A small but definite trend has begun in attracting private capital to Africa as countries take more responsibility for finding the resources to achieve their poverty reduction targets.

To halve the number of Africans living in poverty by 2015, Africa needs to fill an annual resource gap of $64bn, according to estimates from The New Partnership for Africa’s Development (Nepad). This equates to 12% of the continent’s GDP.

Last year, sub-Saharan Africa attracted net capital inflows of $27.9bn, which include foreign direct investment (FDI), portfolio flows, bond proceeds, bank and official loans and aid.

To emphasise the point: Africa requires $64bn over and above this. And with no indication of an imminent large increase in aid, it must attract greater volumes of private capital.

Risk – both real and perceived – is frequently cited as the primary reason for constrained capital flow to Africa. Given the wealth of natural resources, infrastructure requirements and ongoing privatisation of state-owned enterprises, there is no shortage of attention-grabbing investment possibilities. There is also a growing list of successful projects, be they in the extractive industries or telecommunications. And the returns on FDI to Africa are higher than in other regions – about 30% on US investments, compared with 21% for Asia-Pacific and 14% for Latin America. However, on a risk-adjusted basis, returns on investment are far less impressive.

A perception has grown – based on ample experience – that African governments lack the political commitment to long-term policy reforms that would improve their investment environments. Because of this, investors associate Africa with a broad set of variables that raise risks or lower expected returns on investment. These include unstable and uncertain macroeconomic environments; poor governance (including corruption, limited rule of law and lax enforcement of contracts); inadequate legal and regulatory frameworks; poor infrastructure; weak human capital development; and weak financial systems.

Success in turning such perceptions around requires a package of policy interventions, commitment and a lot of patience.

Forces of attraction

African countries are acknowledging the need to attract investment and are mobilising towards this end with the assistance of various bodies, such as the Organisation for Economic Co-operation and Development (OECD), World Economic Forum, various United Nations agencies, the World Bank and the International Monetary Fund (IMF). Increasingly, it is no longer a question of what needs to be done but rather who has the will to do it.

Given that Africa is a diverse continent with heterogeneous legal systems, currencies, and investment, trade and finance rules, there are no quick fixes. Reform will take some time to bear fruit. African states understand that to attract foreign investment they must embark on many of the reforms that investors (both foreign and domestic) seek. These include privatisation, tax reform, legal and administrative transparency, and good governance. In the process of attracting foreign investment, they must also take measures to improve the domestic environment in general and make it easier for Africa’s own entrepreneurs to succeed.

Participants at a meeting of the OECD-Africa Investment Initiative for Growth and Development last year pointed to the emergence of a multi-side dynamic bargain. Clearly, the greatest responsibility for Africa’s growth lies in its own hands. If economic prosperity is to be achieved, African governments will have to accelerate the reform process. They will need to liberalise their economies, reduce their debt and regenerate their education systems. If they fail to tackle these challenges, then no amount of private capital will suffice.

The UN Development Programme (UNDP) aims to monitor, and indirectly improve, governance in Africa. The agency has partnered with ratings agency Standard & Poor’s (S&P) to provide credit ratings for sub-Saharan countries, subsidising the heavy cost of this process. In the latest phase, Mali was assigned a B long-term and B short-term rating by S&P.

Ratings benefits

Mali, one of the world’s poorest nations, is the fifth country to receive a credit rating under the initiative. The rating will help to give it access to international capital markets and – more importantly in the short term – provide current economic data to potential investors.

Ghana was the first country to be analysed by S&P under the initiative, getting a B+ long-term sovereign credit rating in September 2003. Cameroon was next, receiving a B long-term and B short-term rating in November 2003. Benin was given a B+ long-term and B short-term sovereign credit rating in December 2003, and Burkina Faso was assigned a B rating in March 2004. More sub-Saharan African countries are expected to receive ratings this year.

“Through this project, UNDP intends to support countries in their efforts to mobilise resources from private capital markets, which are required to secure accelerated rates of economic growth and reduce poverty,” says UNDP associate administrator Zéphirin Diabré. “With this rating, Mali appears on the map of rated countries and increases its visibility on the international financial scene. The rating will increase the capacity of Mali to mobilise financing and allocate additional resources to poverty reduction and the achievement of the Millennium Development Goals.”

