Credit in Africa: the way forward?

By the summer of 2008, the risks associated with the credit crunch were becoming apparent in the market. Years of ‘easy' money coming out of the US and funded by China meant that the market place was flooded with credit. Assets had become over-inflated, trades had become crowded and investors were highly leveraged. Too many market participants were chasing tiny margins as the only way to make a return. “Value” had evaporated in mature markets and esoteric alternatives were becoming a viable option.

Despite the global downturn, the two areas that have retained much of their interest are sub-Saharan Africa and micro-finance. Whilst Europe, the US and Japan are looking at negative-to-flat growth, the IMF expects growth in sub-Saharan Africa to rise to four percent in 2010 and five percent in 2011. Whilst this is clearly still from a relatively low base, it shows the potential that exists on the African continent. This is partly because Africa has largely been unaffected at a local level by the credit crunch as such a small percentage of the market has historically had access to credit.

Africa is often referred to as being largely unbanked. The growth in mobile phone ownership in Africa as a whole is a significant reference point. To take Kenya as an example – two local mobile phone operators offered a mobile phone payments system, called M-PESA, which enabled participants to make payments by text message and deposit or withdraw cash from agents in petrol stations, supermarkets etc across the country. In the first two years since launch, M-PESA accumulated more accounts than the rest of the Kenyan banking system had managed in a century (The Magic of Mobile Phones, Christine Evans-Pughe, The Institution of Engineering and , copyright 2009).
If you consider such a story, it is hardly surprising that Micro Finance Investment Vehicles (MIVs) are continuing to attract such attention in the developed world. If a large part of Africa has never had a bank account before, then these same people have never had an opportunity to borrow money in a formal way before. If Kenya is an example of Africans' appetite to absorb access to new forms of finance, then the demand for micro-finance must be huge. However, the practice of those with spare capital lending it to those most in need of capital (and therefore willing to pay the highest rates of interest) is not straightforward. There are two main constraints.

Firstly there is the issue of Corporate and Social Responsibility. Those in the wealthier, developed world must respect the wishes of not only the national governments in the countries that they are lending funds into, but also the international perception of what they are doing. If they are seen to be exploiting the poor of Africa, by lending them money on terms that are unduly harsh, in the interests of seeking a greater return for their investors, they will swiftly find nothing other than international condemnation and investors hard to come by. Such investments must be seen to be ethically as well as financially sound. In fact there is much support from the Development Financial Institutions (DFIs), such as African Development Bank, where the investment is seen as beneficial to the local market. Here organisations such as Blue Financial Services of South Africa combine private money with support from the likes of the World Bank's IFC and FMO of the Netherlands, in order to make a social contribution and a healthy return for investors.

Secondly, and perhaps more importantly, the investment must be economically sound. There is no point lending funds at high yields to a client base that is incapable of repaying it. Calculating the capability of repaying the funds has to depend on what currency is being lent to the local Micro Finance Institution (MFI) and its individual clients – partly because of the issues of exchange rate fluctuations (and the burden of carrying them) and partly because of the issue of access to hard currency in order to repay the loan.

Historically both these risks have sat with the in-country borrower. This has placed an undue burden on the local institutions and borrowers, so that either the intermediary MFI has lost all its profits due to the added cost of buying back the USD, EUR etc it was lent in the first place, or the individual borrower is saddled with a much larger debt than they initially envisaged. As an example, let's take a look at the behaviour of the Ugandan Shilling in the run up to and the aftermath of the collapse of Lehman Brothers.

On September 1, 2008 the Ugandan shilling (UGX) stood at 1638 to USD1. However, as Lehman's collapsed and the international banks started to call in all their to the highly leveraged hedge funds, a dollar squeeze started. Whilst this was most apparent in the west, it also had a severe impact on Uganda. Uganda had started to attract speculative investment in the previous seven years, on the back of a more stable economy, higher yielding interest rates and a relatively unvolatile currency. Unfortunately the global credit crunch saw a panic, as investors attempted to return everything to cash and otherwise perfectly sound investments were dropped.

This had the effect of unwinding, in six months, a steady six years' worth of investments into Uganda and saw the UGX move from 1638 on Sep 1, to a high of 2300 by May 15, 2009, a depreciation of 40 percent – this in a country that barely knew what credit was. It hadn't partaken in the global asset inflation bonanza, it hadn't leveraged itself up to its eyeballs in order to punt CDOs, it had simply committed the sin (?) of providing a stable environment in which to invest. As an example, the USD/UGX exchange rate on September 1, 2000 was 1696 – so in the eight years leading up to the fall of Lehman's the exchange rate moved less than four percent and then in the following eight months it moved 40 percent.

For those local MFIs who had borrowed money from the international market in USD in order to lend money locally, they were suddenly faced with a huge liability. They had to find up to 40 percent more UGX in order to repay their loans.

The solution here is obvious and also very complicated. In order for the loan to be ‘fair' and socially responsible, the exchange rate risk must be removed from the borrower. The loan should be denominated in local currency and the repayment amounts fixed.

The complication is that the initial investor is not that interested in taking this foreign exchange risk themselves (although one could argue that if they are willing to take the risk of investing in Uganda for the potential returns available, they must also assume the downside risk of currency devaluation).

Fortunately a third way is starting to appear, with the emergence of organisations such as The Currency Exchange Fund (TCX) in Europe and the approach of a number of international banks. These organisations allow an investor to make their loan in local currency and then hedge the foreign exchange risk, so that they are left with a dollar (or euro) look-a-like loan, without extreme exchange rate movements weighing on the local party or devaluing their own investment. Further, via a partnership with ourselves, INTL Global Currencies (IGC), TCX is allowing its investors to even pass on the settlement risk, so that a shortage of hard currency liquidity does not affect the transacting parties to the original loan. This becomes something for the experts in the local currency, like IGC, to manage, as they are able to access more sources of local currency than a stand alone local MFI (or its local bank) can do.

This way, all parties are winners. The MIV gets to make a socially responsible and much lower risk investment into a potentially lucrative and still growing market; a local borrower can get access to previously unavailable funds, without having to take the risk that the repayments could spiral beyond their control; and the local currency volatility and liquidity risks are outsourced to professionals whose job it is to handle such matters, rather than left sitting as an unwanted side-effect with one party to an initially mutually interesting transaction. An innovative solution indeed. It is our belief such arrangements will become the market norm going forward and will be the benchmark by which all MIVs are judged.

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