Ideas & Debate

Roll out red carpet, not red tape for investors

invest

With a challenging economic outlook ahead, international investment into East Africa and its people is more important than ever.

The energy sector is primed for such investment. In fact, it has been a focus sector for many years, as evident in the ambitious public targets and projects of countries in the region such as Kenya’s Big 4 Agenda and Vision 2030, Ethiopia’s Growth and Transformation Plan II, the development of the South Sudanese National Electricity Bill and the Ruizizi III hydroelectric power project which will provide power to Burundi, Eastern DRC and Rwanda.

The development of renewable energy resources in East Africa has also been the ‘darling’ of development finance institutions for some years.

The availability of development finance from these institutions has enabled several independent power producers to enter the African market with greater confidence, thereby bridging gaps in public infrastructure which may otherwise have remained open.

In current circumstances, it can be difficult to take a step back and acknowledge the importance of a continued focus on our long-term infrastructure goals.

Other issues may seem more important, or at least more emergent. In fact, however, where we continue to focus on our power sector, we will strengthen the public services under the most pressure (i.e. our health systems and social infrastructure), which will in turn enhance our collective resilience in times of crisis. Now is not the time to create unnecessary barriers to foreign investment. To keep our momentum, we need to roll out the red carpet, not the red tape.

To begin with, Governments can always take political and regulatory action to signal their readiness for investment.

The unbundling of the electricity sector in Malawi is one example of a positive message, where the division of ESCOM and creation of ENGENCO in 2016 opened the market and paved the way for further reform in the sector. In the last decade, a number of economies in the region have also taken action to unbundle the electricity sector, as this tends to create opportunities for IPPs and potential investors, as well as (often) improving the performance of the electricity retailers.

Putting in place policies that demonstrate long term commitment to the sector also sends an appealing message.

Development of national energy plans or resources (such as the resource mapping anticipated by Kenya’s 2019 Energy Act), commitment to developing internal resources (like the Kenya-Ethiopia transmission line) and political focus on the sector itself (e.g. Uganda’s Electricity Connections Policy 2018 – 2027 and its Draft National Energy Policy released in October 2019) are indicators of political commitment and a positive long term outlook for the sector.

Where there is a perception about the difficulty of ‘doing business’ in a particular country, regulatory action alone may not be enough to entice desirable investors. Offering fiscal incentives is an oft-used complimentary route to assist investors to manage their exposure and reduce their risk.

Electricity retailers can assist by fixing a tariff which allows an IPP to recover its investment over an appropriate period of time. Reform to electricity pricing in Rwanda in January saw the tariff increasing significantly, with the rationale being that this would allow a better ROI for power producers and encourage investment.

Tax incentives can also be used to entice new IPPs and their financiers. Incentives may simplify tax arrangements for importation/exportation of specialist construction equipment, or provide tax relief for certain investment partners. These incentives may also be used to direct investment in a particular technology, e.g. unique incentives for importation of geothermal technology, where that technology has been identified for focus by the national government.

Any incentive must be carefully considered and applied. Governments must fully understand the implications of offering (or revoking) such incentives and the impact such decisions can have on projects at various stages of commissioning. March 2020 saw the Kenyan Government assenting to pandemic-related tax relief, but the relevant amendment Act simultaneously revoked VAT concessions relied on by power generation companies. For projects in the planning stages, such a change may both affect financial feasibility and impact investor appetite to commit, as it can highlight to investors that a favourable tax position is not guaranteed for the life of the project. For a long-term investor, preservation of the status quo on taxation is equally as important as the need for regulatory stability and certainty.

Investing in an unfamiliar jurisdiction for 20-30 years is a daunting prospect, even with the best advisors and information. The possibility that the political or legal outlook will change dramatically during the tenure of your investment is therefore a risk that has to be understood and managed.

Some countries have a robust legal and regulatory framework, catering for feed-in tariffs, net metering, and clear documentation on the authorisations and permits required for power generation projects. Enshrining these controls in law means investors are able to assess and manage their risk prior to entering the market, and build a mechanism for dealing with legislative change into project documentation. However, Investors may still have significant exposure due to ‘informal’ policy change, where government unilaterally changes the type or level of support available to them. Mid-stream policy change such as this can be a red flag for investors, as it highlights the fragility of their position and the ultimate authority of government to compromise their investment.

Accordingly, ensuring the legal framework is predictable in the long term, and that any changes are executed carefully, with the relevant consultation, is almost as important as having the structure in the first place.

The energy sector globally has been earmarked as one where the pandemic may not have such a significant impact on returns for long term investments. In East Africa, we have a unique opportunity to demonstrate to the global market that the region is able to offer legal certainty and political and economic stability even in times of crisis. It is therefore essential for the development of our power, health and social infrastructure sectors that we, and our systems of government, rise to the challenge and continue to support the power sector.