Deutsche Asset & Wealth Management www.DeAWM.com S5 SPECIAL ISSUE The New Silk Road: Afro-Eurasian investment June 2014 Global Financial Institute Your entry to in-depth knowledge in finance Dr Paul Kielstra The New Silk Road: Afro-Eurasian Investment Global Financial Institute Introduction to “Global Capital Markets in 2030“ Deutsche Asset & Wealth Management’s Global markets face weakening demand in many mature Financial Institute asked the Economist Intelli- markets gence Unit to produce a series of white papers, custom articles, and info-graphics focused spe- In short, while the world’s stock of financial assets cifically on global capital market trends in 2030 (e.g stocks, bonds, currency and commodity futures) is growing, the pattern of that growth sugWhile overall growth has resumed, and the gests that major shifts lie ahead in the shape of capi- value traded on capital markets is astoundingly tal markets large (the world’s financial stock grew to $212 trillion by the end of 2010, according to McKin- This series of studies by Global Financial Institute sey & Company) since the global financial crisis and the Economist Intelligence Unit aims to offer of 2008, the new growth has been driven mainly deep insights into the long term future of capital by and markets It will employ both secondary and primary by a $4.4 trillion increase in sovereign debt in research, based on surveys and interviews with 2010 The trends are clear: Emerging markets, leading institutional investors, corporate executives, particularly in Asia, are driving capital-raising; in bankers, academics, regulators, and others who will many places debt markets are fragile due to the influence the future of capital markets expansion in developing economies, large component of government debt; and stock The New Silk Road: Afro-Eurasian Investment Global Financial Institute Introduction to Global Financial Institute Global Financial Institute was launched in Novem- institutions are hundreds of years old, the per- ber 2011 It is a new-concept think tank that seeks fect place to go to for long-term insight into the to foster a unique category of thought leadership global economy Furthermore, in order to present for professional and individual investors by effec- a well-balanced perspective, the publications span tively and tastefully combining the perspectives of a wide variety of academic fields from macroeco- two worlds: the world of investing and the world nomics and finance to sociology Deutsche Asset of academia While primarily targeting an audi- & Wealth Management invites you to check the ence within the international fund investor com- Global munity, publications white papers, interviews, videos, podcasts, and are nonetheless highly relevant to anyone who is more from Deutsche Asset & Wealth Manage- interested long-term ment’s Co-Chief Investment Officer of Asset Man- views on the economic, political, financial, and agement Dr Asoka Wöhrmann, CIO Office Chief social issues facing the world To accomplish this Economist mission, Global in Financial Institute’s independent, Global Financial educated, Institute’s Financial Institute Johannes website Müller, and regularly for distinguished publications professors from institutions like the University of combine the views of Deutsche Asset & Wealth Cambridge, the University of California Berkeley, Management’s those the University of Zurich and many more, all made of leading academic institutions in Europe, the investment experts with relevant and reader-friendly for investment profes- United States, and Asia Many of these academic sionals like you About the Economist Intelligence Unit The the a variety of pieces covering the financial services world’s leading resource for economic and busi- Economist Intelligence industry including the changing role relationship ness research, forecasting and analysis It provides between the risk and finance function in banks, accurate and impartial intelligence for companies, preparing for the future bank customer, sanctions government agencies, Unit financial (EIU) is and compliance in the financial services industry, and academic organisations around the globe, inspir- institutions the future of insurance A published historian, Dr ing business leaders to act with confidence since Kielstra has degrees in history from the Universi- 1946 EIU products include its flagship Country ties of Toronto and Oxford, and a graduate diploma Reports service, providing political and economic in Economics from the London School of Econom- analysis for 195 countries, and a portfolio of sub- ics scription-based data and forecasting services The the charitable sector He has worked in business, academia, and company also undertakes bespoke research and analysis projects on individual markets and busi- Brian Gardner is a Senior Editor with the EIU’s ness sectors The EIU is headquartered in London, Thought Leadership Team His work has covered a UK, with offices in more than 40 cities and a net- breadth of business strategy issues across indus- work of some 650 country