Lubbe Project 2015

Project finance as a driver of economic growth in Africa
Johann J Lübbe
Research assignment presented in partial fulfilment

of the requirements for the degree of
Master of Philosophy in Development Finance
at Stellenbosch University
Supervisor: Dr J Smith
Degree of confidentiality: A December 2015

Stellenbosch University https://scholar.sun.ac.za
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Declaration
I, Johann J Lübbe, declare that the entire body of work contained in this research assignment is my
own, original work; that I am the sole author thereof (save to the extent explicitly otherwise stated),
that reproduction and publication thereof by Stellenbosch University will not infringe any third party
rights and that I have not previously in its entirety or in part submitted it for obtaining any
qualification.
JJ Lübbe 5 October 2015
17106885
Copyright © 2013 Stellenbosch University

All rights reserved
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Acknowledgements
I would like to express my sincere gratitude towards my wife, Inge, for her unwavering support
during my studies and long periods away from home. Without her patience, support and
understanding, I would not have been able to complete my studies and my research assignment.
Thank you for allowing me the opportunity to further my knowledge and expand my skills and
qualifications. To my two children, Dané and Ivan, thank you for your patience although you did
not always understand my commitments and absence from home.
I would also like to thank Mr Theodor Loots from Business Enterprises at the University of Pretoria
for his support with the econometric modelling and statistical analysis contained in this research
assignment.
To my editor, Yolanda Van der Westhuizen, for her language and technical editing, which ensured
a research assignment of acceptable quality.
Finally, to my supervisor, Dr J Smith, for his support and guidance in completing the research
assignment.
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Abstract
Like many developing countries in the world, African countries face real economic growth, poverty
and inequality challenges. To exacerbate these challenges, African countries also face severe
infrastructure backlogs. These infrastructure backlogs are not limited to the creation of new
assets, but includes the upgrading, refurbishment and rehabilitation of existing infrastructure.
Many researchers have investigated the infrastructure-growth nexus and found that infrastructure
contributes towards an increase in productivity and national output. It is, therefore, important to
understand the role that project finance is, and can be playing in infrastructure development in
African countries, with the ultimate aim of increasing economic growth and development.
The question whether or not project finance contributes towards economic growth was based on
an empirical analysis, making use of secondary data. The control variables chosen for the study
comprised the most common variables used in the literature. A standard panel regression model
was used to determine whether project finance had an impact on economic growth in the African
countries over the period 2000 to 2013. Both a one-way and two-way fixed-effect model was
analysed using three panels.
The research focussed on the finance-growth nexus with a specific focus on project finance. It was
shown that the flow of foreign capital into a country is often a function of the level of development
of the financial system in that country. Project finance as a specific financing mechanism is
particularly successful in attracting local and foreign capital to projects in perceived riskier markets,
i.e. growing economies with weak or underdeveloped financial, legal, institutional and governance
systems. Project finance is, therefore, an effective tool to finance projects in high-risk
environments.
Financial development contributes to both the quality and quantity of capital available in the
financial markets. It is, however, the ‘quality of capital’ that contributes towards, and influences
economic growth and development in an economy.
The results of this study are consistent with the literature and imply that project finance fosters
economic growth.
Although project finance is a complex financing mechanism, it is particularly successful in

economies with weak financial and legal systems, and the use of project finance should be
encouraged by governments in Africa for the provision of public infrastructure. Project finance as
an alternative financing mechanism can play an important role in eradicating infrastructure
backlogs on the African continent and thereby contribute towards economic growth on the
continent. Policy changes should create an enabling environment conducive to and promoting
project finance as a preferred financing mechanism in African countries.
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Key words
Project finance
Economic growth
Financial development
Infrastructure
African countries
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Table of contents
Declaration ii
Acknowledgements iii
Abstract iv
List of tables viii
List of figures ix
List of acronyms and abbreviations x
CHAPTER 1 INTRODUCTION 1
1.1 INTRODUCTION 1
1.2 PROBLEM STATEMENT 3
1.3 RESEARCH OBJECTIVES 4
1.4 IMPORTANCE/BENEFITS OF THE STUDY 4
1.5 CHAPTER OUTLINE 5
1.6 SUMMARY 5
CHAPTER 2 LITERATURE REVIEW 6
2.1 INTRODUCTION 6
2.2 THE FINANCE-GROWTH NEXUS IN THEORY 6
2.3 PROJECT FINANCE AS A CONTRIBUTOR TO ECONOMIC GROWTH 7
2.4 INFRASTRUCTURE DEVELOPMENT IN AFRICA 9
2.5 SUMMARY 12
CHAPTER 3 RESEARCH METHODOLOGY 13
3.1 INTRODUCTION 13
3.2 DATA COLLECTION 13
3.3 DATA ANALYSIS 14
3.4 SUMMARY 15
CHAPTER 4 FINDINGS 16
4.1 INTRODUCTION 16
4.2 MAIN FINDINGS 16
4.3 SUMMARY 24
CHAPTER 5 SUMMARY, CONCLUSION AND RECOMMENDATIONS 26
5.1 INTRODUCTION 26
5.2 SUMMARY OF MAIN FINDINGS 26
5.3 POLICY IMPLICATIONS 27
5.3.1 Africa 27
5.3.2 South Africa 28
5.4 RECOMMENDATIONS 29
5.5 FURTHER RESEARCH 29
REFERENCES 30
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APPENDIX A: DIAGNOSTIC PLOTS 36

