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The New Silk Road: Afro-Eurasian investmentJune 2014 Dr. Paul Kielstra

Deutsche Asset & Wealth Management

S5 SPECIAL ISSUE

The New Silk Road: Afro-Eurasian Investment2

Deutsche Asset & Wealth Management’s Global

Financial Institute asked the Economist Intelli-

gence Unit to produce a series of white papers,

custom articles, and info-graphics focused spe-

cifically on global capital market trends in 2030.

While overall growth has resumed, and the

value traded on capital markets is astoundingly

large (the world’s financial stock grew to $212

trillion by the end of 2010, according to McKin-

sey & Company) since the global financial crisis

of 2008, the new growth has been driven mainly

by expansion in developing economies, and

by a $4.4 trillion increase in sovereign debt in

2010. The trends are clear: Emerging markets,

particularly in Asia, are driving capital-raising; in

many places debt markets are fragile due to the

large component of government debt; and stock

Global Financial Institute

Introduction to “Global Capital Markets in 2030“

markets face weakening demand in many mature

markets.

In short, while the world’s stock of financial assets

(e.g. stocks, bonds, currency and commodity

futures) is growing, the pattern of that growth sug-

gests that major shifts lie ahead in the shape of capi-

tal markets.

This series of studies by Global Financial Institute

and the Economist Intelligence Unit aims to offer

deep insights into the long term future of capital

markets. It will employ both secondary and primary

research, based on surveys and interviews with

leading institutional investors, corporate executives,

bankers, academics, regulators, and others who will

influence the future of capital markets.

The New Silk Road: Afro-Eurasian Investment3

About the Economist Intelligence Unit

The Economist Intelligence Unit (EIU) is the

world’s leading resource for economic and busi-

ness research, forecasting and analysis. It provides

accurate and impartial intelligence for companies,

government agencies, financial institutions and

academic organisations around the globe, inspir-

ing business leaders to act with confidence since

1946. EIU products include its flagship Country

Reports service, providing political and economic

analysis for 195 countries, and a portfolio of sub-

scription-based data and forecasting services. The

company also undertakes bespoke research and

analysis projects on individual markets and busi-

ness sectors. The EIU is headquartered in London,

UK, with offices in more than 40 cities and a net-

work of some 650 country experts and analysts

worldwide. It operates independently as the busi-

ness-to-business arm of The Economist Group,

the leading source of analysis on international

business and world affairs.

This article was written by Dr. Paul Kielstra and

edited by Brian Gardner.

Dr. Paul Kielstra is a Contributing Editor at the

Economist Intelligence Unit. He has written on

a wide range of topics, from the implications of

political violence for business, through the eco-

nomic costs of diabetes. HIs work has included

a variety of pieces covering the financial services

industry including the changing role relationship

between the risk and finance function in banks,

preparing for the future bank customer, sanctions

compliance in the financial services industry, and

the future of insurance. A published historian, Dr.

Kielstra has degrees in history from the Universi-

ties of Toronto and Oxford, and a graduate diploma

in Economics from the London School of Econom-

ics. He has worked in business, academia, and

the charitable sector.

Brian Gardner is a Senior Editor with the EIU’s

Thought Leadership Team. His work has covered a

breadth of business strategy issues across indus-

tries ranging from energy and information tech-

nology to manufacturing and financial services. In

this role, he provides analysis as well as editing,

project management and the occasional speaking

role. Prior work included leading investigations

into energy systems, governance and regulatory

regimes. Before that he consulted for the Commit-

tee on Global Thought and the Joint US-China Col-

laboration on Clean Energy. He holds a master’s

degree from Columbia University in New York City

and a bachelor’s degree from American University

in Washington, DC. He also contributes to The

Economist Group’s management thinking portal.

Global Financial Institute

Introduction to Global Financial Institute

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& Wealth Management invites you to check the

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more from Deutsche Asset & Wealth Manage-

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4

Investment in Africa’s Frontier Markets: Frothy port-

folio gains and long-term opportunities

The next big thing?Frontier markets are currently hot news for portfolio inves-

tors. The term, originally created by the World Bank’s Inter-

national Finance Corporation, has been around for two

decades. It refers to those economies which are at an ear-

lier stage of economic development than emerging mar-

kets but which seem capable of moving toward that status.