experts and analysts tries ranging from energy and information tech- worldwide It operates independently as the busi- nology to manufacturing and financial services In ness-to-business Group, this role, he provides analysis as well as editing, the leading source of analysis on international project management and the occasional speaking business and world affairs role Prior work included leading investigations arm of The Economist into energy systems, governance and regulatory This article was written by Dr Paul Kielstra and regimes Before that he consulted for the Commit- edited by Brian Gardner tee on Global Thought and the Joint US-China Collaboration on Clean Energy He holds a master’s Dr Paul Kielstra is a Contributing Editor at the degree from Columbia University in New York City Economist Intelligence Unit He has written on and a bachelor’s degree from American University a wide range of topics, from the implications of in Washington, DC He also contributes to The political violence for business, through the eco- Economist Group’s management thinking portal nomic costs of diabetes HIs work has included The New Silk Road: Afro-Eurasian Investment Global Financial Institute The New Silk Road: Afro-Eurasian Investment Written by A Global Financial Institute research paper written by the Economist Intelligence Unit June 2014 Investment in Africa’s Frontier Markets: Frothy port- over 10% of the world’s oil, 40% of its gold, and 80% of its folio gains and long-term opportunities platinum According to UN estimates, Africa’s current population of roughly 1bn, can expect to rise by about 50% by The next big thing? 2030 and to be more than double today’s figure by 2050 Frontier markets are currently hot news for portfolio inves- At the same time, the proportion of those who are working tors The term, originally created by the World Bank’s Inter- age will go from 54% currently to 58% in 2030 and 62% by national Finance Corporation, has been around for two 2050 In other words, Africa is set to reap the demographic decades It refers to those economies which are at an ear- dividend many emerging markets have already enjoyed lier stage of economic development than emerging markets but which seem capable of moving toward that status The continent has always had resources, though, and Thus, frontier markets are typically riskier, less liquid, and youth is an economic blessing only when combined have lower market capitalisation than emerging ones but with employment opportunities On this front African hold out the possibility of rapid, prolonged growth economies have been expanding strongly in recent years aided by governments addressing the overarching busi- As developed countries have struggled with stagnation ness environment As then World Bank vice-president for and the BRICs have delivered less dramatic growth, the Africa Obiageli Ezekwesili said in 2012, “In the last decade profile of frontier markets has risen Funds composed of Africa made peace with the concept of macroeconomic equities from these countries are delivering substantial stability as being fundamental for growth.” Reforms have returns, albeit after sharp losses in the aftermath of the been widespread: according to the World Bank’s Ease Global Financial Crisis More specifically, Africa is the cur- of Doing Business data for 2013, of the 15 countries that rent darling of buyers taking a chance on such invest- have seen the most improvement over the last five years, ments: from the start of this year to the end of May 2013, seven are from the continent Governments have also been the MSCI Africa Frontier Market Index is up by 26%, follow- addressing debt: an Ernst & Young study of 15 sub-Saharan ing on a 52% gain in 2012 Some individual markets are states calculated that average foreign state indebtedness seeing even more dramatic rises The All Share Index of as a proportion of gross national income fell from 120% in the Nigerian Stock Exchange gained 34% between Janu- 1994 to just 21% in 2011 Though this is largely a result of ary and May after a 35% rise in 2012 and the Ghana Stock debt forgiveness, better economic management plays an Exchange soared by over 50% in the first five months of important role this year Debt markets are also becoming more attractive: in September 2012 a Zambian sovereign bond offering These efforts are being rewarded: Economist Intelligence raised $750 m and was oversubscribed by 24 times For- Unit figures indicate that eight of the 20 fastest growing eign investors are taking note 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 A story of growth also forecast to be from the continent At a regional level, Africa has much to spark the interest of investors, begin- for most of the last decade, sub-Saharan Africa and North ning with resources – both natural and demographic: it has Africa have seen growth comfortably above the global The New Silk Road: Afro-Eurasian Investment Global Financial Institute average Looking ahead, the IMF predicts that economies to create a distorted, monolithic image of a highly