Memorandum submitted by CDC
INTRODUCTION
This document sets out CDC's observations
on:
- The role that the private sector
can play in alleviating poverty.
- The constraints that the private
sector can face in developing countries.
- Private sector development financing
in:
- risk finance
- SMEs
- microfinance.
- A number of specific examples are
also provided from within CDC's investment portfolio.
BRIEF CDC HISTORY
1. CDC was established in 1948 as
the Colonial Development Corporation to develop the resources
of Britain's colonies. It was renamed the Commonwealth Development
Corporation in 1963, and was given authority to invest outside
the Commonwealth in 1969. In 1997 CDC became a PPP and two years
later transformed from a statutory corporation to a plc.
2. Following re-structuring in 2004,
two separate management companies were spun out of CDC, Actis
and Aureos, leaving CDC as an emerging markets fund-of-funds investment
company.
3. CDC now places its capital, currently
standing at approximately £1.5 billion, with a growing number
of emerging markets fund managers. CDC aims to put 50% of its
capital to work in sub-Saharan Africa and South Asia. In addition,
70% of CDC capital is invested in countries where the per capita
annual income is less than US$1,750. The remaining 30% is invested
in countries where that figure is less than US$9,075.
4. Under the new structure, CDC
is no longer entirely returns-driven. It is therefore able to
direct capital where a specific need or market failure has been
identified. Microfinance, SMEs and agribusiness are examples of
this. This approach allows CDC to have an effect beyond its balance
sheet, adding value over and above the provision of capital alone.
WHAT THE PRIVATE SECTOR CAN DO TO
ALLEVIATE POVERTY
5. In recent years, acceptance and
understanding of the importance of the private sector in the developing
world has grown. The expansion of the private sector in developing
countries is critical to the long term alleviation of poverty.
Without private sector growth generating economic activity and
providing expanding employment opportunities, other development
strategies will inevitably fail. Private sector development must
therefore be seen as a crucial strand of any successful poverty
alleviation approach.
6. The literature on the importance
of the private sector is large. For example, the United Nations
Development Programme identified access to financing as one of
the three 'Pillars of Entrepreneurship' essential for private
sector growth in its March 2004 Report "Unleashing Entrepreneurship
- Making Business Work for the Poor". This submission
does not attempt to repeat the well rehearsed general arguments
on the benefit of the private sector, but does outline CDC's experience,
with real examples.
Capital
7. However, despite this growing
recognition of what the private sector can help achieve in emerging
markets, shortage of risk capital is holding back business growth
in most areas of the developing world. CDC seeks to address this
shortage, but much greater availability of risk capital is necessary
if a step change in the effectiveness of development is to be
achieved.
Power
8. Emerging markets, especially
in Africa and Asia, have an enormous need for safe, clean and
reliable energy.
9. If Africa is to stand any chance
of achieving the Millennium Development Goals, it will need at
least 60 new power plants in the next 5 years and, according to
the World Energy Council, US$600 billion of investment over the
next 25 years.
10. In Asia, the need is also on
a massive scale. The World Energy Council estimates over one billion
people live without electricity, representing 60% of the population.
11. The private sector has an important
role to play here and approximately one third of CDC's portfolio
is in energy.
Case study: Songas power project,
Tanzania
12. One example of how private sector
investment is helping national governments and the supply of clean,
safe and reliable power is CDC's US$125m investment in Songas,
a private power generation company in Tanzania. Songas operates
a power facility in the suburbs of Dar es Salaam. The facility
is supplied by gas from the Songo Songo offshore field through
a 225 kilometre pipeline. Tanzania now has the cheapest rate for
thermal power in East Africa and has made savings estimated at
US$50m a year.
THE CONSTRAINTS ON PRIVATE SECTOR
INVOLVEMENT IN DEVELOPING COUNTRIES
13. Part of the challenge is to
overcome investors' perceptions of emerging markets as commercially
unrewarding. The most effective is to show it is possible to make
acceptable and appropriate returns. The 'demonstration effect'
is the most powerful way of illustrating the potential of emerging
markets to new investors.
14. CDC's palm oil business in Indonesia
and Papua New Guinea is an example of how equity investment adds
value to the business. Over the last 15 years, investments were
made in five palm oil estates in Papua New Guinea and Indonesia.
These were developed and expanded with further capital injections
and consolidated under a top quality management team, resulting
in a world class business. CDC's investment was then sold to an
industry player who will take the business on to its next stage.
The returns from the sale are now being re-invested in other companies
in emerging markets.
