In the latest in our series of online discussions on Africa, AZA asked the question: is prejudice infecting capital markets? To what extent is there a risk bias against Africa?
Speakers:
- Kojo Annan, Chairman and Co-Founder of Vector Global, and son of Kofi Annan
- Christophe Charlier, former Chair of Renaissance Capital
- Fulu Mudau, Fixed income and Currencies for Deutsche Bank
- Michael Nderitu, Chief Risk Officer for AZA
Questions are from Boason Omofaye, Africa consultant at New Markets Media & Intelligence
Is the default risk premium that investors demand for Africa justified?
Michael Nderitu: There is a bias in terms of investment in Africa. Most African countries are not borrowing as much as developed countries. They are borrowing typically at around 40-60% of their GDP while developed countries borrow sometimes higher than 100%. Yet investors demand higher premiums partly because of the dollarization effect, meaning whatever they plough into Africa, once they want to get it out, they will experience dollar shortages because the dollar is a scarce commodity in Africa.
Christophe Charlier: It is also a laziness premium. It is the investors who are lazy. They like countries and companies that return to the market frequently so that when they spend their time and do their homework on a particular issuer, they get the chance to use that research the following year and the year after, several times.
This was an issue when we did, for example, the IPO of Helios Towers. We had to go and educate investors about Tanzania and the DRC, which are the two big countries for that company. A lot of investors told us you know, “Listen, you know DRC, Tanzania, I am going to spend a lot of time understanding the politics, understanding the economy, understanding all of the capital controls, and all the other issues in those countries, but if I will do that only for one issue, it takes too much of my time. It’s just not worth the effort.” The second thing is, liquidity is king. When investors invest in a bond or in a stock, they want to know that it is easy to get in and easy to get out. If they see that they’ve made a wrong call, or if they want to capture the upside that they’ve already gathered, they want to know that they can get out quickly, and that there is a secondary market and that the capital controls are in place.
Another thing is that size maters. For a lot of investors, it is just not worth it to spend time looking at a Eurobond coming from one of the smaller African countries and then to get a $5 million or a $7 million allocation on the bond, when for them unless a ticket is $50 million it’s not worth doing.
One of my catch phrases is that misery loves company. What do I mean by that? Investors know the risk of Argentina: if something happens, all of the investors will get together over a beer and say, “argh, Argentina did it again!” And they will all feel okay because all of their friends will have been in the same boat, and all of them will be suffering equally. If, however, one of them takes a risk on an African country, and the deal goes south, that person will have taken that risk alone and then will need to justify it to their investors, to their bosses and to their investor friends, who will say: “Why did you even bother looking at that?”
Finally, there is always a strong home bias for investors. Investors like to invest at home and then regionally and, typically, in order to justify going very far from the home region, it needs to be about lowering risk by diversifying and increasing the chances of yield.
How critical is data to risk assessment in Africa?
Kojo Annan: Data is important but if the narrative is already biased, then many people aren’t going to delve deeply into the data to either justify or not their investment because they have already built up a picture that has been told to them that Africa has all these inherent risks. I think you can even go a step further and say that the game has already been created in a biased fashion against you, so you are playing a losing game before you start. As a bond investor is looking for interest rates much, much higher than would be applicable in the West, then already you are on a losing footing because as an African government, I am borrowing at 8%, 10%, 12%, and another guy is borrowing at half a percent, 1%: where is the equity there?
These are the some of the fundamental issues that have to be addressed. Because these things have happened historically, it doesn’t mean they cannot be changed. We can’t spend another 20 years, 50 years, 100 years playing a system that doesn’t work. I think fundamental change is required.
Many years ago, Colin Powell told me, “money is a coward – it likes to go where it feels comfortable and it likes to come and go as it pleases.” But money also likes to be in surroundings that it understands.
Is the additional risk attributed to Africa simply a reflection of market economics?
Fulu Mudau: This comes back to your earlier point around data because, for example, one of the data sources that we use to assess investment in Africa is rating agency reports. But is the methodology that they are using appropriate for Africa, and do they really understand African politics? The likes of Zambia, Tanzania and Namibia have questioned the outcome of their ratings and said they weren’t adequately consulted, and that there is a misunderstanding of the situation that’s happening. If our data sources on systemic issues and the actual situations comes from offshore, if we are not telling our own stories, then how do we even start to change the narrative?
