To get more capital, Africa needs more data
Summary
Poor data and small capital markets make it hard to gauge risks and returns
“The concept of risk is completely invented to ensure that investment doesn’t come to Africa," Gagan Gupta told an audience of investors and entrepreneurs earlier this year, to resounding applause. Mr Gupta, whose firm works on logistics and utilities across Africa, is optimistic about the continent and scathing about outsiders’ ability to assess it. Philippe Valahu, the boss of PIDG, an infrastructure-finance group, echoes the sentiment: “I spend a huge amount of my time dispelling risk perceptions," he says. Aubrey Hruby, who advises investors on entering Africa, recalls that “one thing [Americans] always say is, what about corruption? I’m like, how many mayors in America are serving jail time right now for corruption?"
The view that African firms and governments pay a higher cost of capital than is necessary to compensate investors in debt and equity for the risks they assume is widespread on the continent. Regional policymakers even plan to launch an Africa-based credit-rating agency in 2025 to counter the scores of global rating agencies, which they say are plagued by bias. “We are basically given a higher risk profile unfairly. One of the reasons that this is happening is because our balance sheets and economies are not valued correctly," Hakainde Hichilema, the president of Zambia, said earlier this year. Is he right?
How much the continent pays for capital is a matter of urgency. One reason is that governments’ interest bills are soaring as countries labour under a massive pile of debt. Government debt across sub-Saharan Africa reached 60% of GDP in 2023, with two dozen countries’ debt burdens widely considered unsustainable. Three—Zambia, Ghana and Ethiopia—have defaulted since 2020. The ratio of interest repayments to government revenue has doubled since 2010. Managing the debt load will require African countries to get their houses in order. But that would be easier if debt markets were deep and efficient.
The other reason for urgency is that debt (sovereign and private) and equity inflows have stagnated even as investment needs are huge. The UN Economic Commission for Africa reckons that each year the continent gets $100bn less infrastructure financing than it needs. Sub-Saharan African countries issued no offshore foreign-currency bonds in 2023, though some have since begun to return to the market.
Foreign direct investment inflows by multinationals are mediocre, at just under 3% of the global total and 2% of GDP in 2023. Investors undoubtedly face a range of risks, including sovereign default, currency devaluation, illiquidity and corporate mismanagement. Nonetheless, if there is a systematic mismatch between investors’ perception of the basket of risks and the reality, closing it could yield large economic rewards.
At face value risk perceptions for African debt and equities appear elevated. The average credit rating is near an all-time low, according to Fitch, a rating agency. Only Namibia and South Africa have ever received an investment-grade rating for their bonds. In all, African countries must borrow at consistently higher headline interest rates than other emerging markets, according to a recent study by the IMF. Equity valuations in stockmarkets are low, implying poor growth prospects or high risk: in aggregate, listed firms in sub-Saharan markets trade on 13 times profits, according to Bloomberg data. If you exclude South Africa that falls to six times.
Critics of the status quo argue these figures are not a fair reflection of actual risks in Africa. One kind of risk is of default on debt: Moody’s, another rating agency, reckons that default rates on infrastructure projects in Africa are low at 5.5%, compared with 11.9% in Asia and 14.5% in Latin America. Another risk for equity holders is that bad managers destroy value. Yet the average return on equity among the 500 most valuable listed firms on the continent is a solid 15%, better than the stingy valuations imply. Mr Valahu of PIDG says his fund’s losses from two decades of investing in African projects have been a small fraction of what would have been expected based on the implicit rating given to its $1.4bn portfolio by agencies.
So is there a mispricing of the opportunities and dangers of deploying money in Africa? No, says the imf in a recent study of government bonds in 89 countries since 2003. It concludes sub-Saharan African states do face higher interest rates than other countries, even controlling for their risk rating at the point of issuance. However, it goes on to argue that this Africa premium is nonetheless explained by other “structural factors". These include the transparency of a country’s budget process, the size of its informal sector, the sophistication of its financial sector and the quality of its regulatory institutions, which are strong determinants of risk perception.
At the heart of the debate over the Africa premium is bad or inadequate information. Most investors, reasonably, view this as a form of risk. Some of their critics worry it is a form of ignorance. For example, weighing structural factors is a subjective exercise. Many African countries have a history of unpredictable regulatory changes, and convincing outsiders that times have changed may be hard. And estimating risk and returns for private-sector investments, rather than the sovereign lending in the IMF study, is far trickier. The continent’s capital markets are tiny and fragmented. Many projects are hidden inside the books of listed multinational firms or funds. “When an investor is looking at the market, they always focus on data," says Guillaume Arditti, founder of Belvedere, an Africa-focused advisory firm. “And those data do not exist in Africa with the level of granularity investors from the US or Europe are used to."
Addressing both “structural factors" and private-sector opacity requires ending this informational inefficiency. One idea is the African credit-rating agency floated by some governments. There is no harm in having another source of ratings, but a homegrown agency is unlikely to change outsiders’ perceptions by much.
Instead, improving the quality and the availability of investment data is more promising. Governments should be upfront about the structure of their debts, including loans from sovereign lenders such as China, some of which are secret. A plan by the World Bank to create a database that makes it possible to estimate the rates of return on past infrastructure projects should be accelerated. And encouraging more firms to list on regional stockmarkets would reveal more about private-sector activity. The more data investors and firms have, the more probable it is that risk and returns will be priced accurately.
