects across Africa and parts of the Levant. In 2019, EAIF enhanced its product range to accommodate local currency lending. Managing risk is a core function and the aim is to build a multi-currency loan book over time in a selective number of local currencies and across various countries. With three local currency transactions under its belt, one in KES (Kenyan Shillings) and two in XOF (West African Frank), EAIF has successfully added a new dimension to its capabilities as a mobiliser of private capital for infrastructure developments in Africa.

EAIF’s first local currency venture was the Acorn Holdings student housing project in Kenya in partnership with GuarantCo. GuarantCo and EAIF believe that local currency financing for infrastructure projects is gaining momentum. Development finance institutions should increasingly work with local commercial banks and institutional investors to tap vast pools of potentially available capital for infrastructure development either via hybrid hard and local currency solutions or even full local currency solutions.

The Kenyan bond issuance was soon followed with EAIF anchoring a XOF 100 billion 7-year bond issue to raise new capital for Sonatel, Senegal’s’ largest teleconnections business, to upgrade its digital infrastructure. The bond raised the equivalent of USD 170 million.

A second successful XOF bond issue in 2020 was EAIF’s anchor role in a 7 year bond issued by Port Autonome de Dakar, the owner of the Port of Dakar. It raised over XOF 60 billion (USD 107million). The issue marks the start of the process of relocating the capital city’s port and its operations to a new greenfield site.

EAIF is of the view that that local currency lending helps reduce currency mismatch risk for projects and companies acting in local markets as well as for sovereign balance sheets.

For most project developers and investors, including many local investors and corporate banks, convertible foreign currency funding is still the easiest way to invest. For many investors, local currency investing comes with more risks and often higher interest cost, in the short term, which need to be carefully managed. In recent years, development finance institutions, such as GuarantCo which has been providing local currency finance for the past fifteen years, have worked hard to promote the benefits of local currency investing.

There are many risks and challenges that need to be managed and addressed when managing local currency bond issuances, including core issues such as competitive pricing, tenor length, hedging costs and information disclosure. These are the most essential components in building confidence in project promoters and financial markets.

Assessing the social and environmental impact of an infrastructure project is fundamental to the way the Private Infrastructure Development Group (PIDG) and its companies, including EAIF and GuarantCo, do business and the same work goes onto bond financing proposals as with traditional lending.

There is also an important wider economic development benefit. Local currency solutions offered via local capital markets develops corporate finance knowledge and skills at the high end of the services sector. This adds to a nation’s self-reliance, aids business creation and expansion and widens choice for local, and potentially in the long term also international, investors.

Creating momentum among local institutional investors and local banks is critical. Success breeds success. When a new approach to project financing is seen to work others want the same thing to work for them. We have seen this with the successful example of InfraCredit in Nigeria that GuarantCo and the Nigerian Sovereign Investment Authority set up in 2017.

Despite the fact that interest rates are higher for local currency initially, local stakeholders should take a long-term view on foreign exchange risk vis a vis company and sovereign balance sheets and the impact of FX devaluation on end user tariffs.

This includes encouraging longer tenors to match the long horizons of infrastructure projects, deepening engagement with international standards and developing a new asset class in order to support the development of local capital markets. In addition, there is an opportunity to widen the local currency guarantee and loan market by engaging other DFIs and organisations, such as the World Bank, TCX, ATI and increasingly the private sector for hedging products in relation to a selective number of African currencies.

Being part of the PIDG group also allows EAIF and GuarantCo to benefit from the additional resources that PIDG provides including PIDG Technical Assistance grants to fund capacity building programmes. These help local institutional investors and banks build expertise on de-risking local currency transactions. Knowledge nurtures confidence and helps encourage local financial organisations to participate in local currency transactions. It is a virtuous circle. Developing local capital markets strengthens economic resilience, makes new infrastructure more possible, stimulates wider economic performance and in turn can improve the quality of life and life opportunities for many people.

The Emerging Africa Infrastructure Fund provides a variety of debt products to infrastructure projects promoted mainly by private sector businesses in Africa and parts of the Levant. The Fund helps create the infrastructure framework that is essential to sustained economic stability, business confidence, job creation and poverty reduction. It has to date supported nearly 80 completed infrastructure projects across nine sectors in over 20 African countries. As of the end of 2018 the Fund had invested USD 20.082 billion. EAIF is part of the Private Infrastructure Development Group (PIDG). EAIF was established and substantially funded by the governments of the United Kingdom, The Netherlands, Switzerland, and Sweden. It raises its debt capital from public and private sources, including Allianz, the global insurance and financial services company; Standard Chartered Bank; the African Development Bank; the German development finance institution, KFW and FMO, the Dutch development bank. EAIF is managed by Ninety One www.eaif.com