Capital markets in Sub-Saharan Africa
Comment of the Day

October 10 2013

Commentary by Eoin Treacy

Capital markets in Sub-Saharan Africa

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Sub-Saharan Africa’s strong growth performance (see chart 2), improvements in the business environment, ongoing economic reforms as well as robust commodity demand have drawn global investor attention to the continent. Combined with easy conditions in the global financial markets – record low interest rates in developed markets and ample liquidity – this has led to increasing private capital inflows to Sub-Saharan Africa over the last ten years. Private capital inflows, i.e. foreign direct investment and portfolio investment, to SSA increased sharply and nearly quadrupled from USD 13.2 bn in 2003 to USD 48.3 bn in 2012 (see chart 1). Foreign direct investment (FDI) continues to be the main conduit for private investment. In 2012 FDI inflows accounted for two-thirds of total private capital inflows. The nature of these FDI inflows, however, is changing. FDI is no longer directed exclusively towards extractive industries, but increasingly targets the rising African consumer market. Some of the most active sectors over the last few years have been consumer-oriented manufacturing, infrastructure and services.1

... but vulnerable to external developments

Despite the strong overall growth, private capital inflows to SSA have been highly vulnerable to external developments. The financial crisis of 2008/2009 and the spike in the euro area crisis in 2012 significantly slowed capital inflows (see chart 1). It is thus also likely that the recent sell-off of EM assets, sparked by fears about a reduction in the US Federal Reserve’s bond-buying pro-gramme, will have negatively affected investment flows to SSA. South Africa, the only country for which recent data on portfolio flows are available, experienced a reversal of non-resident portfolio inflows in May and June 2013. Especially bond purchases by non-residents turned negative. Net outflows of about USD 632 m in June are, however, relatively modest compared to net outflows of USD 4.9 bn in October 2008 after the collapse of Lehman Brothers, or USD 3.1 bn in September 2011.

Eoin Treacy's view The Sub-Saharan region continues to attract global investor interest as governance improves and economic growth accelerates although both are coming from a very low base.

This low base is one of the most relevant considerations from the perspective of a foreign investor. On the one hand economic growth is surging. This is translating into the development of a middle class and an increased pace of stock market listings. However, because of the low base from which this growth is occurring the relative size of companies and capital markets is small.

Liquidity is a very relevant concern. As long as capital remains abundant, a relatively small number of funds can push prices higher but when that cycle rolls over liquidity trumps all other considerations in the short-term. Fundamental considerations generally reassert themselves once liquidity becomes more abundant.

The UK listed Africa Opportunities Fund has become quite overextended relative to the 200-day MA over the last few months and a process of mean reversion now appears more likely than not.

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