ECA's Thirty-third session of the Commission/Twenty-fourth meeting of the Conference of Ministers/Seventh Conference of African Ministers of Finance
6 - 8 May 1999 Addis Ababa, Ethiopia

IV. Other Sources of External Finance

48. The net rate of return on investment in African countries is higher than in other developing countries. It was estimated at between 20-30 per cent during 1990-1994, on average, as opposed to 16-18 per cent for all developing countries. Yet Africa has not been one of the significant beneficiaries of the dramatic increase in global foreign direct investment flows. FDI flows to Africa amounted to only $4.76 billion in 1997, the same level as in 1996, representing a minuscule 3 per cent of global FDI flows. Moreover, the flows are concentrated on a few countries and activities. Only about 20 countries are beneficiaries, with Nigeria, Egypt, Morocco, Tunisia and Angola together accounting for two-thirds of FDI flows to Africa in 1997 (UNCTAD, 1998b). More than 50 per cent of all FDI went to support the oil and petroleum industry, and most of the rest went to extractive, mainly mining, activities. And one needs to recognizes that the decline in commodity prices, especially those of petroleum, gold, and diamonds could reduce the attractiveness to foreign investors of some of the countries — such as South Africa, Nigeria and Angola — that have been major recipients of FDI in the recent past. Little FDI went to industry or services, where there are the greatest opportunities for technology transfer to sustain the development process. The foreign-funded manufacturing sector, which was dominated by import-substituting industries, remains weak, largely because import liberalization has adversely affected their shares of the domestic market, in addition to large currency devaluations which have undermined their rates of return in foreign currency terms.

49. Africa’s difficulty in attracting foreign investment is attributed to the perception that investing in the continent is a high-risk activity. This perception is rooted in a number of inter-related factors, which have given the continent a negative image, including poor human, social and economic infrastructure, fear of policy reversal, civil conflicts and an inadequate legal framework for the enforcement of contracts. Low levels of income and small market size, poor international competitiveness, weak domestic private sectors, undeveloped domestic financial sectors and rudimentary capital markets are other key constraints to attracting private capital flows. Surveys of foreign investors show that, FDI goes to countries with a stable political and economic environment, transparent and minimal regulations, good infrastructure facilities, a skilled labour force and low production and transactions costs — much the same set of factors that encourage domestic investors. These features have been largely absent in a number of African countries (Fisher et al, 1997) and account for the poor performance. For selected FDI stock indicators for 1987 and 1996, see appendix Table 4.

50. In spite of the constraints to accelerated flows of FDI, there are encouraging signs that this could change. Major steps are being taken by several countries to eliminate those factors that inhibit FDI flows, including maintenance of a supportive macroeconomic policy environment; increased liberalization of markets and trade regimes, business facilitation and improvements in the regulatory framework for private investment. As a result, economic fundamentals in the region are improving, which is an essential inducement for private sector investment (UNCTAD, 1998b, p. 177). Initiatives outside Africa to promote private investment in the continent are also likely to reinforce this trend. Notable among them is the US initiative elaborated in the African Growth and Opportunity Act, which was approved by the United States House of Representatives in March 1998. While there is some lingering debate within the Africa constituency in the US, and some alternative proposals are being put forward, the initiative is a major step in US-Africa trade and investment relations. The proposals in the present initiative include the removal of all quotas and tariffs for apparel and textile imports from Africa; establishment of a $150 million fund for equity investment in Africa; and setting up a $500 million private equity fund for investment in particular infrastructure projects. These funds, to be set up by the Overseas Private Investment Corporation (OPIC) are expected to induce private investors to participate (UNCTAD, 1998b).

51. Domestic and foreign programme and policy initiatives, however, will by themselves not produce durable private investment and development in Africa without key sustainability conditions being met, including raising the productivity and competitiveness of African economies. African countries will need to invest in human capital, physical infrastructure as well as technology. As UNCTAD argues, strong productivity growth in the economies of Bangladesh, India and Indonesia was the key ingredient of their export success. It is, therefore, also imperative that African countries concentrate on improving the competitiveness of their economies in order to gain a foothold in the world economy.

52. In the absence of selective export promotion policies, competitiveness depends on the behaviour of real wages, on productivity growth and on the real exchange rate. A comparison of unit labour costs in African countries and some potential competitors in a number of manufacturing sectors in 1995 shows that in most cases, costs in Africa were much higher than in competing countries. Moreover, in general, unit labour costs in Africa actually increased after 1980 relative to those in competing countries, even though in many cases real wages stagnated or even declined (UNCTAD: 1998a, pp. 198-201). African countries, therefore, will need also to focus on how to improve the productivity and competitiveness of their economies as an integral part of the strategy to attract foreign direct investment and strengthen private sector activities in general.

53. Privatization in Africa is becoming an increasingly important (although far from fully explored) avenue for foreign investment (UNCTAD, 1998b). Expanding privatization programmes in a number of African countries has broadened opportunities for FDI. In the privatization process, foreign investors bring along with them proven managerial capabilities, new technology and market access. Although privatization is attracting foreign direct investment (FDI) in Africa, the amount is small relative to total FDI and compared to privatization-related FDI flows to the rest of the world. Such flows represent less than 5 per cent of all foreign investment in the Africa region, compared to 43 per cent in the transition economies of Eastern Europe, and 15 per cent in Latin America and the Caribbean (White and Bhatia, 1998). The low level of participation by foreigners in privatization in Africa can be directly attributed to the small size of privatized enterprises, weak promotional efforts, lack of transparency of transactions, weak legal systems and the preference for local investors in areas of interests to foreigners.

