Africa rides the Asian zebra
In investment timing is everything. And for South Africa timing appears to have been unfortunate. By 1994, when the country left the shadows of apartheid-triggered sanctions and emerged blinking into the global market place, the Berlin wall had been down for five years.
Foreign direct investment was flowing into the former communist states of central and eastern Europe, which had skilled and cheap labour positioned close to the mature economies of the EU, membership of which already then was seen as a prospect.
Also by the early 1990s South Africa was having to compete for investment with the tiger economies of southeast Asia. Even in the days before Chinese economic growth transformed global investment flows and markets, the Pacific Rim was a concept that was being talked of as the trade axis of the twenty first century.
By contrast, South Africa is located at the far end of a continent that in the three decades since most of its states became independent had failed to achieve the economic growth or political stability of its competitors.
In fact, the country shares many of the problems of its neighbours. An estimated 50% of the population lives below the poverty line, a high unemployment rate is seen as one of the elements fuelling a high crime rate, which in turn has contributed to a flight of skilled workers. And the country has the world's second-highest number of HIV/AIDS patients.
But for Rian le Roux, head of economic research at Old Mutual Investment Group South Africa (OMIGSA), the picture is not as bleak as such factors suggest. "Why should people be interested in South Africa?" he asks. "Well, one should understand developments in a longer-term perspective. In 1994 people had two fears, that there would not be a peaceful political transition and that even if there were, the new government would follow the wrong macroeconomic policies and turn South Africa into Zimbabwe. But neither happened. The government inherited a budget deficit of 7% of GDP, deeply entrenched inflation expectations after 15% inflation over the previous 25 years, an uncompetitive economy protected by high tariff walls and extremely tight exchange controls. But it embarked on an adjustment process from 1994 to 2003 that largely corrected the major economic imbalances and allowed policies to become more growth friendly. Over the past three years the economy has grown by 5% a year and is expected to remain in the 5-6% range over the medium term. Supported by infrastructure expansion, job creation has accelerated and inflation has remained in the 3-6% target range. Moreover, government now runs a budget surplus.
Steve McCarthy, a vice-president of State Street Global Advisors and a senior portfolio manager in its active emerging markets team, is also upbeat. "South Africa has a first-rate financial infrastructure, a highly skilled business community, excellent business reporting and pretty reliable enforcement," he says. "The government's policies have been very pragmatic in terms of getting money down into the poorer echelons of society, and this has been very good for boosting consumer demand, and middle class incomes are also rising. We are seeing the development of consumer lending, but there is still a way to go in extending mortgages to the new black middle class, although growth rates have been quite high."
In fact South Africa certainly has advantages denied most of its northern neighbours. It is the continent's biggest economy, with strong financial and manufacturing sectors, is a leading exporter of minerals and tourism is a key source of foreign exchange. Indeed it is Africa's superpower. The 2006 GDP growth rate was estimated at 4.5%.
So is it a question of South Africa advancing while its neighbours continue to flounder? Not according to Investec Asset Management strategist Michael Power. "I have a very different view of what Africa is about and it is not the view as seen from Europe," he says.
"And that's what makes it exciting; there's nothing that gets people as wound up as telling them that there are others that have seen something and they've missed it. And basically the West - Europe and the US - has missed what is happening in Africa, and Africa is seen in a wholly different light, particularly by Asia and the Middle-east."
For Power the key factor that will turn the continent around is China. "If you have it, China will come," he says. "Why? Because without it, China will fall. You have to understand how important China has become in the world of commodities to understand how at the margin what is happening in the West and the OECD is increasingly marginal."
China looks at Africa according to its most important exports, he says. "East and west Africa have a more agricultural bias, northern Africa including the Bight of Benin is more oil, southern Africa tends to be more minerals."
He adds: "Africa has been left in the no-grow, no-go zone beyond the point of commoditisation, which is the point where one sees the harvesting of capital, the flight of capital, but very little new investment coming in and without that your product or your industry goes ex-growth and you end up with value-destroying crowdedness. But China has rejuvenated Africa's lifecycle."
However, Investec Africa fund manager Chris Derksen does not subscribe to this theory. "Africa is improving but I don't believe it's only the presence of the Chinese causing this change and I don't think it's only a commodity story as such; there's more to it than that," he says. "For example, improving sovereign governance has provided the structural element to the improvement. Commodity prices took off about two and a half years ago and Africa started growing quicker than that five years ago. And many countries that don't have the China exposure are showing great growth. I'm much more a structural/corporate governance believer. I've got more of a deep-rooted belief in what's happening on the continent."
There are hidden opportunities, he says: "There is an improving business and political environment, improving ratings as corporate governance advances and a phenomenal rate of IPOs in places like Nigeria and Egypt due to government privatisations and entrepreneurs listing private companies."
This has been coupled with pension reforms. "Some countries are undergoing pension reforms leading to very high growth in pension funds, which have to be invested somewhere," says Derksen. "Nigeria has a large pension reform underway and at the moment there's between $1bn and $2bn annually coming onto the market that by law has to be invested in Nigeria. It creates a great underpin for the listed equity market, which is why we're seeing so many IPOs now."
And it is not just Nigeria. "The demand for listed equity in places like Uganda and Kenya is just phenomenal," Derksen adds. "The recent Stanbic Bank IPO in Uganda was six times oversubscribed, last year's IPO of the Kenyan government-owned electricity generator KenGen's was four times oversubscribed and the price went from KES11.90, which was a fair indication, to KES34 on the first day."
Liberalised exchange controls have made Kenya, Tanzania, Botswana and Namibia attractive, says Derksen. "Algeria is another very interesting country, with foreign reserves of about $60bn, real economic growth of about 5% and only two stocks listed on the stock exchange. It's emerging from a long period of war and social unrest but its direction is improving. There are huge opportunities there despite the risks.
"Tanzania has a very nice little stock exchange, its market capitalisation is about $3bn. Unfortunately foreigners are only allowed to hold up to 60% of any one company and these quotas were filled long ago by strategic investors who bought at privatisation. But they are trading at double-digit yields and single-digit P/Es.
Such difficulties are another characteristic of the market. "Our experience in getting IPO shares in Kenya and Uganda has been quite negative," Derksen says. "Everything is allocated to local individuals which makes it difficult for foreign investors to get shares and the country doesn't produce any foreign capital injection. But it's a way for the government to put the money back into the locals' pockets."
And the domination of these markets by domestic institutions and individuals has further implications. "It has a very big impact in terms of correlations with other emerging markets," says Derksen. "The African stock exchanges that are in MSCI Emerging Markets - Egypt, Morocco and South Africa - are highly correlated with the MSCI EM. So if there's a hiccup in Turkey, for example, people use South Africa as a proxy for their emerging market exposure. But with the other African markets being largely locally owned, they are totally untouched: they didn't shift in the emerging market crash in May 2006 or in the downturn earlier this year. So there's very little correlation between the returns of African markets. I think that if it was a commodity-based story you should see a high correlation between markets. They will become more correlated over time, it's just nice to be in there early."
Nevertheless, Asian interest in Africa has opened a new trade axis. "People are beginning to realise that the Indian Ocean basin is Asia's Caribbean, and there is going to be the development of an extraordinary trade into that basin," says Power. "And it's a south-south trade, not a north-south trade. Africa's economy has been attached to Europe for the past 500 years. Now it's switching horses, or switching zebras as I call it, and it is going to ride the Asian tiger."