African Renaissance Depends on Internal Growth, Stable Governments — and Patience

While the rest of the world was rocked by the financial crisis and recession, Sub-Saharan Africa, with less to lose, has fared better than many other regions. The crisis was a setback, but the continent’s diverse economic regions are expected to regain their footing in the coming year and experience strong growth relative to other parts of the world. Observers predict that governments will continue reform initiatives, infrastructure will improve and investors will put capital to work across the continent.

Indeed, for many investors, Africa represents one of the few regions still offering an opportunity for outsized gains. As a middle class begins to emerge in many African nations, once poverty-stricken countries will provide the high rates of return on investment earned recently in fast-growing economies, such as Brazil and China, that are now likely to grow more slowly as they continue to mature.

Africa’s gross domestic product, which was increasing at double-digit rates in some countries before the crisis, is likely to grow by between 5.5% and 6% in 2010, according to the African Development Bank. Yet Wharton finance professor Richard Herring notes that significant hurdles to African economic growth remain. He says it is difficult to generalize about Africa because there are so many diverse countries, including those rich in commodities and oil that are poised to make a “great leap forward” if world trade recovers from the crisis.

At the same time, in many parts of Africa, political and social instability continue to hamper growth. “The main obstacle in all too many of these countries is a political system that controls most of the flows of resources for the benefit of the ruling elite rather than making the essential investments in human capital and infrastructure that are essential for sustainable growth,” says Herring.

In the near term, the financial crisis has had less impact on African economies than it has on other parts of the world, notes Idris Mohammed, a partner at Development Partners International in London where he manages a pan-African investment fund. “Africa has done a lot better coming out of this recession than in past economic downturns. That’s primarily because it went into it in a strong position. We think that bodes well for 2010. The past eight to nine years have been good, and when the global economy [rebounds] next year, Africa will return to relatively high rates of growth.”

New Foreign Direct Investment

According to Mohammed, who spoke about private equity investment in Africa at the Wharton Africa Business Forum in November, the recent economic strength in Africa is due to a number of factors. Governments, he says, have made improvements in economic and political freedoms and have learned to become more conservative fiscal managers. African nations have also benefited from debt-reduction programs initiated by Western lenders. As a result, African governments have more flexibility to invest in pro-growth policies and projects. In addition, higher commodity prices buoyed exports, and the continent was able to attract substantial foreign direct investment, particularly from China. Finally, he notes, African businesses have become dramatically more productive due in large part to new communications technology, including mobile phones that are commonplace even in remote villages.

“It’s a nice complement of factors that has really driven this renaissance in Africa. We expect that to continue,” says Mohammed.

Others point to economic reforms that have been adopted across the continent, encouraging investors to finance new projects. In an annual study of business conditions conducted by the World Bank and the International Finance Corp., Rwanda was identified as a top reformer. The report, Doing Business 2010: Reforming through Difficult Times, points to progress in other countries as well. Liberia eased procedures for business start-ups, reduced construction permit fees and initiated a new one-stop trade center. Sierra Leone strengthened investor protections, enhanced access to credit and provided for the reorganization of troubled firms. Burkina Faso and Mali each made reforms in five of the 10 areas covered by the report, while Angola, Cameroon, Ethiopia and South Africa lowered taxes on domestic firms.

Yet Eric Kacou, Rwandan-based managing director of the development consulting firm OTF Group, suggests that despite these signs of progress, it is necessary “more than ever for governments to remove some of the constraints that make life more difficult for businesspeople.” He points to a new type of business leader emerging in Africa. “It used to be that most of the entrepreneurs were people from other colonies who were just interested in trading natural resources,” he notes. “Now, entrepreneurs are coming to the continent and seeing potential markets they can serve. They see products they can develop. They see platforms that are ripe to establish and grow a vibrant firm.” These new leaders, he adds, are a mix of local tycoons, foreigners and people who were born in Africa, grew up or were educated abroad, and have now returned to establish their careers on the continent.