54. There are a number of policy issues with which African countries have to grapple in the process of privatization. The most urgent one is the issue of broadening the ownership base of privatized enterprises to be more inclusive of major national constituencies. If ownership is broadened, national aspirations are satisfied and political acceptance of the process is garnered. Concrete issues relate to the avoidance of concentration in one particular ethnic group as opposed to another; the rich as opposed to the middle class; one political class as opposed to another, and a minority as opposed to the majority. Another important issue is the extent to which foreigners should have control over the "commanding heights of the economy" in the process of privatization. Should foreigners be allowed to own a larger share of most industries or sectors of the economy? In many African countries, there is reluctance to allow foreigners to own majority shares in sensitive areas of the economy such as the banking and power sectors. Some African countries have not yet opened up their economies to foreigners. Opening up is often seen as economic neocolonialism. Nationalists argue that while privatization can be an important source of financial resources for development, African countries have to reconcile financial needs with the delicate issue of complete foreign ownership of important sectors of the economies. It has been noted, however, that selling to foreigners is often the only way to avoid accusations of either tribalism or nepotism (White and Bhatia, 1998).

55. The role of capital markets in the provision of risk capital has come to the promotion of capital markets in an effort to increase domestic resource mobilization, centre stage in many African countries. African countries have in recent times been giving greater attention improve the supply of long-term capital, and encourage the efficient allocation of existing resources. In many countries, there has been renewed activity in old markets while new ones have either emerged or are being planned as a result of the key roles which capital markets are beginning to play. They include lowering the cost of equity capital, thereby stimulating investment and growth. By spreading the risks associated with long-term investment projects and by imposing a degree of control over the investment behaviour of companies, capital markets contribute to more efficient investment. They also enhance the supply of investible funds by attracting foreign portfolio capital. They contribute to the mobilization of domestic resources and the provision of fresh equity capital to the corporate sector (Dailami and Michael, 1990).

56. Capital markets are especially important in attracting portfolio equity funds, which currently are of relatively minor importance in many countries. The exception is South Africa, which attracted the lion’s share — $1.8 billion or 90 per cent — of portfolio flows to Africa in 1996. However, these flows are likely to assume more importance in more countries as capital markets develop. Such investments are usually made by financial institutions, institutional investors (such as pension funds, insurance companies or investment trusts) or individuals. Foreign equity investment is made through direct purchases by individual investors of shares in companies listed on the stock exchange of the countries concerned.

57. Capital markets are also critical to attracting venture capital funds, which in general seek to invest in new and high-risk undertakings (UNCTAD 1998a). Venture capital funds are more likely to consider favourably small-scale investments and, on the face of it, would appear to be more appropriate for African and other developing countries. Unfortunately, because of the small-scale nature of the projects attractive to it, venture capital is unlikely to satisfy the need for private finance in Africa. As the development of capital markets is very important for venture capital funds, African countries should make concerted efforts to expand and to deepen capital markets as an instrument for resource mobilization. There is also a need to develop the regulatory and supervisory framework for the effective functioning of capital markets.

58. Because of their potential for mobilizing foreign and domestic resources, many African countries are now trying to promote and should deliberately support the development of domestic securities markets. But there are challenges to be faced in the process. First, there is the need to put in place supportive infrastructure for the market. Such infrastructure includes efficient, non-banking financial intermediaries (trust companies, brokerage firms, etc.) and reliable communications networks. Second, there is a need for legal and institutional framework for the efficient functioning of such markets. Third, there is a need for an appropriate enabling macroeconomic environment — including political and economic stability, fiscal discipline, and appropriate interest and exchange rate policies. A viable market cannot be developed in an environment where monetary expansion is excessive, and inflation and budget deficits are high. Similarly, financial repression is a major obstacle to the evolution of capital markets. Furthermore, building a strong banking system has to be part and parcel of the process of deepening and broadening financial intermediation in Africa. It will require improvement of the institutional framework and management for effective intermediation, prudential regulation and supervision of banks and non-bank financial institutions; broadening financial instruments available to both savers and investors; and enhancing the contribution of indigenous banking and financial institutions in the mobilization of savings.

59. In a world of global financial flows, the development of capital markets places a lot of responsibility on economic and financial policy managers, as the funds in the market are mobile. At any time, the country hosting the funds is in competition with others that can attract those funds away. The East Asian banking and currency crisis and the massive migration of capital out of the region is testimony to the fact that economic and financial management must be meticulous if foreign capital is going to play a greater and sustained role in the development of African countries. While it is clear that efficient capital markets can play an important part in mobilizing domestic and external resources to support development, the challenges facing many African countries in developing, operating and regulating such markets are enormous. Policy makers should reflect on the fact that notwithstanding the notable efforts made by many African countries to implement economic and financial reforms, FDI flows to most of them remain marginal. Sharing experiences of implementing FDI-friendly policies and the different outcomes in various countries would also be useful. What additional steps need to be taken to enhance Africa’s competitiveness in global capital markets? It would also be appropriate to explore opportunities for enhancing the role of the International Finance Corporation (IFC) and the Multilateral Investment Guarantee Agency (MIGA) in catalyzing private sector investment in Africa.