As other emerging markets falter, sub-Saharan Africa is attracting growing volumes of international capital. Risks in the region remain higher than average but, as political, economic and governance conditions improve and as African market structures evolve, they are risks that more investors are prepared to take. Ironically, there is now a danger of too much interest in the capital markets.
Inflows of private capital to the region rose to an estimated $53bn in 2007, according to the International Monetary Fund (IMF). That compared with $11bn in 2000 and $48bn in 2006, when private flows outstripped official aid (2006: $40bn) for the first time ever.
Foreign direct investment (FDI) made up $21bn of last year’s flows to sub-Saharan Africa, nearly half of it to Nigeria (29%) and South Africa (18%). While FDI has been relatively steady, fluctuating between $15bn and $21bn in the past few years, portfolio investment has grown rapidly from a tiny base. In 2006, it reached $23bn – 14 times the level in 2003. It fell to an estimated $20bn last year, mainly because of a $4bn decline in flows to South Africa.
South Africa still received 88% of the portfolio inflows, however, but the IMF reports a rising trend in countries such as Ghana, Kenya, Tanzania, Uganda and Zambia, thanks to improved risk ratings and attractive yields.
Awakening interest
South Africa has been on international radar screens for many years, but the same has not long been true of countries north of the Limpopo River. It is there that the awakening interest is focused, as the climate in many countries grows more benign.
“There has been a perfect storm,” says Rupert Boyd, global head of distribution at Standard Bank. “It’s a combination of debt relief, strength in commodity prices, a recognition of liberal democracy and improved understanding of the need to provide the right climate for business.”
Nigeria paid off its Paris Club debts – totalling about $30bn – in 2006. The Heavily Indebted Poor Countries (HIPC) programme started by the IMF and World Bank has been providing debt relief for many others, including Ghana, Tanzania, Uganda and Zambia. Now these countries can spend money on physical and social infrastructure instead of just servicing their debts. Nigeria is building roads and bridges for the first time since independence. Ghana is finally attending to its exhausted energy and transport infrastructure.
Infrastructure deficit
Some Africa commentators point out that the infrastructure deficit in the continent remains enormous and that the real challenge is to find a way of attracting private investment into viable and secure projects. Nonetheless, increased state spending is filtering into the wider economy.
| “Government spending is making a key difference,” agrees Joseph Rolm, a vice-president at fund managers T Rowe Price International, whose Middle East and Africa fund, launched last September, has attracted $800m. “It is very positive. Governments are spending for the first time ever in a meaningful way and a lot of it is going into infrastructure.” |
| “We have seen the average debt burden fall from 60% to 20% of GDP over a decade,” says Stuart Culverhouse, chief economist at Exotix, a boutique investment bank that specialises in frontier markets. “You can’t underestimate the positive exogenous shocks, like rising oil and commodity prices, but they would have meant nothing without domestic improvements. We have seen high commodity prices before but the proceeds were frittered away.” |
Sovereign ratings
The award of sovereign credit ratings has made it easier for investors to justify committing funds. Ghana received a B+ long-term currency rating from Standard & Poor’s (S&P) in 2003. Nigeria got its first ratings in 2006: BB- from both Fitch and S&P. Earlier this year, S&P cut Kenya’s rating from BB- to B+ after the outbreak of political violence in the country.
Domestic treasury bill and bond markets have developed across the continent, encouraged by the fact that tapping local currency markets provides insulation from foreign exchange movements. There is, however, little secondary trading, and bringing liquidity to bond markets is one of the region’s challenges.
Kenya has the most developed market and the most developed yield curve, with regular auctions and primary bidders, and tenors of up to 15 years. Maturities are being extended in some other markets, with Nigeria, Uganda and Tanzania now issuing out to 10 years and Botswana to 12. Other relatively advanced bond markets can be found in Zambia (which, along with Uganda, has abolished all capital controls), Ghana and Mauritius.
In the past 18 months, attractive yields have been drawing foreign investors into selected local currency debt markets. Some are not convinced that relaxing capital controls, and so exposing the currency to the herd mentality of foreign investors, is always a good idea.
“This type of purchase of government securities is of concern to the authorities – in bigger countries as well as smaller ones – because of the difficulties it creates in managing [foreign exchange] risk,” says Michael Fuchs, lead financial economist for Africa at the World Bank.
“I have heard of one small country where the purchase of such securities in pass-through form has been equivalent to half its foreign exchange reserves.”
International splash
It is in the international debt capital markets that the region has been making a splash recently. The African Development Bank (AfDB) began spotlighting regional currencies in 2005, when it issued bonds denominated in Botswanan pula that were equivalent in value to about $40m. In 2006, it followed up with a smaller issue in Tanzanian shillings and another in Ghanaian cedi. So many investors wanted to participate in the cedi deal that the size was increased from the equivalent of $30m to $45m.
Early in 2007, AfDB issued its first bond denominated in Nigerian naira equivalent to $100m. The one-year transaction settled in Europe in US dollars, and many investors were betting that the naira would strengthen. It did. Nonetheless, like its predecessors, the issue focused welcome attention on the region and its improving economies.
