By Antoinette M. Sayeh

(Version in Français)

Sub-Saharan Africa’s “frontier markets”—the likes of Ghana, Kenya, Mauritius, and Zambia—were seemingly the destination of choice for an increasing amount of capital flows before the global financial crisis. Improving economic prospects in these countries was a big factor, but frankly, so too was a global economy awash with liquidity.

Then the crisis hit. And capital—particularly in the form of portfolio flows—was quick to flee these countries as was the case for so many other economies.

Fast forward to 2011. Capital flows are coming back to the frontier, but in dribs and drabs.

Learning from experience

In our recent Regional Economic Outlook we examined the experience of sub-Saharan Africa’s frontier markets, with a view to understanding how they can best make use of these inflow to meet their own development and growth objectives.

Contrary to popular perceptions, bilateral donors and international financial institutions are no longer the main source of funding (including capital flows and transfers) for investment and growth. Most of the six-fold increase in inflows since 2000 came from the private sector—a sharp departure from the previous decade. And this was true for countries other than South Africa and Nigeria, the two largest countries that typically account for 50–60 percent of these flows.

But, then when the crisis hit, the sharp withdrawal of capital from almost all the frontier markets was most evident for fixed-income investments (such as treasury securities) and equities.

And, now, with the increasing attention of investment bank publications on sub-Saharan Africa following the global crisis, some might suggest that investors are putting their money where their mouth is.

But are the good times rolling again? Not so fast…

The evidence so far is rather mixed. Private investors, possibly smarting from financial losses a few years ago, have not rushed in like lemmings. They seem more discerning now, looking more closely at country-specific circumstances. For instance, portfolio flows have picked up in a few of the frontier markets such as Ghana and Mauritius, and, to a lesser degree, Zambia, but have remained flat in most of the other countries.

The sharp decline in yields following monetary policy easing in frontier markets in the wake of the crisis has curbed the appetite of most fixed-income investors in countries such as Kenya and Uganda. That said, foreign direct investment and other equity investment were not hit too badly during the crisis, and seem to be recovering nicely in most countries. Bank credit lines have fully recovered, except for Nigeria, where the vestiges of a domestic banking crisis are still lingering.

Macroeconomic management challenges

The increasing reliance on private external financing poses challenges for macroeconomic management, given the relative size and volatility of these flows.

  • First, although net private capital inflows to sub-Saharan Africa constitute only about one tenth of total net private flows to emerging and developing countries, the inflows are large relative to the economic size of the recipient countries.
  • Second, the more volatile flows have the potential to cause considerable difficulties in monetary management in sub-Saharan Africa, given shallow financial markets. For instance, in proportion to reserve money, nonresident holdings of government securities have swung from almost nothing to more than 40 percent in some countries.

So what can countries do to manage large inflows should they resume? The IMF has recently developed a framework to help countries manage large capital inflows. The main message is that, while there is no substitute for implementing appropriate macroeconomic policies, countries can choose from a menu of policy options to respond to capital inflows. For example, tightening fiscal policy can reduce inflows that may be attracted to high yields resulting from high fiscal deficits. However, in some cases, it may also be appropriate to consider taxes, certain prudential measures, and capital controls.

To sum up, except for a few countries, the volume of capital inflows in sub-Saharan Africa’s frontier markets has yet to return to the heydays of 2006-08. So the primary interest of most policymakers in the region is how to further induce stable and beneficial private flows—which now exceed official flows—to support investment and growth. But they should stand ready in case sharply rising inflows give rise to macroeconomic management problems.