15. Nonetheless, the countries of
the developing word are immature markets for private equity. More
fund managers are emerging, but identifying firms to manage capital
is still a challenge in most markets.
16. Finding deals and investment
opportunities is often difficult, mainly because there is a shortage
of well trained and experienced business people. More aid is required
for business training and education.
17. The general business environment
overall is often unfavourable because of problems such as bureaucracy
and corruption. More aid needs to be directed towards assisting
governments in streamlining administrative and bureaucratic procedures.
18. The World Bank/IBRD report "Doing
business in 2005" found that businesses in poor countries
face much larger regulatory burdens than those in rich countries.
They face three times the administrative costs, and nearly twice
as many bureaucratic procedures. The report also cited weak property
rights as a problem.
19. Poor infrastructure, too, is
a barrier to business growth. In India, for example, Prime Minister,
Dr Manmohan Singh, has estimated a requirement of US$150 billion
for investment in infrastructure to achieve the quantum leap the
country needs for future development.
20. It is for this reason that private
sector investment in transportation, communications and energy
is especially transformative.
PRIVATE SECTOR DEVELOPMENT FINANCING:
RISK FINANCE
21. There has been an increased
interest in private equity in some parts of the developing world
in recent years. In India, for example, 2005 was a record year
with private equity and venture capital investments reaching US$2.3bn,
which was almost double the figure for 2004. Fund managers have
broadened the focus of their investments beyond the technology
and service sector emphasis of three to four years ago and investments
size has also grown over the period. Robust stock markets and
more mergers and acquisitions have generated strong returns. Several
fund managers have raised over-subscribed funds, but the market
is still relatively small.
22. There were good levels of fundraising
in Africa in 2005, driven by improvement in general economic performance
in a number of countries plus some landmark transactions, such
as Celtel.
Case study: Celtel, pan-Africa
23. CDC backed Celtel as a start-up
in 1998 and subsequently contributed to three further rounds of
funding. The company provides mainly cellular network services
across Sub-Saharan Africa and manages 13 mobile and one fixed
line telecoms operations in 13 countries. CDC has supported Celtel's
expansion by helping to win licence bids, to mobilise funding
and to make acquisitions through leveraging its public and private
sector contacts on behalf of Celtel.
24. Celtel has outperformed all expectations,
growing revenue in excess of 115% per annum, establishing the
company as the largest African mobile operator outside South Africa.
Since its start-up it has moved from a standing start to providing
coverage for 30% of Africa's population and in so doing has transformed
access to telephony for more than five million customers in a
continent characterised by poor communications.
25. In March 2005 Celtel was acquired
by MTC and CDC's returns from the sale of its 9.3% stake in the
company are now able to be re-invested in companies in emerging
markets where risk capital is scarce.
Case study: The Palms Shopping Centre,
Lagos
26. A further example of the effectiveness
of provision of risk finance is The Palms Shopping Centre in Lagos.
This is a joint venture with a Nigerian developer. Through its
fund manager Actis, CDC has provided a significant proportion
of the equity and has underwritten debt in the project to provide
a more attractive platform for bank finance.
27. Completed in December 2005,
The Palms provides over 60 retail outlets and a multiscreen cinema.
Formal retail facilities provide a much needed amenity in urban
Africa. Apart from direct and indirect employment, The Palms has
an important development impact in professionalizing the supply
chain by stimulating demand and raising quality standards.
28. However, examples like this
are the exception and although interest in private equity is growing,
Africa overall remains a relatively immature market.
FINANCE FOR SMEs
29. Access to capital for small
and medium sized enterprises is scarce in emerging markets. Although
China, for example, is the world's largest recipient of foreign
direct investment, the Chinese SME sector is starved of capital.
The established private equity players tend to concentrate on
major investments such as privatisations, leaving a large number
of viable businesses with little access to the capital required
to operate efficiently and to grow.
Case study: Pacific Green, Fiji
30. Pacific Green Industries in
Fiji is an example of the kind of growth smaller companies can
achieve when capital and business skills are made available through
private equity investment.
31. Pacific Green Industries manufactures
furniture and architectural products, using wood from senile coconut
palms and sells its products worldwide. Managed by Aureos, a fund
manager specialising in the SME sector, the US$15m Kula Fund,
to which CDC committed US$5m, made an investment of US$2m in 1999
to assist the company in its expansion. The business outstripped
expectations and Kula was asked to provide second round financing
to develop export markets in the United States and Europe. Sales
and profits are six times higher than they were when Kula first
invested.