viii
List of tables
Table 4.1: Project finance-growth relationship for the period 2000 to 2013 17
Table 4.2: Descriptive statistics per year for all 23 countries 18
Table 4.3: Descriptive statistics per year for five highest-growth countries 18
Table 4.4: Descriptive statistics per year for five lowest-growth countries 19
Table 4.5: Descriptive statistics of variables 20
Table 4.6: Diagnostic summary of the one-way fixed-effects model 21
Table 4.7: Correlations of parameter estimates of the one-way fixed-effects model 21
Table 4.8: Diagnostic summary of the two-way fixed-effects model 21
Table 4.9: Correlations of parameter estimates of the two-way fixed-effects model 22
Table 4.10: Parameter estimates 22
Table 4.11: Model fit statistics for a one-way random-effects model 23
Table 4.12: Hausman test for random-effects 23
Table 4.13: Breusch Pagan test for random-effects (one way) 23
Table 4.14: Parameter estimates for one-way random-effects model 23
Table 4.15: Model fit statistics for a two-stage dynamic panle 24
Table 4.16: Sargan test 24
Table 4.17: Parameter estimates for two-stage dynamic panel model 24
ix
List of figures
Figure A.1: Diagnostic plot for the one-way fixed-effects model 36
Figure A.2: Diagnostic plot for the two-way fixed-effects model 37
x
List of acronyms and abbreviations
bn billion
BRICS Brazil, Russia, India, China, South Africa
FDI foreign direct investment
GC government consumption
GDP gross domestic product
GMM generalised method of moments
IMF International Monetary Fund
MSE mean squared error
OECD organisation for economic cooperation and development
PF project finance
PICC Presidential Infrastructure Coordinating Commission
PG population growth
PPP public-private partnership
SOC state owned company
SPV special purpose vehicle
SSA sub-Saharan Africa
SSE sum of squared errors
US Unites States of America
US$ United States of America dollars
WDI world development indicators
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CHAPTER 1
INTRODUCTION
1.1 INTRODUCTION
Many factors influence and/or cause economic growth and development. For many years,
researchers, economists, policy makers and governments have investigated and researched the
causal link and relationship between financial development and economic growth. However,
researchers have conflicting views on the finance-growth relationship and the impact or importance
of financial development on economic growth. Some researchers argue that financial development
does not cause or is not important for economic growth, but rather follows or is a consequence of
economic growth (Lucas, 1988; Robinson, 1952). On the other hand, some researchers have
found that financial development and the strength or depth of a country’s financial systems
(sophistication of financial systems) do contribute towards economic growth (Miller, 1998;
Schumpeter, 1911; King & Levine, 1993; Thiel, 2001; Ndikumana, 2000). For the latter school of
thought the question is not ‘if’, but rather ‘how’ financial development can affect economic growth.
financial markets. It is, however ,the ‘quality of capital’ that contributes towards and influences the
economic growth and development in an economy (Kleimeier & Versteeg, 2010).
Financial development consists of many financial instruments that can potentially contribute to
economic development. One such specific instrument is ‘project finance’, which is of particular
importance due to its ability in facilitating and promoting infrastructure development, specifically in
underdeveloped financial markets. Infrastructure in itself is also a contributor to economic growth
(Sanchez-Robles, 1998; Egert, Kozluk & Sutherland, 2009). The World Bank recognised the
importance of infrastructure and found that a one per cent increase in the overall infrastructure
stock translates into a one per cent increase in gross domestic product (GDP) (World Development
Report, 1994). By its very design, project finance is intended to promote investment management,
good governance and management of project risks.
Project finance has seen a dramatic increase in recent years, increasing from around US$12.5
billion (bn) in 1991 (Kleimeier & Versteeg, 2010) to around US$280 bn in 2013, with a deal count of
548 (Infrastructure Journal, 2013). After reaching record levels of investment in 2007 (around
US$320 bn), the total global project finance volume fell to around US$180 bn in 2009 following the
global financial crisis of 2008/9. Volumes increased in 2010 and 2011 to around US$242 bn and
US$248 bn respectively and decreased somewhat during 2012 to US$186 bn (Infrastructure
Journal, 2013). According to the Infrastructure Journal (2013), Europe (US$209 bn) was the
leading region in terms of the volume of project finance transactions followed by the Americas
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(US$207 bn) and Asia & Pacific region (US$189 bn) over the period 2011 to 2013. Africa and the
Middle East benefitted the least from project finance transactions with a volume of US$111 bn.
According to data obtained from the Thomson Reuters Loan Pricing Corporation’s Dealscan
Database, Africa attracted project finance transactions to the value of US$80.8 bn over the period
2000 to 2014. South Africa, Egypt and Nigeria were the African countries that benefitted the most
from project finance transactions between 2000 and 2014, with transaction values of US$22.5 bn,
US$15.5 bn and US$11 bn respectively. The three African countries that benefitted the least over
this period were Libya, Malawi and Ethiopia, with transaction values of US$0.09 bn, US$0.1 bn and
US$0.2 bn respectively. However, only 24 African countries benefitted from project finance over
the period 2000 to 2014, with the remainder of the countries not attracting any project finance
transactions. When compared to the BRICS countries (the association of five major emerging
world economies of Brazil, Russia, India, China and South Africa), African countries perform
poorly. Brazil, Russia and South Africa were the BRICS countries who benefitted the least from
project finance transactions between 2000 and 2014, with transaction values of US$30.7 bn,
US$65.8 bn and US$22.5 bn respectively. The leading BRICS countries in respect of project
finance transactions over this period were India with US$215.1 bn, and China with US$241.1 bn.
According to Chan, Forwood, Roper and Sayers (2009), governments around the world are
increasingly investing in infrastructure as a means of counteracting the global financial crisis, in an
attempt to stimulate their respective economies through, amongst others, job creation and
improving economic performance. This infrastructure investment initiative, however, is hampered
by the availability of funding, also as a result of the crisis. To support this occurrence, Kumo
(2012) found that there was a strong multilateral causal link between economic infrastructure and
GDP growth in South Africa. This means that “economic infrastructure investment drives the long
term economic growth in South Africa while improved growth feeds back into more public
infrastructure investment”. Kumo (2012) further found a “strong two way causal relationship
between economic infrastructure investment and public sector employment reflecting the role of
such investments on job creation through construction, maintenance and the actual operational
activities”. Increased employment could in turn contribute to further infrastructure investments
indirectly through multiplier effects across the economy. In order for South Africa to reach its
socio-economic and other growth targets, Kumo (2012) believes that the South African government
should increase and sustain the level of infrastructure investment in years to come.
Project finance by its very nature is intended to be used in both developed as well as
unsophisticated financial markets and is designed to account for risk and to reduce transaction
costs. Project finance further accounts for the inability of developing economies to mobilise and
pool savings. Project finance can, therefore, also be used in lower-income and developing
countries. Kleimeier and Versteeg (2010) found that project finance was a strong driver of
3
economic growth in low-income countries with a move from the 25th to the 75th percentile in project
finance resulting in an annual growth of 0.67 percentage points.
1.2 PROBLEM STATEMENT
Like many developing countries in the world, African countries face real economic growth, poverty
and inequality challenges. To exacerbate these challenges, African countries also face severe
infrastructure backlogs. These infrastructure backlogs are not limited to the creation of new
assets, but includes the upgrading, refurbishment and rehabilitation of existing infrastructure.
Many researchers have investigated the infrastructure-growth nexus and found that infrastructure
contributed towards an increase in productivity and national output (Sanchez-Robles, 1998; Egert
et al., 2009; Aschauer, 1989; Canning, 1999; Esfahani & Ramirez, 2002; Calderon & Serven,
2008). Calderon and Serven (2008) also found that the lack of adequate infrastructure was a
major constraint for economic growth in sub-Saharan Africa (SSA). The South African Presidential
Infrastructure Coordinating Commission’s (PICC) research showed that for every three per cent
rise in infrastructure spending, South Africa’s GDP increased by one percentage point
(Engineering News, 2015c).
According to Rabinowitz (2008), South Africa is faced with two key infrastructure challenges,
namely (i) the significant infrastructure backlog and the spend that will be required to eradicate this
backlog; and (ii) the limited borrowing capacity of government and State-Owned Companies
(SOC). Financing of infrastructure will, therefore, have to be done using alternative funding
mechanisms such as off-balance sheet or project finance models. The provision and financing of
public infrastructure will also have to involve the private sector. During the recent Gauteng
Infrastructure Investment Conference (held on 16 and 17 July 2015 in Johannesburg, South
Africa), various speakers confirmed the need for the South African Government to partner with the
private sector to ensure that the required infrastructure was provided. The Gauteng Premier, Mr
David Makhura, reiterated that the Gauteng Government would have to partner with the private
sector to respond to the R1 300 billion (over 15 years) social and economic infrastructure
requirements in the province (Engineering News, 2015a). The Minister in the Presidency of South
Africa, Mr Jeff Radebe, warned that ‘on budget’ resources are limited and that ‘off budget’ solutions
would have to be pursued in order to address the infrastructure challenges faced by South Africa.
Mr Radebe noted the ‘user pay’ principle as one of the mechanisms to finance critical infrastructure
projects (Engineering News, 2015d). This view was supported by the Industrial Development
Corporation’s Khumo Morolo, who warned that conventional investment mechanisms to fund public
infrastructure development was no longer sufficient and that innovative financing mechanisms and
models are needed to fund public infrastructure. Morolo suggested the establishment of special
purpose vehicles with the ability to enable revenue-generating infrastructure projects (Engineering
News, 2015b).
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It is, therefore, important to understand the role that project finance is, and can be playing in
infrastructure development in African countries with the ultimate aim of increasing economic growth
and development.
Very little research exists on project finance in Africa and South Africa, and project finance (in its
purest form) in South Africa is rare (Rabinowitz, 2008). The recent Independent Power Producer
programme in South Africa has, however, resulted in increased project finance transactions.
Nevertheless, the real impact that project finance has had on economic growth in Africa remains
unclear. Although Kleimeier and Versteeg (2010) included some African countries in their study, a
study on the effect of project finance on economic growth in African countries alone has not been
done. African countries probably find themselves in the unique situation of facing specific
challenges (of governance, large infrastructure backlogs, corruption, conflict and perceived
lawlessness, being landlocked, large unemployment, low levels of human capital development,
etc.), while at the same time experiencing extraordinary growth prospects and opportunities. This
study is aimed at answering the following research question:
 To determine whether project finance has contributed towards economic growth and
development in African countries over the past 14 years.
1.3 RESEARCH OBJECTIVES
Esty (2004) argued that due to the growing demand for investment in infrastructure and the
increased importance of project finance as infrastructure financing mechanism, both public and
private sector role players (corporate executives, engineers, lawyers, bankers, government officials
and politicians) need to understand what project finance is, its benefits and value, and how to
structure projects that are bankable.
The purpose of this research is to:

i) Illustrate the fact that project finance contributes towards economic growth;
ii) Create awareness and highlight the importance of project finance for economic growth and
development in a country;
iii) Motivate and promote the use of project finance as an appropriate financing mechanism in
Africa and specifically South Africa; and
iv) Motivate policy changes that will create an enabling environment conducive to and promoting
project finance transactions in South Africa.
1.4 IMPORTANCE/BENEFITS OF THE STUDY
This research investigated and determined whether project finance was a contributor to economic
growth in Africa over the past 14 years. The research is important for the following reasons:
 To increase the awareness that project finance contributes towards economic growth;
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 To promote project finance as an alternative funding mechanism for infrastructure