How much is this risk premium impacting business in Africa?
Kojo Annan: It has a massive impact. If an African country is paying rates four, five times more than in the developed world then, as a business, fundamentally you are already at a huge loss before you even start to try and get a return on whatever you are using the bond or the funds for.
These rates are based on historic biases that all of these countries will default or the projects won’t work, or that the economic or financial sophistication is not there in these markets. These are narratives that have been pushed for decades and decades and keep getting pushed. Yet, we all know that today this is simply not the case because there are so many Africans who have the same skill set or more as anybody in New York or London or Paris, and they have been to the same schools and have been to the same universities and they use the same jargon.
These biases keep getting perpetuated. This is the narrative that we have to change. It has to be done yesterday.
To what extent is the risk premium impeding local entrepreneurs and production?
Fulu Mudau: In the private equity sector, you often hear that there is too much money and not enough fundable projects. But when you delve deeper, you actually find that there are projects that are fundable, however that money is requesting a very high premium and the targeted IRR is so high that they are not able to meet each other half way. So, it isn’t the case that there aren’t fundable projects and there aren’t good sustainable businesses that investors can invest in. The reality is that the high target premium simply precludes any meeting of minds. The premium that investors are requesting to put their money in Africa is simply too high.
How will African countries navigate debt amidst the Covid crisis?
Christophe Charlier: Covid is the perfect storm. What we should be thinking about in this situation is what each of the countries needs to do in order to create capital markets that allow them to be able to raise money to invest and at reasonable rates in the future. When I have discussions with central bank governors and decision makers in different countries, my recommendation is always that you need to invest in developing the domestic capital markets, you need to have local pension funds, you need to have local mutual funds, you have to have the insurance companies and banks encouraged to invest and to promote the real economies, not just buying government bonds.
South Africa’s PIC is the largest investor on the continent. In a lot of IPOs that we’ve done in the past, PIC has played an important role as an anchor investor. They play an important role in the markets. But PIC has been completely not present in the African capital markets now for months and months, and it is starting to look like years. That is not helpful. These are tough times but let us go forward for the future and develop the domestic markets as much as we can because foreign investors will look for big risk premiums to make it worth getting out of bed to look at African paper, but local and regional investors will require less premium because they understand the risks and they will have their own home bias, they understand the economy, they understand the politics. If the proper instruments are in place, they would be the backbone of the capital markets, not foreigners.
How can Africa improve trading and investment?
Michael Nderitu: Africa really has been impacted by the dollarization effect and the cost of accessing dollar liquidity but if you look at it, Africa is a victim of its own doing. African governments are very good at having trading blocs but they don’t follow through, they don’t coordinate, they don’t ensure that, other than doing a press conference, they make these trading blocs really work. When these trading blocs really work to improve our ability to coordinate to ease business, this is when we will be able to kill the dollarization effect so that we can trade locally.
Even local trades are all too often settled in dollars, so it’s up to us to help our governments initiate trading blocs and make them work to kill cumbersome investment requirements and legislative processes.
Kojo Annan: Covid provides a great opportunity to the continent: it is time for us to do a complete reset. Rather than going back to the way the system was, it is time to re-imagine Africa, to start building our own local enterprise and trade with ourselves and take control. When push comes to shove, we are on our own. Nobody was coming to bail us out when they thought we were going to die in the millions, so if that is not a wakeup call for the continent, I don’t know what is.
Now there are crypto-currencies and so many other digital leapfrog transformation technologies that are emerging, it enables us to re-imagine this whole economic structure. The United States in the past three months has printed something like 3 to 4 trillion dollars under qualitative easing. That is the whole GDP of the continent of Africa and they printed it in four months. So, when we are still here as a continent of 1.3 billion people, begging for debt forgiveness, clearly something is wrong. It requires major fundamental change for us to actually take control of our futures because the system today is broken; it simply cannot work for us. It really takes bold transformational change to work out future steps so we can determine our own future.
Christophe Charlier: Covid has had such a drastic effect, not just for the African economies but also the European and the American economies, and those countries now are rethinking their supply chains – the massive reliance on manufacturing coming out of China. Countries are realizing that that’s no longer a safe beneficent model for them to build on and this creates opportunities for countries like Morocco or Egypt that are already industrialized, that have an educated base, that have the port facilities and the industrial facilities and all that to really position them as an alternative to manufacturing and imports coming out of Asia.