Though Mali is not expected to tap the capital markets soon, a rating serves two other equally important roles. First, it is an independent assessment of a country’s economic and political management, overcoming a key challenge facing potential investors: a lack of reliable, independent information about countries and markets. And second, it is ballast against forces that may upset reform efforts. Having got the rating, there is an inherent incentive to earn an upgrade rather being subjected to the ignominy of a downgrade.

Combined, the APRM and the UNDP’s ratings initiative go some way to addressing another problem: a generalised view of Africa. Under-resourced and lacking know-how, Africa’s investment promotion agencies have struggled to register with potential investors, and are often overshadowed by wealthier, more aggressive agencies in other parts of the world. As a consequence, perceptions prevail that the same problems are common across Africa, represented most often by war, famine and corruption. Distinctions between countries like Uganda, which has had more than 10 years of sound economic management, and Malawi, which has pursued a far less ambitious reform agenda, are not often made. Credit ratings, in particular, are a comparable, independent means of separating the good from the bad.

Search for transparency

Individual countries are taking a leading role in addressing specific shortcomings in their operating environment. One such problem is corruption. Africa’s worst offenders – Nigeria, Angola and Kenya, according to anti-corruption monitoring and campaign group Transparency International – have all embarked on anti-corruption drives. Nigeria has signed up to the Extractive Industries Transparency Initiative, a more transparent means of accounting for payments to government. Angola is working with the IMF to improve transparency in its oil and gas sector. And in Kenya, President Mwai Kibaki put corruption at the top of his agenda when he came to power. Like other reforms, there is no quick fix but there is more vigour in dealing with the problem than before.

Regional co-operation

Africa is also realising the advantages of regional integration, recognising that most countries are not only poor but also small. Regional integration is seen as critical to creating a larger economic space, with more opportunities for investors and entrepreneurs.

There are considerable unexploited opportunities in Africa to promote growth through regional co-operation. Creating larger, more integrated markets, facilitating cross-border investment and allowing the free movement of people, carries economic and political benefits. Existing initiatives – including the Economic Community of West African States, the Common Market for Eastern and Southern Africa, the Community of the States of Central Africa, the Southern African Development Community, the Central African Economic Community and the West African Economic and Monetary Union – are designed to gain from economies of scale and attract investment.

Capital markets

Just as important as attracting FDI, strengthening Africa’s capital markets is crucial to attracting private capital. African stock exchanges delivered some of the highest rates of return in 2003. In dollar terms, the bourses in Ghana and Nigeria were up 144% and 98% respectively. That is not enough to attract investors, however. Apart from South Africa, stock exchanges on the continent are shallow and illiquid, transaction costs are high and regulatory frameworks are weak. This is on top of country-specific political and economic risks.

“These are issues that bother investors … there is a concern about the robustness of [African] markets. This concern is largely to do with poor market infrastructure that results in delays in trade and settlement; lack of transparency as a result of weak regulation; and illiquid markets that prevent investors from liquidating their interests quickly,” said Patrick Asea, director of the economic and social policy division of the UN Economic Commission for Africa, speaking at an Africa capital markets meeting in Egypt in March.

But the stock exchanges exist and that is a start. There were just six in 1998; now there are more than 20. And, much like the moves to attract FDI, there is a growing consensus about the measures needed to enhance these markets. This includes improvement to market infrastructure, and strengthening regulatory and legal frameworks. Such improvements take time, financial and technical resources, and will. Support from various bodies, including the UN Economic Commission for Africa, the UNDP and the New York Stock Exchange, is important in providing funding and technical know-how.

The potential is significant. The stock of capital flight from sub-Saharan Africa is estimated at $148bn, representing about 33% of the private wealth of the continent, compared with less than 10% in Asia and Latin America. The reasons: investments offshore have historically offered a better risk-adjusted return; and there has been a dearth of instruments in which to invest.

Ndi Okereke-Onyiuke, head of the African Stock Exchanges Association and director general of the Nigeria Stock Exchange, is an indefatigable campaigner for Africa’s stock exchanges. Her first priority is make sure that Africa’s exchanges attract the attention of offshore analysts and traders by getting the continent’s largest corporations listed on local bourses. She is trying to put pressure on the Nigerian government to get oil exploration companies listed on the country’s stock exchange. She is also pushing for privatisation, keenly awaiting the day when Nigeria’s telecommunications company, NITEL, and the National Electric Power Authority list. Such large stocks, she says, would give investors something to look at.