development in Africa; and
 To facilitate the development of infrastructure in Africa upon the acceptance of project
finance as a preferred financing mechanism for infrastructure in Africa.
1.5 CHAPTER OUTLINE
The first chapter of the research assignment sets the context and background to the study and
includes the research problem, research question and objectives of the research. The second
chapter provides a theoretical framework for the research in the form of a comprehensive
theoretical and empirical literature review. Chapter 3 presents the research methodology and data
used, while Chapter 4 reflects the results of the empirical analysis. Chapter 5 contains the
summary, conclusion and recommendations of the research assignment.
1.6 SUMMARY
Researchers have investigated the link and relationship between financial development and
economic growth for many years. Financial development contributes to both the quality and
quantity of capital available in the financial markets and Kleimeier & Versteeg (2010) argued that it
was the ‘quality of capital’ that contributed towards and influenced the economic growth and
development in an economy. Project finance is a financial instrument that can potentially
contribute towards economic development, especially in undeveloped financial markets. Project
finance is intended to be used in both developed and undeveloped financial markets and is
designed to account for risk and to reduce transaction costs. Project finance is an alternative
financing mechanism that can be used to raise project capital in low-income and developing
countries where capital and investment is scarce. The next chapter will explore the theoretical and
empirical literature to investigate the finance-growth relationship as well as to determine whether
project finance contributes to economic growth.
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CHAPTER 2
LITERATURE REVIEW
2.1 INTRODUCTION
A literature review is performed to determine and investigate the theory behind the link between
financial development and growth. Specific focus is on project finance as a financial instrument to
promote economic growth. The literature review firstly focused on the theory behind the finance-
growth nexus, whereafter the growth enhancing properties of project finance was investigated.
2.2 THE FINANCE-GROWTH NEXUS IN THEORY
The traditional literature argues that economic growth is determined mainly by the quantity of
capital as the key determinant of financial development, i.e. financial development will lead to an
increase in capital, which in turn leads to economic growth. However, Schumpeter (1911) argued
that finance stimulated growth not through the creation of more capital (by increasing savings), but
rather through the improved allocation of savings, i.e. improving the quality of capital. Hasan,
Koetter and Wedow (2009) confirmed this view in a recent study, which compared the importance
of the quality of finance and the quantity of finance in Europe. Hasan et al. (2009) found that “an
increase in the efficiency (i.e. quality) of bank finance creates up to five times more growth than a
corresponding increase in the quantity of bank finance”.
Merton and Bodie (1995) defined the primary function of financial systems as the facilitation and
allocation of resources across space and time in an uncertain environment. Levine (1997) and
Levine (2004) analysed this primary function and broke it down into five ways in which financial
markets could contribute towards the quality of capital. Firstly, financial markets facilitate the
trading, hedging, diversification of portfolios and pooling of risk, through various instruments and
mechanisms such as insurance products and pension funds. Secondly, sophisticated financial
markets (i) improve access to capital and (ii) improve capital allocation. This will result in the
lowering of financial restraints as well as lowering the cost of capital. Thirdly, financial markets
promote and enforce good corporate governance and control, which deals with information
asymmetries and agency costs. Fourthly, financial markets mobilise savings and facilitate the
pooling of funds. Lastly, financial markets facilitate the production and exchange of goods and
services.
This view that financial markets increase economic growth is supported by empirical evidence and
research. King and Levine (1993) found that an improvement in a financial system would result in
an increase in economic growth. Levine and Zervos (1996, 1998) found that well developed stock
markets had a direct positive impact on economic growth.
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Emerging economies and developing countries are, however, faced with the challenge of
increasing their economic growth while it is still developing, reforming and improving its financial
systems. One way of achieving this is by importing finance in the form of international capital
flows. International capital can increase the quantity of capital, lower the cost of capital, and, if
structured correctly, increase the scope of risk diversification (Kleimeier & Versteeg, 2010).
However, it is important to maintain and focus on the quality of capital rather than on the quantity of
capital in emerging markets. It is also imperative that proper consideration is given to the riskiness
and cost of foreign capital so that it is not to the detriment of emerging economies.
The question, therefore, remains which types of finance is available to emerging economies where
financial markets are still underdeveloped and international capital flows are risky. Kleimeier and
Versteeg (2010) identified two types of capital, namely portfolio equity investments and foreign
direct investment (FDI). International equity investments are, however dependent on well-
developed stock markets, which are often not available in emerging economies. According to
Hausmann and Fernandez (2000), FDI was not dependent on sophisticated domestic financial
markets and could be used to substitute domestic financial markets. However, some research has
shown that FDI is only beneficial if a certain threshold of development has been reached. A lack of
human capital, underdevelopment of financial markets or institutions and trade restrictions can
hamper the positive impact of FDI on economic growth (Borenszteina, De Gregoriob & Leec, 1998;
Alfaro, Chanda, Kalemli-Ozcan & Sayek, 2004; Durham 2004; Balasubramanyam, Salisu &
Sapsford, 1996). Similarly, Blomström, Lipsey and Zejan (1992) and De Mello (1999) found that
only high-income countries and Organisation for Economic Co-operation and Development
(OECD) countries would benefit from FDI. Reisen and Soto (2001) found that developing countries
should not rely solely on domestic savings, but should also encourage and facilitate FDI and
portfolio equity inflows to stimulate long-term growth prospects.
2.3 PROJECT FINANCE AS A CONTRIBUTOR TO ECONOMIC GROWTH
Gatti (2013) defined project finance as “the structured financing of a specific entity – the SPV, or
special purpose vehicle, also known as the project company – created by sponsors using equity or
mezzanine debt and for which the lender considers cash flows as being the primary source of loan
reimbursement, whereas assets represent only collateral”. According to Yescombe (2014), project
finance is “a method of raising long-term debt financing for major projects through ‘financial
engineering’, based on lending against the cash flow generated by the project alone; it depends on
a detailed evaluation of a project’s construction, operating and revenue risks, and their allocation
between investors, lenders and other parties through contractual and other arrangements.” By
design, project finance is aimed at large-scale, complex projects (often infrastructure related) with
significant risk and information asymmetries. Project finance transactions are characterised by
high leverage, i.e. relatively low levels of equity (provided by project sponsors) compared to high
levels of debt. Debt is either in the form of limited or no-recourse loans. Project finance
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transactions are further aimed at allocating risk (construction, operating, demand, price, etc.) to the
parties best equipped to manage and mitigate the risk (Gatti, 2013). Chan et al. (2009) argued that
the choice of a financing mechanism was often influenced by the project risk and the most
appropriate mechanism was the one that would ultimately best manage the project risk (assigning
a specific risk to a party best placed to manage/mitigate the risk).
Project finance transactions are designed around the establishment of a ring-fenced special
purpose vehicle (SPV) and a number of contractual arrangements. Project finance as a financing
mechanism is, therefore, able to be implemented in undeveloped financial markets where it will,
through the characteristics listed above, emulate and ‘artificially create’ well-developed financial
markets. Project finance is, however, dependent on a strong legal and regulatory environment
where contracts are honoured and the rule of law is enforceable. Kamanga (2008) found that
governance (and in particular the rule of law) played a major role in attracting private sector
investors in project finance deals. Project finance is often implemented as an alternative to
corporate finance, but has the following advantages over corporate finance. Firstly, it increases
the availability of finance and, secondly, it reduces the overall risk associated with the project
(Ahmed & Fang, 1999). Project finance is, therefore, an attractive alternative financing
mechanism, especially in developing countries and emerging economies (where it has seen
significant expansion during the 1990’s according to Ahmed & Fang, 1999) where financial
development remains low.
Project finance is strongly associated with the provision of long-term finance, which in turn will
support future economic growth. The Group of Thirty (2013) promulgated four principles that
should govern the provision of long-term debt. First, the Group of Thirty (2013) argued that in
order to meet the investment needs of the real economy, financial systems should be designed to
pool individual and corporate savings into an adequate supply of financing with longer-term
maturities. This may typically be in the form of pension funds and insurance products. Second,
that long-term finance should be provided by entities with longer-term financing horizons. Third,
that long-term investment should be supported by a range of financial instruments. Fourth, that an
efficient global financial system (including regulation) should promote economic growth through
stable cross border flows of long-term finance.
It is important to measure the effectiveness and advantage of project finance against the five ways
in which financial markets can contribute towards the quality of capital as defined by Levine (1997),
in order to substitute domestic financial markets and to manage transaction costs:
 Risk management: Like most financial products and instruments, project finance is also
characterised by the risk/return principle where a high risk investment will require a high
return. However, Kleimeier and Versteeg (2010) argued that when capital was scarce
(particularly in domestic markets) and investors were risk averse, they would prefer low
risk/low return investments. This phenomenon will have a negative impact on economic
9
growth as higher risk projects, which often have a higher growth impact, will be overlooked.
Project finance may not change the investment behaviour of domestic investors, but will
continue to attract international investors and ensure capital flow towards growth enhancing
projects (Kleimeier & Versteeg, 2010).
 Capital allocation: Project finance improves the efficiency of capital by allocating capital to
growth enhancing infrastructure sectors. Project finance further provides for all aspects of
capital requirements such as operation, maintenance and replacement, and, therefore,
further enhances the allocation of capital. However, care should be taken to prevent
improved capital allocation that will reduce risk to such an extent that it will lower saving rates
(Levine 2004).
 Corporate governance: The design and structure of project finance lends itself to promote
good corporate governance and to substitute for lacking domestic structures. The advanced
legal and risk management structures, which is integral to project finance, is based on
international best practise and intended to facilitate and promote investment in projects.
Hainz and Kleimeier (2006) found that project finance is the preferred financing mechanism
in countries with high political (sovereign) risk and poor governance structures.
 Mobilise savings and facilitate transactions: Project finance by definition is aimed at