Larry D. Bailey, president of LDB Consulting in Washington, D.C., and vice chairman of Africare, a Washington, D.C.-based African aid organization, says investors are turning to Africa because “all the emerging economies have emerged. Africa has the greatest potential.” Latin America and China are well on their way to becoming established developed economies, he notes. Meanwhile, in Africa, natural resources are bountiful with frequent new discoveries of oil and gas. “It’s going to be incumbent on Africans not to be exploited this time around,” Bailey states. “You have a younger generation of Africans going back home and they are going to put pressure on governments to manage these resources well.”

Given the vast size and diversity of Africa, business and economic prospects for the new year vary by region and sector.

In East Africa, especially Kenya, key industries are well-integrated in the world economy and have suffered as a result of the worldwide business slump, according to Laila Macharia, CEO of Scion Real in Kenya. European demand for Kenyan vegetables, cut flowers and tourism is down. She notes that in 2005 and 2006, private equity funds and other investors were pumping money into local stock exchanges and opening branches in the region. “Now, much of that money has been pulled out of the markets, causing a slump in values.”

In the early days of the crisis, East Africans working abroad who contributed billions of dollars to the regional economy cut back as they grew uncertain about their own jobs. Yet those contributions are rebounding, according to Macharia, providing a multiplier effect throughout East African economies.

She says that the crisis is being used as a reason to support conservative financial measures that prohibit the development of secondary mortgage markets or derivatives that might otherwise help boost investment and growth. Africa, she adds, has the opportunity to introduce these types of financial mechanisms with strong regulations right from the start, rather than having to add new oversight later, as is happening in the United States and Europe.

“For East Africa, the long-run outlook is very good,” says Macharia, noting that the English-speaking region has a strong complement of educated managers. “Our countries are organizing themselves into a common market, and our demographics bode well for sustained growth for several decades.”

Growth in West Africa, which is largely dependent on oil and other commodities, is expected to remain flat for the next two years, predicts Daouda Thiam, a management consultant based in Cote d’Ivoire. “At the beginning of 2008, most of the countries were growing. Then the growth stopped because of the spike in oil and food prices and some mismanagement as well. Now, we are going on the downward slope. I cannot tell if we have hit bottom yet.”

Natural gas and energy sectors are strong and could be harnessed to produce badly needed electricity throughout Africa, but Thiam says that would raise concerns about climate change. Meanwhile, he notes, political instability remains a concern in oil-producing Nigeria.

Welcoming the World Cup

In Southern Africa, the Fédération Internationale de Football Association (FIFA) World Cup to be held this summer in South Africa is expected to drive growth, according to Malcolm Pryor, CEO of the South African Enterprise Development Fund. Pryor, who spoke on a panel about microfinance during the Wharton Africa Business Forum in November, says the region is already benefiting from investment in infrastructure — including roads to accommodate three million visitors expected to attend the World Cup games between mid-June and mid-July.

In addition, investment in infrastructure — such as power projects and an expansion of broadband capability that has occurred over the past three years throughout the region — is expected to pay off in productivity and economic growth, according to Pryor. In Africa, he says, some technologies are going to leapfrog typical patterns of adoption in developed countries. For example, the widespread use of mobile telecommunications technology may make mobile banking more available across Africa than in Western countries, thereby reducing the cost and effort of providing financial services to people living in remote regions.

“The process of politically delivering on the promises at the end of apartheid by the South African leadership will continue to be a challenge, but an emphasis on housing, health care and education seems to bring renewed vigor,” Pryor says, adding that governments in South and Central Africa have taken a stronger role in the prevention and treatment of HIV/AIDS.

Pryor notes that while African banks were not directly affected by the crisis and are not holding toxic assets of their own, the resulting lack of liquidity in the world financial system is increasing the cost of borrowing to finance projects in Africa. “But I see some financing coming back into the market. Transactions that were put on hold are again being revived and the banks are more willing to be a financial partner.”

Meanwhile, continued economic progress in Africa will depend on the development of stable financial systems and ongoing investment. “Interest in investing in Africa has really mushroomed in the last five years,” says Dawn Hines, co-founder of Aventura Investment Partners, an early-stage investment fund targeting the rural food system in Africa. For example, agriculture had been considered a risky, low-margin business until the global food crisis emerged in 2007 and investors suddenly wanted to add agriculture to their portfolios.

