Originally published on The Africa Report
To meet the Sustainable Development Goals (SDGs) by 2030, approximately USD 7 trillion in private sector capital needs to be unlocked in developing countries. As policy makers grapple with the reality that trillions still need to be raised to bridge the gap, innovative finance is proving to be instrumental in offering asset owners and investors options to meet strong policy action with improved funding, especially for underserved sectors like micro, small and medium enterprises (MSMEs).
Globally, MSMEs play a crucial role in the economic development and social mobility of millions of people, through the provision of public goods and services, and creation of jobs. In Africa, MSMEs are estimated to contribute to 70% of the region’s total employment. This number should balloon, given the rising population expected to enter the workforce in the next 10 years, but won’t if MSMEs cannot grow. Without adequate support to the MSME sector, unemployment, poverty, and other development challenges will worsen, ultimately delaying sustainable development and economic prosperity on the continent.
According to a study by the International Finance Corporation (IFC), MSMEs face an astounding finance gap of over USD 331 billion in Africa. To meet the staggering gap in funding to support MSMEs in the region, there needs to be a greater adoption of innovative forms of financial structuring like blended finance to incentivize commercial investors to invest in MSMEs working towards a sustainable and prosperous Africa.
Blended finance is the use of catalytic capital from public or philanthropic sources to de-risk transactions and improve their risk-return profile allowing for increase private sector investment. According to Convergence, the global network for blended finance, transactions targeting development projects in Africa have helped mobilize up to USD 50 billion to date. Illustrative blended transactions tracked in Convergence’s Historical Deals Database include the Universal Green Energy Program by Deutsche Group, which has raised USD 302 million to increase access to clean energy in Sub-Saharan Africa, especially for rural populations, the Global Alliance for Vaccines and Immunizations (GAVI), which since 1999 has raised more than US$9.3 billion from both private and public investors, and the International Finance Facility for Immunization (IFFm), that has raised more than USD 5 billion from investors for immunization programming. It should be noted that 55% of the beneficiaries of such transactions are MSMEs.
As with other emerging regions, there is no doubt that real investment risks exist in Africa; such as political instability, informality of the market, and currency volatility. Yet, savvy investors looking for alpha are navigating these risks by instituting appropriate hedges within a blended capital structure. According to Convergence’s Historical Deals Database, specific to Africa based transactions, concessional capital from public and philanthropic sources is present in most blended finance transactions, followed by technical assistance, credit enhancement, and pre-investment stage grants.
The importance of blended finance approaches to facilitate investment into MSMEs is apparent in these deals. For instance, deploying capital to smallholder farmers presents many risks, which can be attributed to low productivity due to a reliance on rain-fed agriculture with limited alternatives for irrigation, the unavailability or unaffordability of inputs, such as improved seeds and fertilizer, as well as poor farming practices. Against these challenges, the African Agriculture and Trade Investment Fund raised USD 170 million through a blended structure with concessional capital (in form of first loss capital) and a parallel technical assistance facility that helped to attract USD 106 million from private investors.
Similar structures are also present in the financial services sector. The African Local Currency Bond Fund is a USD 180 million fund that acts as an anchor investor and provides technical assistance to first time or innovative local currency bond issuances. The fund’s capital structure included credit enhancement in the form of a first loss tranche (representing 26% of the total fund size), and the fund further benefitted from a parallel technical assistance facility of USD 6 million. This blended fund plays an important role in local capital market development, while facilitating capital raises for local financial institutions and companies in the local bond market. It also points to the efficacy of blended finance in de-risking investments and mobilizing private capital that would otherwise not actively finance these types of transactions.
For African countries to improve access to finance for MSMEs, it is paramount to create investable opportunities using approaches such as those provided by blended finance. The results of such structures can reduce the funding gap to support African MSMEs, and, in turn, help realize a sustainable and prosperous future.