Thus, frontier markets are typically riskier, less liquid, and

have lower market capitalisation than emerging ones but

hold out the possibility of rapid, prolonged growth.

As developed countries have struggled with stagnation

and the BRICs have delivered less dramatic growth, the

profile of frontier markets has risen. Funds composed of

equities from these countries are delivering substantial

returns, albeit after sharp losses in the aftermath of the

Global Financial Crisis. More specifically, Africa is the cur-

rent darling of buyers taking a chance on such invest-

ments: from the start of this year to the end of May 2013,

the MSCI Africa Frontier Market Index is up by 26%, follow-

ing on a 52% gain in 2012. Some individual markets are

seeing even more dramatic rises. The All Share Index of

the Nigerian Stock Exchange gained 34% between Janu-

ary and May after a 35% rise in 2012 and the Ghana Stock

Exchange soared by over 50% in the first five months of

this year. Debt markets are also becoming more attractive:

in September 2012 a Zambian sovereign bond offering

raised $750 m and was oversubscribed by 24 times. For-

eign investors are taking note.

A story of growthAfrica has much to spark the interest of investors, begin-

ning with resources – both natural and demographic: it has

over 10% of the world’s oil, 40% of its gold, and 80% of its

platinum. According to UN estimates, Africa’s current pop-

ulation of roughly 1bn, can expect to rise by about 50% by

2030 and to be more than double today’s figure by 2050.

At the same time, the proportion of those who are working

age will go from 54% currently to 58% in 2030 and 62% by

2050. In other words, Africa is set to reap the demographic

dividend many emerging markets have already enjoyed.

The continent has always had resources, though, and

youth is an economic blessing only when combined

with employment opportunities. On this front African

economies have been expanding strongly in recent years

aided by governments addressing the overarching busi-

ness environment. As then World Bank vice-president for

Africa Obiageli Ezekwesili said in 2012, “In the last decade...

Africa...made peace with the concept of macroeconomic

stability as being fundamental for growth.” Reforms have

been widespread: according to the World Bank’s Ease

of Doing Business data for 2013, of the 15 countries that

have seen the most improvement over the last five years,

seven are from the continent. Governments have also been

addressing debt: an Ernst & Young study of 15 sub-Saharan

states calculated that average foreign state indebtedness

as a proportion of gross national income fell from 120% in

1994 to just 21% in 2011. Though this is largely a result of

debt forgiveness, better economic management plays an

important role.

These efforts are being rewarded: Economist Intelligence

Unit figures indicate that eight of the 20 fastest growing

economies in the last five years are African and nine of the

20 that will see the greatest growth in the next five years are

also forecast to be from the continent. At a regional level,

for most of the last decade, sub-Saharan Africa and North

Africa have seen growth comfortably above the global

The New Silk Road: Afro-Eurasian InvestmentA Global Financial Institute research paper written by the Economist Intelligence UnitJune 2014

The New Silk Road: Afro-Eurasian Investment Global Financial Institute

Written by

5 The New Silk Road: Afro-Eurasian Investment

average. Looking ahead, the IMF predicts that economies

in sub-Saharan Africa will grow at around 6% annually over

the next two years, well surpassing the global figure of 4%.

To 2030, CitiGroup has forecast that, the continent’s share

of global GDP will go rise from 4% to 7%.

Michael Lalor, lead partner at Ernst & Young’s Africa Busi-

ness Centre, notes two important attributes of this growth.

The first, he says, is that “the progress we’ve seen has been

sustained over a decade. It is not just one or two years of

growth.” Second, although “natural resources remain a key

driver of growth and investment, the extent of diversifica-

tion is often overlooked.” Only about a third of the conti-

nent’s growth has been commodity-related. Manufactur-

ing, telecoms, and local services, are all seeing marked

activity. Consumer spending, meanwhile, accounts for

over 60% of sub-Saharan Africa’s GDP and is also rising

substantially according to the World Bank. Indeed, domes-

tic growth and low levels of debt have helped to cushion

African states from the economic difficulties facing much

of the rest of the world.

