FDI has been one of the principal beneficiaries of the liberalisation of capital flows over recent decades and now constitutes the major form of capital inflow for many SSA countries, including some low-income ones like Chad, Mauritania, Sudan and Zambia. Economies are often considered less vulnerable to external financing difficulties when current account deficits are financed largely by FDI inflows, rather than debt-creating capital flows. For instance, in South Africa in 2007, FDI covered the whole of the current account deficit. There is no denying the importance of FDI inflows both for their contribution to sustaining current account imbalances in countries and for their contribution to broader economic growth, through technological spillovers and competition effects.
Prior to the financial crisis, foreign direct investment (FDI) inflows to Africa had been rising strongly since 2002, reaching USD 53 billion over 2007, a 47.2 per cent increase on 2006 and their highest historical level. In 2007, USD 22.4 billion was directed to North Africa and USD 30.6 billion to Sub-Saharan Africa. Africa’s share of global FDI flows registered a significant decline to 2.9 per cent of global FDI in 2007, down from 3.2 per cent in 2006. Even according to recent estimates45, while global FDI may have fallen by up to 20 per cent in 2008; flows to Africa have remained resilient, growing by 16.8 per cent to USD 61.9 billion over 2008, despite the slowdown. The rate of return of FDI in Africa has been, increasing since 2004 and, at 12.1 per cent, was the highest among developing host regions in 2007. Mergers and acquisitions (M&As) in Africa rose by an estimated 157 per cent to USD 26 billion in 2008.
Behind a large share of the rise in FDI lies surging prices for raw materials, particularly oil, which fuelled a boom in commodity-related investment. High raw-material prices also helped maintain outward FDI flows from Africa, which remained stable at USD 6.5 billion in 2007. As a percentage of gross fixed capital formation, inflows stabilised at 21 per cent. Nevertheless, with the advent of the crisis, lower world demand and depressed prices for Africa’s commodity exports are expected to affect investment levels, with particularly negative short-term effects for the resource-exporting countries in the region.
Attracting FDI into diversified and higher value-added sectors remains difficult in many countries. According to UNCTAD data, the primary sector remained the main focus of foreign investment. However, foreign interest in communications, manufacturing and infrastructure investments also increased. Service-sector investment rose in North Africa, but remained negligible in Sub-Saharan Africa, barring financial institution buy-ins. Notably, some commodity-exporting countries have been making significant efforts to move up the value chain by, for example, expanding their refinery activities (Côte d’Ivoire, Egypt, Nigeria), though higher labour costs than other developing countries still hobble the potential for FDI in manufacturing.
FDI increased in 36 countries, and declined in 18. Top FDI destinations for 2007 were: Nigeria (USD 12.5 billion) Egypt (USD 11.6 billion) and South Africa (USD 5.7 billion) followed by Morocco, Libya, and Sudan. South Africa shifted back to a positive balance after having found itself a net exporter of investment capital in 2006, according to preliminary estimates, South African inflows more than doubled over 2008 to USD 12 billion. The most attractive countries for investment tend to hold significant natural resource endowments, active privatisation programmes, liberalised FDI policies and active investment promotion activities.
FDI levels and prospects still vary widely by region, sector and country. North Africa’s sustained privatisation programmes and investment-friendly policies continued to attract large FDI inflows, reaching USD 22 billion in 2007, a 15 per cent increase on 2006.FDI investments in North Africa were the continent’s most diversified, with projects in textiles, oil and chemicals and the production of generic pharmaceuticals. Inflows to Egypt remained substantial, reaching USD 11.6 billion. Privatisations also boosted FDI to the sub-region (for example the privatisation of the Crédit Populaire d’Algérie and the USD 5.4 billion foreign entry into Libya’s state-owned Tamoil). West Africa continued to benefit from the commodity boom and ambitious privatisation schemes, leading to inflows of USD 15.6 billion in 2007. Nigeria still accounted for 80 per cent of total West African investment, mostly reflecting oil industry expansion projects.
Central African inflows grew by 28 per cent to USD 4.1 billion. East Africa, still the lowest recipient of FDI on the continent, saw a 65 per cent increase in FDI flows in 2007, from USD 2.3 billion to USD 3.8 billion, thanks to new prospects in the primary sector and through projects in Madagascar46 and privatisations in Kenya.
