From Africa Recovery, Vol.17 #2 (July 2003), page 12

Foreign investment on Africa's agenda

NEPAD aims to attract a larger share of global capital flows

By Ernest Harsch

For African economies to grow and prosper, "capital markets are essential," says Ghanaian Minister of Finance Yaw Osafo-Maafo. "The lack of capital is one of Africa's major stumbling blocks."

That view -- presented at an April forum of hundreds of African business executives and stock market officials -- is increasingly common among African leaders. Until just a few years ago, when they spoke of financing for Africa's development, they usually meant government spending, donor assistance, official lending or other sources of public funds. But the New Partnership for Africa's Development (NEPAD), adopted in 2001 as the main development framework for the continent, has added a strong emphasis on increasing private flows to Africa as one way to help overcome the region's resource gap.

Some African countries already offer attractive opportunities for prospective investors, and as a result, Africa has seen a modest rise in foreign capital inflows over the past decade. But up to now, high levels of poverty, poor infrastructure, bureaucratic red tape, corruption and fears of political instability have led most investors to steer clear of the continent. The challenge facing African governments is how to draw them in.

Photo : ©Eric Miller / iAfrika.com

Senegalese President Abdoulaye Wade, one of NEPAD's most active proponents, has often maintained that no country in the world has managed to develop itself with just foreign aid or borrowing. Those countries that have been successful have also utilized private capital, both domestic and foreign. "We are convinced," President Wade said during a visit to Tokyo in mid-May, "that the private sector can play the same role [in Africa] that it has played in Japan." Therefore, he said, it is necessary "to create the conditions for private capital to be able to invest in African countries."

However, President Wade has also cautioned that "growth generated by private investments does not automatically translate into an improvement in the people's well-being." For that to happen, governments cannot leave everything to the market, but also must play a strategic role. Mr. Zéphirin Diabré, associate administrator of the UN Development Programme (UNDP), similarly told Africa Recovery that "the role of government is critical to ensure that there is good distribution of the wealth that has been created" (see interview "Zéphirin Diabré: It's time to act on investment").

A yawning gap

As recently as the 1980s, an African government's openness to foreign investment was largely a reflection of political or ideological orientation. But with the end of the Cold War and the further worsening of Africa's economic predicament, foreign investment now is seen more as a matter of practical necessity.

Economic growth in Africa has averaged about 3.5 per cent annually over the last five years, notes African Development Bank (ADB) President Omar Kabbaj. He points out that this is far below the NEPAD estimate of 6-8 per cent needed in Africa to achieve the Millennium Development Goals. (The MDGs were adopted by world leaders in 2000, and include reducing by half the proportion of people living on less than $1 a day by the year 2015.)

Achieving faster economic growth requires significantly higher investment rates, Mr. Kabbaj argues. These now are generally low, ranging from 16-22 per cent of gross domestic product, compared with the 30 per cent generally needed for high growth. Yet there are severe constraints on quickly increasing domestic investment rates, he continues, "given the widespread poverty and the low level of savings" that are prevalent in many poor African countries. Therefore, some form of external financing is essential.

Studies by the ADB suggest that aid flows to African countries would need to increase by between 50 and 100 per cent to help them attain levels of economic growth that would make possible significant reductions in poverty. But that is doubtful in today's aid climate. Over the past decade, official development assistance to Africa has been in sharp decline, falling by around 35 per cent between 1992 and 2001.

Even if that decline can be reversed -- and a number of key donors are in fact pledging to boost their assistance to Africa -- aid flows are not likely to grow enough to fully finance NEPAD's ambitious goals. Nor will prevailing levels of debt relief generate sufficient savings to bridge the gap. Increased export earnings could be another source of external resources, but low world prices for Africa's primary commodity exports and serious difficulties in gaining access to Northern markets put severe limits on the continent's trade prospects.

Despite the evident difficulties, African leaders are calling on their external partners to take action on all these fronts. Simultaneously, they are appealing to private investors to make their own contribution. Hundreds of business executives expressed interest during a forum on private sector financing for NEPAD held in Dakar, Senegal, in April 2002, the first of a number of such conferences around the continent.