facilitating large investments and transactions by crowding in a number of investors. This is
done through syndication where syndicates often comprise large international banks and
financing institutions. Project finance is, however, often aimed at pooling international
funding and does not always contribute towards mobilising domestic savings and
transactions (Kleimeier & Versteeg, 2010).
Chege (2001) identified the following conditions as essential for the success of project finance
transactions:
 A supportive policy environment, which creates a conducive macro-economic environment;
 A stable economic environment;
 An economic and country environment where business is transparent, contracts are
respected and disputes are resolved efficiently and fairly; and
 A stable legal and regulatory environment conducive to private sector investment and
activity.
2.4 INFRASTRUCTURE DEVELOPMENT IN AFRICA
Governments are traditionally responsible for the provision (owning, operating and maintaining) of
public infrastructure (such as water services, roads and transportation, electricity, and social
amenities such as schools, hospitals, etc.). According to Chege (2001), infrastructure expenditure
10
in developing countries is mostly funded by host governments directly from the fiscal budgets. It is
estimated that countries in SSA finance around 65 per cent (approximately four per cent of SSA’s
GDP) of its infrastructure expenditure from public sector budgets (International Monetary Fund,
2014). Governments, however, do not always possess the required skills and expertise to access
the different sources of funding and are often reliant on the private sector for this expertise.
Increased private sector involvement in the financing of infrastructure projects are, therefore,
critical to provide for the increasing demand for infrastructure. While trading services (water and
sanitation and electricity services) provide an opportunity for the private sector to become involved
in the provision of infrastructure through the implementation of user charges, the non-trading
services will mostly remain a public service. A government’s involvement in the provision of
infrastructure may also be required where the benefits of an infrastructure project will extend
beyond the direct users and may exceed the potential revenue from user charges (Chan et al.,
2009).
The National Treasury of South Africa has developed a public private partnership (PPP) model and
established a PPP unit in the National Treasury with the mandate to identify, prepare and close
PPP transactions in the public infrastructure space in South Africa. PPPs seem to have fallen into
disfavour in both the public sector as well as the private sector. It is important to explore the
reasons why PPPs have not met expectations in South Africa. A general perception exists that
PPPs are synonymous with privatisation. Privatisation has met with strong resistance in South
Africa and the privatisation perception even extends to the concept of private finance. More
importantly, PPPs are seen as being synonymous with project finance. This misconception has led
to a legislative framework being established for PPPs instead of a more general framework that
would enable and indeed facilitate project finance transactions – of which both PPPs and private
concessions would form subsectors.
The African continent has seen strong economic growth in recent years, but despite a significant
infrastructure backlog, only ten per cent of global private investment flowed to infrastructure in
Africa between 1990 and 2011, compared to 40 per cent to Latin America over the same period
(Wentworth, 2013). International infrastructure experts attribute this to the “shallowness of national
utility markets in Africa” and highlight the strategic importance of presenting regional infrastructure
projects to the private sector (Wentworth, 2013). Harris (2003) identified overstaffing and
mismanagement in the public sector in Africa as two of the factors that contributed towards
insufficient investment in infrastructure, inadequate planning, poor maintenance and unsustainable
sector governance in Africa. Chege (2001) identified the barriers to private sector involvement in
infrastructure projects as policy and regulatory concerns, weak domestic capital markets and the
high transaction and bidding costs. South Africa, however, has advanced financial and utility
markets, but still struggles to prepare bankable infrastructure projects.
11
Calitz and Fourie (2010) highlighted the importance and increasing acknowledgement by the public
sector of the need to separate bankable from non-bankable infrastructure projects. To this effect a
larger portion of traditionally tax-financed projects are now being regarded as self-financing
projects that can be financed within or outside government budgets. Calitz and Fourie (2010)
further made the very important observation that if more projects were financed on a self-financing
project finance basis, it would leave additional fiscal space on government budgets to finance the
non-bankable portion of the public infrastructure projects, i.e. where a ‘user pays’ principle could
not be applied. Calitz and Fourie (2010) identified the following factors as the main reasons why
South Africa’s ability to mobilise private capital (loans and equity) ranked superior to that of other
developing countries:
 South Africa’s well developed financial markets (trading of bonds and shares and in which
institutional funds represent an important source of funding);
 The South African government’s status as a borrower of good standing with a relatively good
credit rating;
 A programme of gradual and phased privatisation of public enterprises; and
 Steady development of public-private partnerships.
In considering the sources of loan financing, Calitz and Fourie (2010) importantly noted that South
Africa (as an upper middle-income country) was increasingly seen as a source of development
finance and donor funding rather than a destination. It is for this reason that private capital will
remain the primary source of loan and equity finance in South Africa.
In a study on the importance of infrastructure for growth in SSA, Estache, Speciale and Veredas
(2005) argued that inadequate infrastructure was a major constraint for sustainable and inclusive
growth in SSA. Foster and Briceno-Garmendia (2009) estimated that the SSA region required
around US$ 93 billion per annum to provide for the demand in infrastructure. Estache et al., (2005)
estimated the annual infrastructure spending requirement to be between nine per cent and 13 per
cent of GDP, against a norm of between five to six per cent (Gutman, Sy & Chattopadhyay, 2015).
Policy decisions are amongst the main factors contributing to the current infrastructure gap in SSA.
Calderon and Serven (2008) also found that the lack of adequate infrastructure was a major
constraint for economic growth in SSA.
Calderon and Serven (2008) identified geographical features (specifically the large number of land-
locked countries in SSA) and the remoteness of African economies to global markets as two of the
most important reasons why Africa was struggling to compete on global markets. This results in
higher transport costs, which directly impacts on the competitiveness of African economies in world
markets. High transportation costs further hampers intra and inter-regional trade and economic
development in SSA. Low population densities exacerbate the problem. This leads to the
importance of infrastructure in SSA in unlocking the region’s economic development potential.
12
Hulten (1996) argued the importance of the effective use of infrastructure and showed that the
inefficient use of infrastructure reduced some of the benefits generated by investments in
infrastructure. Hulten (1996) compared the growth experience in Africa with that of East Asia and
found that more than 25 per cent of the differential growth rate between these two regions could be
attributed to the difference in the effective use of infrastructure resources. When comparing low
and high-growth economies, Hulten (1996) found that more than 40 per cent of the growth
differential could be attributed to the efficiency effect, making it the single most important reason of
differential growth performance. Hulten (1996) further noted that private investments in
infrastructure (for example through project finance) had a far greater impact on economic growth
than public investment in infrastructure.
2.5 SUMMARY
In considering the extent of financial development in a country and the impact it has on economic
growth, it is important to consider both the quantity and quality of capital. Although the literature
reveals different perspectives, many researchers argue that the quality of capital is more important
than the quantity of capital. The quality of capital becomes even more important when considering
the primary function of financial systems as the facilitation and allocation of resources across
space and time in an uncertain environment.
The challenge remains for emerging and developing markets to grow their economies while
domestic financial markets and systems are still underdeveloped. This leads to the challenge of
finding the most appropriate type of finance that will attract investments into emerging economies
where financial markets are still underdeveloped and international capital flows are risky.
Project finance is a flexible financing mechanism, which can be adapted to different market
conditions and risk situations. Therefore, project finance is an ideal mechanism to be utilised in
underdeveloped financial markets. Project finance is also ideally suited for infrastructure projects,
which are often associated with high-growth investment characteristics.
13
CHAPTER 3
RESEARCH METHODOLOGY
3.1 INTRODUCTION
The question whether or not project finance contributes towards economic growth was based on
an empirical analysis, making use of secondary data. For the purpose of this study, the research
methodology and data analysis was based on the research by Kleimeier and Versteeg (2010). The
control variables chosen for the study were according to Alfaro et al., (2004), as well as Kleimeier
and Versteeg (2010), and comprise the most common variables used in the literature. A cross-
country analysis was performed on the African countries over the period 1 January 2000 to 31
December 2013.
3.2 DATA COLLECTION
The set of control variables was obtained through secondary data sources. GDP (in current US
dollars) and GDP per capita (calculated as gross domestic product divided by mid-year population)
were obtained from the World Bank’s World Development Indicators (WDI). Data on project
finance (PF) transactions was obtained from Thomson Reuters Loan Pricing Corporation’s
Dealscan Database. The project finance deals were obtained from the ‘Totals & Averages Report’
and grouped according to host country and year of financial close. Transaction values were based
on the debt component of each deal and excluded any equity component.
With regard to the control variables, data on schooling was obtained from the Barro-Lee
Educational Attainment Dataset (Barro & Lee, 2010) and reflects the average total years of
schooling in the adult population. Population growth (PG), government consumption (GC),
openness (trade volume), inflation and FDI were also obtained from the WDI. Population growth is
reflected through the annual population growth rate for year t being the exponential rate of growth
of mid-year population from year t-1 to t, expressed as a percentage. Government consumption
reflects the final consumption expenditure of households and government as a percentage of GDP.
Openness is defined as imports plus exports over GDP. Inflation is measured by the annual
growth rate of the GDP implicit deflator and shows the rate of price change in the economy as a
whole. FDI refers to direct investment equity flows in the reporting economy and is expressed in
current US dollars. The law variable reflects the ‘rule of law’ and captures perceptions of the
extent to which agents have confidence in and abide by the rules of society. The law variable was
obtained from the World Bank’s Worldwide Governance Indicators. Kleimeier and Versteeg (2009)
also used the black market premium (difference between the parallel and official exchange rate) as
a control variable, but due to this data set not being available for the sample countries over the
analysis period, this variable was excluded from the analysis.
14
3.3 DATA ANALYSIS
The methodology followed to determine whether project finance has an impact on economic
growth was analysed by way of a standard panel regression model using the following equation:
(3.1)
where K is the number of independent variables/regressors, β is a k-dimensional coefficient vector

