As highlighted in the just-released Global Economic Prospects report, international capital flows to developing countries had a strong recovery in 2010. These flows are projected to rise further in the medium term and much of the increase is expected to be in foreign direct investment (FDI) inflows. Sub-Saharan Africa may have a better chance of receiving international capital flows in this new cycle of capital flows that it did previous ones.
Outside of South Africa, foreign private capital flows into Sub-Saharan Africa almost exclusively come in the form of FDI. And while such flows represent as much as 20 percent of total gross capital formation in the region, for years FDI inflows have been almost exclusively focused on the extractive sector. Indeed, the high commodity prices of recent years have supported large capital inflows to many resource-rich African countries and helped to sustain these flows even during the crisis.
However, several Sub-Saharan African countries appear to be better positioned to receive more international capital flows in the current cycle. The investment climate in most countries is improving (see figure); and many have improved their macroeconomic policies and debt sustainability (Radelet 2010). As a result, market makers are increasingly talking of several African countries’ being on the verge of an economic takeoff (McKinsey 2010; Young 2009; and Pinkovsiy and Xala-i-Martin 2009). In fact, for global investors, several countries in the region represent relatively untapped large and rapidly growing markets (regional GDP is projected to grow by more than 5 percent annually between 2010 and 2012).
Source: World Bank staff calculations, Institutional Investor Country Ratings
As a result, multinationals are increasingly recognizing Africa’s potential and getting interested in entering the local market to take advantage of the opportunity to serve the local economy. The region has been attracting FDI into new sectors in services (telecom, banking). For example, Walmart has made an offer of 13 times the pre-tax earnings of the South African MassMart (which has 290 stores in 13 African countries), in order to secure a foothold on the continent. Africa is also becoming an attractive destination for portfolio investment flows. Countries like Ethiopia, Ghana, Nigeria, and Rwanda are identified by several fund managers as possible destinations for Africa-centric investment funds.
Increased investment and trade ties with other developing countries have been playing an important role. While some of the South-South flows are intra-regional (coming from Tanzania, South Africa and Kenya), inter-regional South-South investment from China, Brazil, India and Malaysia has surged in recent years. The recent acquisition of telecom company Zain Africa by Indian Bharti for $10.7 billion is the largest South-South acquisition ever.
The potential and promise of Africa‘s future is clear. But continued success is not guaranteed. Concerns about the quality of growth and political stability remain. The realization of Africa‘s promise will depend on the continuation of policy reforms and institutional development that have underpinned the recent improvement in economic performance, building on the foundation that has been laid. And, even if the potential is realized, the absorption capacity of these countries will be a crucial factor in determining the extent to which they benefits from better access to international capital flows. With limited experience dealing with large capital flows, some countries may have difficulty managing the volatility that can accompany them.