The next frontier

01 Jan 2011

The potential and risks of investing in Africa

10 years of Vision: Seven years on, Africa remains very much in the ‘frontier’ category of markets with corruption, political instability and currency volatility among the factors that continue to deter many investors. Excluding high income countries, foreign direct investment has fallen by more than 40% in the Middle East & North Africa and has been flat in sub-Saharan Africa. The South African stockmarket has almost doubled over the period but the currency has declined 50% against the US dollar. 

In the aftermath of the FIFA World Cup, Vision 2011 examined the economic prospects for investing in Africa.

2010 was a landmark year for Africa. It was the hundredth anniversary of the independence of South Africa, 50 years since the independence of Nigeria (and 16 other African countries) and it saw its first staging of the FIFA World Cup. Starting from a low base and with many possible inhibitors, is Africa now a continent with potentially unrivalled opportunities?
 
The economic possibilities are huge in this resource-rich and largely untapped continent, but political change is needed before these can be fulfilled and the Chinese have recently seized the initiative over the rest of the world in tapping Africa’s riches.  
 
The continent of Africa covers 11.7m square miles and comprises 54 countries. Economically and culturally the North African states bordering the Mediterranean such as Egypt, Libya and Algeria are generally aligned with the Middle East, to form what is known as MENA (Middle East and North Africa).
 
The majority of the other countries we term Sub-Saharan Africa (SSA). 53 of the 54 countries form the African Union, which is seeking to improve co-operation between the states and indeed within individual countries, which are often split by inter tribal-disputes. The exception is Morocco. The population of Africa as a whole is 15% of the world total, but it contributes only about 3% of the global GDP1.
 
Egypt was a leading civilisation for over 2000 years BC, aided by the fertility of the Nile Delta. Having been superceded by the Greeks, Romans, Turks et al, Africa has not yet seen a second flowering. The industrial revolutions in Europe and now Asia have left it far behind. Africa has been plundered for its resources over many centuries and was largely colonized by European powers in the 19th and early 20th centuries.
 
The table below provides a recent snapshot of a representative sample of important African countries and how Africa compares to other emerging countries.
 
  DRC Egypt S Africa SSA MENA China India Brazil
Land area
(million sq miles)
0.91 0.39 0.47 9.39 3.40 3.71
1.27
3.25
Population
(million)
66 83 49.3 839 331 1331 1155 194
2009 GDP
(US$ billion)
11 188 286 927 1059 4985 1310 1572
GNI per capita
(Current US$)
160 2070 5770 1096 3594 3590 1180 8040
Life expectancy
(years)
48 70 51 52 71 73 64 72
External debt
as % GNI
118 20 16 N/A N/A 9 19 16
DRC: Democratic Republic of Congo; SSA: Sub-Saharan Africa; MENA: Middles East and North Africa; GDP: Gross domestic product; GNI: Gross national income
Source: World Bank, October 2010, Williams de Broë Research estimates
 
 
Although all countries have regained their political independence, this is not true economically and many remain dependant on outside aid. Much of this aid is co-ordinated by the Organisation for Economic Co-operation and Development (OECD) through the Development Assistance Committee (DAC) members.
 
Official Development Assistance (ODA), as aid is formally called, comes in many guises and is remarkably difficult to measure accurately. $117bn of debt owed by the poorest countries has been written off by donor countries since 2005 under various initiatives2 and a variety of programmes are funded through the DAC with an eye on the Millennium Development Goals, the principal one of these being to halve the incidence of poverty by 2015.
 
The largest areas for assistance are social programmes in education and health; improvement to production has only constituted 10-15% of total aid from the OECD in most of the past 20 years3. The OECD forecasts $126bn as the total of ‘official aid to developing countries’ in 2010.
 
Of that, if prior years are any guide, more than $40bn4 will go to Africa. It is worth noting that China is in receipt of $1.5bn of official aid each year from the OECD, but is believed to be spending vastly more than that sum itself in developing trade and political ties with Africa. 
 
There are no official statistics for the aid that China extends to Africa. It tends to come in the form of loans on concessionary terms to assist in the building of infrastructure or facilities, punctuated by the occasional high profile project, an example of which is a $6bn loan announced in 2008 to the Democratic Republic of Congo (DRC) with the specific objective of gaining access to raw materials.
 
Sinomines invested $3bn to buy a majority stake in new mines with rights to 10m tonnes of copper. Roads and rail links will be improved to enable production to start in 2013, making the annual spend on these projects alone about $2bn. This deal incidentally was brokered by China Eximbank.
 