to be estimated, xit is a k-dimensional vector of independent variables/regressors, and the uit term
determines the error structure. Both a one-way (where uit = ɣi + ϵit) and two-way (where uit = ɣi + αt
+ ϵit) fixed-effect model were analysed using three panels over the periods 2000 to 2005 (five
years), 2006 to 2010 (five years), and 2011 to 2013 (four years).
Missing data was as far as possible imputed by the average value of the corresponding panel, if at
least half of the observations for that panel was not missing. By following this approach, a
complete dataset could be formed after data aggregation to the three panels, except for the
Openness and Schooling variables. For the Schooling variable, missing values were imputed by
the average over the entire 14-year period, since the countries that had missing values had
missing patterns for more than half the observations in each period/panel. Openness was
calculated as (Imports + Exports)/GDP, but only for the years in which all three these variables
were present. Thus, for the imputed values, Imports, Exports and GDP were stored only for the
years in which none of these three variables were missing. Only those African countries that had a
cumulative Project Finance value of greater than zero (23 countries) were included in this study.
Table 4.1 contains a list of the countries that formed part of the study.
The aggregation approach and data transformation for the regression were done in the following
manner. Countries with no PF volumes during the study period from 2000 – 2013 were excluded,
resulting in N = 23 countries. Missing data for the years of PG, Inflation, and Law was imputed by
the average for the available data for the respective periods/panels. This could be done, since
none of these variables had more than half of their observations missing. For the Schooling and
Government Consumption variables, missing values were imputed by the average over the entire
14-year period, since the countries that had missing values had missing patterns for more than half
the observations in each period/panel. Initial GDP was calculated as the log of the GDP per capita
for the first year in each period/panel, i.e. this value will be the same for all years in a particular
period/panel. Openness was calculated as (Imports+Exports)/GDP, but only for the years in which
all three these variables were present. Thus, for the imputed values, Imports, Exports and GDP
were stored only for the years in which none of these three variables were missing.
The variables in the imputed table were then aggregated to create the variables to be inserted in
the models. Growth is the dependent variable and the mean value over each period was selected.
15
The PF values were aggregated (summed) and multiplied by 100 (for expression as a percentage)
and then multiplied by 1 000 000 (since the units are in millions of dollars), and divided by the
aggregated value of GDP per period. The FDI values were aggregated and multiplied by 100 (for
expression as a percentage), and divided by the aggregated value of GDP per period. Population
growth was calculated as the mean of the imputed values per period. Schooling was calculated as
log(1+mean(Schooling)), where the average was taken from the imputed values per period.
Inflation was calculated as log(3+mean(Inflation)), where the average was taken from the imputed
values per period. The ’3+’ term replaced the ’1+’ used by Kleimeier and Versteeg (2010), to avoid
errors when taking logs. This was necessary, because many African countries experienced
negative inflation over the study period. Law was calculated as log(mean(Law)), where the
average was taken from the imputed values per period. Government Consumption (GC) was
calculated as log(mean(GC)), where the average was taken from the imputed values per period.
Initial GDP had the same values for all years in a particular period. The Imports, Exports and GDP
variables used in calculating Openness were as described earlier, i.e. only used for the years in
which all three variables are non-missing. Openness was therefore calculated for each
period/panel, as the log(mean(Imports+Exports)*100/mean(GDP)).
3.4 SUMMARY
The research assignment is based on an empirical analysis of various control variables comprising
the most common variables used in the literature. The dependent and control variables were
obtained through secondary data sources and a cross-country analysis was performed on the
African countries over the period 1 January 2000 to 31 December 2013. A standard panel
regression model was used to determine whether project finance had an impact on economic
growth in the sample countries over the period 2000 to 2013. Both a one-way and two-way fixed-
effect model was analysed using three panels over the periods 2000 to 2005 (five years), 2006 to
2010 (five years) and 2011 to 2013 (four years).
The next chapter reports on the findings of the empirical analysis.