“The issue of food production has gone a little bit under the radar in the last year because of the financial crisis, but I think the food crisis is going to rear its head again,” says Hines. As the world grows richer, demand for meat and grain to feed cattle will put pressure on food prices — driving demand for production in Africa where arable, irrigated land is plentiful. “There are opportunities for agriculture in Africa,” she notes, making it all the more incumbent on governments “to do the right thing” by, for example, “investing in agriculture and making sure farmers have access to fertilizer and equipment.”

In Africa, development aid from governments or non-profit organizations represents a significant chunk of the overall economy, as much as 75% of GDP in the small Central African country of Sao Tome and Principe.

Natasha Quist, regional representative for the World Wildlife Federation in Central Africa, says the financial crisis will take a toll on organizations that are dependent on donations from individuals or charities that have suffered declines in the value of their assets. However, she says, programs that depend on large donations from governments are not experiencing a drop-off in funding. In particular, she notes, work that can be linked to good government or climate change continues to enjoy strong support. Many nations and multinational agencies — whose missions are oriented toward economic growth — are focusing more intensely on Africa as other countries that once competed for funds, such as Malaysia or India, begin to climb out of poverty.

Bailey says African nations need to develop their own financial networks without relying on international financial centers overseas. “At some point in time, they have to take control of their own market,” he says. “The whole mindset has to change. London and Paris will no longer be the center of African affairs. Africans want to control their own destiny like everyone else.”

Yet some observers predict that Chinese investors will continue to play a major part in development across the continent in 2010. Kacou says they were initially interested in natural resources and construction, but are now moving into a range of sectors — including hospitality, local manufacturing and distribution. “The impact … has become very widespread within African economies,” he suggests, noting that Western nations are sensitive to Chinese expansion in Africa, fearing the Chinese will gain market share and promote dictatorships. In Kacou’s view, however, the source of the investment is less important than whether the investment will lead to productive growth.

Family Dynasties

As important as the source of foreign investment is the fact that, despite economic opportunity, African nations remain troubled. “Continuing civil wars in many countries not only destroy lives and waste resources, but also encourage people with education and valuable skills to leave,” says Herring, adding that South Africa has shown it is possible to change governments regularly without chaos. Yet many rulers in Africa want to keep power for life and establish dynasties to enable their family or tribe to maintain control for years to come.

Much of Africa’s political problem is a result of “clumsy” national boundaries drawn in the colonial era, Herring argues. In some cases, the best solution would be to redraw the borders to better represent tribal boundaries, although Herring cautions that impetus for this change must come from the African people themselves, not outsiders. “At some point, African countries may realize that diversity can be a wonderful resource,” he says, “but for the last two decades it has been a disastrous burden.”

Going forward, Mohammed suggests that African economic growth will hinge on development of a new model based on internal growth within Africa, not a model based on exports of commodities or low-cost manufactured goods that has often been used by developing economies to stimulate growth. “We think what’s happening in Africa now is that growth will be driven by domestic demand. We see that in terms of increases in agriculture, the banking and financial sectors, consumer goods and staples — food, drink, housing, transportation, all these things that need to be locally produced. Those are what will drive growth in Africa.”

He says an analysis of economic performance over the past years comparing oil-producing countries to those without oil concludes that countries that had to rely on internal markets for growth did better than those with oil to export. “This bodes well for economic growth in the future. The recent financial crisis has shown we are all linked, but I think Africa is much more insulated than places like China from what happens in the global economy. There is an emerging middle class growing across Africa, and that is what will drive improved economic growth.”

Thiam’s pet peeve is competing tiny flagship airlines that are heavily subsidized by governments but do not meet traveler’s needs, inhibiting business growth and productivity. “If you all have just two or three aircraft, it can’t work,” he says. “My hope is that these countries can get together and create one big airline to fly between the countries. The demand is there.”

According to Bailey, an important aspect of any African investment and development strategy is patience. “Things just don’t happen as quickly there. You want them to happen and eventually they will, but you have to go in with a long-term interest in the continent. You have to go in with an idea of building capabilities so the people will be able to run their own businesses at some time. The younger generation is going to demand that.”

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