African capital is misaligned with the continent’s needs and potential. Local capital pools are underutilised in supporting private sector growth and foreign capital is curbed by structural inefficiencies and perceived risks. As a result, small and medium businesses receive fragmented finance, which stifles long-term growth. Nieros Oyegun Sørensen explores strategies to optimise capital flow, long-term planning and patient capital.
Africa’s economic growth and success directly hinges on the private sector, which accounts for 80 per cent of total production and two-thirds of investment, and employs 90 per cent of the continent’s working-age population. Africa’s large companies have proven to be tremendously resilient, growing revenues, on average, by 4.9 per cent annually from 2015 to 2021. Despite recent years seeing a drop due to, among other factors, uncertain global economic conditions, Africa stands at a pivotal juncture where the alignment of capital with sustainable growth will be the differentiating factor in unlocking its vast economic potential.
Often touted as the next frontier of global economic growth, the continent possesses vast potential across multiple sectors, from agriculture and natural resources to emerging industries like fintech and renewable energy. However, capital misalignment continues to create significant barriers. Small and medium-sized enterprises, the backbone of African economies, struggle with high borrowing costs, perceived risks, and inadequate financial infrastructure, leading to short-term, fragmented capital flows that stifle long-term growth.
To deal with its diverse industries and growing demand for innovation, Africa can adopt capital allocation principles, focusing on critical sectors like renewable energy, digital infrastructure and manufacturing to unlock its economic potential and pave the way for inclusive growth.
Diverse pools of capital
A diverse array of capital sources characterise the African economic landscape, yet these sources are often misaligned with the continent’s pressing development needs. Local capital pools, such as pension funds and insurance companies, remain underutilised in supporting private sector growth.
Despite regulatory shifts allowing these funds to invest in alternatives like private debt, private equity and venture capital, many remain overly allocated to foreign markets and sovereign debt, missing the opportunity to support local enterprises effectively with the best matched capital. Global capital pools, including investment firms and development finance institutions(DFIs), have shown interest in African markets. However, structural inefficiencies and perceived risks continue to curb the full impact of these investments.
A prime example of mobilising local capital is the Kenyan Pension Funds Investment Consortium (KEPFIC), established in 2020 with backing from the World Bank and the US Agency for International Development (USAID). With KEPFIC having grown to 24 members who collectively manage over $5.2 billion in assets, investments have been made into infrastructure and alternative assets that would be too challenging and expensive for individual pension funds to handle alone. If similar strategies were adopted across the continent, local institutional capital could significantly address Africa’s infrastructure gap, which hinders economic growth by two per cent each year and diminishes productivity by as much as 40 per cent.
Strategies for efficiency
Capital allocation in emerging markets depends on complex factors, including risk assessment, data availability, liquidity, and localised, sector-specific opportunities. To optimise capital flow, Africa must explore financial structures that support long-term planning and patient capital. Blended finance, which combines concessional funding from philanthropic sources with commercial investments, is one such structure. For instance, the International Development Association’s $2.5 billion Private Sector Window(PSW), supported by the World Bank and the Multilateral Investment Guarantee Agency (MIGA), reduces investment risks and attracts capital into high-impact projects that traditional financing methods overlook.
Traditional closed-ended private investment funds often place pressure on investors to exit while the asset may still have substantial headroom for value appreciation. Global economic volatility, particularly in Africa, has slowed growth and resulted in low-yielding investments, leading to significant macroeconomic fluctuations before exit. Moreover, fund managers in Africa face challenges such as currency risks and political and economic uncertainties, which extend the time needed to achieve returns.
In such environments, permanent capital vehicles (PCVs) can offer a more viable long-term solution for both managers and investors. Unlike traditional fund structures, this approach increases the flow of capital to smaller businesses, reduces the pressure to exit within a predetermined timeframe, and allows for patient capital to make follow-on investments, especially across developing economies, which enhances the possibility of achieving risk-adjusted returns.
Impact investing and Development Finance Institutions (DFIs) are crucial in supporting ventures that deliver financial returns and social benefits. These models are vital for sectors like healthcare, education, and infrastructure, where they can drive sustainable development while appealing to investors. To further optimise capital flow, foreign exchange (FX) liquidity must be improved and supportive government fiscal policies refined. The Johannesburg Stock Exchange, for example, serves as a key player in fostering a financially independent ecosystem, alleviating challenges related to capital repatriation, and enabling smoother investor exit strategies.
By addressing the complexities of its markets through sound financial strategies and supportive policies, the continent can improve returns and create a more sustainable investment ecosystem, boosting investor confidence and decreasing risk perceptions.
Debunking risk perceptions
One of the significant barriers to capital inflow to Africa is the high-risk misconception. This perception gap is one of the main factors contributing to the continent’s estimated $200 billion trade and investment financing gap. According to UNCTAD, the flows of foreign direct investment to Africa dipped to $53 billion in 2023 compared to $82 billion in 2021.
Global pools of capital and investors that should be coming to the continent perceive African markets as excessively risky, leading to inflated capital costs and diminished valuations. This perception is compounded by the tendency to treat Africa as a monolithic entity rather than recognising its diverse countries, each with distinct economic trajectories and sector strengths.
Initiatives like Prosper Africa play a pivotal role in challenging these risk perceptions. Through US investor delegation trips, Prosper Africa exposes investors to a pipeline of promising deals, explores investment opportunities, and facilitates connections with top private equity and venture capital funds across the continent.
Consumer spending is projected to reach $2.1 trillion by 2025, and the rate of return on foreign investment is higher in Africa than in any other developing region. In 2022, Africa received six of the world’s top 15 megaprojects in greenfield investment (when a multinational builds affiliates from scratch in a foreign country, instead of buying existing operations), each valued at over $10 billion. This testifies to the continent’s immense potential and how aligned capital can spur significant growth.
To advance economic growth on the continent, policy makers should advocate for reforms that mobilise institutional capital, offer risk mitigation tools, and promote partnerships between private sector actors to unlock the full potential of Africa’s diverse economies.
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