Beyond the declarations of intent regularly renewed at international summits, we must finally scale up to massively finance SMEs in Africa, to spur private sector development and thus meet the challenge of better development of the continent.
On May 18, 2021, the summit on the financing of African economies has been held in Paris, organized by the French government. The objective of this summit is to “give oxygen” to African countries to cope with the current economic crisis. Indeed, if the health crisis has spared a large part of Africa, the economic crisis has strongly hit the continent. The worldwide crisis has not only resulted in an increase in public debts but also in a collapse of private financial flows to Africa (foreign direct investments, remittances). In this context, it is reasonable to think that dealing with public debt will not be enough to address the challenge of financing Africa. Solutions must also be found to finance the private sector, with a special attention to Small and Medium Enterprises (SMEs) and start-ups.
Limited access to credit is one of the most important obstacles to the development of SMEs and start-ups.
The development of a dynamic private sector is indeed essential to improve the living conditions of the population thanks to its role in the creation of wealth and jobs. Limited access to credit is one of the most important obstacles to the development of SMEs and start-ups. Local financial intermediaries have difficulty supporting these actors, who are at the heart of the structural transformation of African economies.
The limits of official development assistance for business support in Africa
While a portion of official development assistance (ODA) is directed towards supporting the private sector, the current situation is not very satisfactory, as shown in the study “How to strengthen the contribution of the private sector to African development by improving its financing?“.
On the one hand, ODA provided for private sector support remains modest. For instance, only 7% of the total amount allocated by the European Commission under the European Investment Plan have targeted SMEs.
The balance is currently tilted in favor of profitability and risk management at the expense of impact.
On the other hand, the current modalities of private sector assistance fail to target firms and projects with a high impact. The challenge for donors is to find a balance between three imperatives: return, risk management and investment impact. The balance is currently tilted in favor of profitability and risk management at the expense of impact. Current financial instruments, whether direct or indirect, do not allow for the targeting of SMEs and start-ups, which are the most impactful firms.
Increasing support for the private sector to improve its impact
As a result, it seems essential to ensure that ODA massively increases its support to private sector in Africa. An increase in private firms support requires overcoming the ideological reticence to allocate public funds to private actors.
Increasing support to private enterprises is essential to meet the employment challenge facing African economies. To take the measure of this challenge, it is useful to recall that only 3 million jobs are created each year on the continent while 10 to 12 million young people enter the labor market at the same time. This challenge will increase in light of future demographic developments. It is therefore essential for the continent to create (stable and remunerative) jobs in order to avoid strong social and political tensions. Job creation will require supporting formal enterprises, which are the only ones likely to provide these decent jobs.
It is therefore urgent to increase the amount of ODA to private sector in Africa. That implies breaking with a caricatured vision that opposes the private sector and development. Private enterprises are essential for the continent’s takeoff and should be given the attention they deserve. Beyond job creation, the development of the productive private sector has many effects on the development of economies by promoting innovation, fiscal mobilization (and therefore public investment) and the pacification of post-conflict areas.
Additional ODA to private sector must help to change practices
Increasing the volume of official development assistance to private sector is only the first step. Additional resources for private sector support must help to change current practices to improve impact of investments. In particular, ODA should be used to oriented investment towards investments with more impact.
On the one hand, there is a strong need to target high-impact firms, such as pioneering firms investing in new markets or high-growth firms. Orienting funds towards high-impact firms implies increased risk-taking due to radical uncertainty about the evolution of these companies. Additional public resources will help to de-risk these investments.
Official development assistance to private enterprises will help to compensate the low financial returns of investment in low-income countries.
On the other hand, operating in African markets implies additional costs due to the moderate size of investments, high default rates, or additional financial risks (such as foreign exchange risk, security risks, and uncertainties in the business environment). These specific conditions imply lower returns. Official development assistance to private enterprises will help to compensate the low financial returns of investment in low-income countries and release the financial constraint.
Improving private sector financing, particularly for SMEs and start-ups, is essential to Africa’s development. The current architecture of ODA is struggling to fulfill this mission. To improve the situation, we recommend a substantial increase in ODA to private sector in Africa, which implies overcoming cultural reticence and admitting that private firms can be full-fledged actors of this public policy. We also recommend using these additional public resources to de-risk investments and reduce the financial burden of supporting SMEs and start-ups.