Addressing the Difficulties of Multilateral Development Banks and Financing Local Entrepreneurs

Local content requirements (LCRs) require companies to fulfill a minimum threshold that incorporates either local labor or locally sourced goods and/or services. Many countries in Africa have turned to LCRs to improve the participation of local contractors, suppliers, and domestic workers in high-tech and large-scale infrastructure projects as well as to provide quantitative targets for domestically manufactured goods or services in the tendering process.

Countries like Angola, the Republic of the Congo, Equatorial Guinea, and Gabon, have used LCRs to leapfrog technological barriers in the extractive sector, compelling foreign oil companies to not only transfer expatriate job positions to locals, but also create linkages with local small and medium scale enterprises (SMEs) in the value chain.

LCRs favor the domestic economy by raising the technical capacity of domestic industries through technology transfers, creating employment, and increasing uptake of domestically manufactured goods and supplied services. LCRs are seen as key tools to enhance the local value chain and unlock the development potential of primary and auxiliary industries.

The Problem

However, despite the establishment of clear LCR policies, local companies are struggling due to a lack of financing opportunities and limited technical knowledge. While technology transfers to local companies can easily be arranged through joint ventures with international firms, the inability to access financing from Multilateral Development Banks (MDBs) — including concessional loans — remains one of the biggest obstacles for local companies.

To access this kind of funding, most multilateral development banks require a bankable (i.e., reliable or profitable) proposal that must meet the requirements of the financier for them to provide capital for the LCR project. A bankable proposal must therefore methodically show replicable financial indicators, reliable financial results, and auditable records, and demonstrate how the project will generate revenue streams. In addition, some financiers require that proposals address the social and environmental implications of the project — both positive and negative.

Research, including World Bank Reports, identify the lack of bankable proposals as the reason why many MDBs shy away from backing local companies in capital-intensive, long-term infrastructure investments. Proposals from foreign companies have higher bankability, while project proposals from local content providers have a hard time generating investor confidence.

For MDBs, the likelihood of being saddled with severe debt accrued from loans backing LCRs remains an enduring risk due to poor contracting practices and project failure. Many MDBs are averse to LCR financing due to their higher vulnerability to corruption and rent seeking practices from the ruling elite. LCRs create higher opportunities for malfeasance in public office due to exploitable loopholes that are easily filled by intermediaries, where ruling elites function as go-betweens for foreign companies and local firms to extract commissions and kickbacks. Such practices grossly inflate project costs.

Moreover, by virtue of requiring local participation, discretionary political power is often used to award LCR contracts to government-favored entities at the expense of qualified local firms. As such, since MDBs have robust fiduciary framework to help combat corruption and fraud, some domestic firms are often designated to be ineligible to participate in donor funded projects.

It is possible that the lack of understanding as to what contributes to a bankable proposal stems from the fact that firms soliciting funding from MDBs consider the bankability aspect of the project as the responsibility of the MDBs themselves. Evidence from working papers discussing the bankability of proposals in climate finance, funding for energy, and the extractives sector, indicates a highly pervasive attitude among many domestic firms receiving concessional finance for public-private sector projects that MDBs will bear the financial risks.

The Difficulties in Formulating a Proposal

Formulating financing proposals is a complex multi-layered process — more so for high tech infrastructure projects. It requires standardized, replicable approaches afforded by experience, project planning, design, and implementation.

In demonstrating such bankable proposals, the World Bank report indicates that most firms in Africa use proposals backed by ''out-of-date engineering studies with little or no analysis''. This realization resulted in the African Development Bank (AFDB) investing in several project development companies, preparation funds, platforms, and tools such as Project Navigator, which offers "comprehensive, easily accessible, and practical information, tools and guidance to assist in the development of bankable renewable energy projects." A similar initiative was launched by the United Nations Conference on Trade and Development report (UNCTAD), which has helped in developing countries to prepare, promote, and facilitate bankable Sustainable Development Goals (SDGs).

Addressing the Pitfalls of LCR Financing

Due to the opacity involved in many LCR tenders, transparency requirements could have a substantial impact on the quality of outcomes. Increasing information and circulation to local companies about upcoming projects can easily build capacity for businesses to understand the environment from which they emerge and develop, thereby improving local companies' ability to compete for financing. This kind of transparency can help increase civic participation which translates to a higher level of accountability from public officials. In Rwanda, the government established a Local Content Unit (LCU) to address such constraints by preparing and training local firms on a rolling basis to become approved vendors to multinationals.

Further, using a results-oriented approach, local companies could improve their eligibility for financing by participating in a credible performance review system. Performance-based financing (PBF) or results-based financing (RBF) is one such tool.

According to the World Bank, RBF "offers incentive payments on the basis of results achieved to businesses that deliver pre-specified outputs." By having clear targets and properly defined scope of the outputs, lenders use RBF to look at the key performance indicators (KPI) to monitor the performance and implementation of a project, which mitigates project failure.

By using RBF appraisal reports, domestic firms are also regularly assessed on their ability to comply with explicit legal targets set out by the lenders and the country's public financial management system. Thanks to the stringent fiduciary standards set out by MDBs, domestic firms are thus no longer incentivized to engage in corrupt practices. Moreover, MDBs like the World Bank have established outreach programs like workshops and seminars, targeting governments and local contractors in a bid to help them meet procurement standards.

Considering that LCRs are state-sponsored initiatives, governments must play a bigger role in de-risking some projects by also assuming the risk of project failure through budgetary certainty and regulatory integrity to catalyze more financing from MDBs. After all, risk is inherent in any given project and MDBs cannot be expected bear all the risks.

Charles Waiganjo holds post-graduate qualifications in both philosophy and political science. He completed his studies at the Université Michel de Montaigne, and at the Université de Bordeaux.

Photo Source: Business loan agreement or legal document concept by William Potter/Shutterstock.com

The opinions expressed on this blog are solely those of the authors. They do not reflect the views of the Wilson Center or those of the Carnegie Corporation of New York. The Wilson Center's Africa Program provides a safe space for various perspectives to be shared and discussed on critical issues of importance to both Africa and the United States.