Investment in sub-Saharan Africa on the rise as capital markets gather steam
Demand for sub-Saharan African (SSA) assets is increasing as anticipation continues to build towards the region’s future growth potential, in particular a nascent rebalancing away from resource-dependency towards a consumer market.
Investors are being drawn to SSA bonds and stocks by the search for yield, meagre returns in emerging and global equities, and improved access to the region’s capital markets. This is in addition to the portfolio diversification these assets offer.
There’s also a compelling economic argument: the region’s economies have enjoyed a decade-long expansion with growth rates of 4% to 7% and this was the only regional grouping, apart from Asia, to continue growing during the global financial crisis.
While predicted growth in developed and many emerging markets (EMs) is being revised downwards, the IMF recently upgraded its economic forecast for SSA to 5.4% for this year and 5.7% in 2014.
The five fastest-growing economies of 2013 will be Sierra Leone, Gambia, the Democratic Republic of Congo, Mozambique and Ghana. All are expected to enjoy growth of at least 8%.
Even worries over slowing demand from China and other export-manufacturing economies for the commodities on which many SSA economies depend heavily seem unable to dim the optimism.
With infrastructure key to unlocking the region’s economic potential, construction of roads, bridges, railways, ports and airports will see substantial increases in inflows of private capital, according to the World Bank.
And better infrastructure will help fuel the $1.07 trillion consumer sector, which has doubled since 2000 to around 60% of the region’s GDP, into what McKinsey & Co argues will be Africa’s largest business opportunity.
The consultancy forecasts the sector will grow by $410 billion by 2020 to almost $1.5 trillion as demand for goods and services from SSA’s burgeoning, and more urbanized, middle-class grows.
So far, FDI has comprised the bulk of foreign investment, helping fuel development of the region’s key-export resources industries – oil and gas, and metals and minerals. These days, FDI is focused towards private consumption-oriented sectors, including consumer manufacturing, services and infrastructure.
Not being vulnerable to reversals, FDI has helped insulate the region from this summer’s portfolio investment outflows from EMs, sparked by fears the US was about to wind down its money-printing stimulus programme.
Of the $60 billion in private capital flows into the region’s economies this year, only about $20 billion – split roughly 50/50 – will be portfolio investment in equity and debt markets.
While inflows are limited by a lack of depth and liquidity in SSA markets, these barriers have also shielded them from outflows because the difficulty of getting in, and out, means investors tend to buy and hold.
However, demand for portfolio investment is on the rise, particularly for equities, which have held up well to the risk-off pressures on EMs. Equity returns are outperforming EMs as measured by international benchmark indices.
Increasing demand and a wider investor base has seen sub-Saharan countries virtually triple their local currency debt issuance from $11 billion in 2005 to $31 billion last year, but these assets are mostly held domestically. Governments are now widening their investor base by tapping international markets with Eurobonds for long-term financing to take advantage of the lower rates available.
However, even though yields on recent government debt issues have been pushed substantially higher during the past few months by as much as 200 basis points, demand appears to be continuing to outstrip supply.
Planned Eurobond issuance by repeat and first-time issuers is scheduled to increase eight-fold this year to around $7.7 billion, with recent placements by Nigeria and Ghana heavily oversubscribed.
“Countries that have come to the market since the January/February all-time low in nominal yields have still managed to get pretty decent rates,” says Stuart Culverhouse, chief economist at Exotix in London. “Investors have been willing to look at these bonds and we’ve seen in many countries very high demand for bonds – three, four or five times oversubscribed.
“There’s still a lot of demand for EM frontier, and Africa in particular, which given the dearth of issues around EM may be seen as offering a little bit more diversification because Rwanda is not going to be the same as some other EM countries, and domestic fundamentals have also improved.”
He adds: “They’re not a homogenous block, but they all offer interesting risk-reward characteristics, and investors are becoming more comfortable with going down from EM into the frontier space.
“In many ways, the sovereign risks are not that significantly magnified by going down from EM to frontier, given the deterioration in mainstream EM’s fundamentals.”
Excluding South Africa, SSA has 13 sovereign bonds issuers and 16 sovereign Eurobond bond issuers, including Ghana and Nigeria, which have come back to the market with follow-on bonds.
“It used to be that you got one bond per country and that was all their scope, or capacity, for borrowing, so that’s the next phase and we’ll start seeing more multiple bonds,” says Culverhouse.
“There’s still a few countries that haven’t issued that could, such as Kenya, which might issue by the end of the year, but about half of the issuers have come just in the last year or so.”
The more issues there are, the more reliable the sovereign yield curve becomes, eventually extending the investor base to foreign fund managers, institutional investors and pension funds.
One substantial chink in the positive growth story is the region’s number-one economy South Africa, which accounts for around a third of SSA’s GDP.
As the largest economy with the most developed markets, and greatest depth and liquidity, South Africa is the most exposed to capital flows. It has been hit hard by EM turmoil, with the rand losing 18% of its value.
Inflation is nudging 6.5% but with growth expected to struggle to reach 3% this year, the central bank cannot raise rates. The country is also grappling with large fiscal and current-account deficits.
Nigeria, the number-two economy, has suffered from its exposure to global markets to a lesser degree but has transparency and corruption issues, and an Islamist insurgency to deal with.
Instability in east Africa could also derail prospects there, including plans to link it with Lagos, Dakar and other economic centres in west Africa with the $4.2 billion trans-African highway.
“Things are on the move and some countries are really showing promise,” says Colin Waugh, partner at SCP Africa. “You’ve got some countries that are showing signs of developing a broad consumer-base through emerging middle-classes and others that are still at the stage of either relying on one or two natural resources or an advantageous position for trade in the continent.
“Ghana and Zambia are quite likely to be pretty prosperous because they’ve got a mixture of already being democratic with middle-classes, who are spending money and rapidly becoming global consumers, as well having resources.”
He adds: “Then you’ve got places like Mozambique, which has really hit the radar in the last year or two with its resources base in natural gas, but no middle-class to speak of, no manufacturing and a terribly under-educated workforce.
“The spread of wealth in places like Ghana and Zambia and their broadly democratic types of economy suggest they could become more like what we think of as middle-ranking economies with consumers, investors and local ownership of resources.”
Waugh concludes: “Although there’s not much at the moment, equities are the future and countries that can get liquid, reliable listed-equities markets going – perhaps with dual listings to give it a boost initially, proper market-making and electronic trading – they’ve really got a big chance if they can get their companies on the bourse.
“There has been a significant amount of interest in both sovereign Eurobonds and local currency bonds, certainly in the last year or two, but it stretches back to pre-crisis 2007. It took a bit of time for that early interest to come back, but particularly since 2012 that interest has grown.”