diverse in sub-Saharan Africa will grow at around 6% annually over continent Those discussing the current positive economic the next two years, well surpassing the global figure of 4% story should avoid the same mistake To begin with, much To 2030, CitiGroup has forecast that, the continent’s share of the current good news – population prospects, eco- of global GDP will go rise from 4% to 7% nomic reforms, and resultant growth – applies largely south of the Sahara while political and social changes are Michael Lalor, lead partner at Ernst & Young’s Africa Busi- taking a toll in North Africa South Africa, the largest econ- ness Centre, notes two important attributes of this growth omy in the region, has also not kept pace with its sub-Saha- The first, he says, is that “the progress we’ve seen has been ran neighbours; in 2012 its 2.5% GDP growth kept down sustained over a decade It is not just one or two years of the broader regional figure of 4.3% growth.” Second, although “natural resources remain a key driver of growth and investment, the extent of diversifica- In considering frontier capital markets, though, the prob- tion is often overlooked.” Only about a third of the conti- lems facing these parts of the continent are of only indirect nent’s growth has been commodity-related Manufactur- import because South Africa and the major economies of ing, telecoms, and local services, are all seeing marked North Africa are already considered emerging markets The activity Consumer spending, meanwhile, accounts for difficulty is deciding just which countries are members of over 60% of sub-Saharan Africa’s GDP and is also rising the frontier club when looking at portfolio investment substantially according to the World Bank Indeed, domes- Growth alone is not sufficient: in the last five years Rwanda tic growth and low levels of debt have helped to cushion has had the fourth fastest rising GDP in Africa and recently African states from the economic difficulties facing much issued a $400m bond on world markets, but with an entire of the rest of the world economy worth just over $6bn it lacks depth for potential investments That is not to say doing business in Africa is trouble free Simplistic comparisons with emerging giants are problem- In practice, frontier portfolio investment in Africa revolves atic as the continent’s 54 countries fragment markets not around a handful of countries and is dominated by the only through diverse regulatory regimes but also in terms purchase of Nigerian securities Although no universally of cultures, tastes and languages Corruption remains agreed list of frontier markets exists, most include only a endemic in sub- Saharan countries, including Nigeria few African states Nigeria is inevitably one MSCI’s Afri- and Kenya which are tied for 139th place (out of 174) in can Frontier Markets Fund – a frequently cited index of Transparency International’s Corruption Perception Index the performance of these markets – includes equities Moreover, although regulation is improving, progress from there, as well as Kenya, Tunisia and Mauritius but has according to Mr Lalor remains, “uneven and moves at what very few holdings in the latter two A close look at other sometimes feels like a frustratingly slow pace.” Indeed, for African funds usually shows that, beyond a single invest- Weyinmi Omamuli – a sub-Saharan African economist– it ment or two in any given country, most money goes into is the slowness in reforming political and regulatory struc- these countries as well as, sometimes, Ghana with the tures that is the greatest threat Failure to provide policies large majority headed to Nigeria Among all investors, the that allow further growth and the development of neces- bias toward that country is even more marked The EIU sary infrastructure will undermine the ability of Africans to estimates that net portfolio investment into sub-Saharan earn and spend further “Consumer growth,” she explains, Africa (excluding South Africa) rose from $5.1bn in 2011 although substantial “is still pretty vulnerable.” 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 But where is the frontier? Africans have frequently, often justifiably, complained These are net figures The only other frontier country seeing about the extent to which writers generalised bad news inward portfolio investment on the same scale as Nigeria is The New Silk Road: Afro-Eurasian Investment Global Financial Institute Mauritius but even more money – as far as can be pieced investor interest in the continent remains strong and a together from different data sources – then flows out from flood of hot money does not create a bubble Nevertheless, some of the 27,500 holding companies controlling $400bn investors are likely to struggle to find such opportunities in assets located in this tiny tax haven African portfolio as so many businesses remain outside of listed exchanges frontier investors, then, may point to the potential opportunities across the continent, but in practice most are really Should all this worry Africa’s frontier? Probably