How investors ought to think about investing in Africa
March 2017 | SPECIAL REPORT: EMERGING MARKETS – OPPORTUNITIES AND RISK MANAGEMENT
Financier Worldwide Magazine
Over the past few years, the attention being paid to African markets has increased significantly. This has been spurred by investors who are targeting so-called ‘higher returns’ in higher growth economies. Affirming this is the IMF’s ‘World Economic Outlook’ report of October 2016 which states that between 1998 and 2015, the average GDP growth rate of Sub-Saharan African countries was at least five times faster than that of advanced economies. Indeed, 2017 forecasts by the IMF indicate that Côte d’Ivoire, Tanzania, Senegal and Ethiopia are expected to be among the world’s fastest growing economies – with GDP growth rates expected to register above 6 percent. Investment opportunities in these markets are understood to exist in sectors such as cocoa trade, gold mining, agribusiness, construction, power, healthcare and general infrastructure.
However, if one turns to the principle of risk vs. return, it goes without saying that commensurate risks accompany higher investment returns. This principle is especially pertinent in Africa because of the complicated, and risky, attributes of conducting business. For example, the World Bank’s ‘Ease of Doing Business Index’ for 2016 highlights that a significant proportion of African countries still rank in the bottom half of the scale. Ethiopia and Senegal are ranked poorly at 159/190 and 147/190 respectively, despite the fact that such markets possess attractive features. To complicate matters further, some of the red flags of doing business in Africa are dynamic in nature – owing to ongoing macroeconomic, technological, legal and regulatory, societal and cross-border trade reforms – the pace of which varies from country to country.
In order to further highlight peculiar challenges and risks that are associated with investing and operating in Africa, we have chosen to focus on the issues outlined below.
High perceived corruption levels
According to Transparency International’s ‘Corruption Perceptions Index 2016’, which tracks the performance of 176 countries, many African countries continue to experience pervasive corruption risks. Transparency International points out that African nations are plagued by, amongst other issues, untrustworthy and badly functioning public institutions, such as the police service and the judiciary. According to the rating scale, among the worst performers are the Democratic Republic of Congo, Chad, Uganda and the Central African Republic.
It’s not all doom and gloom, however. The latest ‘Mo Ibrahim Index on African Governance’ indicates that 70 percent of African citizens now live in a country that has seen improved governance levels since 2006; although improvements are gradual. Mitigating such issues requires investors to implement, and follow, stringent internal control and compliance mechanisms in a bid to reduce the risk of corruption. This should be adopted in all types of business undertakings, including joint ventures, acquisitions or greenfield operations. It is also important for investors to map the relationships and dealings with local partners and suppliers, as a failure to do so increases the venture’s exposure to possible flouting of both domestic and international local anti-bribery and corruption legislation. Once the investment decision is made, the importance of monitoring and oversight of company policies and standards cannot be downplayed.
Poor public infrastructure
Despite substantial reinvestment in infrastructure development in Africa over the past decade, sub-par levels of infrastructure still pose a threat to businesses and investments. In its ‘2014 Africa Infrastructure Country Diagnostic (AICD) report’, the African Development Bank says that Sub-Saharan Africa’s infrastructure needs exceed $93bn annually over the next 10 years. Deficits are present in road, rail, port, and power and telecommunications infrastructure. Companies that actually overcome such challenges tend to apply practical solutions such as installing backup generators, using water tanks and constructing treatment plants and even at times coming up with creative partnerships with local governments to pave roads. Some investors, especially in the mining sector, partner with local authorities to construct much-needed power plants. By employing this approach, investors can counter the negative impact of unpredictable costs on their businesses by locking in certain costs upfront.
Familiarity with local dynamics
The understanding of cultural differences, language barriers, poverty levels and societal history represents a not so obvious challenge when conducting business in Africa. It must be reiterated that Africa is not one homogenous entity. Therefore, a country specific and tailored approach is required to mitigate risks. Working with local partners with the relevant experience is also an excellent idea, for in this way, foreign investors can build trust and goodwill with local actors and authorities.
Investors must pay attention to local political developments, for a failure to do so can impact on the viability of a business venture. Where a change of regime could increase opportunities for investors, on the other hand, changes to laws and regulations could also prove detrimental. Contract renegotiations or having an operating licence revoked are examples of unforeseen risks that can be precipitated by a change of regime.
An example is that of the large South African bank, First National Bank (FNB). In 2011, FNB had its purchase of First Bank Zambia reversed at the eleventh hour when the then Zambian president Michael Sata came to power. Although the reasons for the reversal remain unclear, the fallout could have been mitigated, in part, by spending more time on the ground and in mapping all the moving parts of the transaction, especially to understand the potential risks from the political world.
Security related issues must be taken into account when looking to invest in Africa. Ever evolving terrorism-related threats affect West, Central and East African countries including Nigeria, Kenya, Somalia, Mali and Chad. Indeed, this makes the operating environment even more challenging and increases the cost of doing business. In other markets, such as Burundi, the presence of domestic security issues also adds a different dynamic. Managing and mitigating these risks is difficult owing to their sporadic natures. That said, experienced investors and local businesses work in close cooperation with local, and international, security companies that are ‘plugged in’ to security developments. Typically, these local security companies assist investors with devising appropriate risk management plans. Detailed assessments are conducted to identify impacts of specific threats on operations. With increased senses of preparedness and awareness, businesses should operate in a more organised manner.
Many African countries are vulnerable to adverse commodity price movements. Focusing on two relevant markets, Angola and Nigeria, the sharp decrease in oil prices seen in 2014 negatively impacted both countries’ ability to generate foreign currency earnings, leading to a foreign exchange liquidity crisis, and the oil price shock has resulted in the inability of both governments to generate much-needed tax revenues. This scenario has led to accompanying cuts to expenditure plans. Investors have had to contend with slower economic growth, declining business confidence and foreign currency shortages. Though investors can purchase insurance in mitigation of currency liquidity, such insurance often comes at a high cost.
For investors to see the full benefits of their investments, they must look to invest more than their capital. A significant amount of time and effort should be spent on the ground to understand and map the risks. Investors ought to work in close collaboration with local partners, and other advisers, who will assist with overcoming unexpected challenges. Investors should also reach out to local authorities in markets that appear to be opaque.
Brian Dlamini is a consultant at Afriwise. He can be contacted on +27 10 596 8519 or by email: firstname.lastname@example.org.
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