The year before, Nigeria had been the first regional sovereign to air the possibility of issuing its own Eurobond. The IMF was less keen on the idea, so it was left to Ghana to become the first sub-Saharan country apart from South Africa to price an international bond. Offering a coupon of 8.5%, the $750m 10-year issue attracted an astonishing $3bn-plus of orders. And that was in September 2007, hardly the best time for a new issuer to come to market.
Ghana’s reception was not lost on Gabon, which successfully launched an offshore bond in December. It raised $1bn in a 10-year issue, priced at 8.2% (inside guidance of 8.5%) and pulling in orders worth $2.5bn. At the same time, Ghana Telecommunications raised $200m via Ghana’s first dollar-denominated corporate bond. Kenya had talked of coming to the international public debt markets early this year, but its stormy December elections have put paid to that for the time being.
Equity markets
Equity markets, where they exist, are often even smaller than the bond markets. Only half of the 44 sub-Saharan states have them and only nine of those, according to the IMF, have more than 20 listings. This lack of size still deters many foreign institutions, and the markets tend to be dominated by local investors. Worries that African equities will succumb to the volatility that is now affecting other emerging markets act as a further deterrent.
“Africa has the potential for strong returns, with low correlation to other markets,” says John Cleary, managing director and chief investment officer at emerging markets fund of funds specialists Focus Capital. “But our preferred route is via debt.”
Even so, as a group and excluding South Africa, regional equities have been outperforming other emerging markets, driven partly by a recent spread of popular capitalism. The outperformance itself is not a recent phenomenon. Exotix has developed a range of weighted US-dollar sub-Saharan Africa indices from 1990 covering the whole region excluding South Africa (SSA); central southern Africa; east Africa and Mauritius; and west Africa. Since 1990, the SSA index has outperformed South Africa itself as well as the MSCI indices for the Far East and Europe.
African companies have been under-researched but Exotix points out that many of them are profitable, dividend-paying, with strong market positions and good cash flow. Moreover, many are the local arms of large multinationals and so have decent standards of corporate governance.
New indices
Exotix’s indices were launched in January 2007, stealing a march on a more familiar name in that business – S&P, which got around to launching its own African index range in April. While the S&P Pan Africa Index tracks 12 markets including Egypt, Morocco, South Africa and Tunisia, the S&P Africa Frontier Index isolates Pan Africa’s eight sub-Saharan constituents. They are Botswana, Côte d’Ivoire, Ghana, Kenya, Mauritius, Namibia, Nigeria and Zimbabwe. The indices aim to capture 80% of each country’s total market cap. S&P says its Africa Frontier index gained 52% over the past three years, compared with 18% for Pan Africa.
Nigeria, with its sheer size and oil revenues, has the largest equity market and the one attracting most foreign attention. Foreign investors are especially keen on its reformed banking sector, which now contains fewer and better capitalised banks, some of which are regarded as world class. Nigeria’s certificate-based capital controls have caused foreign investors some heartache in the past, though the system has now been streamlined. Kenya’s market is regarded as more up to date and user friendly, as are those in Zambia and Uganda.
Initial public offerings
Foreign or domestic, many investors have been drawn into these markets by a growing pipeline of initial public offerings (IPO). The sale of 30% of state-controlled electricity generator KenGen in 2006 began a retail frenzy on the Nairobi Stock Exchange. Before long, banks were offering ‘share loans’ and last year the exchange reckoned 700,000 Kenyans owned equities.
Nigeria has travelled the same curve, as its banking reforms unleashed a wave of IPOs and mergers. Banks have even been advertising personal loans for the purpose of buying their own shares. With standards of governance that are not always impeccable, some of these booms seem fated for a bust.
Consolidation to come
Some form of regional market consolidation seems to be on the cards, although not any time soon, and perhaps not as a standalone phenomenon. Closer co-ordination of financial infrastructure in general – central banks, payment systems, stock markets – is being actively discussed by multilateral institutions and all parties. One obstacle is a proliferation of existing sub-regional co-operative organisations in which no two countries belong to identical groupings.
Meanwhile, back on the international trading floor, Africa funds have been appearing like stars after sunset. South African institutions are understandably interested in their near-neighbours. One, Pamodzi, has raised $1.3bn to invest in Africa. Investec and Standard Bank’s Stanlib are very active in the region. Further afield are investors such as Renaissance, whose chief executive Stephen Jennings once said that Africa was his second “once-in-a-lifetime” opportunity (Russia was his first). New Star, Imara, Charlemagne Capital, Mango Capital have all joined the queue. Blakeney Management has been at the head of it for years.
Few of them are likely to have an easy ride. African capital markets remain relatively undeveloped. As they mature, they will not only suffer inevitable growing pains, but will also become more exposed to the ups and downs of the international herd. Ironically enough, it is their very isolation from world capital markets and associated woes, such as the credit crunch, that makes them so attractive today.
Some money managers accept all that and remain positive. “We’re always looking for the next big thing and Africa could be it,” says Focus Capital’s Mr Cleary. “There are risks – you’re giving up liquidity and transparency – and you need to go in for the medium or long term. The worst thing in fund management is to buy low volatility and sell high. You have to ride the volatility to get your return.”