not First sending hot money to Nigeria and one or two other places, of all, frontier economies almost by definition have thin while others use Mauritius as a base to control their hold- capital markets As economies grow over the long term, ings, often in India so should market capitalisation This has already been happening According to World Bank data, between 2002 The implications for investment and 2012, total market capitalisation in sub-Saharan Africa Capital markets are supposed to link those looking for bet- (excluding South Africa) rose by a total of 4.1 times – more ter returns with firms looking to grow The narrowness of than double the rate in high income OECD states (1.9 portfolio investment in African frontier markets, however, times) If the continent follows the path of Asia’s emerging arises because they are currently still too thin to perform giants, this accumulation will accelerate: India and China this function to any large degree The total market capi- saw total market capitalisation rise by factors of 9.6 and 8.0 talisation of firms on Nigeria’s exchange is roughly $70bn respectively during the same period The factors described – about equivalent to eBay, the 45th largest American above which bode so well for African economic growth company Kenya, the next most liquid, has a market capi- should thus help with capital accumulation in the equity talisation of only around $20bn However, MSCI, basing its markets, although investors should be prepared for plenty assessment on both on the value of shares and their avail- of bumps along the way ability to trade, estimates that the free-float adjusted market capitalisation of the major exchanges in Nigeria, Kenya, To move growth along, notes Mr Lalor, “There is a strong Tunisia, and Mauritius are collectively below $30bn Given case to be made for their regional consolidation: this will the market size, resources and population of sub-Saharan help to create critical mass and accelerate the develop- Africa, this leaves significant potential for growth as yet ment process” Authorities are certainly looking at the idea untapped January 2013 saw the first meeting of the West African Capital Markets Integration Council which has been estab- Debt markets are also small at the moment According to lished by the Economic Community of West African States the IMF, government and corporate bond market capitali- The body, made up of the heads of local exchanges and sation as a proportion of GDP in sub-Saharan Africa out- securities commissions, has been established to help cre- side of South Africa is among the lowest in the world The ate common regulatory standards and a common trading corporate figure is just 1.3%, compared to 23% in China, platform across the region Meanwhile, in August 2012, 46% in Europe, and 99% in the United States the East African Community founded the East African Securities Regulatory Authority which has been looking For those looking to cash in on rapid index growth in the at joint supervision of companies cross listed in national short term, market size clearly presents a problem As exchanges and mutual recognition of licenses of capital the Economist commented in February, currently “There market professionals The slow progress of the Southern are not enough listed African firms to absorb even a frac- African Development Community’s Committee of SADC tion of the ignorant money itching to flow south of the Stock Exchanges (CoSSE), which has been promoting inte- Sahara.” Overall, Mr Lalor explains, “Outside of South Africa, gration since 1997, shows that good intentions alone will capital markets are clearly still very immature.” Those very not be enough It has had some success in harmonizing few African frontier firms that can tap into capital markets regulation, but adoption of common technology has not may enjoy very cheap access to capital as long as current occurred and, as Beatrice Nkanza, CEO of CoSSE wrote last The New Silk Road: Afro-Eurasian Investment Global Financial Institute year, “Robust cross-border trading between the region’s portfolio investment in Nigeria will drop to between $5bn stock exchanges is not yet the norm.” Nevertheless, if bet- and $ 7bn annually for the next four years This will bring ter ties can be established between markets it should help down the sub-Saharan figure to the same range over that increase overall market depth and liquidity At the same period.) time, common regional regulations would improve transparency, especially in smaller markets Instead, direct investment – be it greenfield or acquisitions – seems the much more likely way for those with money to The development of the region’s debt markets, on the benefit from Africa’s growth in the short and medium term other hand, may not be so straightforward Ms Omamuli Foreign direct investment has risen substantially in recent points out that many sub-Saharan countries, as a condi- years: E&Y reports that since 2007 the value of greenfield tion of their debt relief from international lenders, have FDI projects in sub-Saharan