32. The coconut palms, which Pacific
Green sources from the main islands of Fiji, were previously left
to decompose or to be used as fire wood. They are now converted
into
furniture, cutting the demand for healthy
timber and reducing environmental degradation. The harvesting
of trees also represents an important source of income for wood-cutters
and the transport sector.
33. Kula worked with Pacific Green
to improve corporate governance so that it could list on the South
Pacific Stock Exchange in Fiji, which it did successfully in 2001.
Case Study: BRAC Bank, Bangladesh
34. Investing capital in local financial
institutions that provide small businesses acts
as a catalyst for increased economic activity. Through its fund
manager ShoreCap International, CDC has invested in BRAC Bank
which provides loan and general banking facilities to SMEs in
Bangladesh. This sector, comprising businesses such as grocers,
corner shops, clothes retailers and some small manufacturers,
had traditionally been under-served by the established banking
community. BRAC Bank is now the fastest growing bank in Bangladesh
in both deposits and credit, making average SME loans of US$6,500,
and also offering loans and credit cards to consumers. It has
around 400 regionally-placed loan processing units offering services
in the heart of rural and urban communities and employs over 700
business loan officers - around 60% of total staff.
MICROFINANCE
35. Microfinance provides the working
poor with access to more affordable capital and is defined primarily
as the provision of unsecured, short-term loans (typically up
to $100 for new borrowers and up to $175 for experienced borrowers)
primarily to individual women or groups of mostly women borrowers
and / or to micro enterprises. The term is also increasingly applied
to the provision of other financial services to micro entrepreneurs
(e.g. savings accounts and insurance).
36. Even though a number of non
government organisations have ventured into microfinance, their
reach and scale have been very limited as compared to the estimated
demand.
37. The key barrier to growth and
sustainability of microfinance institutions is that most intermediaries
are government-owned financial institutions providing credit to
low income households on a non-profit basis. This segment of their
business operations is not very profitable, and profits would
further reduce if they were to be burdened with the task of building
up the MFI sector. The challenge is to attract for-profit financing
sources to fund the delivery of affordable financial services
to the poor in a way that is commercially viable, profitable and
therefore sustainable.
38. The key task is to bring microfinance
into the regulated economy. This is the only way to ensure sustainability
in the sector.
39. India, for example, has a large
network of approximately 66,500 banks across the country with
almost half of them in rural areas. Despite this, the Indian financial
system has failed to provide access to the poor, especially the
rural poor. Almost 60% of households do not have access to a bank
account; only 20% of rural households have access to credit from
a formal source and 87% of marginal farmers do not have access
to any formal credit.
Case study: BSFL, India
40. BSFL in India is an example
of CDC's investments in microfinance, managed by ShoreCap International.
41. BSFL is a non-bank finance company
regulated by the Reserve Bank of India.
42. It is the flagship of the BASIX
Group, an Indian livelihood promotion institution that leads the
industry in product development, commercial operations, foreign
investment, and mainstream financial sector linkages.
43. BSFL provides microfinance in
rural areas, offering individual and group-based microcredit and
insurance products.
44. It makes agricultural loans
to farmers for crops, livestock, irrigation and equipment, business
loans for small-scale commerce or manufacturing and general purpose
loans to self help groups, which deliver credit and other services
to poor women.
45. BSFL is itself a profitable
business. The management team has been developed and new hiring
and training has strengthened the institution's human resource
capacity. BSFL remains well capitalized and has continued to find
financing from local banks.
Case study: Micro Kenya
46. Micro Kenya, an investment within
CDC's portfolio managed by Aureos, is an example of how microfinance
institutions can grow their business.
47. The company began its operations
with low-risk payroll based lending, offering loans to companies'
employees with repayment deductions being made through the payroll.
48. The company has now grown its
operations, setting up a distribution network to offer credit
directly to borrowers in untapped markets which the banks have
been reluctant to enter.
CONCLUSIONS
49. Private sector development is
a critical strand of development strategies and ultimately the
only sustainable route to alleviating poverty by driving wealth
creation and overall economic growth.
50. However, growth in the private
sector of developing economies is often constrained by lack of
access to capital, a lack of well trained and experienced business
managers, an over-regulatory stance by developing country governments
and poor transport, energy and communications infrastructure.
51. Aid programmes need to be directed
towards business training, the streamlining of bureaucracy, and
infrastructure.
52. Demonstrating to other investors,
both public and private, that appropriate returns can be made
in emerging markets is crucial in deepening capital markets.
February 2006
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