Private equity falls short on Africa development

March 24, 2017

by: Judith Tyson, Overseas Development Institute

Since 2011 there has been considerable interest from international investors in Africa. The prospect of high returns — matched by high risk — has brought more than $16bn in capital to the region from specialist private equity funds. But optimism that this will finance development needs to be tempered.

This is partly because capital flows have slowed. Indeed, only $2.5bn was invested in 2015 and $3.8bn in 2016 compared with the 2014 peak of $8.1bn. However, such cyclical slowdowns are typical of investment patterns in frontier markets and may reverse.

More problematic is that the majority of financing is going to sectors in Africa that have limited or no positive effects on economic growth.

For example, the extractive sector received $4.8bn, or 21 per cent, and the consumer sector $3.2bn, or 14 per cent, of all funds but do not stimulate structural economic change. Similarly, the telecommunications sector received $5.7bn, or 25 per cent, of all funds despite already being well-funded, making incremental gains for growth small. By contrast manufacturing, a sector that is key to job creation and structural change in the economy, received a mere $0.6bn, or 3 per cent, of investments.

Some development finance institutions are trying to redress this. The UK’s CDC Group, for example, prioritises sectors that are underfunded and important to growth and is also investing exclusively in low-income countries. This is helpful but greater partnerships with private investors are needed to rebalance finance towards the right sectors for development.

There is a problem of the business model. Private equity funds typically finance mid-tier companies in need of capital to grow. But in low-income countries such supposedly bankable projects do not exist. Neither does an ecosystem of infrastructure and institutions needed to allow investments to succeed.

Policy efforts are focused on creating bankable projects. But this seems like a serious categorisation error. There are no bankable projects. And there won’t be until the infrastructure — especially power and transport — needed to support them is in place. And this will need a much more co-ordinated effort across governments, donors and private investors than is present today.

Judith Tyson is a research fellow at the Overseas Development Institute, a UK think-tank on international development and humanitarian issues.