Insight & Analysis

Entering Africa: liquidity issues unwound

Published: Nov 2019

With Africa home to some of the fastest growing economies in the world, corporations are flocking to the continent to cash in on the success of many of the countries. For a Eurocentric or US-based treasurer, however, the tumultuous state of liquidity and difference in regulation can be quite a shock. Last week we explored how to prepare to enter Africa, so now we ask what should treasurers expect to find when they get there?

Victoria falls in the morning

The current state of affairs

According to the World Bank, as of 2017, 24 African countries had surpassed the 55% debt-to-GDP ratio suggested by the International Monetary Fund. This somewhat worrying figure suggests that nearly half of all countries across the continent are highly vulnerable to economic changes and have governments that are not as capable of providing economical support in the event of a recession.

Chris Paizis, Head of Corporate FX & International Banking, Absa Group, notes the disparity in liquidity of African countries. “If you look at a place like Nigeria, which by GDP is the largest economy in the continent, their FX liquidity onshore is around US$150m – US$200m per day.” Compare that to South Africa, he says, which onshore is about US$4-5bn per day, or Mozambique where liquidity might be as low as US$15m per day, and the difference in development of local financial markets becomes clear.

Paizis states that there is a perception in sub-Saharan Africa that hedging is quite expensive, which is a statement that should be unpacked and measured against hedging objectives. Currently the markets are fairly nascent, he says. As a result, most people are concerned about compatibility and therefore there tends to be a very low percentage of hedging anyway. Of course, that isn’t to say it doesn’t happen, and there are various instruments available to help – though pricing will not be transparent or freely observable, he comments.

“With regards to cost it depends on two things,” Paizis says. “Firstly, what are you trying to protect, and what is your budget for it? Secondly, what is the quality of the counterpart that you’re trading with? Because by putting on a longer-term hedge you’re also introducing potential counterparty risk, which is not so common in the more developed world.” As a result of this risk, most activity in currency is very short term in sub-Saharan Africa he notes.

Challenges and how to overcome them

When it comes to treasury in Africa, Paizis mentions that one of the largest hurdles to overcome is the one related to local regulations. “You can’t access those markets in the traditional ways. You can’t go into a multi-bank platform and hope to get the liquidity you need out of the banks, so a partnership with regional banks and strong local banks is key in getting anything done,” he says.

This might lead to a temptation by corporates to stick to specific regions; however, says Paizis, depending on the industry, generally local market conditions do not deter companies from investment. “But it does take a lot of work and a very different approach to getting things done,” he notes.

A key thing to remember, according to Paizis, is that “you can handle a volatile currency and lower liquidity if you’re used to it, but what’s difficult to hedge against is changes in regulations.” He gives Zambia as an example, where there have been quite a lot of regulatory volatilities over the past few years. This leaves a company at risk of making decisions prior to entering the country, based on what regulations are in place at the time, but when actually getting on the ground there, things may have changed. “The local authorities might be well-intentioned in what they’re trying to achieve… but it makes life for a corporate very difficult to manage,” he says.

The value of a good partnership

“In terms of investment, and especially being able to take dividends out and perpetuate funds, there is a lot of regulation and paperwork that has to be done properly upfront,” notes Paizis. He recommends caution and working with the right partners to alleviate some of the risk.

This comes with its own set of challenges, and Paizis suggests finding a bank “that’s able to fulfil all the banking that’s expected globally, that can also do it for you on the African continent.” That will need to include compliance, money-laundering, and being able to assist with things like local exchange controls and regulations. “The admin tends to be quite heavy on the African continent too, and that’s something that you might not have in Europe or the US,” he adds.

Paizis believes that African financial markets are developing quickly, and that with the right investment the continent has a lot of potential. His parting piece of advice is “don’t be scared of constraints that can be managed, just be prepared to do things slightly differently.”

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