I would put Nigeria also in that basket, not as much for the industrialization but for the massive work force that can be used for some of the manufacturing that has been done out of China for the last decades. So this is an opportunity for certain countries in Africa to benefit from supply chain modifications that may come out of the Covid situation.
To what extent do credit risk ratings inform risk pricing of investments?
Michael Nderitu: Investment banks tend to have fewer analysts focus on researching African companies because most of these companies are smaller in size so they are not big ticket. There is a lack of spending on the ground on analyst and investment professionals in Africa to try and understand how they can manage and mitigate risk, so they often rely on very biased ratings from S&P, Moody’s. We lack people deployed to understand the credit analysis of African markets.
What is the potential for fintech to drive growth and investment?
Fulu Mudau: Fintechs hold so much potential in so many sectors. Health care particularly I think is where they can play a huge role, and in the banking and investment services sectors there are a lot of gaps, and there’s a need from retail and business customers for services to be cheaper and faster, and fintechs can plug that hole. But I feel like our regulations are constraining fintechs from growing. The regulatory framework particularly in the telco sector and in financial services actually doesn’t allow a fintech to grow and compete properly with established legacy institutions. The regulation is framed in such a way that the fintechs are still dependent on these legacy huge telcos and banks, so we have an opportunity now to revise our framework and make the legislative environment such that it encourages growth.
And we know this will also help in the investment side because if you are an investor looking in at a fintech, even if it’s a wonderful idea, if they can’t implement it because of a regulatory road block then it’s not going to fly, so there is a massive opportunity for regulators on the continent to optimize this. We’ve got so many brilliant entrepreneurs on the ground on the continent, how do we pave the way so that it is easier for them to actualize those businesses and deliver sustainable solutions?
Kojo Annan: You need to also ensure that the regulation is cross border because otherwise, if I am a fintech operation in Gambia or Togo, or in some of the smaller countries, I don’t get the economies of scale, and if I am an investor, I don’t want have to weigh up different regulations across each region, so it would be good if there can be some consistency at least across certain economic blocs.
Christophe Charlier: If you look at the constraints across countries in Africa, obviously financial payments is a big issue, so this is a massive opportunity to really leapfrog certain technologies. I don’t need fintech in France, where I am right now, because I have a bank account, I have a credit card, everything works fine. But there is a low level of bank accounts across Africa, and people can use their mobile phone instead because there is a higher penetration of mobile phones. Regulation needs to be put in place to build sticks and carrots to encourage the development of fintech both in terms of digital banking to facilitate B2B and B2C but also to address issues like tax collection. One company, for example, has developed a technology to effectively in real time collect VAT, and if you can put these technologies into countries and in regions that facilitates tax collection. It facilitates transactions. It allows economies and companies to grow much more swiftly.
How significant is politics in terms of deciding the risk premium?
Fulu Mudau: If we look at the rating methodology of Moody’s, S&P, the big rating agencies, politics and their own misunderstanding of the situation generally accounts for 30% to 50% of the rating – so that is a huge chunk. I don’t think it’s a bad thing that politics counts in the risk premium, I think what is unfortunate is that there is such a wide misunderstanding of what is actually happening on the ground, and what these events mean for policy and policy making institutions, and whether they actually translate into a worse economic situation or not. The issue is around a misunderstanding of whether what we hear happening in politics and what we read in the newspaper really impacts the economic and institutional fundamentals of the country or not.
Christophe Charlier: The other point, going back to the geopolitics, is that size matters, and in order for Africa’s voice to be heard, regional players like the African Union and other regional groupings need to have a louder voice because individual countries going up against China or the US or the European Union are just not powerful enough.
Kojo Annan: Post-Covid we have had the black lives matter movement, and I think it’s all interlinked because you have to go backwards before we can go forward. We have smaller countries because we were historically divided by colonialism. It is the same people that colonized you that are writing the stories about your countries, so it goes back to my original point you have to do a reset because you are playing a no-win game. The same people that colonized you also control the illicit outflows that we don’t talk about, that go out of the continent in the billions every year.
Michael Nderitu: We have to really do proper assessments because the political risks in Africa are totally different from the US and elsewhere, so the investment banks, the investors have to really put effort in. For the credit ratings, I would wish that they could adjust the measures so that they reflect the true science on the ground of what is actually happening in Africa.
