Mthuli Ncube, Head of Research, Quantum Global Group
Foreign investors are increasingly becoming aware of the tremendous potential and financial reward the African continent offers. Foreign Direct Investments (FDI’s) deliver a number of important contributions to economic development in terms of employment and foreign exchange. In 2016, Africa benefitted from USD 51 billion of FDI. There are various investment opportunities that will generate investor returns whilst contributing towards economic and social development such as Agribusiness, Infrastructure and Healthcare amongst many other areas. Global investment firm Quantum Global has recently developed an innovative tool designed to guide investors on the most attractive African markets for investment in the short to medium term.
Each component of the newly developed Africa Investment Index (AII) (Growth, Liquidity, Risk, Business Environment, Demographics and Social Capital factors) enables for calculation of the risk premium for each African country – therefore presenting a more substantial case when considering African investment opportunities. Countries are then ranked in the AII according to their score.
Sub-Saharan Africa’s growth is predicted to continue to rise throughout 2018, including in low-income countries such as Ethiopia, Tanzania and Rwanda who are currently at the forefront of African growth. The AII’s Growth Factors look specifically at Domestic investment (as % of Gross Domestic Product), the size of an economy as well as economic growth. Kenya for example, is ranked in the AII as the fifteenth most attractive economy for investments, but in terms of economic growth, the country ranks sixth. Kenya’s growth performance has been driven by strong domestic demand and public infrastructure investment in a context of low oil prices and domestic macroeconomic stability. Domestic consumption has been growing rapidly on the back of a growing middle class, rising incomes and rapid expansion of credit. Both the World Bank and International Monetary Fund (IMF) are forecasting growth in Kenya for the next 3-4 years. Kenya’s travel and tourism industry is a strong component of this growth. According to the World Travel and Tourism Council’s 2017 report, this sector is expected to have risen by 6.0% in 2017 and will account for 10% of the country’s GDP –which is almost the same as Kenya’s banking sector.
The AII measures Liquidity Factors according to the level of domestic real interest rates and excess money supply, with the latter denoting the money that is available in the economic system, and theoretically positively influences consumption, spending and ultimately GDP. In the AII, South Sudan is rated first for both real interest rate and excess money supply in the Liquidity Factors, but is also ranked amongst the least attractive economies for investment overall. According to the World Bank Group, livelihoods in South Sudan are concentrated in low productivity, unpaid agriculture and pastoralist work outside of the oil sector. The slump in the oil and gas prices has thus impacted South Sudan’s financial sector and led to a decrease in the available liquidity for energy projects and other investments. The IMF argues that in order for South Sudan to steady inflation, peace resolutions to conflict, fiscal deficit, exchange rate stability and a recovery in both oil production and non-oil GDP would need to be achieved.
Social Capital factors
The AII uses a Social Capital Factor which looks specifically at the level of knowledge, networks and connections in a given country, with Facebook penetration used as a proxy. It is no secret that strong local relationships play a huge role in a business’s successful integration and growth on the continent. African businesses have begun populating Twitter, Facebook and other forms of social media, bringing new, varied narratives and thus business opportunities to the forefront. The high penetration of Facebook on the continent will help boost financial inclusion, with increased virtual communications which is creating further business and investment opportunities. The AII’s Social Capital factor is an innovation as no other investment index or doing business guide takes such a factor into consideration when considering African investment opportunities. Tunisia ranks first in the AII’s Social Capital Factor. And while North Africa is a region where revolutions in the forms of the Arab uprisings were accelerated through the use of Social Media, there are strong indicators that the applications for business purposes are now equally strong. Morocco’s Digital Program 2020, which was developed last year is just one of the examples of an African country using the digital economy as a building block.
The AII takes into account Risk Factors which measure a country’s credit rating standing, risk of currency depreciation (as measured by inflation differentials), import cover ratio (capturing the risk of foreign currency reserves required to cover critical imports), current account and external debt levels. Sub-Saharan Africa and especially its oil-exporting economies, has seen many credit downgrades and lowered growth outlooks in 2016, raising the importance of financing for development even higher. Foreign investors and businesses working in Africa encounter daunting economic, political and social risks that reduce their ability to make mid to long-term investment decisions. Investors value balanced, consistent, and predictable regulation in a given country. For instance, South Africa’s credit rating was downgraded by S&P and Fitch to BB+ (junk investment status) in March and April this year, and by Moody’s to Baa3 due to rising political and institutional risks which is threatening the growth outlook. Irrespective, South Africa, Africa’s second largest economy is ranked fourth on the AII, scoring very well on growth factors (size of GDP), ease of doing business and the demographic factor (size of population).
Business Environment Factors
The AII categorises the Business Environment Factors according to the ease of doing business in a given country. It is constructed from macroeconomic and financial indicators and the World Bank Group’s Ease of Doing Business indicators. Mauritius, which ranks first on the AII’s business environment factors benefits from its long-established links in Africa and position as a natural conduit for exponential growth in the emerging Africa trade corridor. It is a stable and mature democracy, which has actively sought and welcomed foreign investors and businesses for many decades and is strategically positioned and built on more than two decades of expertise in cross-border finance. Various African focused investment firms such as Quantum Global have already set-up a homebase in Mauritius in order to bring them closer to investment opportunities on the continent.
Afric’s demographic dynamics are shaping its present and future development agenda and the trends will vary from country to country. The population currently stands at 1.2 billion and some of the most populated countries include Nigeria, Ethiopia, Egypt and the Democratic Republic of Congo. The AII uses the demographic factor which accounts for the size as well as the potential market at present and in the future. According to the IMF, the number of Africans joining the working age population will exceed that of the rest of the world combined by 2035. A growing population as well as a rising new middle class is fuelling demand for new infrastructure investments as part of the urbanisation process.
Uganda for example, which has a population of over 38 million, has one of the youngest and most rapidly growing populations in the world. The country ranks 12th in the AII overall and 10th in the AII’s demographic factor. The population increase will further strain the availability of arable land and natural resources and overwhelm the country’s limited means for providing food, employment, education, health care, housing, and basic services. Currently Uganda’s rate of urbanisation stands as 5.43% annual rate of change (2010-15 est.), highlighting the growing demand for goods and services as well other infrastructural investments.
The case for African investments is becoming an increasingly discussed topic given the intricacies and nuances of doing business in each individual African country. Some existing tools such as the World Bank’s Doing Business Index (used as a subset in the AII) which ranks individual countries according to the Ease of Doing Business Ranking, do demonstrate some degree of correlation between the AII’s indices and indicators.
The AII however is the most comprehensive index yet to assess countries for their investment attractiveness. It goes beyond any other index by taking into account the size of an economy, size of population and risks – in particular exchange risks, debt and liquidity, and will also look at indicative pricing for deals and transactions and the valuation of Private Equity multiples. The social capital factor is also an innovation, as no other index has taken such a factor into consideration. The risk in the real sector of the economy is captured by the spread in liquidity factors, between the lending rate and the risk-free Treasury bill rate, in a country. Adjusting this spread with factors such as GDP size of the economy, demographics, ease of doing business, Facebook penetration, then yields a risk-premium for the country. This then enables the calculation of a ball-park Price-to-Earnings multiple appropriate for each country. In conclusion, the AII not only enables the ranking of countries in terms of attractiveness for investments but gives a guide on the pricing of risks and the valuation of investment deals in a country.