As investors witness rising competition and fewer lucrative opportunities in developed and traditionally attractive emerging markets, such as those in South Asia, Africa is increasingly in the spotlight.
In September, McKinsey Global Institute, a U.S.-based management consultancy, said, “With its population expected to nearly double to 2.5 billion people by 2050, [Africa] presents myriad opportunities for robust, inclusive growth that harnesses rich natural resources and abundant human potential.”
However, Africa faces economic, structural, and foreign risks. An IMF paper titled “Managing Fiscal Risks in the Middle East and North Africa,” published in June, said, “When risks materialize, they often have major and lasting implications on fiscal deficits and debt as well as the conduct of fiscal policy going forward.”
Making matters worse is that most African “countries and policymakers are often caught off guard, forcing them to adopt ad-hoc measures,” the International Monetary Fund (IMF) said. That limits African governments’ abilities to implement long-term policies, instead acting as economic firefighters, the IMF added.
Legacy of risk
Africa has always been a high-risk investment environment that is difficult to forecast. The IMF paper noted that between 2011 and 2021, two-thirds of fiscal deficits were wider and debt ratios higher than predicted the previous year.
Even during its good economic spells, forecasts were off. “Absolute actual debt realizations have deviated from the previous year’s forecast by a median of 3.8% of GDP,” the IMF paper said. “Government deficits have deviated by a median of 1.3% of GDP.”
The continent also “has a track record of comparatively volatile economic growth and sharp exchange rate movements,” the IMF paper said. “Many of the factors associated with the materialization of fiscal risks in [Africa] are likely to remain sources of vulnerability.”
Another risk the IMF cited is the continent’s dependence on fossil fuels, as global price fluctuations dramatically affect the economic outlook of net importing and exporting African nations.
The IMF said the other incumbent risk in the continent is “high government involvement in the economy and large state ownership of firms and banks.” The result is a crowding out of the private sector and startups from many potentially lucrative opportunities.
Risk in 2023
Africa has been on an economic roller coaster since the COVID-19 pandemic, mainly because of supply chain disruptions. Meanwhile, the war involving Russia and Ukraine, both significant suppliers of grain and fuel for Africa, has been raising risk levels throughout the continent since the February 2022 invasion.
In a September report from the Economist Intelligence Unit (EIU) titled “Africa’s Operational Risk Outlook,” 16 of the continent’s 52 countries have seen their risk levels rise compared to 2022. Egypt is one of those nations. That higher risk score was driven mainly by increasing macroeconomic risks, it said.
That is more worrying for African nations compared to other countries as positive GDP growth rate outlooks are the top reason foreign investors are drawn to invest in the continent. According to the EIU report, the “macroeconomic subcategory” always had the best scores compared to other subcategories. The report said that status is mainly due to “relatively fast economic growth that comes with expanding populations.”
Investors considering Africa face other substantial challenges. “Political stability and government effectiveness [are still] the biggest risks,” the EIU explained. Meanwhile, the continent’s financial sector is witnessing “high risks of … distress” from “rising public debt levels and comparatively low levels of banking supervision and autonomy.”
The EIU said the “five best-rated African countries” are Mauritius, Cabo Verde, Botswana, South Africa and Morocco. That is due to their “comparatively business-friendly tax and trade policies and relative political stability and government effectiveness.”
The “worst-rated” are Sudan, Somalia, Guinea, Eritrea and the Central African Republic. The EIU blamed their “entrenched political instability, pervasive graft, and uncertain government policy … with regard to foreign businesses.”
African governments have struggled to attract fresh investments over the past few years, meaning states had to issue more local and foreign debt. “Given the well-defined challenges these economies are facing … we are saying there is a silent debt crisis that has been taking place,” Ayhan Kose, deputy chief economist at the World Bank Group, told The Financial Times in November.
Investopedia, an economic glossary, says that is worrying, as a sovereign default makes it “expensive or impossible for [the country] to borrow money in the future.”
That scenario also hurts local banks, pension funds and individual sovereign bond investors. They “could face … risks through their heavy exposure to local-currency sovereign bonds, which could … be subject to write-downs as part of restructuring strategies.”
The EIU report added that sovereign defaults make public and private commercial banks reluctant to give loans to individuals and businesses. That causes GDP growth rates to stall or contract. Investopedia added that inflation would rise as a result of those disruptions.
Uncomfortably high debt levels are expected in African nations. The IMF’s paper noted that “on average, a large macroeconomic shock occurs once every eight years and causes government revenues to drop by 2.8% of GDP, while debt increases by almost 12% of GDP.”
For next year, the EIU warns, “Africa is approaching a maturity wall on its Eurobonds that begins in 2024, with most of the continent unable to tap international markets to roll over maturing debts.” As a result, an “increasing number of countries are seeking restructuring deals … ahead of an expected spike in debt servicing in 2024 [and] 2025,” the report said.
The IMF report said such developments raise the probability of defaults in the coming two years. That means governments are more likely to bail out private and public-owned businesses if their bankruptcy would threaten the economy at large, putting more pressure on the state’s budget.