Africa outside South Africa accepted limits on their future level of commercial borrow- has grown at a compound annual rate of 22% Meanwhile, ing under the Debt Sustainability Framework, which regu- even as the EIU sees foreign portfolio investment drop- larly assesses countries’ debt burdens over a 20-year hori- ping to a lower plateau in these countries, it is projecting zon “You will see more countries coming onto the market a slight increase in overall FDI in 2013 FDI is also much but what people forget is really that the amount they can more widespread among countries, with Angola, Nigeria, borrow is very limited.” If those countries, as a result, not Ghana, Equatorial Guinea, and the Republic of Congo each tap into debt markets at all, it can have a knock-on effect receiving over $2bn in inward FDI in 2012 and Zambia pro- on corporate borrowing Without a sovereign debt rating jected to join this group in 2013 Even Liberia is seeing a against which to benchmark themselves, companies in a $3bn investment in plantations spread over several years given country rarely move onto debt markets by Sime Darby, a Malaysian multi-national As Mr Lalor says, “It is obviously important to develop capital markets with For many countries in the region, the current size of capi- depth and resilience However, equity flows/investment tal market is less of a focus than their overall investment are arguably less important at this point in Africa’s relative inflows Mr Lalor notes that “While the capital is no doubt development than investment in infrastructure and green- welcome, the risk with portfolio investment is that it is field projects.” often short term in nature, and can create volatility Clearly developmental policies cannot be shaped around these Asian investment shorter term capital flows.” At this stage, the region needs A broader look at FDI leads to another leading investment long term capital but opportunities exist for those with a story in African that has been attracting attention recently: high risk tolerance and a willingness to venture in for the the source of the investment A recent UNCTAD report long haul showed that, although France and the United States still provided the most inward FDI in 2011 for the continent, Nor are all Africans, entirely comfortable with the dangers the next three countries were Asian: Malaysia, China, and of foreign portfolio investment Nigeria’s Central Bank, for India These states also have the 4th, 6th, and 7th largest example, has highlighted the short-term nature of rapid ris- overall African FDI stocks Much of the Indian and Malay- ing foreign portfolio investment – which in the last quarter sian investment goes to Mauritius which likely sees at least of 2012 was double the value of FDI – as a threat to external some investments routed elsewhere Chinese investors use account stability Renaissance Capital, an investment bank the island less as a tax haven and their growing stake in specialising in emerging markets, has even speculated the continent may even be under-estimated Despite such that Nigeria might re-impose capital controls in some form caveats, the UNCTAD data are consistent with the grow- to prevent the rapid reversal of portfolio investment and ing presence of Asian companies on the ground, including the attendant disruption that could cause (The issue may such notable activity as the $10.7bn purchase by India’s resolve itself The EIU, citing lower expected oil revenues Bhati Airtel of the African mobile phone networks of Zain available to drive economic growth, predicts that foreign 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 current growth cycle more sustainable In previous eras, commodity 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 investment 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 economy, as it transforms from a purveyor of raw materials to an economic partner and market in its own right Global Financial Institute Disclaimer Global Financial Institute Deutsche Asset & Wealth Management represents the asset management and wealth management activities conducted by Deutsche Bank AG or any of its subsidiaries Clients will be provided Deutsche Asset & Wealth Management products or services by one or more legal entities that will be identified to clients pursuant to the contracts, agreements, offering materials or other documentation relevant to such products or services This material was prepared without regard to the specific objectives, 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Africans have frequently, often justifiably, complained These are net figures The only other frontier country seeing about the extent... whether direct, indirect, consequential or otherwise suffered by the recipient of this document or any other person The opinions and views presented in this document are solely the views of the. .. and the other business units of Deutsche Bank The views expressed in this document constitute the author’s judgment at the time of issue and are subject to change The value of shares/units and their