Africa: Simple Case for Investing in Sub-Saharan Africa

Business Day (Johannesburg)

OPINION
2 September 2008
Posted to the web 2 September 2008

Jonathan Garner and Michael Wang
Johannesburg

SUB-Saharan Africa - the continent excluding Algeria, Egypt, Libya, Morocco, and Tunisia, and, for this purpose, SA - is showing similar investment opportunities to the former Soviet states and the east Asian economies at a similar stage of their development, in the 1990s and 1980s respectively.

The investment case for sub-Saharan Africa is simple. It is one of the fastest growing regions in the world, with 6% real gross domestic product (GDP) growth a year since 2001 and projected GDP growth of 6%-7% a year from 2008 to 2010, behind only Asia and the Gulf countries within the emerging-market universe.






It is also is one of the areas with the lowest investment flows from foreign institutions. The total free-float market capitalisation of sub-Saharan African stock markets excluding SA is just $75b n compared with $3 200b n for emerging markets overall.

Though the region still lags emerging market peers in human capital development and gross fixed capital formation, the trend towards increasing economic liberalisation and integration into the global economy, and particularly the Chinese growth dynamic, is a positive.

There are signs that the growth is due to more than just improving terms of trade and is more likely attributable to economic reforms and improved fundamentals .




As part of structural adjustment programmes, many African countries have taken reforms to liberalise capital account and exchange rates, reduce trade tariffs, privatise state-owned enterprises and ease restrictions on private investment. These reforms have generated smaller public and private deficits, more prudent use of commodity windfalls, lower inflation, and higher international reserves, making the region less vulnerable to a cyclical downturn.

Fiscal discipline is now much more entrenched as a result of two decades of stabilisation programmes, which tightened public sector wage policies, lowered central government expenditure targets and improved tax collection. Fiscal restraint has in turn helped to bring inflation in the region to its lowest level in nearly two decades. The headline consumer price index has fallen from a peak of 50% in 1994 to 7,2% last year.

Increasing forex reserves are another indicator of more prudent macroeconomic policies this cycle, resulting in a decline in currency risk in the region, helped also by lower current account deficits.

Coupled with improved macroeconomic fundamentals, these reforms have begun to stimulate a revival in capital flows to the region, which have increased fivefold since 2000. The pace of increase has been among the fastest of any region.




But capital inflows into sub-Saharan Africa are still small because of the high costs of doing business in the region relative to other regions, though improvements, such as licensing and tax payments, have been made. In addition, the institutional environment in sub-Saharan Africa (rule of law, freedom of press, independent judiciary, and business environment) remains one of the weakest globally.

The overall political climate in sub-Saharan Africa has also improved dramatically since the end of the Cold War. The number of African countries holding multiparty elections has also increased from three in 1973 to 40 in 2005.

So given the recent economic improvements, an obvious question is how far the region is from marking the transition from "frontier" to "emerging market" status.

Compared with the Association of Southeast Asian Nations region in 1980, just prior to its "take-off" phase of growth, sub-Saharan Africa has lower inflation, higher reserves and stronger foreign direct investment flows, though GDP growth is slightly lower and debt higher.

Undoubtedly this comparison is superficial, but it does suggest some of the historical prerequisites for transitioning to more mature "emerging market" status do exist in sub-Saharan Africa, though, notably, the concerns over weaker political institutions and the spectre of internal conflict are still more prevalent.

For a transition to the high, steady state growth rates found in east Asia, sub-Saharan Africa will require a higher rate of savings and investment. However, sub-Saharan Africa's rising working-age population should help savings and investment ratios going forward.

In terms of potential returns from sub-Saharan African equity markets over the next year, the record-high valuations that stocks are trading on suggest that much of the region's expected growth and structural improvements are already priced in.

However, as growth in corporate earnings exceeds that of emerging markets, and the region's economic fundamentals improve further, investing in sub-Saharan Africa stocks on a three- to five-year basis is an appealing investment proposition. Botswana, Ghana and Mauritius have the most favourable combinations of market valuations and strong macro fundamentals.



Garner and Wang are, respectively, head of global emerging market strategy and global emerging market strategist at Morgan Stanley.