Those pressures are exacerbated by government exemptions and support programs designed to protect or promote industries like tourism in Egypt in the wake of COVID-19 lockdowns.
Too many public-private partnerships (PPPs) and power-purchase agreements (PPAs) add to a government’s fiscal risks. They “create debt-like obligations on the government, as they commit the [national] budget to regular payments far into the future,” the IMF report said. “Similarly, when faced with the possible bankruptcy of a PPP or PPA, operators of critical infrastructure, the government may have little choice but to organize and financially support a bailout.”
The EIU said Africa’s sovereign debt risks have a “high probability [and] very high impact.”
Unexpected and aggressive changes in global commodity prices, particularly fossil fuels and food, are a significant risk to those who want to invest in Africa. The IMF report said such volatilities are particularly damaging to the continent as external forces influence their prices. “Fluctuations in commodity prices typically generate unforeseen significant deviations in fiscal outcomes,” it said.
To maintain prices during inflation, net importing and exporting African nations subsidize locally sourced and imported commodities for businesses and individuals.
The IMF report said that approach increases fiscal risks as “subsidy outlays rise with the market price of oil and other inputs.” In Africa, subsidy risks are amplified further due to the continent’s low economic resources. The EIU report warns that eventually, “subsidy regimes [will] buckle under the fiscal strain.” That has been most evident in Angola, Malawi, Nigeria, Ethiopia, Sudan and Madagascar.
The IMF report noted that while structural reforms would ensure that African nations limit commodity price volatility risks, “in several countries, reform implementation has been uneven and spending on subsidies has therefore remained elevated or reduced only gradually.”
Government and central bank decisions can amplify or calm investors’ concerns over investing in Africa. The EIU report said the top consideration for investors is how the state deals with inflation. “High regional inflation drives up business input costs and fuels widespread social unrest,” it explained. [It is a “high probability, high impact” factor.
The EIU report said national inflation factors include “lingering supply-chain tightness, high regional food prices and local currency weakness” against the dollar. The EIU said inflation risks are particularly evident in Ghana, South Africa, Kenya, Tunisia, and Madagascar.
Keeping prices in check is particularly critical to African countries, as rampant inflation depresses household and business spending. That results in worse GDP growth rate outlooks, which the EIU said is the top reason FDI comes to the continent. Inflation “is especially crucial against a backdrop of entrenched, widespread poverty and high unemployment across most of Africa,” they said.
The IMF report also noted the risks of rising interest rates in Africa to slow, or at least limit, inflation. “It is another fiscal risk, increasing the cost of borrowing and servicing debt, reducing economic activity [as people save rather than spend], and thereby [decrease] government revenue,” the IMF explained.
Exchange rate volatility is another risk for investors. The IMF report said it increases the cost of imports and foreign currency sovereign debts. It also lowers confidence in the local currency, resulting in businesses and individuals converting their savings to dollars to preserve its value (dollarization), leading to further devaluations in the local currency. The IMF report said, “Exchange rate volatility has been comparatively high [due to recent] adjusting foreign exchange rates and floating previously fixed currencies.”
The EIU report also noted “widespread corruption in public services, bureaucratic red tape, a lack of accountability among civil servants and limited government control beyond key urban capital centers.” Such corruption leads to a “lack of judicial independence, excessive state authority, infrastructure deficiencies, shallow financial markets and [low] skill labor.”
The result is that development projects and investments are likely compromised on the ground. The EIU report said, “Weak governance and entrenched corruption in the region could also exacerbate mismanagement, [causing] cost overruns and delays.”
Corruption and bureaucracies have caused progress on the African Continental Free-Trade Area (AfCFTA) to “remain slow,” noted the EIU report. The result is that even if investors find an African country they can invest in, they still need to overcome trade barriers to access the continent despite AfCFTA.
Big government risk
“Large government ownership and public sector balance sheet interlinkages further contribute to fiscal risks from banks in the regions,” said the IMF
The most prominent example is the domination of state-owned banks (SOBs) in various African countries. The IMF cited Algeria (89% of the national banking sector) and Egypt (74%) as prime examples. “SOBs in the region are usually highly exposed to [state-owned enterprises (SOEs)] and the public sector (about half of total bank assets in Algeria and Egypt),” the report said.
The IMF also noted that nonfinancial SOEs pressure the state budget due to their “loss-making activities, poor dividend performance, non-repayment of loans, calls on government guarantees, recapitalizations or asset sales below book value.”
The report also pointed out that government involvement in business could “lead to complex crossclaims between government and SOEs, hindering fiscal management.”
Regardless of the extent of the risks, the IMF report stressed the importance of “ensuring the collection of regular, timely and comprehensive fiscal data covering the entire public sector, as well as other macroeconomic data [to become] the foundation for analysis.”
That likely will require governments to develop new systems to “seek out relevant information that may not currently be systematically collected,” the EIU report said, “transparent recording and assessment of fiscal risks, such as exposure to various economic shocks, financial information on guarantees and SOEs, and information on the likelihood and impact of natural and climate disasters.”
Such data would enable policymakers to “strengthen firewalls between different fiscal risks,” the EIU report said. That increases “the chance that risks can be contained when they materialize.”