16
CHAPTER 4
FINDINGS
4.1 INTRODUCTION
The research is based on an empirical analysis making use of secondary data. A standard panel
regression model was used to determine whether project finance had an impact on economic
growth in the sample countries over the period 2000 to 2013. Both a one-way and two-way fixed-
effect model was analysed using three panels. The study focused on African countries with 23
countries forming part of the sample. The remainder of the countries did not have any significant
project finance transactions over the study period. The results of the analysis is provided and
discussed below.
4.2 MAIN FINDINGS
Africa consists of 54 countries (Worldatlas, 2015). Less than half (23 countries in total) of the
countries benefitted from project finance transactions over the period 2000 to 2013. Projects in the
23 countries attracted debt to the value of around US$ 74 billion over the period. South Africa,
Egypt and Nigeria were the African countries that benefitted most from project finance transactions
between 2000 and 2013, with transaction values of US$22.3 bn, US$14.8 bn and US$10.2 bn
respectively (see Table 4.1 below). The three African countries that benefitted the least over the
period were Libya, Malawi and Ethiopia, with transaction values of US$0.09 bn, US$0.1 bn and
US$0.2 bn respectively. It is interesting to note that Ethiopia and Libya were amongst the highest
growth countries, but had some of the lowest value of project finance over the study period. The
volume of project finance transactions is, however, small when compared to the GDP of the
recipient countries. When comparing the overall value of project finance transactions in the 23
countries (US$ 74 billion) over the study period, with the total GDP of the same countries of around
US$ 16 139 billion, it can be seen that the value of the project finance transactions only amounted
to around 0.5 per cent of total GDP. The three countries that showed the highest GDP over the
study period is again South Africa, Nigeria and Egypt (which countries also attracted the most
project finance transactions as was shown above). The value of project finance transactions to
GDP in these countries are 0.57 per cent, 0.38 per cent and 0.73 per cent respectively. According
to the World Bank Data (2015), out of the 23 countries forming part of the study, eight countries are
classified as upper middle-income countries, seven as lower middle-income countries and eight as
low-income countries.
Tables 4.2, 4.3 and 4.4 provide descriptive statistics for all 23 countries, the five highest growth
countries and the five lowest growth countries respectively. When comparing the annual volume of
project finance transactions in Africa, it is clear that the use of project finance has increased from
17
around US$ 1.2 billion in 2000 to around US$ 7 billion in 2013. The value of project finance
transactions was at its highest during 2008 and 2012, with values of around US$ 14.8 billion and
US$ 15.2 billion respectively. It is also evident from Tables 4.3 and 4.4 that higher-growth
countries attracted more project finance.
Table 4.1: Project finance-growth relationship for the period 2000 to 2013
Country income Mean PF
classification Mean Growth PF volume
Country name (% real US$ x
(World Bank Data, (%) (real US$ x million)
2015) million)
Gabon Upper middle income 0.212769 564 0.215261

Cameroon Lower middle income 1.046502 1 248 0.635688
Malawi Low income 1.246199 145 0.205881
Kenya Lower middle income 1.559665 1 308 0.252453
Mali Low income 1.685984 253 0.504239
South Africa Upper middle income 1.862886 22 349 0.571436
Algeria Upper middle income 1.986483 4 751 0.249991
Egypt Lower middle income 2.577357 14 845 0.729362
Burkina Faso Low income 2.821458 250 0.264322
Tunisia Upper middle income 2.931335 1 398 0.255139
Botswana Upper middle income 2.96008 1 670 1.130666
Uganda Low income 3.178182 492 0.551537
Morocco Lower middle income 3.330512 2 481 0.205143
Mauritius Upper middle income 3.352427 262 0.192569
Tanzania Low income 3.814725 792 0.391206
Zambia Lower middle income 4.074455 1 696 0.751948
Ghana Lower middle income 4.104203 6 778 1.559789
Libya Upper middle income 4.234792 89 0.008854
Mozambique Low income 4.342680 971 0.707251
Nigeria Lower middle income 5.157684 10 240 0.384311
Ethiopia Low income 5.912857 230 0.050647
Angola Upper middle income 6.018554 902 0.065024
Liberia Low income 6.639700 240 0.878688
Source: Author, 2015.

18
Table 4.2: Descriptive statistics per year for all 23 countries

Project finance in % of GDP
PF volume
Year Mean Standard Maximum
(real US$ x million)
deviation
2000 1 212 0.219483 0.830615 3.927041
2001 1 812 0.145331 0.878887 6.228519
2002 2 933 0.282349 1.159406 7.477466
2003 645 0.055727 0.320671 2.228796
2004 1 800 0.124973 0.526224 3.344153
2005 2 689 0.057826 0.229751 1.370341
2006 5 007 0.052641 0.270753 1.660875
2007 4 543 0.208301 0.688964 3.700511
2008 14 760 0.309532 1.078687 6.928921
2009 8 871 0.539523 2.257389 14.495140
2010 3 856 0.101266 0.445340 2.695963
2011 3 667 0.181171 0.777848 5.345665
2012 15 188 0.268582 0.748032 4.490860
2013 6 971 0.372647 1.748590 12.301640
Table 4.3: Descriptive statistics per year for five highest-growth countries
PF volume
deviation
2000 - - - -
2001 - - - -
2002 1 477 0.499688 1.117337 2.498441
2003 104 0.445759 0.996748 2.228796
2004 120 0.027321 0.061091 0.136604
2005 870 0.155013 0.346621 0.775067
2006 - - - -
2007 325 0.039050 0.087320 0.195252
2008 1 822 1.538129 3.019719 6.928921
2009 259 0.195883 0.309841 0.709058
2010 - - - -
2011 501 0.064234 0.115756 0.267010
2012 5 562 0.248342 0.525777 1.187958
2013 1 543 2.627158 5.410872 12.301640

19
Table 4.4: Descriptive statistics per year for five lowest-growth countries
PF volume
Deviation
2000 127 0.801283 1.633801 3.715197
2001 600 1.245704 2.785478 6.228519
2002 - - - -
2003 - - - -
2004 213 0.732221 1.466551 3.344153
2005 - - - -
2006 - - - -
2007 552 0.376873 0.628193 1.448768
2008 213 0.118679 0.265374 0.593395
2009 250 0.633191 1.263294 2.882337
2010 - - - -
2011 316 0.256104 0.419806 0.966627
2012 629 0.488503 0.536112 1.148857
2013 618 0.425309 0.676800 1.550908
Source: Author, 2015
Table 4.5 below provides detailed descriptive statistics for the variables used in the panel
regressions. On average, the cumulative inflow of project finance amounted to 0.47 per cent
compared to FDI inflow of around 4.5 per cent. It was, however, shown that the ratio of project
finance to GDP in a recipient country remained small. Table 4.1 also illustrated that some
countries experienced significant growth while the value of project finance in these countries
remained low.
20
Table 4.5: Descriptive statistics of variables

Variable Label Mean Std Dev Min 25th Pctl 50th Pctl 75th Pctl Max
Growth Growth (%) 3.26 8.10 -62.47 1.21 3.03 4.82 102.78
Initial Initial GDP 1390.69 1670.76 124.84 236.10 406.12 2245.33 6548.57
GDP per capita
(real US$)
PF perc PF (% of 0.47 1.49 0 0 0 0.12 14.50
GDP)
FDI perc FDI (% of 4.55 8.90 -5.98 1.07 2.81 4.76 91.01
GDP)
Schooling Schooling 4.07 1.85 0.91 3.05 3.76 5.44 8.28
(years)
PG Population 2.43 1.01 -2.63 1.67 2.63 3.01 6.68
growth (%)
GC Government 82.03 19.59 32.18 75.95 83.88 91.22 187.53
consumption
(% of GDP)
Law Law 28.60 20.73 0 9.13 27.38 44.98 82.69
Inflation Inflation (%) 9.93 15.32 -32.81 2.84 6.39 12.64 142.48
Openness Openness 72.74 27.03 30.73 53.88 66.62 90.87 179.12
perc (% of GDP)
The analysis followed a systematic process of removing insignificant variables in both the one-way
and two-way fixed-effect models. The fit diagnostics of the one-way and two-way fixed-effects
models were then compared to assess whether the time-effect plays a significant role in the fit of
the model. Tables 4.6 and 4.8 present the one-way and two-way fixed-effects models. The
adjusted r2 value is included as an additional measure. Tables 4.7 and 4.9 present the correlations
between the various parameters. A diagnostic plot for each of the two models is provided in
Annexure A.
21
Table 4.6: Diagnostic summary of the one-way fixed-effects model

Step Action SSE MSE Root MSE r2 F-test Adj r2
1 Removed Ethiopia, Mali and 111.87 3.4959 1.8697 0.6357 0.4503 0.294169
Namibia
2 Replaced countries, 126.4499 3.2423 1.8006 0.6545 0.0355 0.371013
removed Schooling
3 Removed FDI 126.5593 3.164 1.7788 0.6542 0.0262 0.386205
4 Removed Initial GDP 127.3472 3.106 1.7624 0.652 0.0081 0.397366
5 Removed Intercept 127.3472 3.106 1.7624 0.652 0.0031 0.397366
6 Removed GC 128.6444 3.063 1.7501 0.6485 0.0026 0.405798
7 Removed Law 130.38 3.032 1.7413 0.6437 0.0020 0.411691
Table 4.7: Correlations of parameter estimates of the one-way fixed-effects model