That is not to say doing business in Africa is trouble free.

Simplistic comparisons with emerging giants are problem-

atic as the continent’s 54 countries fragment markets not

only through diverse regulatory regimes but also in terms

of cultures, tastes and languages. Corruption remains

endemic in sub- Saharan countries, including Nigeria

and Kenya which are tied for 139th place (out of 174) in

Transparency International’s Corruption Perception Index.

Moreover, although regulation is improving, progress

according to Mr Lalor remains, “uneven and moves at what

sometimes feels like a frustratingly slow pace.” Indeed, for

Weyinmi Omamuli – a sub-Saharan African economist– it

is the slowness in reforming political and regulatory struc-

tures that is the greatest threat. Failure to provide policies

that allow further growth and the development of neces-

sary infrastructure will undermine the ability of Africans to

earn and spend further. “Consumer growth,” she explains,

although substantial “is still pretty vulnerable.”

But where is the frontier?Africans have frequently, often justifiably, complained

about the extent to which writers generalised bad news

to create a distorted, monolithic image of a highly diverse

continent. Those discussing the current positive economic

story should avoid the same mistake. To begin with, much

of the current good news – population prospects, eco-

nomic reforms, and resultant growth – applies largely

south of the Sahara while political and social changes are

taking a toll in North Africa. South Africa, the largest econ-

omy in the region, has also not kept pace with its sub-Saha-

ran neighbours; in 2012 its 2.5% GDP growth kept down

the broader regional figure of 4.3%.

In considering frontier capital markets, though, the prob-

lems facing these parts of the continent are of only indirect

import because South Africa and the major economies of

North Africa are already considered emerging markets. The

difficulty is deciding just which countries are members of

the frontier club when looking at portfolio investment.

Growth alone is not sufficient: in the last five years Rwanda

has had the fourth fastest rising GDP in Africa and recently

issued a $400m bond on world markets, but with an entire

economy worth just over $6bn it lacks depth for potential

investments.

In practice, frontier portfolio investment in Africa revolves

around a handful of countries and is dominated by the

purchase of Nigerian securities. Although no universally

agreed list of frontier markets exists, most include only a

few African states. Nigeria is inevitably one. MSCI’s Afri-

can Frontier Markets Fund – a frequently cited index of

the performance of these markets – includes equities

from there, as well as Kenya, Tunisia and Mauritius but has

very few holdings in the latter two. A close look at other

African funds usually shows that, beyond a single invest-

ment or two in any given country, most money goes into

these countries as well as, sometimes, Ghana with the

large majority headed to Nigeria. Among all investors, the

bias toward that country is even more marked. The EIU

estimates that net portfolio investment into sub-Saharan

Africa (excluding South Africa) rose from $5.1bn in 2011

to $10.9bn in 2012. The equivalent figures for Nigeria are

$3.5bn and $10.3bn, or 94% of the total in the latter year.

These are net figures. The only other frontier country seeing

inward portfolio investment on the same scale as Nigeria is

Global Financial Institute

6 The New Silk Road: Afro-Eurasian Investment

Mauritius but even more money – as far as can be pieced

together from different data sources – then flows out from

some of the 27,500 holding companies controlling $400bn

in assets located in this tiny tax haven. African portfolio

frontier investors, then, may point to the potential oppor-

tunities across the continent, but in practice most are really

sending hot money to Nigeria and one or two other places,

while others use Mauritius as a base to control their hold-

ings, often in India.

The implications for investmentCapital markets are supposed to link those looking for bet-

ter returns with firms looking to grow. The narrowness of

portfolio investment in African frontier markets, however,

arises because they are currently still too thin to perform

this function to any large degree. The total market capi-

talisation of firms on Nigeria’s exchange is roughly $70bn

– about equivalent to eBay, the 45th largest American

company. Kenya, the next most liquid, has a market capi-

talisation of only around $20bn. However, MSCI, basing its

assessment on both on the value of shares and their avail-

ability to trade, estimates that the free-float adjusted mar-

ket capitalisation of the major exchanges in Nigeria, Kenya,

Tunisia, and Mauritius are collectively below $30bn. Given

the market size, resources and population of sub-Saharan

Africa, this leaves significant potential for growth as yet

untapped.

