Africa: why ODA must (also) support private companies

the health crisis had little impact on Africa, the continent on the other hand suffered greatly from the economic consequences of the global slowdown. Africa experienced its first recession in 25 years in 2020. Unlike Western economies, few African countries have been able to put in place large-scale economic and social aid to mitigate the effects of the crisis. Several countries could even follow Zambia and quickly find themselves in default.

The summit on the financing of African economies, which was held in Paris on May 18, set itself the objective of bringing financial breathing to African economies. The ambition displayed? Collect $ 100 billion to partially meet Africa’s financing needs estimated at $ 1.2 trillion by the International Monetary Fund (IMF).

The results of the summit remain mixed. While it has enabled progress in particular on access to vaccines and the future allocation of special drawing rights, the amounts involved are a “drop in the bucket” compared to the needs, in the words of Senegalese President Macky Sall. French President Emmanuel Macron, at the origin of the summit, himself admitted that the account was not there.

An important point has gone unnoticed. The final communiqué underlined the importance of supporting the private sector, and in particular micro, small and medium enterprises (MSMEs) to ensure long term growth of the continent. Although these are above all declarations of intent, the focus on the private sector is bringing about a notorious paradigmatic change around official development assistance.

Faced with the employment challenge

Official development assistance (ODA) is usually more associated with donations to support social sectors (education, health) or to deal with humanitarian emergencies than with support to the private sector. A limited share of ODA nonetheless goes to companies.

This choice to direct scarce public resources to private actors is explained by the essential role that companies play in economic development. (Formal) businesses allow households to escape poverty by providing decent jobs when the African Development Bank estimates that three quarters of those entering the labor market in Africa cannot find jobs.

This job deficit is likely to worsen in the years to come due to demographic changes on the continent. Recourse to informal jobs, dominant on the continent, remains unsatisfactory. The vast majority of informal enterprises struggle to grow beyond the family circle and provide low-paying jobs with little protection for employees.

Beyond these effects on employment, companies remain an essential source of innovation. They also make it possible to improve the financing of the State by widening the tax base. A dynamic private sector facilitates integration into global value chains and improves export performance (and therefore the entry of foreign currency allowing access to imported goods).

The effects may also be more diffuse. The existence of job prospects can, for example, encourage future employees to train, in turn improving the level of education of the population. It is also a source of pacification of social relations in fragile and post-conflict zones.

Direct or indirect funding?

Official development assistance to the private sector is channeled mainly through Development Financial Institutions (DFIs), which are development organizations specializing in financing businesses in low and middle income countries. The DFIs bring together both the departments or specialized institutions of multilateral development banks, like the IFC for the World Bank, and many national organizations such as the European DFIs (brought together in the EDFI network), the US International Development Finance Corporation or FinDev Canada.

DFIs differ from private investors in two ways. On the one hand, projects supported by DFIs require not only financial sustainability but also positive effects on other economic actors, on society and on the environment. In other words, these institutions must combine three imperatives: financial profitability, risk management and impact (economic, social and / or environmental).

On the other hand, these investments benefit from public support in order to promote this third dimension. This contribution of resources allows DFIs to provide financing at preferential conditions (reduced rate, extended maturity, grace period) and to offer technical assistance services to clients almost free of charge.

DFIs use both direct and indirect finance to support private enterprises. Direct financing is assimilated to loans or equity investments intended for (non-financial) companies.

Indirect financing most often takes the form of lines of credit or guarantees provided to financial intermediaries operating in low-income countries. These are most often commercial banks and microfinance institutions, but also more and more investment funds dedicated to companies in emerging countries.

The funding is indirect because the funds allocated to these financial intermediaries follow a specific purpose and must be used to support investments related to this objective. For example, in the event that a DFI provides a line of credit to a bank to support women’s entrepreneurship, the local bank will need to demonstrate that it is using the funds raised for this purpose.

Direct financing has the advantage of allowing donors to fully control the use of funds. The downside is that due to their lesser knowledge of the field, they are sometimes unable to target MSMEs. Indirect financing, admittedly imperfectly, makes it possible to fill this gap by splitting up significant financing provided to a financial intermediary into numerous small investments intended for local businesses.

Rebalancing priorities

Current studies show that DFIs are struggling to find a balance between the above three imperatives. Priority remains given to the profitability – risk management combination, to the detriment of the impact (economic, social and environmental) of the investments. This difficulty in targeting companies with a high impact can be explained by various sources.

One of the main obstacles is the difficulty of assessing the impacts of investments. While profitability and risk can be easily monetized, it turns out to be more complex for impacts. These cover qualitative aspects (quality of jobs created, gender equality, preservation of the environment, support for social cohesion, etc.), materialize in the (very) long term and are sometimes diffuse (effect on the community). local, on the value chain, etc.). Progress in measuring the impact of investments therefore seems essential to improve the allocation of resources to high impact investments.

In addition, donors do not always succeed in funding the companies with the greatest impact. Not all businesses have the same ripple effect on the economy and society. Some companies are real powerhouses. These are often pioneer companies, which create new markets (either by innovating or by setting up in neglected areas); it can also be a question of high-growth companies which are at the origin of the majority of job creation and innovation.

Funding these high impact businesses involves high risk taking. It is very complex to identify ex ante whether the projects carried out by these firms will be viable. Pioneer companies are exploring new markets, the development of which remains unknown. Identifying future high growth companies is a complicated exercise even when resorting to the most advanced methods of dealing with “big data”.

A hole in the racket

Finally, these companies are most often MSMEs. However, financial activity has a fairly high irrecoverable fixed cost, including the cost of evaluating loan files and that of monitoring investments. It therefore seems more profitable to direct funds towards large projects and companies which can absorb these fixed costs.

DFIs that benefit from public funds could use these resources to offset risk and extricate themselves from short-term financial constraint. However, as we show in a recent study, DFIs pursue a conservative lending policy and struggle to finance, directly or indirectly, MSMEs.

They ask their clients for a large number of guarantees that most African companies are unable to provide due to lack of reliable financial data. Moreover, when their investments amount to millions of euros, the actual financing needs of MSMEs tend to be in the order of tens or hundreds of thousands of euros. There is a lack of financial intermediaries on which to rely to finance a “missing middle”, an existing gap between micro-finance (loans of up to a few thousand euros) and bank loans (starting from several hundred euros). thousands of euros).

The final summit communiqué shows that the identified obstacles are recognized. It remains to pass from good intentions to actions since the announcements do not imply any quantified objective. In particular, it seems useful to increase the volumes of aid in order to reduce the risks and offset the costs incurred by the action in favor of MSMEs in Africa.