In the CFA Institute’s September/October 2011 issue, Patrick Mutimba, CFA – Director of investments at Makerere University in Kampala, Uganda – looks at Africa’s potential to join the BRICs as an alternative investment destination, especially that of AAEMNS (Algeria, Angola, Egypt, Morocco, Nigeria, and South Africa):

“…I believe Africa will be the next big destination for investment flows because it shares many demo- graphic and natural resource characteristics with the BRIC markets. For instance, Africa has very low levels of market penetration in many sectors, sometimes with old and obsolete technology, which presents the opportunity for new technologies to meet needs in a better way. Also, governments are eager to attract investors and give attractive incentives, such as generous tax breaks and profit repatriation.

Africa is a diverse continent with many countries posting strong growth, albeit from a low base. The major African attractors of investor flows are the larger economies with higher market cap/GDP ratios. Only eight African countries posted a GDP greater than US$50 billion in 2010. Two of these (Libya and Sudan) are largely oil producers and are in some political transition. Angola and Algeria are also among the larger economies. In my view, the most likely candidates to attract increased invest- ment are Egypt, Morocco, Nigeria, and South Africa. They have a combination of relatively larger economies and high stock market cap/GDP ratios, indicating some meas- ure of liquidity—a key element for portfolio investors. This ratio can be estimated at 30 percent for Nigeria, 34 percent for Egypt, 70 percent for Morocco, and 344 per- cent for South Africa (using publicly available 2010 data and current exchange rates). Hence, these economies likely could be the major focus of international invest- ment flows, mainly in the form of portfolios flows to the capital markets and foreign direct investment.

The table compares two blocks—BRICs and AAEMNS (Algeria, Angola, Egypt, Morocco, Nigeria, and South Africa)—in some economic indicators.

The other smaller African economies are growing faster than these six but, being smaller, are coming from a smaller base and could suffer shocks from strong invest- ment flows. Outsized opportunities will exist for portfolio and FDI returns in the other smaller economies of Africa, possibly from countries such as Ethiopia, Ghana, Kenya, Rwanda, Tanzania, Uganda, and Zambia.

With the advent of multinational corporate organizations, there is increasing financial integration among African countries. Liberalization of the capital accounts gives investors confidence that they can come into a market, execute their business objectives, and repatriate the funds as they wish. Unfortunately, this trend is likely to increase the volatility of currency exchange rates and security prices. During the 2008–09 period, the markets that suffered security-price depression in Africa were mostly the more integrated ones. The more “decoupled” markets seemed to do better because they suffered less from the effects of international capital’s “flight to safety.”

Despite the various positive developments, reaching the level of the BRICs or even surpassing them will be a long-term process and will not be achieved in the short or medium term. Before growth can really accelerate, African countries will need to overcome several obstacles: competing for international capital, promoting domestic R&D, finding the right solutions for political difficulties, balancing tradeoffs of internal versus external debt, improving agricultural productivity, and meeting the expectations of a young and increasingly educated and ambitious population.

Competing for Capital. One of the major sources of inflows in Africa is remittances by Africans living abroad, and the continent received about US$40 million in 2010. By comparison, Brazil (to take only one of the BRIC mar- kets) had inflows estimated at about US$100 billion for all of 2010 and about US$37 billion in the first quarter of 2011. GDP disparities versus the BRIC markets are also glaring. The BRICs still offer viable return opportunities over the medium term and will continue to attract much of the investable capital. As already mentioned, Africa is growing fast but from a relatively small base.

Domestic R&D. A key element in BRICs is internally driven R&D, which makes foreign capital flows more rele- vant for the local communities. The key element here is the ability to attract and retain skilled personnel and leverage their knowl- edge and skills to develop appropriate interventions into social challenges. Consider an example from India, where satellite technology has been used to deliver agricultural interven- tion solutions to far-flung communities or in telemedicine (surgical operations being carried out with the support and input of distant medical specialists). Africa needs to strengthen and watch its R&D progress closely. Most of the current business is based on solutions originating from elsewhere. Africa should take more con- trol in driving and harnessing the changing consumption patterns of its residents. Inadequate attention to innova- tion will leave it in a position of continued weakness.

Political Stability. The understanding of the right politics for business may also be interpreted more widely, drawing from countries as diverse as Israel, China, and Saudi Arabia. Can Africa put an end to the old paradigm in which the local politics worked against good business? There is still more work to be done in that area. In some economies, political and economic predictability are key considerations for international business. If African politics can be understood by the business community (and vice versa), more progress will follow.

External versus Internal. Many of Africa’s economic sectors are highly underpenetrated and underdeveloped. This situation provides an opportunity for those with a good understanding of the local risks to go in after their targets. Such development will translate into widespread growth in GDP eventually but not in the short term, mainly because of the low base. Formal savings rates are still very low. Will Africa fund its growth with external debt only?

Agriculture. Africa has a large chunk of the world’s arable land, most of which is firmly within the tropics, yet agricultural productivity is still rather low for a host of reasons. Although we should expect Africa to be able to feed its population, agricultural productivity still has a long way to go to meet this challenge.

Population. Africa’s population growth rate is still probably the highest on the globe. The population growth has been catapulted by the continued high birth rates in combination with falling child mortality as well as increas- ing life expectancy and generally better heath care. GDP growth over the next few decades needs to be much higher than population growth rates. Continued steep popula- tion growth could be the bottleneck that would delay growth. The six key African markets identified above are still projected to slightly reduce their populations over the next five years as a group. Does this trend mean that more growth from burgeoning middle classes can be expected to come from the smaller African economies? Education levels are gradually changing across the continent, leading to rising incomes in some sectors. At the same time, global technology is changing fast and altering consumption patterns. Access to credit is getting easier. Lifestyle diseases are becoming a bigger problem in Africa, with obesity rising in urban areas, even among children. Although Africa’s population is set to change in terms of composition (becoming older), about 50 percent of the population is currently under 20 years old.

Can political authorities see the time bomb they are standing on in terms of educated, ambitious, knowledgeable, but unemployed young people? Terrorist groups could lure some of these youth to join diabolical schemes. To address this challenge, one way is to encourage local enterprise by ensuring affordable access to credit and equity capital, which would include modifications to standard collateralization approaches, ensuring access to regional markets, ensuring long-term development and maintenance of infrastructures for busi- ness, and diversifying the economies. Society’s attitude toward life is changing with growing urbanization. A big part of the economies in Africa is in the informal sector— subsistence               farming,                  informal business,      and      credit — activities that are not captured by national data (i.e., not included in GDP). More transition from the informal economy to the formal economy will present more busi- ness opportunities, with possible spin-offs for the capital markets via initial public offerings. If appropriate wide- scale interventions, such as collateralization of the infor- mal assets, are promoted (I refer to an idea that is well elucidated in Hernando De Soto’s The Mystery of Capital), the opportunities to grow will expand.

Africa is likely set for a long spell of growth. Replacing the BRICs as a major recipient of investment flows seems to be a long way off, but eventually, Africa will join the BRICs as an alternative investment destination.