Financial markets in Africa still underdeveloped

Modern, robust and transparent financial markets are essential to attract investors to the African continent and fund economic growth, according to a research report by the Official Monetary and Financial Institutions Forum (OMFIF) as part of its annual study into the development of financial markets in African countries.

The research, in collaboration with Absa, again puts SA first in its ranking of African countries in respect of different aspects in an attempt to measure the state of financial markets on the continent. Absa and OMFIF have just announced the latest Absa Africa Financial Markets Index ratings, described as a key reference tool for policy makers and investors to guide their efforts in developing robust financial markets.

It comes as no surprise that SA is found to have the best regulation, largest and most liquid markets, robust legal frameworks and best access to investment capital and foreign exchange while the rest of Africa is far behind, and deteriorating.

The research report and a presentation by the researchers seem to focus on the improvements countries have achieved since the previous year’s survey, but from the figures investors will (unfortunately) probably think the financial markets in most African countries have become less attractive and welcoming.

Overall score is down

The overall score for the whole of the African continent declined, with more than half of the 20 countries’ measures in both years registering a disappointing worsening in the state of their financial markets.

And the scores of the laggards are dismally low, with Ethiopia scoring only 27 out of a possible 100, Angola 30 and Malawi 37. SA scored 89, with Mauritius in second place with a score of 79.

Rank	Country	Score	Comments
1	South Africa	89	Foreign exchange controls eased but ratings downgrade hit liquidity
2	Mauritius	79	Market infrastructure and tax environment favourable to foreign investment
3	Nigeria	65	Firmer close-out netting rules set to boost repo and derivatives markets
4	Botswana	63	T-bill issuance reform expected to deepen bond market
5	Namibia	61	Large pension fund assets under management, but illiquid markets
6	Ghana	59	Active foreign exchange market and stronger legal framework
7	Kenya	58	Improving corporate action governance structure
8	Morocco	56	Improving market and business environment
9	Zambia	53	Stronger framework for resolving insolvency
10	Uganda	52	New primary dealer system set to spur bond market activity
11	Seychelles	51	Rapid growth in market capitalisation and number of equity listings
12	Tanzania	50	High transparency in stock market and low tax on dividend income
13	Rwanda	50	Strong macroeconomic outlook and healthy banking assets
14	Egypt	50	Liquid equity and foreign exchange markets
15	Eswatini	49	Large pool of domestic assets and growing stock exchange
16	Ivory Coast	41	Expanding bond market and positive macroeconomic outlook
17	Mozambique	43	Growing stock exchange and attractive tax environment for listed securities
18	Malawi	37	Improving transparency, financial stability after IFRS & Basel III adoption
19	Senegal	37	Promising regional market growth but lacking local institutional investors
20	Lesotho	33	Securities exchange still awaiting inaugural listings
21	Cameroon	32	Bond and equity markets lifted by regional merger of exchanges
22	Angola	30	Debt crisis overshadows positive tax reforms
23	Ethiopia	27	Development of market infrastructure in progress

Source: Absa Africa Financial Markets Index, Official Monetary and Financial Institutions Forum

The report notes that financial markets improved in Mauritius and Seychelles over the last year, narrowing the gap between them and SA.

The index measures the state and development of financial markets in a country by way of six main categories or pillars, each gauging a few important aspects the researchers believe investors would deem critical.

Pillar 1

The first category considers the size and liquidity of each country’s financial markets, as well as the diversity of products available. The report states that, on average, countries’ scores dropped by 0.6 from last year.

“This partly reflects the decline in local equity indices as markets reacted to Covid-19. Liquidity was more mixed, as a fall in foreign investor activity in equities was partly offset by central banks and local investors in bond markets,” says the report.

Read: African central banks may say they’ve done what they can for now

“Market capitalisation decreased across most markets in the index, but exchanges have remained operational with staff working remotely during the virus disruption. However, initial public offerings were put on hold in many markets because of the pandemic.”

Pillar 2

This evaluates African markets’ openness to foreign investment based on the ease of moving capital, liquidity of foreign exchange markets, rigidity of foreign exchange regimes and availability of reliable foreign exchange data.

