Value add in Africa: First steps in a long journey

23Jan 2019
By Financial Times Reporter
Financial Times
Value add in Africa: First steps in a long journey
  • Tanzania’s recent cashew crisis underscores the need for Africa’s commodity producers to add value at home.
  • Export credit agency finance could be one solution to help Africa build an industrial base that is still restrained by weak local players and poor crop yields, writes Sarah Rundell.

TANZANIA President John Magufuli’s orders to hike cashew prices to protect the country’s struggling farmers,-

African farmers grow around 45 per cent of the world’s cashew nuts, yet 90 per cent of the continent’s crop is exported for processing overseas, denying the industry the opportunity to add value at home and increase Africa’s share of global trade. File photo

backed up by a pledge to buy Tanzania’s entire 2018 crop when private buyers acting for processors in Vietnam and India refused to pay, underscores the enduring problem for so many of Africa’s commodity producers.

African farmers grow around 45 per cent of the world’s cashew nuts, yet 90 per cent of the continent’s crop is exported for processing overseas, denying the industry the opportunity to add value at home and increase Africa’s share of global trade. The Africa Cashew Alliance estimates that a 25 per cent increase in raw cashew nut processing in Africa would generate more than $100 million household incomes in the sector.

As it is, Tanzania’s farmers get rock bottom prices and the country imports its own nuts back after processing to meet buoyant domestic demand. It’s easy to sympathise with the Tanzanian government, but crop seizures and price hikes aren’t a long-term solution. This lies in developing a local processing industry to add value at home, rather than giving the cashews away to Vietnam and India.

“It’s like Africa is a donkey working for everybody. We produce what creates wealth, but we get next-to-nothing for it because we do not add value. If we continue to trade in commodities we will continue being marginal players rather than serious players in the global market,” says Benedict Oramah, president and chairman of the African Export Import Bank (Afreximbank).

Accessing the finance to add value at home is one of the biggest challenges for Africa’s agri-processors and mirrors the scarcity of trade finance for Africa’s SMEs. Most are shut out by international banks which have no appetite to lend to any projects below investment grade or offer the small parcels of capital needed to empower local industry.

They also face a prohibitive cost of funds from local banks, which lack liquidity and favour fixed deposits over SME lending anyway. Although the number of local and regional banks financing value-add amongst their domestic client base – often under Afreximbank’s lead – is growing, many projects fail to get off the ground.

Witness how Nigeria still loses 45 per cent of its abundant tomato harvest before it reaches domestic consumers because of a lack of finance to fund the most basic value-add like cold chain storage.

“Nigeria spends the same amount as it costs in lost tomato production on importing tomato paste into the country,” says Larry Umunna, country director Nigeria at non-profit organisation Technoserve, currently involved in a YieldWise project funded by the Rockefeller Foundation to reduce post-harvest losses in the tomato value chain.

It’s a vicious circle, because adding value is a key way for firms to better access trade finance as it makes more sense from a lending point of view, explains Giles Hedley, investor relations manager at Barak Fund Management, whose funds include the Mikopo structured credit fund, providing longer-term credit to processing plants in metals and agriculture.

“We had a borrower who had landed a very good tender and needed financing to expand. They approached every bank in South Africa and were turned away. They had been accessing short-term trade finance with us and eventually came to us for the longer-term loan too,” he says.

Banks’ reluctance to finance value-add is matched by investor apathy too, says Hedley. Despite growing demand for finance from Barak’s existing borrowers as they graduate from straight-forward trade finance and working capital solutions to longer-term finance for capex projects, investors aren’t keen.

“The Mikopo fund is up and running and has a good track record, but investor inflows are slow. From a yield perspective it is attractive, but risk and unrest in Africa means tying up longer-term capital in the continent is risky. It involves financing out to five years, but the sweet spot is about three years.”

Where Hedley does see more investor enthusiasm for value-add, however, is the environmental, social and governance (ESG) angle around local job creation and long-term sustainability. It’s a theme that also aligns with the UN’s sustainable development goals, another metric institutional investors increasingly try to integrate into their portfolios. “Investors want to talk to the impact side of an opportunity rather than just the financing and commercial side,” Hedley says.

The enduring problem of access to capital has prompted some experts to look at the value-add conundrum through a different lens. African factories and processors should exploit their comparative advantage of labour and recognise their comparative disadvantage of capital, says Afreximbank’s Oramah.

Adding value to bauxite to produce aluminium requires heavy capital investment, he explains. Instead, Africa could continue to export bauxite and import aluminium ingots to press into sheets, a last mile of value-add requiring intensive labour.

Cotton is another example. Rather than ginning cotton into yarn, producers should invest in the end of the value chain and make garments.

“You can export the cotton raw, import fabric and make garments. If you spend $10 million in making garments, you will probably employ 1,000 workers, grow your exports and build more factories. In a capital-scarce economy, it may make sense to export the raw materials, import something back that requires labour-intensive activity to produce, then re-export,” Oramah explains. 

The role of ECAS

Export credit agencies (ECAs) offer one way for Africa to access cheaper finance for big ticket industrialisation, whilst benefitting their own domestic exporters. Africa’s richest man, Aliko Dangote – also behind the continent’s value-adding pasta and flour factories – recently arranged $4.5 billion in debt financing, which included backing from commercial and development banks and ECAs, for a giant Nigerian oil refinery to reduce Nigeria’s dependence on imported petroleum.