So far, the record of success in actually attracting foreign investment to Africa has been mixed. In the early 1990s, inflows of foreign direct investment (FDI) to Africa averaged only around $2-3 bn per year. This more than doubled by the latter half of that decade, and reached a record peak of $13.8 bn in 2001 (see graph). Last year, however, net FDI inflows to Africa were estimated to have dropped to just $7 bn, reflecting the depressed world investment climate. Flows will likely remain at that level in 2003, according to World Bank forecasts, although most will go to just a few African countries, mainly in oil or minerals.

In relation to the small size of most African economies, even such modest FDI inflows are becoming significant. In 2001, for example, gross FDI in sub-Saharan Africa was equivalent to 8.1 per cent of the region's total GDP (compared with just 1 per cent in 1990). That ratio was higher than for any other developing region, notably surpassing both East Asia and the Pacific (4.6 per cent) and Latin America and the Caribbean (4.4 per cent).

Yet in comparison with total foreign investment, which has grown spectacularly over the past decade, the flows to Africa still remain small. In 2001, sub-Saharan Africa attracted only 8 per cent of total FDI flows to the developing world.

'Painstaking reforms'

According to Mr. Osafo-Maafo, the Ghanaian finance minister, Africa has the potential to become "the next global investment horizon." Similar optimism was expressed by many of the other officials, executives and investors who attended the 14-15 April "African Capital Markets Development Forum," organized jointly in New York by the UN Development Programme (UNDP), the New York Stock Exchange and the African Stock Exchanges Association (ASEA).

As Ms. Ndi Okereke-Onyiuke, chairperson of the ASEA, pointed out, Africa offers some of the highest profit rates in the world. According to studies by the UN Conference on Trade and Development, foreign companies gained average returns of 29 per cent on their investments in Africa during the 1990s, much higher than in most other regions. But profitability is only one factor that potential investors take into account.

Mr. Osafo-Maafo noted that Ghana is now considered a relatively attractive destination for foreign investment in Africa, not only because of the high rates of return that are possible there, but also because of the country's political reforms, measures to combat corruption and improvements in the way the private sector is able to conduct business. That outcome, he said, is "not a miracle, but a result of painstaking reforms."

From the perspective of the foreign investor, most African countries present enormous hurdles, Mr. Alan Patricof, vice-chairman of Apax Partners investment house in the US, told the participants at the New York forum. He highlighted numerous difficulties, including:

• corruption and bureaucratic red-tape
• weak legal systems
• poor infrastructure
• shortages of skilled labour.

To reduce corruption and red-tape, Mr. Patricof recommended that African countries set up "one-stop" centres at which investors could obtain all their necessary licences and other forms of approval, rather than having to deal with a plethora of separate administrative "tollgates" that take time and give local officials opportunities to exact kickbacks or other personal benefits.

Not all problems lie with excessive government involvement, Mr. Patricof added, but also with the absence of appropriate regulation. In much of Africa, rules of corporate governance "practically don't exist," he said. That makes it possible for both domestic and foreign companies to avoid full disclosure of their accounts, enabling them to evade their tax obligations.

Lesotho's Minister of Finance Timothy Thahane pointed to the importance of financial sector reforms, including the development of regulatory frameworks for banks, insurance companies and other institutions. Stronger and more diversified financial systems, he said, will encourage both investment and savings.

Many participants observed that conflict and political instability tend to discourage investors from coming to Africa. Even countries far from current conflict zones are affected by this negative image, since investors often view an entire region, and even the continent as a whole, through a single lens. Therefore, they noted, NEPAD's emphasis on achieving peace and security is essential for helping make Africa a more attractive outlet for investments over the long term.

US Assistant Secretary of State for African Affairs Walter Kansteiner pointed out that there also are short-term remedies. The US government's Overseas Private Investment Corporation, for example, helps finance political risk insurance schemes in Africa. He also supported African proposals for greater regional integration among neighbouring countries, so as to develop larger and more attractive markets.

