Financial opportunities and challenges faced by SMEs in advancing green business development in Africa

This session will look at the financial opportunities and challenges faced by MSMEs in advancing green business development in Africa. It will look at private and public sources of financing for green business development.
Good morning ladies and gentlemen,
Post the 2015 Paris Climate Change Conference, or COP 21, the role of the private sector in both implementing and financing climate change mitigation and adaptation initiatives has escalated. The side-effects of climate change upon economic activity is no longer solely the responsibility of the state. Indeed, if green growth is not adopted amongst all economic agents, then climate change will threaten widespread global economic activity. This does not only apply to large polluting enterprises, but to all industries, including small and medium enterprises (SMEs).
As a quick side-note, I am sure that over the course of this workshop we are all by now very familiar with the concept of green growth. But, if you let me, I will quickly explain that the definition I follow is one frequently adopted amongst the international community. That is:
Green growth describes economic activity that benefits job creation or economic growth and is compatible with, or driven by, reduced emissions, improved efficiencies in the use of natural resources and the protection of ecosystems.
Now I will return to the importance of SMEs in facilitating green growth.
Particularly in Sub-Saharan Africa, where large informal sectors are characterised by either the self-employed or small and medium-sized enterprises (SMEs), SMEs provide an enormous contribution to the economy. Successful SMEs tend to locate themselves in an integral position in value chains, therefore becoming essential to economic activity in certain sectors and significant to economic value addition. The dominance of SMEs also renders their importance to employment and job creation significant.
Therefore, SMEs are vital in Africa to stimulate value addition and employment, and so ultimately to achieve industrialisation and economic development. Given the importance of SMEs to industrialisation and economic development, it is imperative that they are shown the importance of, and sufficiently incentivised, to operate in a sustainable manner to achieve the objectives of ‘green growth’.
Fortunately, SMEs are well positioned to adapt to the transition towards a globally green environment. Overcoming the challenges of climate change requires the adoption of new technologies and practices. Yet, to maintain their competitive edge, SMEs tend to be more innovative than larger industries and are more flexible and less constrained when adopting new innovations. Furthermore, as I have already mentioned, SMEs tend to be intimately positioned within value chains. This characteristic increases the opportunity of beneficial spill-over effects and green knowledge gains throughout the value chain.
However, we are all aware that individually, both SMEs and green business development are particularly susceptible to suffer from financing shortfalls, or tight financing conditions. Combining the two is likely to exacerbate the financial constraints suffered by each entity, despite increasing their importance in a new economic environment. This presentation will now focus on the financing challenges faced by SMEs when adopting green developments, before considering how those challenges may present new opportunities to SMEs when sourcing green financing.
Challenges and opportunities
As I hinted above, SMEs operating in green business are particularly susceptible to a harsh financing environment. The challenges vary from higher upfront capital costs, lesser SME investment capacity and financial competence amidst higher interest costs, lacking green technical competence amongst smaller financial institutions and a generally weaker African financial system.
Now, let’s explore the challenges in a little more detail to see how we might overcome them.
Higher upfront capital costs: leapfrogging
Unavoidably, the whole world will have to adopt green business development in the foreseeable future. Although developed countries industrialised under mass coal burning, this is simply not an option for Sub-Saharan Africa. Given the current state of the world and the substantial, and rapidly growing, Sub-Saharan African population, a repeat of European industrial revolutions across Sub-Sahara would be extremely detrimental to the planet, very likely to tip climate change beyond the point of return.
So Sub-Saharan African countries have no choice but to adopt green business development as they pursue economic development, whilst developed countries must adapt their economies similarly.
Initially, this may appear as an extra challenge in the African development saga, yet this may not be wholly true. There is an opportunity for Sub-Saharan countries to use their deficits, particularly in infrastructure and industry, to leapfrog to more modern, efficient and ultimately green technologies. By skipping the less efficient and more dirty technologies that were utilised by developed countries in their development and implementing green technology from the onset, Sub-Saharan Africa may actually accelerate their development.
By comparison, many developed countries may incur sizeable costs in transitioning their industry and infrastructure from its current state to the green alternative.
Ultimately, the relatively high upfront capital cost of green business development is a prerequisite. Therefore installing green technologies from the onset to aid economic activity, rather than transitioning at a later date, may actually be the least cost option.
Higher upfront capital costs: energy
Admittedly, green business developments do tend to incur larger initial capital costs than their less environmentally friendly counterparts. Quite simply, green technology tends to be more expensive. However, the main reason why green technology is more expensive at present is that the technology is newer. The cost of green technology has fallen in the recent period and will continue to do so over time as new innovations reap efficiency gains.
Furthermore, green technology typically has a lower operational cost. In fact, when calculated over the long-term, the cost of green interventions diminishes substantially.