PF PG Inflation Openness
PF 1.00000 -0.08953 -0.07033 0.03111
PG -0.08953 1.00000 0.08758 0.16627
Inflation -0.07033 0.08758 1.00000 0.03179
Openness 0.03111 0.16627 0.03179 1.00000
Table 4.8: Diagnostic summary of the two-way fixed-effects model

Step Action SSE MSE Root MSE r2 F-test Adj r2
1 Removed Ethiopia, Mali and 109.5791 3.6526 1.9112 0.6432 0.5611 0.262613
Namibia
2 Replaced countries, 124.2405 3.3579 1.8324 0.6605 0.0633 0.348527
removed Schooling
3 Removed FDI 125.0819 3.2916 1.8143 0.6582 0.0510 0.361374
4 Removed Initial GDP 126.0385 3.2318 1.7977 0.6556 0.0181 0.373015
5 Removed Intercept 126.0385 3.2318 1.7977 0.6556 0.0076 0.373015
6 Removed GC 127.6436 3.1911 1.7864 0.6512 0.0067 0.380880
7 Removed Law 130.2724 3.1774 1.7825 0.6440 0.0058 0.383512
From Tables 4.6 and 4.8 it is shown that the additional αt vector estimated for a time-fixed effect is
not significant, and that the one-way fixed-effects model for the cross-sections (countries) only
yields a better fit. The full set of estimated parameters for the model is presented in Table 4.10.
22
Table 4.9: Correlations of parameter estimates of the two-way fixed-effects model

PF PG Inflation Openness
PF 1.00000 -0.13179 -0.13235 0.12595
PG -0.13179 1.00000 0.17202 0.09482
Inflation -0.13235 0.17202 1.00000 -0.05827
Openness 0.12595 0.09482 -0.05827 1.00000
Table 4.10: Parameter estimates

Standard t value Pr > |t|
Variable Estimate Label
Error
CS1 -5.00254 7.4111 -0.68 0.5033 Cross sectional effect 1
CS7 1.07445 6.7542 0.16 0.8744 Cross sectional effect 7
CS17 1.75474 7.6520 -0.23 0.8197 Cross sectional effect 17
PF 0.790896 0.3539 2.23 0.0307
PG -1.39942 0.4975 -2.81 0.0074
Inflation -0.87849 0.4200 -2.09 0.0424
Openness 2.84282 1.6553 1.72 0.0931
Source: Author, 2015

23
For completeness, a one-way random-effects model was also fitted to the data. The same model
that was developed for the fixed-effect models was used, but now assuming a random cross-
sectional effect, instead of a fixed-cross-sectional effect. The model fit statistics are shown in
Table 4.11.
Table 4.11: Model fit statistics for a one-way random-effects model

SSE MSE r2 DFE Root MSE
144.4694 2.1563 0.4052 67 1.4684
Although the mean squared error (MSE) and root MSE values are smaller than that of the one-way
fixed-effects model, the sum of squared errors (SSE) and r2 values are larger and smaller
respectively, which indicate that the fit has not improved. The corresponding adjusted r2 value is
0.017888, which is much smaller than the 0.411691 for the comparative fixed-effects model.
The Hausman test for random effects indicates that the random-effects model is valid (because of
the large p-value, the null hypothesis cannot be rejected).
Table 4.12: Hausman test for random effects

DF m value Pr > m
4 0.43 0.9802
The Breusch-Pagan test comes to the same conclusion (because of the small p-value, the null
hypothesis of no random effects is rejected).
Table 4.13: Breusch Pagan test for random effects (one way)
DF m value Pr > m
1 6.84 0.0089
Under the one-way random-effects model, the model parameters are presented in Table 4.14.
Table 4.14: Parameter estimates for one-way random-effects model

Variable Estimate Standard error t value Pr > |t|
PF 0.780659 0.2942 2.65 0.0100
PG -1.39002 0.3884 -3.58 0.0006
Inflation -0.85213 0.3435 -2.48 0.0156
Openness 1.964547 0.3357 5.85 <0.0001

24
A two-stage dynamic panel was also estimated, using generalised method of moments (GMM), to
ensure that the possible endogeneity issues that may arise are accounted for. Following Kleimeier
and Versteeg (2010), two instruments were incorporated: PF (Project Finance) and Inflation were
used along with their two lags, and in addition, a constant ’intercept’ term, and the dependent
variable itself. The model fit statistics are shown in Table 4.15.
Table 4.15: Model fit statistics for a two-stage dynamic panel

SSE MSE DFE Root MSE
116.7750 6.1461 19 2.4791
The Sargan test indicates that this model is also valid (because of the large p-value) as shown in
Table 4.16.
Table 4.16: Sargan test

DF Statistic Prob > ChiSq
39 18.52 0.9978
The model parameters and their associated p-values are shown in Table 4.17.
Table 4.17: Parameter estimates for two-stage dynamic panel model

Variable Estimate Standard error t value Pr > |t|
PF 0.644383 0.0873 7.38 <0.0001
PG -1.88654 0.3055 -6.18 <0.0001
Inflation -0.62731 0.0376 -16.68 <0.0001
Openness 2.151087 0.2032 10.59 <0.0001
The conclusion is similar to that of Kleimeier and Versteeg (2010), in that a valid model may still be
obtained, even after making absolutely sure that the endogeneity is accounted for.
The one-way fixed-effects model provided the best fit, with Project Finance, Population Growth,
Inflation, and Openness as regressor variables. Of these, the second most influential variable
(after Openness) proved to be Project Finance.
4.3 SUMMARY
An empirical analysis was done making use of secondary data. A standard panel regression
model was used to determine whether project finance has an impact on economic growth in the
sample countries over the 14-year period. Both a one-way and two-way fixed-effect model was
analysed using three panels. The analysis eliminated various countries from the initial group of
25
African countries due to the unavailability of data and concentrated on a sample of 23 African
countries. The results of the analysis proves that Project Finance is the second most influential
variable and that it did contribute towards economic growth in the sample countries over the study
period.
The next chapter provides a summary, conclusion and recommendations of the research
assignment.
26
CHAPTER 5
SUMMARY, CONCLUSION AND RECOMMENDATIONS
5.1 INTRODUCTION
In this study, the finance-growth nexus was investigated, with a specific focus on project finance. It
was shown that foreign capital flow into a country is often a function of the level of development of
the financial system in that country. Project finance as a specific financing mechanism is
particularly successful in attracting local and foreign capital to projects in perceived riskier markets,
i.e. growing economies with weak or underdeveloped financial, legal, institutional and governance
systems. Project finance is, therefore, an effective tool to finance projects in high-risk
environments.
financial markets. However, it is the ‘quality of capital’ that contributes towards and influences the
economic growth and development in an economy.
5.2 SUMMARY OF MAIN FINDINGS
Fixed-effects models were developed for modelling growth in African countries, as measured by
the log change in GDP. The one-way fixed-effects model provided the best fit, with Project
Finance, Population Growth, Inflation, and Openness as regressor variables. Of these, the second
most influential variable (after Openness) proved to be Project Finance. A one-way random-effects
model was also developed, but although valid, proved to have a poorer fit than that of the fixed-
effects model. A dynamic panel was used to assess the effect that possible endogeneity may have
on the model. For this, the coefficient for PF lowered from 0.790896 to 0.644383.
If all other model inputs are held constant at c, then the estimated coefficient of PF acts as a slope
parameter in a straight-line formula. An increase of one per cent in the aggregated (over three
years) value of PF, as a percentage of the aggregated (over three years) value of log change in
GDP, will have a 0.79 per cent increase in the average growth for that same three year period.
The results of this study are consistent with the literature and the findings of Kleimeier and
Versteeg (2010), and imply that project finance fosters economic growth. Kleimeier and Versteeg
(2010) specifically found that the effect of project finance was more profound in low-income
countries compared to middle and high-income countries. It was shown in this study, which
comprised low income, lower middle-income and upper middle-income countries that project
finance did contribute towards economic growth in the sample countries. This proves significant
given the specific challenges faced by the African continent in order to realise the growth
opportunities experienced over the past decade.
27
The importance of project finance for economies in Africa should, therefore, not be
underestimated. Not only does project finance provide a mechanism to finance large-scale
infrastructure (which is often the only financing mechanism available), but at the same time
contributes towards economic growth in a country. Improved economic growth will in turn lead to a
reduction in poverty and inequality and will contribute to the much-needed human capital
development on the African continent.
Although project finance is a complex financing mechanism, it is particularly successful in countries

