Developing Africa’s financial markets

Priorities to attract greater foreign investment

Between 2005-15 economies in Africa expanded by 50%, more than double the global average for the period, according to International Monetary Fund data. This supported the popular ‘Africa rising’ narrative, the belief in the continent’s unstoppable development; reality did not oblige.

The 2014-15 downturn in global commodity prices weighed heavily on the net-commodity-exporting region. Declining export revenues led to widening fiscal imbalances, currency depreciation and deteriorating capital inflows, exposing the risks of a lack of diversification in sources of economic growth. Cases of poor governance and unstable politics have further tested the continent. Although countries have made significant advances in recent years, challenges persist, as last week’s developments in Zimbabwe highlight.

According to its latest World Economic Outlook, published last month, the IMF forecasts an acceleration in the rate of GDP growth across sub-Saharan Africa to 2.6% in 2017 and 3.4% in 2018, up from 1.4% in 2016. While this is a welcome improvement, the 2017 rate is substantially lower than the average in emerging and developing (4.6%) markets overall. This is despite Africa’s faster rate of population growth, suggesting an even wider disparity in core economic performance.

Policy-makers should prioritise strengthening economic governance, improving the sustainability of fiscal positions and diversifying sources of economic growth in Africa. Another essential but often overlooked consideration for the next stage of Africa’s development is the expansion of its financial markets. This should enable governments to achieve their objectives by providing additional sources of funding for domestic corporations.

The Barclays Africa Group Financial Markets Index, prepared by OMFIF, evaluates the state of financial market development in 17 countries across the continent according to six pillars: market depth; access to foreign exchange; market transparency and the tax and regulatory environment; the capacity of local investors; underlying macroeconomic opportunity; and the legality and enforceability of financial contracts, collateral positions and insolvency frameworks.

Africa’s financial markets have grown significantly over the last few decades. The continent is home to 30 stock exchanges, a six-fold increase from the 1980s. The total amount of issued sovereign bond markets has increased to more than $200bn in 2016 from $28bn in 2000. However, the index highlights that markets remain fragmented and shallow, allowing great room for development across most economies.

Deep financial markets are crucial for translating economic opportunity into investment inflows by enhancing the opportunities for foreign investors to access the market.

Ethiopia, while projected to be the fastest growing economy among those tracked by the index, comes last in the overall ranking because of its underdeveloped financial markets. Out of the 17 countries tracked, it is the only one without a securities exchange.

The opposing scenario is problematic as well. Sophisticated financial market infrastructure is a necessary but not sufficient condition for attracting investment. Economic prospects matter too. South Africa, the continent’s largest and most developed economy, leads the index with a score of 92 out of 100, topping the list in all six pillars. Its worst performance is in the area of ‘macroeconomic opportunity’, owing to weak growth prospects and slow progress on macroeconomic reforms. Such challenges motivated rating agency Standard & Poor’s decision to downgrade South Africa’s local currency credit rating from BBB to BB+ non-investment grade or ‘junk’ status, and to lower the rating on the country’s international debt to BB.

Policy-makers should aim to achieve a combination of improving macroeconomic prospects and deepening financial markets, seeing the two as necessary complementary forces to attract foreign investment and facilitate development. The index, which will be updated on an annual basis, is intended to be a practical tool to facilitate these objectives, for policy-makers and investors alike.

Danae Kyriakopoulou is Chief Economist and Head of Research at OMFIF.

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