Consolidation ahead

The long-term goal is, inevitably, consolidation. According to Ms Okereke-Onyiuke, an eventual landscape may be one in which Nigeria leads the merger of west African stock markets, South Africa leads the merger of southern African stock markets, and Nairobi and Tunisia lead the merger of eastern and northern African stock markets respectively.

Consolidation will prove to be a matter of survival. South Africa’s stock exchange has invested heavily in infrastructure and supervision, ensuring that the Johannesburg Securities Exchange remains at the forefront of technological and supervisory trends. The price has been an increasing number of delistings – in part a consequence of rising compliance costs. South Africa has also had to weather the impact of some of its largest corporations, such as Anglo American and SA Breweries (before its merger with Miller), moving their primary listings to international exchanges because, they claimed, they could lower their cost of capital by tapping global demand.

New culture needed

If Africa’s biggest and most sophisticated stock exchange is struggling, what possible hope is there for the continent’s other bourses? Ms Okereke-Onyiuke agrees that consolidation is inevitable but believes that Africa needs to develop a stock exchange culture first, appealing to companies and investors alike. Without it, there will not be anything to consolidate.

The situation is not hopeless. Recognition of the value of strong capital markets spurred the International Finance Corporation (IFC), the private sector arm of the World Bank Group, to announce in April that it would become an anchor investor in the newly-formed Emerging Markets Small Cap Fund. The fund has a global focus and will invest primarily in companies listed in emerging markets with market capitalisation below $500m. The fund has an initial target size of $200m and will be managed by Emerging Markets Management (EMM).

“Investors and market researchers often pay too little attention to smaller listed companies, especially in the emerging markets. The Emerging Market Small Cap Fund will demonstrate the value of investing in this sub-asset class. IFC’s engagement will help to attract other private sector investors and increase trading volumes and liquidity,” says Teresa Barger, the IFC’s director for private equity and investment funds.

Market movements

Despite dwarfing the rest of the continent, South Africa’s capital markets are not the only ones to show signs of life. In April, the East African Development Bank (EADB) announced that it would issue a $20m bond equivalent in Kenya shillings through private placement in Kenya – the first seven-year instrument in the Kenyan market. The bonds previously issued by the bank have had three, four and five-year tenures.

EADB director general Godfrey Tumusiime says: “Since EADB pioneered the issuing of corporate bonds in the region in 1996, it has had a successful bond issuing and servicing experience, mobilising about $90m, which has been invested in the productive sectors of the three East African economies. The seven-year bond is part of the bank’s intervention to strengthen and deepen the capital markets in the member states.”

The EADB plans to issue a $15m bond this year in the Tanzania market. Plans are also under way to issue longer dated tenures of up to 10 years. Last year, Tanzania’s first corporate bond issue took place.

Elsewhere, Botswana launched its inaugural government bond last year. Even Sierra Leone, which has only recently emerged from civil war, was tapping the market. The west African country issued its first government bonds raising $71.3m, which will help the government to rebuild the war-ravaged country.

These are small examples but they are indicative of a trend. It is unlikely that Africa will drown under a deluge of private capital soon but there are clear signs that the countries want to assert more responsibility for resolving the problems themselves.

Self-help mechanism The African Peer Review Mechanism (APRM), an offshoot of Nepad, is responsible for monitoring the quality of political and economic governance in African countries. Consistent with the broader aims of Nepad, the objective is to ensure that countries’ policies are generally pro-growth. The first review will begin soon in Ghana; 15 other countries have volunteered to undergo assessment.

The APRM is important for two reasons. First, it marks a more muscular approach to persuading countries to implement and adhere to prudent political and economic policies. And because it is an African-inspired, owned and managed process, it stands a better chance of success. Whatever their merits and no matter how pure the intentions of outsiders, Africans are inherently suspicious of foreigners dictating political or economic terms.

Second, the APRM is not just a monitoring vehicle; it is also a vehicle for mutual learning and developing a blueprint for good governance and best practice that is proven in Africa. By observing, learning and sharing, the APRM is well placed to evolve a domestic policy framework for FDI in Africa, including general laws and regulations, public services, macroeconomic policy, customs procedures, the regulation of FDI, incentives and trade-related investment measures.

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