Uncertainty in Africa

To those wondering what will become of nascent capital markets in emerging and frontier economies in the wake of last year’s financial upheaval, I recommend a fascinating piece by Niall Ferguson in this Sunday’s New York Times Magazine; read it not for a prediction of what will happen but rather as a warning against overreaction. In it, Ferguson examines the human reflexes that drive reactions to financial crisis:

"For reasons to do with human psychology and the failure of most educational institutions to teach financial history, we are always more amazed when such things happen than we should be. As a result, 9 times out of 10 we overreact. The usual response is to introduce a raft of new laws and regulations designed to prevent the crisis from repeating itself. In the months ahead, the world will reverberate to the sound of stable doors being shut long after the horses have bolted, and history suggests that many of the new measures will do more harm than good."

Ferguson elaborates on the positive impact of financial innovation in the U.S. and abroad, dangers notwithstanding. For instance, the securitization of credit lowered costs for consumers in the U.S., while the globalization of finance drove huge growth improvements in emerging economies, particularly Asia. Now investors are pulling back and regulators are swooping in - both healthy reactions so long as they aren’t overdone.

Yet it’s difficult to know where the crisis and the reactions that follow will leave Africa’s markets. A recent paper, titled How the Economic Crisis Is Hurting Africa–And What to Do About It by Todd Moss of the Center for Global Development, examines the effect of recent economic turmoil on capital flows to Africa as the continent struggles to steady itself amidst second and third-order financial sector aftershocks. For instance:

"One unfortunate outcome of the crisis may be the strangling of the nascent and potentially very sizeable private equity sector. The Emerging Markets Private Equity Association reports that the number of its member funds targeting Africa rose from 16 to 21 in 2008 and new funds jumped by 37 percent to $3.2 billion. But it also expects a very difficult fundraising environment in 2009–10. Most of the private equity raised in recent years to invest in Africa (much of it with some official component, such as the multiple funds started by the Overseas Private Investment Corporation or the African Development Bank) should be locked up for the long term and is unlikely (or unable) to exit quickly. However, this asset class was just beginning to establish itself and the many funds that had not yet completed fundraising or were still being formed may find their plans delayed until the global situation stabilizes and appetite for frontier emerging markets returns."

The effects on Africa’s private equity market are still uncertain. Much depends on whether investors see more risk in Africa these days than they did before financial crisis hit developed markets, says Moss:

"The other unknown is how investors will interpret risk in Africa over the medium term. Many of the large institutional investors had begun to look seriously at frontier emerging markets such as Africa. Whether they will now recoil because of the perceived risk or view Africa as a potential diversification play in a turbulent world is still far from clear."

The risks to business in Africa are real, but by no means should they prohibit investors from expanding their portfolios into one of the few regions of the world that is maintaining growth despite the present economic climate. There is also the fact that growth in Africa is driven by the formalization of a huge amount of economic activity that has until recently remained too disorganized to tap. It turns out we’ve all got some learning to do, and the lessons the developed world is re-learning about solid business practices are the same ones African businesses are starting to absorb. The recent economic experience should draw investors and stable businesses together, wherever in the world they are.