A Large Frontier Market Resembles Latin America of the ‘90s

In the past seven years, Africa has gradually appeared in U.S. investors’ crosshairs, and from their perspective, we think Africa is in the sweet spot now, where Latin America was 20 years ago

By Richard Fox, Carmen Altenkirch

September 2014

For those ready to take a long-term position on the continent, we don’t deny there will be bumps along the road, both figuratively and literally. Although the frontier economies in sub-Saharan Africa (SSA) are maturing, they continue to face enormous structural challenges and lack much basic infrastructure. Even for the strongest reformers, these deficiencies will take time to address. We recognize risks remain while acknowledge improvements need to continue, much like the Latin American investment climate had been viewed by North Americans in the mid-1990s.

Now we’re telling investors that the risks in speculative-grade rated Mozambique, Ghana and Kenya are similar to those currently seen in Ecuador, Venezuela and the Dominican Republic, with which U.S. investors are more familiar. All are rated ‘B’ or ‘B+’ by Fitch Ratings.

Debt-relief initiatives of the 2000s, which provided African nations with a clean balance sheet, helped catalyse African economic improvement over the last several years. This echoes the Latin American experience when bank debts were restructured and finally securitised in the 1980s and 1990s, bringing access to the U.S. investor base.

But in Latin America, as in Africa more recently, debt relief was achieved only after those countries had demonstrated a long track record of economic and structural reform and improved economic management under IMF and World Bank programmes. In time, debt relief allowed nations to borrow money on commercial terms for bankable projects to facilitate growth and they took on more debt.

Africa was left relatively unscathed after the world financial crisis. In 2008, Africa benefited from not being very integrated into the global financial system. But integration is a double-edged sword. As Africa’s exposure to the developed world through trade and investment deepens, Africa will become more integrated and susceptible to contagion effects from global markets. We saw the first signs of that last spring during the ‘taper tantrum’. But it was an African sovereign — Nigeria — rather than a mainstream emerging-market nation, which re-opened market access for emerging and frontier markets in July — a sign of growing and maturing investor interest.

Higher U.S. interest rates may be the next test of Africa’s resilience. Emerging and frontier markets such as Africa could be negatively affected by investors’ rotation back into relatively safer instruments not exposed to the volatility of developing economies. But that would primarily affect portfolio investment. Foreign Direct Investment (FDI) has so far proved to be more durable amid general and growing interest in doing business in Africa.

Africa isn’t just a commodity story. Export revenues and foreign investment in resources have certainly been a success story for some countries, like Mozambique and Zambia. But more generally, a decade of strong growth, more stable governments, improved rule of law and a better business environment have all boosted confidence and help explain why companies domiciled in developed economies are looking to garner market share in select African nations. For instance, the most populous country on the continent with about 170 million inhabitants, Nigeria, is on the radar of global corporations looking to expand. Also, in the U.S., the White House touted Africa’s potential and investment climate from Aug. 4 to 6, during an historical three-day U.S. Africa Leaders Summit. The President pointed out some U.S. corporate entities, including Coca-Cola, Marriott and General Electric, have announced projects in Africa, to join those in the energy, resources and financial sectors that have been there for years.

Wall Street appears to have also staked a claim. Blackstone Group and Carlyle Group are both teaming up with Dangote Industries, owned by Africa’s richest man, for energy infrastructure projects. Carlyle’s partnership also plans investments in the financial services, consumer and agribusiness sectors, which are considered the cornerstones of the African economy.

Africa’s infrastructure needs are enormous, far too big to be satisfied by one funding source alone. Africa therefore enjoys one of the most diverse funding bases of any continent, ranging from aid, remittances and concessional assistance at one extreme , through FDI and growing portfolio investment, and, increasingly, private-equity funding. The challenge is to put those resources to good use, avoiding another debt problem and instead generating attractive investment returns through stronger growth and higher living standards.

Originally published at thewhyforum.com.