Debt markets are also small at the moment. According to

the IMF, government and corporate bond market capitali-

sation as a proportion of GDP in sub-Saharan Africa out-

side of South Africa is among the lowest in the world. The

corporate figure is just 1.3%, compared to 23% in China,

46% in Europe, and 99% in the United States.

For those looking to cash in on rapid index growth in the

short term, market size clearly presents a problem. As

the Economist commented in February, currently “There

are not enough listed African firms to absorb even a frac-

tion of the ignorant money itching to flow south of the

Sahara.” Overall, Mr Lalor explains, “Outside of South Africa,

capital markets are clearly still very immature.” Those very

few African frontier firms that can tap into capital markets

may enjoy very cheap access to capital as long as current

investor interest in the continent remains strong and a

flood of hot money does not create a bubble. Nevertheless,

investors are likely to struggle to find such opportunities

as so many businesses remain outside of listed exchanges.

Should all this worry Africa’s frontier? Probably not. First

of all, frontier economies almost by definition have thin

capital markets. As economies grow over the long term,

so should market capitalisation. This has already been

happening. According to World Bank data, between 2002

and 2012, total market capitalisation in sub-Saharan Africa

(excluding South Africa) rose by a total of 4.1 times – more

than double the rate in high income OECD states (1.9

times). If the continent follows the path of Asia’s emerging

giants, this accumulation will accelerate: India and China

saw total market capitalisation rise by factors of 9.6 and 8.0

respectively during the same period. The factors described

above which bode so well for African economic growth

should thus help with capital accumulation in the equity

markets, although investors should be prepared for plenty

of bumps along the way.

To move growth along, notes Mr Lalor, “There is a strong

case to be made for their regional consolidation: this will

help to create critical mass and accelerate the develop-

ment process”. Authorities are certainly looking at the idea.

January 2013 saw the first meeting of the West African

Capital Markets Integration Council which has been estab-

lished by the Economic Community of West African States.

The body, made up of the heads of local exchanges and

securities commissions, has been established to help cre-

ate common regulatory standards and a common trading

platform across the region. Meanwhile, in August 2012,

the East African Community founded the East African

Securities Regulatory Authority which has been looking

at joint supervision of companies cross listed in national

exchanges and mutual recognition of licenses of capital

market professionals. The slow progress of the Southern

African Development Community’s Committee of SADC

Stock Exchanges (CoSSE), which has been promoting inte-

gration since 1997, shows that good intentions alone will

not be enough. It has had some success in harmonizing

regulation, but adoption of common technology has not

occurred and, as Beatrice Nkanza, CEO of CoSSE wrote last

Global Financial Institute

7 The New Silk Road: Afro-Eurasian Investment

year, “Robust cross-border trading between the region’s

stock exchanges is not yet the norm.” Nevertheless, if bet-

ter ties can be established between markets it should help

increase overall market depth and liquidity. At the same

time, common regional regulations would improve trans-

parency, especially in smaller markets.

The development of the region’s debt markets, on the

other hand, may not be so straightforward. Ms Omamuli

points out that many sub-Saharan countries, as a condi-

tion of their debt relief from international lenders, have

accepted limits on their future level of commercial borrow-

ing under the Debt Sustainability Framework, which regu-

larly assesses countries’ debt burdens over a 20-year hori-

zon. “You will see more countries coming onto the market

but what people forget is really that the amount they can

borrow is very limited.” If those countries, as a result, do not

tap into debt markets at all, it can have a knock-on effect

on corporate borrowing. Without a sovereign debt rating

against which to benchmark themselves, companies in a

given country rarely move onto debt markets.

For many countries in the region, the current size of capi-

tal market is less of a focus than their overall investment

inflows. Mr Lalor notes that “While the capital is no doubt

welcome, the risk with portfolio investment is that it is

often short term in nature, and can create volatility. Clearly

developmental policies cannot be shaped around these

shorter term capital flows.” At this stage, the region needs

long term capital but opportunities exist for those with a

high risk tolerance and a willingness to venture in for the

long haul.