In Southern Africa, Angola remained a net capital exporter in 2007. South Africa, the continent’s most diversified economy after having become a net exporter of capital in 2006, once again registered positive net inflows of USD 5.7 billion. Preliminary estimates suggest a further boost of inflows over 2008, reaching USD 12 billion at year’s end. South Africa’s stock of FDI at work in the country remains the highest in the continent by far at USD 93 billion, nearly a quarter of total FDI stock in Africa (standing USD 393.4 billion at end 2007). In 2007, FDI to the LDCs increased to USD 10 billion, from USD 9.6 billion the previous years.
Ten African countries introduced policy measures to improve the investment climate in 2007, most notably improving regulations pertaining to FDI and transnational company involvement in the economy. Regional entities also introduced FDI-promoting measures in 2007, including the COMESA Common Investment Area, which ambitions to establish a free investment area by 2010 and help its members, most of which are too small to attract sufficient investment to support national development and regional integration projects. ECOWAS created a department to promote cross-border investment and joint ventures so as to promote investment and promote public-private partnerships and is working to deepen the financial integration of the sub-region through its Finance and Investment Protocol. The SADC is also undertaking a joint investment promotion programme with the EU. In May 2008, the AfDB signed a memorandum of understanding with the Export-Import Bank of China, with provisions for co-financing and guarantees for public and possibly private sector projects.
FDI outflows from Africa remained strong in 2007 at USD 6 billion, though short of the peak of USD 8 billion of 2006. This performance was due to expanding operations of trans-national corporations, particularly from South Africa but also from countries that had been benefiting from high commodity prices. Top contributors to outward FDI were South Africa, Egypt, Morocco, Liberia, Angola, Algeria and Nigeria, mostly investing in natural resources exploitation and the services sector. South African firms invested heavily in banking, ICT and infrastructure. South African TNCs accounted for 80 per cent of total African outflows in 2007, with Morocco, Liberia and Nigeria accounting for a further 12 per cent. Though African FDI outflows remained centred on extraction, African TNCs also engaged in telecommunications and retail-sector investments.
While the boom in commodity markets contributed to maintaining growth in foreign investment through 2008, lower demand and depressed raw material prices brought on by the crisis have made disinvestment a looming prospect. This is echoed by the latest UNCTAD survey findings, stating that only 20 per cent of investors plan to increase investment in Africa between 2007-09 (against 80 per cent for Asia), illustrating foreign investors’ narrow perspective on African investments.
The composition of non-FDI capital flows shows persistent variations between country groupings: ODA and bank lending predominate in Low Income Countries (LIC); equity flows are largely restricted to South Africa; bond financing is making inroads into middle-income countries, even though Nigeria had to cancel its first global Naira-denominated bond issue in early 2009 due to bad market conditions. South Africa is also developing into a source of external financing for other African countries.
The value of cross-border mergers and acquisitions (M&A) activity fell sharply in 2007 to USD 10.2 billion from USD 19.8 billion in 2006, partly due to fewer extractive and exploration projects for sale. Nevertheless, preliminary estimates for 2008 show sharp swing back of 157 per cent to USD 26.3 billion47, thanks to a massive jump in M&A activity in Egypt to USD 15.9 billion.
China expanded its support to Chinese investments in Africa, building on its general investment policy on Africa adopted in 2006. In 2007 the Export-Import Bank of China financed over 300 projects in the region, constituting almost 40 per cent of the Bank’s loan book. The Industrial Bank of China (ICBC) made a large investment in the Standard Bank Group of South Africa. Japan announced in May 2008 its decision to set up a USD 2.5 billion investment fund (the Facility for African Investment, managed by JBIC) to help Japanese firms do more business in Africa, as part of its target to double Japanese private-sector investment on the continent to USD 3.4 billion by 2012.
Sovereign Wealth Funds and national investors are also investing more in Africa’s infrastructure and have become, through their sheer size (predicted to reach at least USD 5 trillion by 201248), important potential sources of FDI. Also increasing importance are investors from the Middle East, especially, but not limited to, North African projects.
While Africa was recently being hailed as an exciting financial frontier, even barring the crisis, local equity markets remain small, and local currency debt markets often too illiquid to exert a significant growth impact. Though the number of functioning stock markets has risen from five in 1989 to sixteen in 2007, in effect, the majority of African exchanges list only a handful of companies and are highly illiquid. There was for example no trading on the Maputo Stock exchange for the whole of 2004. Excluding South Africa’s Johannesburg Stock exchange (JSE, with 401 listed companies in 2006), the average number of domestic companies listed per exchange was only 43 in 2006.
In response to perennial size and liquidity problems, two exchange operators are attempting to create centralised, continent-wide exchanges49. The Johannesburg Stock Exchange (JSE), the largest on the continent, is attempting to bring the largest African firms to make secondary listings in South Africa. The second initiative involves Financial Technologies, the operator of India’s commodity exchange, which is seeking to establish a pan-African commodity bourse. Based in Botswana, Bourse Africa could facilitate trades across the continent.