Hand in hand with human rights issues comes a propensity to confiscate rights or assets from foreign investors, a significant discouragement to further investment.
The International Monetary Fund (IMF) has taken a dim view of the terms of the deal, as the DRC is already heavily indebted (see table) and some renegotiation has been enforced. Considering that China comprises about 8% of world GDP1, we might expect it to offer aid to Africa approaching $3bn per annum to reflect its economic importance.
 
While such initiatives receive more attention than perhaps they deserve, there is a steady flow of support and China suggests that its recent experience of rapid economic development and urbanisation can be of use to African governments.
 
But the political angle is as important as the economic, China is keen to have support in global arenas such as the UN and Africa has become an important ally. Chinese aid is also seen to carry fewer terms and conditions than those imposed by traditional sources, especially in respect of human rights.
 
Hand in hand with human rights issues comes a propensity to confiscate rights or assets from foreign investors, a significant discouragement to further investment. Corruption is also a hazard when operating in Africa. Inward investment is another means by which Africa’s economic performance can be lifted. Net foreign direct investment (FDI) into both SSA and MENA was estimated at $35bn each in 20081 and after a drop in 2009 will have picked up again in 2010 as commodity markets recovered.
 
Remittances from nationals based overseas, both through official and unofficial channels, are an important source of foreign revenues for many African countries. The UN Economic Commission on Africa (UNECA) produced an economic report in 2010 as part of its aim to promote the high-level sustainable growth needed to reduce unemployment. This estimated official remittances at $38bn in 2009. Unemployment though is not particularly high in SSA, but much employment is in the informal economy or on family land and adds little value and even less tax revenue.
 
Where Africa lags is in the export of services.
The most powerful engine for growth should be trade. Exports of goods from Africa to countries outside Africa in 2009, a down year, amounted to $339bn5, broadly speaking a third of its GDP1. Export value is balanced by imports, but interestingly Africa runs a trade surplus with North America arising from oil, and a trade deficit with all other regions, including Asia, reflecting the lack of added value in its exports.
 
The chart opposite shows that Europe is still the most important destination for Africa’s exports, but Asia is closing fast. Where Africa lags though is in the export of services and the vast majority of the exports are raw materials that do not demand large labour input. There are hopes that the current round of trade talks will put Africa in a better position, with for instance a reduction in farm subsidies in the USA, but we are sceptical.  
 
The UNECA sees Africa’s role in the coming decades to be a source of cheap manufacturing, as its young and increasingly better-educated work force is more gainfully occupied. Necessary catalysts for this are a better banking system, improved physical infrastructure and reduced trade tariffs so goods can move more easily within Africa, improved communications, as well as a reduction in crime and corruption.
 
The impact of disease, including most recently HIV/AIDS, on Africa’s economic potential should not be ignored. 22.3m people in SSA are infected with HIV/AIDS 1 and more than one million die each year6, plus nearly a million die each year from malaria7. This is why life expectancy is so low in the DRC and South Africa (see table above).
 
Graph of African exports
 
The wealth that has been generated for centuries from Africa’s mineral resources has tended to end up in a limited number of hands. Africa has key resources in oil, platinum, uranium, bauxite, chrome, copper, cobalt, iron ore, coltan (used in mobile devices), manganese as well as gold and diamonds. The breakthrough that the continent needs is to translate that wealth into wider economic development.
 
This should in turn reduce the incidence of corruption, as legitimate wealth can be created, and improve healthcare and education. An enlarged network of stock markets would also enable capital and wealth to be created and retained within Africa. South Africa has the most developed economy and financial system and is a popular choice for Emerging Markets funds.
 
Superior growth may be found in the other, much smaller, more volatile stock markets in which Frontier Markets funds are now exploring but at present these markets’ total market capitalisation is less than just one of the top companies in the FTSE 1008.

Deep in the IMF website is a link to the World Economic Outlook in Maps, which colours the countries of the world according to their projected annual growth in GDP, the darker the country the higher the growth.
 
From 2011 to 2015 these maps show Asia as the darkest continent, but Africa consistently comes second. It rode out the financial crisis well, mainly due to low levels of external debt and lack of exposure to the global banking system and after a period of heady freedom more governments are realising that economics should come before politics if their prospects are to improve.
 
Africa has a better chance of capturing its potential for itself than for many decades if not centuries. Patience will be required though, the final ingredient we feel is needed is a strong leader in one of the key countries to grasp the opportunities.
 
Sources:
1: World Bank 2010
2: World Bank 2009
3. OECD 2010
4. UNECA ERA 2010
5. World Trade Organization 2010
6. UNAIDS
7. WHO
8. Thomson Datastream, as at September 2010

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