Nor are all Africans, entirely comfortable with the dangers

of foreign portfolio investment. Nigeria’s Central Bank, for

example, has highlighted the short-term nature of rapid ris-

ing foreign portfolio investment – which in the last quarter

of 2012 was double the value of FDI – as a threat to external

account stability. Renaissance Capital, an investment bank

specialising in emerging markets, has even speculated

that Nigeria might re-impose capital controls in some form

to prevent the rapid reversal of portfolio investment and

the attendant disruption that could cause. (The issue may

resolve itself. The EIU, citing lower expected oil revenues

available to drive economic growth, predicts that foreign

portfolio investment in Nigeria will drop to between $5bn

and $ 7bn annually for the next four years. This will bring

down the sub-Saharan figure to the same range over that

period.)

Instead, direct investment – be it greenfield or acquisitions

– seems the much more likely way for those with money to

benefit from Africa’s growth in the short and medium term.

Foreign direct investment has risen substantially in recent

years: E&Y reports that since 2007 the value of greenfield

FDI projects in sub-Saharan Africa outside South Africa

has grown at a compound annual rate of 22%. Meanwhile,

even as the EIU sees foreign portfolio investment drop-

ping to a lower plateau in these countries, it is projecting

a slight increase in overall FDI in 2013. FDI is also much

more widespread among countries, with Angola, Nigeria,

Ghana, Equatorial Guinea, and the Republic of Congo each

receiving over $2bn in inward FDI in 2012 and Zambia pro-

jected to join this group in 2013. Even Liberia is seeing a

$3bn investment in plantations spread over several years

by Sime Darby, a Malaysian multi-national. As Mr Lalor says,

“It is obviously important to develop capital markets with

depth and resilience. However, equity flows/investment

are arguably less important at this point in Africa’s relative

development than investment in infrastructure and green-

field projects.”

Asian investmentA broader look at FDI leads to another leading investment

story in African that has been attracting attention recently:

the source of the investment. A recent UNCTAD report

showed that, although France and the United States still

provided the most inward FDI in 2011 for the continent,

the next three countries were Asian: Malaysia, China, and

India. These states also have the 4th, 6th, and 7th largest

overall African FDI stocks. Much of the Indian and Malay-

sian investment goes to Mauritius which likely sees at least

some investments routed elsewhere. Chinese investors use

the island less as a tax haven and their growing stake in

the continent may even be under-estimated. Despite such

caveats, the UNCTAD data are consistent with the grow-

ing presence of Asian companies on the ground, including

such notable activity as the $10.7bn purchase by India’s

Bhati Airtel of the African mobile phone networks of Zain.

Global Financial Institute

8 The New Silk Road: Afro-Eurasian Investment

Asian investment is often mischaracterized as no more

than an attempt to ensure access to the continent’s raw

materials. However, according to UNCTAD, the majority of

such investment, whether measured by value or deals, is

in services or manufacturing. Only about a quarter of the

money from the BRICS went toward investments related

to primary goods. One example of the broader extent of

investment is Industrial and Commercial Bank of China’s

2007 acquisition of 20% of Standard Bank for $5.5bn. This

wider focus, believes Ms Omamuli, will help make the cur-

rent growth cycle more sustainable. In previous eras, com-

modity demand in developed countries usually drove rises

or falls GDP. Now lower cost labour and growing consumer

markets are allowing African countries and Asia’s emerging

economies “to form a different type of relationship based

on mutual interests, not just resource transfer.”

African economies have strong prospects for growth and,

alongside this, capital markets are likely to develop and

mature. However, they are too small to channel the funds

of those interested in these frontier markets into African

development. Dramatic index gains may simply reflect too

many buyers chasing too few securities. Foreign invest-

ment will nevertheless play an important part in Africa’s

future, but for the foreseeable future it will take the form

of direct investments by those with the patience to see

through the inevitable ups and downs of frontier market

development. These funds whether from the East or the

West, can also help reshape Africa’s role in the world econ-

omy, as it transforms from a purveyor of raw materials to an

economic partner and market in its own right.

Global Financial Institute

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