Although, energy is more typically generated and distributed by large enterprises and not SMEs, it provides an easy example for cost comparison purposes. A recent Citibank study estimates that between 2014 and 2020, USD 190 trillion will be invested in energy to meet the growing global demand. If 40 per cent of the USD 190 trillion investment, or USD 76 trillion, is invested in renewable sources of energy then there will be a cost saving of USD 1.8 trillion. Admittedly, this figure is negligible when compared to the gross investment. However, if no additional resources are dedicated to renewables than at present, the cost of environmental damage incurred is likely to amount to USD 72 trillion.
It might quickly be worth highlighting that renewable energy can also be produced at a small scale with minimal running cost. For example, domestic solar generators, which are particularly efficient in sunny African climates, may offer free power to a household once installed.
Therefore, when considering the often larger up-front cost of green investments, one should not forget the longer run operational costs, or the often overlooked cost to the environment, both of which may render green investments cheaper in the long-term. Thus the high capital cost of many green investments should not be a challenge per se, they just require more long-term financing before they become profitable. In this case, perhaps a key challenge to financing SMEs undertaking green business development in Africa is a lack of long-term financing and underdeveloped financial markets.
Lack of long-term financing and underdeveloped financial markets
Financial markets in Sub-Saharan Africa are famously underdeveloped, characterised by inadequate regulation, prohibitively high interest rates, capital markets that are dominated by short-term government securities and a lack of diversity in financial instruments. The lack of financial development more acutely affects SMEs, who do not have the reputation to assure risk-averse financiers in a relatively unregulated environment, who are not large enough to transact on capital markets, nor are they provided for by the financial sector with specialist financial instruments.
On the whole, SMEs are more likely to seek finance from trusted local micro-finance institutions. However, whilst micro-finance institutions may be better equipped to serve SMEs, they lack the knowledge and business acumen of larger financial institutions. Micro-finance institutions are less likely to appreciate the importance and future prosperity of green business development and so are at a greater risk of overlooking the sector.
However, this situation is not completely hopeless. Sub-Saharan Africa is currently experiencing rising FDI inflows, which will circulate throughout the economy, should encourage investment and ultimately financial market development. As financial markets develop, a wider range of financial instruments will enter the market that will be better suited to SMEs following green business development.
Lesser SME investment capacity and financial competence amidst higher interest costs
As mentioned above, financial markets in Sub-Saharan Africa suffer from prohibitively expensive interest rates. Green SMEs may suffer disproportionately high interest rates due to their lack of collateral that may be used for security and due to the greater perceived risk involved in financing new technologies. In addition, SMEs may be perceived to be a greater risk to investors as their size may limit their investment capacity and the financial competence of their staff; even if the enterprise is large enough to boast a finance department, they may not be able to attract the best financiers.
Yet, a vast opportunity lies in the enormous amount of capital set aside by developed countries to promote green business development amongst developing countries. Take for example, the Green Climate Fund. The Green Climate Fund was designed under the United Nations Framework Convention on Climate Change to support green projects, programmes and policies, amongst others in developing countries. Post the 2015 Paris Climate Change Conference, the Green Climate Fund has been reinforced and aims to raise USD 100 billion per year to finance green business development.
The Green Climate Fund is just one example, but across the public sector and private sector, donors and investors are increasingly searching to finance green business development.
So by adopting green business development, SMEs in Sub-Saharan Africa may actually increase their sources of available funding and advance their reputation in an increasingly green business environment.
Naturally, SMEs are likely to be financially constrained when conducting green business development in Sub-Saharan Africa. Indeed, most businesses in the region are somewhat constrained under shallow financial markets. Green SMEs are particularly constrained under their higher perceived risk, their specific need for more long-term financing and for specialist financial instruments.
However, at present, there are a number of exciting opportunities for green SMEs that promise vaster, and more specific, support than ever before.
Firstly, Sub-Saharan Africa is a growing recipient of FDI inflows. If well harnessed, expanding FDI inflows promise greater investment to the region, which will undoubtedly benefit green SMEs, but also expanding FDI inflows promise financial market development. Financial market development will greatly benefit green SMEs by increasing the range of investments sought by financiers and by introducing a wider pool of financial instruments, some of which are likely to better meet the demands of green SMEs.
Secondly, SMEs adopting green business development benefit from the opportunity to leapfrog older, less efficient technology and practices and immediately embrace newer, green and more efficient technologies. Their increased business flexibility over larger enterprises allows faster uptake of more modern innovations, which will increase their efficiency and competitive edge.
Thirdly and finally, there is already an enormous pool of capital devoted to funding green business development in developing countries, some of which is specifically targeted at SMEs, and some of which is less specific. However, by employing green business development, SMEs may actually be increasing their chances of obtaining tailored financing.
Ultimately, green business development is not a preference, not for developed countries, not for large enterprises working in developing countries, and not for SMEs working in developing countries. It is mandatory to protect our planet. All industries, including SMEs, must work towards green business development. There is definitely ample space for policy makers and financial institutions to do more to support green SMEs, however vast, and growing, opportunities do already exist for SMEs to develop in a green business environment, which are waiting to be harnessed.