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Buy Africa
Economies are prospering but political stability is fragile

Feb 19th 2008
From The Economist Intelligence Unit ViewsWire

Some hedge funds, brokerages and offshore investors believe that the time is ripe to "buy Africa". It is certainly the case that price-earnings ratios for many African stockmarkets were above their sectoral equivalents in mature markets in 2007, but the ongoing fallout from the subprime mortgage crisis in the US should act as a reminder that what goes up eventually comes down.
The markets can turn very quickly—and very substantially. In Africa 1.01: Unlocking Investment Potential, published before subprime realism had begun to set in, emerging-market investment bank Renaissance Capital concludes that the continent "has probably turned the corner on its relative economic decline," thanks to "a supportive global backdrop for commodity exporters", hugely improved national balance sheets and "a political commitment to better economic policies".
The binding constraint on most African economies has now shifted, it says, from a lack of foreign exchange and high cost of capital to "chronic infrastructure bottlenecks, reflecting the surge in GDP growth after years of investment neglect". Renaissance argues that "a bet on the sustainability of Africa’s recovery" is that sufficient funding and political will exist to overcome this key constraint, although it admits that infrastructural improvements will need to be "ongoing for some time". On the basis of this conclusion, Renaissance suggests three main investment targets for those seeking to cash in on frontier market opportunities in Africa:
• Domestic companies that make or supply cement or other building materials as primary inputs for infrastructural and related construction and real estate projects. This will remove the "current primary wedge" to African economies achieving higher rates of sustainable economic growth.
• Firms that supply retail markets, especially fast-moving consumer goods. Growth in these markets will "capture the broadening base of economic development," Renaissance says.
• The funding of these two opportunities, notably through consumer banking and micro-finance companies.
It is certainly true that growth in Africa has been, and will be, constrained by infrastructural bottlenecks—as is apparent from the power-supply problems that have bedevilled growth in Nigeria and parts of East Africa for years, while recently emerging as a serious obstacle to recovery and expansion in Southern Africa. However, far from being the consequence of inadequate funding, these are the result of weak political commitment, poor (or non-existent) planning and the conviction that a foreign donor or lender will come to the rescue. Thus politicians in South Africa and Zambia were well aware that there would be a power problem from 2007 onwards, but they failed to act until it was too late. This problem is replicated throughout Africa, where inadequacies are apparent not in hardware so much as "software" such as skills, technology and above all good governance.
The bottom millions are being marginalised
On the face of it, as Renaissance suggests, it makes sense to invest in consumer markets that "capture the broadening base of economic development". The reality, however, is that in many—probably most—African economies the base is not broadening at all. The bottom millions in rural areas and urban slums are as deeply mired in poverty as they were a decade ago. The commodity booms in oil, gas and metals are leading to a surge in cheap consumer goods imported from Asia, not booming domestic manufacturing companies (with the exception of those making foodstuffs, beer, soft drinks and cigarettes).
Thabo Mbeki’s failure to retain the presidency of South Africa's ruling party is largely attributable to the failure of the "boom" to alleviate poverty and unemployment. There is a fast-growing black middle-class (the so-called black diamonds), but it is what has been happening below, to the bottom millions, that swept Jacob Zuma and his followers into power within the African National Congress.
The truth is that in Africa, politics dominate, and the political environment can deteriorate with surprising rapidity—as demonstrated by the problems in Kenya in the wake of its December 2007 presidential polls. Unfortunately, analysis of African stockmarkets often overlooks (or understates) the critical role of good-quality institutions. A February 2008 study of the South African stock exchange—The Determinants of Stock Market Development in Emerging Economies: Is South Africa Different?—written for the IMF concludes that strong institutions are necessary to reduce political risk and thereby boost confidence in local stock exchanges. If analysts in the hedge fund or venture capital industries pay insufficient attention to this aspect they are likely to misread and misinterpret African politics, and thus investment prospects.

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