with weak financial and legal systems. The use of project finance should be encouraged by
governments in Africa for the provision of public infrastructure. Project finance as an alternative
financing mechanism can play an important role in eradicating infrastructure backlogs on the
African continent. Policy changes should create an enabling environment conducive to and
promoting project finance as a preferred financing mechanism in African countries.
5.3 POLICY IMPLICATIONS
5.3.1 Africa
Sawant (2010) found in a study conducted on the economics of large-scale infrastructure

investment that “host governments can reduce the costs of project finance by implementing a
stable policy environment for project finance investments”. In a study conducted on infrastructure
finance in developing countries, Estache (2010) found that one of the main challenges to improve
service delivery was “the inability of reforms to address the complex institutional and political
characteristics of the infrastructure sector”.
It is, therefore, important for governments in Africa to encourage the use of project finance as a
mechanism to finance infrastructure by creating an enabling environment for the use of project
finance. Although project finance can be used in emerging markets and underdeveloped
economies, political support for the use of project finance is essential. Without a willingness by
governments to use project finance as a financing mechanism, the use of project finance will not
yield the intended results.
The following policy considerations will contribute towards creating an enabling environment for the
use of project finance:
 Support the notion of the private sector investing in, and sharing in the risk and profits of
providing infrastructure;
 Support the establishment of special purpose vehicles;
 Consider legislation that will streamline and simplify the legal environment to support the use
of project finance without compromising on best practice and the rule of law;
 Support the ‘user pays’ principle, encourage society to pay for services and encourage
appropriate cost recovery mechanisms;
28
 Establish a project preparation environment where projects are properly prepared, structured
and ‘de-risked’ to ensure bankability; and
 Create capacity within the public sector by providing training, skills development, and
ensuring continuity at official level.
It is further important for governments in Africa to consider and employ appropriate activities to
prepare projects and progress these projects to bankability. Such project preparation activities
should aim to successfully ‘de-risk’ projects in order to make them attractive for commercial banks,
development finance institutions and other funders to invest in the projects.
5.3.2 South Africa
It was mentioned above that South Africa is also facing significant infrastructure backlogs with
simultaneous pressure on the public sector responsible for the provision of the required
infrastructure. South Africa is in search of alternative funding sources and the involvement of the
private sector would relieve the pressure on the public finances.
Project finance provides a real solution to the problem. While project finance will enable the
provision of much needed infrastructure, it will, at the same time, contribute towards economic
growth in South Africa as was shown in this study. The South African government should,
therefore, consider project finance as an alternative financing mechanism, which can specifically
be applied to the trading services in the municipal environment, for example water supply,
sanitation, electricity and solid waste removal. South Africa is facing looming water shortages and
the municipal water services (water supply and sanitation services) sector requires critical
interventions. South African municipalities are primarily responsible for the provision of water
services. These municipalities are, however, facing increasing balance sheet lending constraints
and are consequently struggling to provide the required services and to meet the increasing
demands. It is specifically in this sector where the benefits of project finance can be maximised.
Project finance, however, is often incorrectly viewed as being synonymous with privatisation. This
misconception ultimately leads to strong resistance from civil society, labour unions, etc.,
especially with the provision of potable water supply being an essential service. Project finance
should, however, not be confused with privatisation as it is possible to apply the principles of
project finance in the public sector without relinquishing ownership and control to the private
sector.
The success of project finance in South Africa (and specifically in the municipal environment) is
dependent on the following factors:
 The political will to employ project finance for the provision of public infrastructure;
 Application of the ‘user pays’ principle and the will to enforce the necessary cost recovery;
 Cross-subsidisation between the rich and the poor to account for economic vs. social
projects;
29
 Consolidation and gearing of grant funding (to unlock commercial funding and ensure
affordability);
 Capacity, expertise and continuity of municipal officials at local government level; and
 Acceptance and support by organised labour of the use of project finance.
5.4 RECOMMENDATIONS
It is recommended that governments throughout Africa take notice of the benefits of project finance
in the provision of infrastructure and the way in which it contributes towards economic growth. It is
important for governments to provide the enabling environment to support the use of project
finance. By creating a friendly and conducive environment for the use of project finance,
governments will be able to attract foreign capital to perceived high-risk environments, which would
otherwise not receive quality capital investments. This will relieve the pressure on the public sector
for the provision of infrastructure, which will in turn support economic growth.
Governments should make the necessary policy changes to ensure the successful implementation
of project finance. Policy changes may include amendments to existing legislation to facilitate the
establishment of special purpose vehicles, changes to the legal system governing the public
sector, changes to procurement systems and the manner in which unsolicited bids are considered,
and strengthening public sector institutional capacity.
By creating a conducive policy and regulatory environment, governments will be able to create
international best practice and attract foreign investors to invest in much needed infrastructure in
Africa.
5.5 FURTHER RESEARCH
This research has shown that project finance in general serves as a driver of economic growth in
African economies. Future research can focus on:
 Appropriate project preparation methodologies to effectively structure projects for project
finance transactions;
 Determining whether there are specific sectors in which project finance are more successful
than others; and
 Determining the key bottlenecks that impact on the application of project finance in the
municipal sector in South Africa.
30
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36
APPENDIX A:
DIAGNOSTIC PLOTS
Figure A.1: Diagnostic plot for the one-way fixed-effects model
Source: Auhtor, 2015.

37
Figure A.2: Diagnostic plot for the two-way fixed-effects model
Source: Auhtor, 2015.
The correlation pattern is changed somewhat as compared to the one-way fixed-effects model
however, none of these correlations are particularly large.

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Project finance as a driver of economic growth in Africa

Research assignment presented in partial fulfilment

Degree of confidentiality: A December 2015

JJ Lübbe 5 October 2015

Copyright © 2013 Stellenbosch University

Although project finance is a complex financing mechanism, it is particularly successful in

APPENDIX A: DIAGNOSTIC PLOTS 36

List of acronyms and abbreviations

1.2 PROBLEM STATEMENT

1.3 RESEARCH OBJECTIVES

The purpose of this research is to:

1.4 IMPORTANCE/BENEFITS OF THE STUDY

 To promote project finance as an alternative funding mechanism for infrastructure

1.5 CHAPTER OUTLINE

2.2 THE FINANCE-GROWTH NEXUS IN THEORY

2.3 PROJECT FINANCE AS A CONTRIBUTOR TO ECONOMIC GROWTH

 Mobilise savings and facilitate transactions: Project finance by definition is aimed at

2.4 INFRASTRUCTURE DEVELOPMENT IN AFRICA

3.2 DATA COLLECTION

3.3 DATA ANALYSIS

where K is the number of independent variables/regressors, β is a k-dimensional coefficient vector

The next chapter reports on the findings of the empirical analysis.

4.2 MAIN FINDINGS

Gabon Upper middle income 0.212769 564 0.215261

Source: Author, 2015.

Table 4.2: Descriptive statistics per year for all 23 countries

Source: Author, 2015.

Source: Author, 2015.

Source: Author, 2015

Table 4.5: Descriptive statistics of variables

Source: Author, 2015.

Table 4.6: Diagnostic summary of the one-way fixed-effects model

Source: Author, 2015.

Table 4.7: Correlations of parameter estimates of the one-way fixed-effects model

Source: Author, 2015.

Table 4.8: Diagnostic summary of the two-way fixed-effects model

Source: Author, 2015.

Table 4.9: Correlations of parameter estimates of the two-way fixed-effects model

Source: Author, 2015.

Table 4.10: Parameter estimates

Source: Author, 2015

Table 4.11: Model fit statistics for a one-way random-effects model

Source: Author, 2015.

Table 4.12: Hausman test for random effects

Source: Author, 2015.

Source: Author, 2015.

Table 4.14: Parameter estimates for one-way random-effects model

Source: Author, 2015.

Table 4.15: Model fit statistics for a two-stage dynamic panel

Source: Author, 2015.

Table 4.16: Sargan test

Source: Author, 2015.

Table 4.17: Parameter estimates for two-stage dynamic panel model

Source: Author, 2015.

5.2 SUMMARY OF MAIN FINDINGS

Although project finance is a complex financing mechanism, it is particularly successful in countries

5.3 POLICY IMPLICATIONS

Sawant (2010) found in a study conducted on the economics of large-scale infrastructure

5.3.2 South Africa