In other examples, mining groups looking to take elements of their African projects off their balance sheet and push project development are contracting out to suppliers of heavy equipment and power generation particularly. It’s providing export opportunities backed by ECA finance, notes Mark Norris, partner at Sullivan & Worcester.

The UK’s ECA, UK Export Finance (UKEF), for one, is working with the country’s exporters on a range of opportunities in Africa’s agricultural sector, including the provision of machinery and vehicles, irrigation systems, post-harvest storage facilities and livestock welfare, says Adam Harris, its head of civil, infrastructure and energy.

ECAs may provide the machinery and services to develop Africa’s mines and farms, but their mandate to promote their own domestic exports doesn’t move the needle on developing Africa’s own manufacturing and local content base. However, this may soon change. Under OECD rules, ECAs can only finance 30 per cent of the content for an Africa-based project from domestic African suppliers and service providers.

Now pressure to change these rules is growing, says Chris Mitman, founder and head of agency finance at Investec Bank, who attended the OECD stakeholder meetings in Paris in November. “Local companies that might get involved in contracts can’t access significant ECA-backed funding. If the OECD rules can be changed and ECAs can support more local content for projects where they can source locally, it will be great for developing local sustainable business and industry.”

ECAs are also becoming more open to working with Africa’s local and regional banks, which are beginning to develop export finance expertise and an ability to tap ECA finance, says Mitman.

Historically, some ECAs have pushed back from working with African banks because of concerns around their credit ratings and their proximity to borrowers. “ECA see local and regional banks as valuable partners. The question now is whether local banks are well resourced enough to develop the opportunity.” Mitman adds that ECAs’ strict controls over the use and application of funds ensures a visibility that will also encourage international lenders into African projects.

Local content woes

But putting new manufacturing equipment into African factories requires exporters to drill down on where they can sell their wares and local content providers to secure ECA support in a complicated process.

In the oil, gas and mining sectors, where local content refers to local companies taking ownership stakes in mines and oil fields as well as the value-add of refineries or petrochemical industries, the number of viable local companies able to supply local equipment or services is an issue. A successful local procurement environment needs knowledge, tools and capital to grow, says Mukund Dhar, a partner at law firm White & Case.

“Without an enabling environment, the risk is local players are unable to fully participate in projects, or are only able to supply at uncompetitive prices because they have to import services and goods to be able to re-supply procurers,” he says. Local content participation also depends on local firms accessing capital in the constrained local bank market. “It gets challenging when the local partner needs to fund their participation in the development of the project or of the resources, and can’t access the finance to do so.”

It means international investors may end up financially carrying local participants; worse still, a local participant’s share of the expenses gets funded by the international participant on the back of a costly loan that leaves the local player bereft of any dividend unless commodity prices double or expenses collapse. “It can result in meaningless or illusionary participation,” says Dhar, who also notes the importance of local currency funding for local participants.

International banks tend to lend in dollars or euros with significant foreign exchange exposure for the borrower. “Loans may carry low interest rates but soft costs in terms of currency exposure and minimum sizes of debt necessary can be crippling. More exposure to local currency could be a game changer,” Dhar explains.

Yet take-up of UKEF’s local currency financing for African buyers of UK exports has been slow, says Harris. In 2016, UKEF expanded the number of local currencies in which it could support buyer credit financings to include 15 African currencies. “Like all local currency borrowers, African borrowers have to weigh up managing forex risk on the one hand versus the interest rates they pay on the other. We are yet to close our first African currency transaction, but we hope that with greater awareness of UKEF’s offer more borrowers will want to explore this route,” he says.

Another worry for UK companies sourcing local content is the Bribery Act. “UK companies need adequate procedures to ensure that the person in the local country isn’t engaging in bribery and corruption because that becomes a strict liability offence,” says Norris, adding that the requirements of the Act are increasingly being imposed on contracting parties even if they are not a UK business.

It’s a similar story in the agricultural sector, where poor yields and feeble local production often struggle to support value-add in factories and processing plants, forcing the agri-processors that do exist to import their raw materials. “We still find in many of our countries that the competitiveness of the average farmer is questionable,” says Umunna.

He draws on yield data to illustrate his point. Nigeria produces 1.8 tonnes of corn per hectare, compared to Egypt, which produces 7.7 tonnes per ha. Rice yields in Nigeria vary from between 1.3 tonnes per ha to 2.2 tonnes per ha, compared to Egypt’s yields of 9.5 tonnes per ha. Such poor crop yields hit agricultural processors’ bottom line, who always look to source commodities cheaply, he explains. “Nigeria’s agricultural sector needs to improve production if it wants to be a major supplier to the processors.”

Encouragingly, companies such as Olam, Nestlé and Unilever, which has invested $30 million in two tea processing sites in Rwanda, and Coca Cola, which opened a new value-add drinks factory in Nairobi in 2018, are starting to invest more in local production backed by ‘Build Africa’ and ‘Source Africa’ strategies.

But Umunna would like to see them do a lot more. “The multinationals argue that their actions are influenced by consumer demand, but they also have the power to influence demand with Made in Africa strategies. It’s like that Chinese proverb ‘a journey of a thousand miles begins with a single step’.”

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