The African Union has also been looking to develop a pan-African Stock exchange50, but the project remains in early stages. Widespread exchange controls, incompatible regulatory regimes and national resistance remain formidable hurdles to any pan-African exchange project.
As of March 2009, the Johannesburg Stock Exchange (JSE) had lost 45 per cent from its peak in May 200851. This is not a bad performance, relative to that of many mature markets, but the rapid currency depreciation following the repatriation of foreign capital has exacerbated the impact of the fall.
Private equity fund raising, static at USD 2.3 billion in 2006 and 2007, increased to USD 3.2 billion for 2008, bringing the total funds invested through private equity funds to USD 7.6 billion for 2008. South Africa’s private equity industry reached ZAR 86.6 billion in funds under management at end-2007, an increase of 46 per cent over 2006, and with funds under management representing 2.8 per cent of GDP, up from 1.7 per cent in 2006. Sixty-four per cent of funds raised over 2007 were from US sources, up from 39 per cent in 2006. Private equity investment activity reached 5 per cent of total South African M&A activity (measured in terms of deal size i.e. debt and equity) in 2007. South African private equity investment activity reached 11th place in 2007 global rankings, its highest ever position.
Nevertheless, knock-on effects of the downturn are starting to be felt through the suspension of projects. A USD 3.3 billion Nigerian-Chinese deal to build cement plants throughout the continent was suspended52. A USD 9 billion agreement between China and the Democratic Republic of Congo for mineral resources in exchange for infrastructure has also stalled, in part due to unwillingness from Western creditors to write off the country’s significant outstanding debt as it contracts new debt53.
The Institute of International Finance forecast in January 2009 that net private sector capital flows to emerging markets would fall to about USD165 billion in 2009 from the USD466 billion recorded in 2008, and warned that capital flows to emerging markets are in danger of collapse as the financial crisis in developed economies chokes off the supply of credit to developing economies. According to the IIF, commercial banks are expected to make a net withdrawal of about
USD61 billion from emerging markets in 2009. Remittance inflows to Africa, estimated at USD 10 billion for 2007, are also set to fall by up to a third as the economic situation of migrants in developed host countries deteriorates.
While the small size and isolation of Africa’s financial markets initially appeared to provide effective protection in the first stages of the financial crisis, it has quickly become clear that the continent, dependent on external factors such as the Asia-driven commodity boom for its outstanding growth run of recent years, is very much in the front line for the second-round effects of a global recession.
Africa’s access to external finance is likely to be severely constrained, creating uncertainty as to how it will secure the substantial foreign investment it requires to fund projects, create jobs, finance current account deficits and continue to develop. With global banks pulling back capital from all emerging markets, African banks, while not initially affected by the crisis and little exposed to toxic instruments, will find themselves with much tighter credit conditions limiting the availability of trade finance and constraining their own lending.
There is however the possibility that South-South investments could help take up some the slack. Two recent examples are noteworthy. First, the Liberian government has recently signed a USD 2.6 billion agreement with a Chinese company, China Union, to excavate iron ore, in what constitutes one of the largest ever FDI projects in the continent54. Secondly, the Brazilian company Petrobras has announced a massive expenditure plan for the period 2009-2013, reaching USD 174 billion, of which 2 billion are planned for Nigeria and 800 million for Angola55. Over the medium to long term, as commodity prices recover investor interest can be expected to return. These new forms of co-operation are not without risks, however.
Nevertheless, the impact of tighter credit conditions on African small and medium businesses is likely to be limited. Most companies have always had very limited access to bank credit, which accounts for example for only 10 per cent of the capital lent to Nigeria’s manufacturing sector.
As private sources of capital dry up, so development finance institutions, such as the IFC, will have a critical role to play. The African Development Bank’s plans to triple lending for African infrastructure schemes in an effort to salvage key projects are an indication of the increasingly important role multilaterals, development banks and DFIs may be led to play should downside risks materialise fully.
The AU has established the African Investment Bank, which while not yet functional, appears to be making some progress, with a proposed launch set for 2011. To be based in Tripoli, Libya, and wholly-owned by African actors, the bank is designed to serve finance private sector development and development initiatives, notably infrastructure.
A possible positive outcome for the crisis may be that African banks develop innovative means to tap the continent’s domestic savings, which remain underutilised. To replace ebbing revenue sources, African banks could very well develop consumer businesses and domestic loans.