It considers countries’ resilience to volatility by measuring portfolio flows against foreign exchange reserves. The report says that since the first edition of the index in 2017, several countries have loosened capital controls and moved towards more flexible exchange regimes.

During the last year, scores measuring these aspects were largely unchanged. Generally, countries maintained strong reserve positions, although there was more variability in foreign exchange activity.

Pillar 3

A Pillar 3 scores countries based on regulatory frameworks, tax systems and market transparency as a healthy market environment is key to attracting capital. Countries perform best in this pillar, scoring 67 out of 100 on average.

Pillar 4

Local investors’ willingness to invest in domestic markets can have a significant impact on market development and growth. Pillar 4 measures local investor capacity based on the amount of pension fund assets available in the country relative to the population and market capitalisation.

While African countries tend to perform poorly in this regard, especially if their pension systems are not yet well established, this pillar showed the greatest improvement from the previous year.

Interestingly, Namibia scored the highest in this category – its total pension assets are nearly twice the size of local market capitalisation, indicating that Namibian pension funds can play an important role in spurring market activity.

Pillar 5

Pillar 5 assesses countries’ macroeconomic performance, export competitiveness and banking sector health. It evaluates the quality of governance based on external debt management and financial sector transparency.

The average score in this category improved by 1.1 points, subdued by adjusted growth forecasts reflecting the impact of Covid-19. SA regained its first place this year, says the report, despite its poor economic performance.

Its compound annual growth rate over the last five years is the lowest in the index at just under 1%, while the International Monetary Fund expects South Africa to post the weakest recovery of the countries in the index over the next two years.

However, high living standards, a relative low ratio of non-performing loans to gross loans and a large export market share was enough to put it in first place.

Pillar 6

Pillar 6 measures the all-important legal framework and enforcement of contracts, a critical aspect to foster investor confidence. In essence, this scores countries based on the enforceability of market-related financial contracts, adoption of standard master agreements and the strength of insolvency frameworks.

“By establishing a common fact base that allows cross-country comparisons, the index helps anchor policy discussions between regulators, exchanges, investors and corporates on how to promote the open, accessible and transparent markets that are best placed to mobilise capital and promote investment on the continent,” states the report.

Key tool

Absa Group CEO Daniel Mminele says that since its launch in 2017, the index has become a key reference tool used by policy makers and market participants to guide their efforts in developing robust financial markets in Africa. Unfortunately, the Covid-19 pandemic also weakened markets.

“The Absa Africa Financial Markets Index is being released at a time when many African countries are grappling with the profound economic and health challenges posed by Covid-19,” says Mminele.

Read: Emerging markets are going to pay the price again

“The outlook remains highly uncertain in most markets, as downside risks continue to persist. With the global economy forecasted to contract in 2020, our continent is expected to experience the first severe recession since 1992, placing pressure on public finances, and eroding the progress that many countries had made towards poverty alleviation and sustainable development goals.

“These unpredictable operating conditions foretell challenging times for financial markets for the foreseeable future, requiring continued effort from stakeholders, and even more regional economic collaboration than ever before, in order to maintain stability and regain market confidence,” says Mminele in his introduction to the research report.

Read: World Bank sees Sub-Saharan Africa GDP rebounding in 2021

The research shows that there has been improvement, despite the lower average scores. “When the index was first released in 2017, only three out of 17 countries scored above 50, with many performing poorly on more than 40 indicators considered,” say the researchers.

“This year, 11 out of 23 countries scored above 50, indicating improvements across the board. Stronger legal frameworks and growing local investor capacity contributed to better scores overall.

“The countries whose standing improved the most from last year were Ghana, Morocco and Seychelles. Firmer rules enforcing close-out netting boosted Ghana’s standing, while improving business environments in Morocco and Seychelles earned them points,” says the report.

Unfortunately, economic growth and investment opportunities are often prerequisites for the development of healthy financial markets.

With this in mind, the OMFIF report dispatches more bad news than good: “The initial impact of the pandemic was felt by countries with high levels of external debt as global investors pulled back investments. The withdrawal of international capital impacted the region’s stock markets as liquidity dropped in the first half of 2020.”

In simple terms, the report seems to say that Africa needs more chickens, which is only possible by getting more eggs, for which we need more chickens.