In addition, a number of investment analysts have noted that it is very hard to draw in foreign investors when a country's economic climate is not conducive to domestic investment. At the NEPAD financing conference in Dakar last year, Nigerian President Olusegun Obasanjo emphasized, "The first reflex of a foreign investor arriving in an African country is to see how the local private sector is behaving . . . to see which sectors are working and to know whether local people are investing in them."

For African countries, the type of foreign investment they try to attract can be an important consideration for their future development, notes Mr. Kenneth Kwaku of the World Bank's Multilateral Investment Guarantee Agency, which provides risk insurance to investors and lenders active in developing countries. Much foreign investment in Africa today is based on the extraction of oil, minerals and other natural resources, with little local processing. Attracting investments that add value and stimulate economic development, he says, will require "no longer relying on our natural resources, but on skills and knowledge." To get companies to become more active in such areas, he adds, will mean stemming the tendency of African professionals and skilled workers to leave the continent (see article "Reversing Africa's 'brain drain: new initiatives tap skills of African expatriates").

Stock markets gear up

In addition to foreign direct investment, some flows to Africa are in the form of equity investments -- trading company shares, government bonds and similar financial instruments. For sub-Saharan Africa, such portfolio equity inflows increased from $2.9 bn in 1995 to $8.9 bn in 1999. They then fell to $4 bn in 2000 and virtually collapsed the following two years, as global stock market activity suffered severe turbulence and decline (see graph, page 13).

For the largest African companies, major world stock markets provide a good "platform for accessing international capital markets," New York Stock Exchange Vice-President Bryant W. Seaman told the April forum. The NYSE itself now lists seven African companies, with a total capitalization of $26 bn. Reflecting a growing interest in Africa, trading in their shares leaped by 700 per cent between 1999 and the early months of 2003, Mr. Seaman noted.

By contrast, most African stock markets are very small -- "frontier" markets in the vernacular of international investors -- with the exception of South Africa's Johannesburg Stock Exchange and the markets in Egypt, Morocco and Tunisia. Their combined capitalization reached $245 bn in 2002 (with the JSE share accounting for $183 bn). This was barely a tenth of the total capitalization for all "emerging market" exchanges, and less then 1 per cent of the world total.

The number of African stock markets has been growing however, from 10 about a decade ago to 18 active exchanges today. And while they may be small, says Ms. Okereke-Onyiuke, they represent a "virile" force that should attract greater international interest in the years ahead.

The stock exchange in Abidjan, Côte d'Ivoire, which lists companies from six francophone countries in West Africa, is one of the few regional stock markets in the world. Plans are under way to also set up a second regional exchange in East Africa.

Many of the companies listed on these African exchanges -- more than 2,200 in 2002 -- generate high returns for their shareholders. In 2002, for example, the JSE index showed an average return of 27.9 per cent (calculated in US dollars), while the Abidjan exchange reached 27.4 per cent, Ghana 33.3 per cent and Botswana 41.4 per cent. By contrast, that same year, the US's Standard and Poors 500 index registered a 22.4 per cent loss, while the combined index for all emerging markets fell by 7.5 per cent. One reason for Africa's high profitability, notes Ms. Okereke-Onyiuke, is that most African companies are still "in their growth stage," that is, they are relatively new ventures with considerable room for expansion.

Yet many investors simply do not know about these opportunities. Most African exchanges are not included in the main equity market indices and therefore attract few portfolio funds targeted toward global emerging markets. For potential investors who are knowledgeable, the high profitability of these African companies is counterbalanced by uncertainties about their long-term performance, in addition to concerns about the stability of most African economies.

This lack of a strong, positive image is one reason why African stock markets have shown an interest in forging closer ties with the highly developed exchanges of New York, London and other global commercial centres, to gain better international exposure. "We need support from grown-up exchanges," Mr. Osafo-Maafo said to his colleagues at the NYSE, "to learn from your experiences."

At the same time, he added, African countries can do much to make their economies more viable and attractive targets for potential investors. "Africa, properly managed, could be the future of portfolio investment."

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