Investment in Africa: a volatile future?

Go back 20 years and investment in Sub-Saharan Africa largely stemmed from charities and NGOs – a trend known as the “aid narrative”. While the need for aid has certainly not abated, nowadays the narrative has somewhat shifted – with investors seeking long-term investment in what many now consider an awaking giant.

As investors turn their eyes – and their funds – towards emerging markets across the continent, the growth in Africa’s foreign exchange (FX) market is set to be exponential. Yet, for this growth to continue unimpeded, a number of obstacles – namely the challenges of currency illiquidity and volatility, as well as the global phenomenon that is “de-risking” – must first be addressed. And given the uncertainties it seems that the best way to ensure investment flows into and out of Africa will be to embrace new technology with respect to the provision of foreign exchange.

 The investment narrative

The move towards an “investment narrative” reflects Africa’s new high-growth, high-opportunity environment. Certainly, the World Bank forecasts that in 2018 the Africa nations of Côte d’Ivoire, Djibouti, Ethiopia, Ghana, Senegal and Tanzania will represent six of the 10 fastest growing economies in the world – which is both a reflection of growing investment and a trigger for more.

Yet one of the largest drivers of investment in Africa is China – with many now considering it their “second continent”. Since the turn of the millennium China has invested $86bn in over 3,000 infrastructure projects, and Chinese-African trade has grown from $10bn to a peak of US$215 billion. For China this is likely to be merely the beginning. In 2013 China announced a trillion-dollar infrastructure project involving as many as 71 countries. Known as the Belt and Road Initiative (BRI) it is hoped this project can become a “21^st century silk road” – connecting Asia with Eastern Europe and Africa via a “belt” of overland routes and a maritime “road” of shipping lanes. Recently, Senegal became the first African country on the Atlantic coast to sign up for the BRI. Given that the Forum on China-Africa Cooperation (FOCAC) is scheduled to meet in September, more announcements are sure to follow.

Research conducted by PwC predicts that traditional assets under management in Africa will rise to nearly $2trn by 2020

For development to be sustainable, however, Africa requires a healthy stream of private investment. Fortunately, trends indicate such investment is on the rise. Research conducted by PwC predicts that traditional assets under management in Africa will rise to nearly $2trn by 2020 – up almost $1.7trn from 2008 totals. This growth is likely to be bolstered by a series of regulatory changes, such as a recent amendment in South Africa that doubled the proportion of a pension fund that can be invested in Africa.

Thus, as Africa emerges as a viable investment opportunity, the demand for the timely, reliable and competitively-priced sourcing of currency continues to intensify. Unfortunately, for those investing in Africa, this demand has not yet driven supply. In fact, many of Africa’s currencies are illiquid. For instance, the Gambian dalasi is much harder to source than the US dollar. Though an unsurprising fact, it is precisely this that has the potential to stagnate Africa as the next high-growth emerging market.

 Exchange rate volatility  

Even treasurers who are able to source illiquid African currencies may be hit with a further headache – exchange rate volatility. A volatile currency can lead to volatile operations, increasing risk and often reducing investment.

For instance, currency volatility is often prevalent in Zambia. In 2015 falling copper prices, looser monetary policy and fiscal concerns meant the kwacha fell 42% against the US dollar – making it the third worst performing currency that year.  In the first quarter of 2016, however, a 19.9% appreciation crowned the kwacha the best performing currency in the world.

More recently, volatility in Africa has been the result of a number of wider global trends. In fact, the recent downward spiral of the Turkish lira – compounded by the potential for a prolonged world trade war – has begun to dampen investor appetite in many emerging markets across Africa. The South African rand, for example, has fallen 14% in 2018 so far.

An unstable currency is not just a challenge for investors: it also impacts African central banks as they attempt to maintain fiscal normality

Yet an unstable currency is not just a challenge for investors: it also impacts African central banks as they attempt to maintain fiscal normality. For instance, when a domestic currency is volatile the cost of sourcing G10 currencies – the 10 most traded currencies in the world – rises. This pushes up the cost of imports, and can even increase levels of inflation and debt.

Ethiopia – one of the fastest growing economies in the world – is currently facing precisely this challenge. The country’s illiquid currency market, as well as its high-dependency on imports, has led to severe FX shortages. In fact, the government – in a desperate attempt to increase its foreign reserves – devalued the Ethiopian birr by 15% in 2017. It was hoped this move would bolster exports, though this has yet to materialise. In fact, as the crisis intensifies, China – which lent Ethiopia $13bn between 2006 and 2015 – is beginning to scale back its investment in the region. Without a workable solution to illiquid and volatile markets, therefore, this could become a trend which defines Africa’s future.

Further challenges

A “Perfect storm” of increased compliance costs, record penalties, and tightening regulations has thus led to increased risk for financial institutions globally. This has caused many correspondent banks to cut ties with African countries deemed “high-risk” – leaving vast areas all but cut off from the international banking system.

For instance, Liberia – despite years of democracy – recently saw the retreat of most international correspondent banks. It therefore remains important to choose the right transaction banking partner who – through an enhanced client due diligence-led approach – can reopen and maintain access to international markets.

Unfortunately, this retreat coincided with the Ebola humanitarian crisis. Of course, providing Ebola relief on the ground in Liberia relies on the ability to move aid program funds into the country. Yet, with limited access to the currency markets, remittance of funds into the country was heavily circumscribed.

Towards a digital solution?

Mobile banking is providing a solution to millions of “unbanked” people across Africa. Requiring only a $5 phone and a banking SIM card, this technology is reshaping the path towards financial inclusion. For instance, in Kenya 19 million mobile banking users now transfer as much as 15 billion Kenyan shillings ($150m) each day. This has added liquidity to an otherwise illiquid market and has provided a much-needed tool for the payments many take for granted.

The digitalization of the FX market is also feeding optimism. New currency trading platforms have helped fill the gap for local African currencies. For instance, Crown Agents Bank’s EMpowerFX platform offers nimble access to over 500 currency pairs, with live integrated news feeds to track market fluctuation. Such modern currency trading technologies have generated greater liquidity at more competitive prices, which helps ensure access to local funds. This, in turn, ensures that central and local commercial banks have a ready supply of G10 currencies.

Organisations continuing to work and invest in Africa must therefore look towards niche FX market for the right transaction partners. In this regard, Crown Agents Bank is well positioned to provide sector expertise, liquidity and high levels of connectivity which will help to offset the disadvantages of having to operate within a sometimes illiquid, sporadically volatile, local currency market.