Country: Ethiopia

Capital Markets Impact Report

Africa stands at a crossroads: the continent has just exited a recession following the COVID-19 pandemic, but the recovery is fragile. Beyond the health dimensions of the COVID-19 crisis, the pandemic caused an estimated 6.1% fall in per capita incomes in 2020 – setting living standards back by a decade in a quarter of sub-Saharan Africa.

The IMF estimates that employment fell by about 8.5%, and more than 32 million people were thrown into extreme poverty in 2020, erasing at least five years of progress in poverty eradication.

Economic recovery will face headwinds primarily due to limited fiscal space for countercyclical support, a temporary collapse in private capital inflows from overseas, and the rumbling African government debt crisis, which continues to play out unevenly across much of the continent. In addition, there has been a significant shift in the pricing of African Eurobonds, with some countries effectively shut out from the international debt markets due to increased risk-aversion.

Meanwhile, on the heels of the pandemic, the unprovoked Russian invasion of Ukraine in February 2022 has brought turmoil to the global markets and increased inflationary pressures. As the manifold effects of the conflict reverberate globally, a key risk factor to monitor for African economies will be the impact of sharply rising global costs for food staples and critical agricultural inputs such as  fertilizer. Ukraine is the world’s largest exporter of wheat and wheat prices have risen more than 80% in Q1 2022 compared to their 2017-21 average, creating acute challenges especially for those African countries running both food and balance of payments deficits. At the same time, the war in Ukraine brings into focus the strategic importance of African markets for global economic stability: to take just one example, new Liquid Natural Gas (LNG) export mega-projects under development across the continent – from Senegal and Mauritania to Mozambique and Tanzania – hold the potential to help reduce global energy dependency on Russia.

Looking beyond the near-term geopolitical uncertainty, many African countries are also faced with the twin challenge of climate change and biodiversity loss, which threaten to erode recent and future developmental gains across the continent. The sixth assessment report by the Intergovernmental Panel on Climate Change (IPCC) indicates that Africa is a natural capitalreliant continent and remains one of the most vulnerable to climate change. The IPCC report forecasts that extreme weather conditions will persist in Africa, increasing the risks of droughts and flooding, especially in coastal and low-lying areas.

Furthermore, Africa faces significant transition risks to a net zero carbon world. Unless they are proactively managed, the legal, policy and technological changes involved in the transition could leave an array of stranded assets on the continent whilst rendering whole sectors uncompetitive.

But the moment of crisis also presents an opportunity to build back better. By efficiently channelling growing pools of domestic and international savings towards critical parts of the real and social economy, capital markets are a key enabler to achieve the United Nations Sustainable Development Goals (SDGs). Capital markets also play an important role in green finance by funding climate smart investments that support mitigation, adaptation and resilience to climate change and bio-diversity loss. Furthermore, local currency capital markets can reduce currency and refinancing risks, improving the financial sector’s resilience to external shocks and supporting more efficient intermediation of scarce domestic savings. Finally, deeper capital markets have a key role to play in mobilising and directing the patient investment needed to build Compact, Connected, Clean and Resilient cities, thereby unlocking the significant ‘urbanisation dividend’ available in a continent that is the fastest urbanising world-wide.

At FSD Africa, we believe the role of Africa’s capital markets has never been more critical. The mobilisation of domestic resources through stronger financial intermediaries and capital markets is already a key African Union priority, encoded into its ‘Agenda 2063: The Africa We Want’ strategy – the continental blueprint for transforming Africa into a global powerhouse of the future. Since 2015, from our headquarters in Kenya, our dedicated team of Capital Markets development professionals at FSD Africa has been driving capital markets innovation and development. As you will read in this briefing note, the team operates across the continent, leading over 50 initiatives in more than 30 countries. We work in close partnership with private sector leaders and governments on a range of flagship programmes – from product development in areas such as gender, green and carbon-linked sustainability bonds to regulatory support, policy development, new market infrastructure, engagement with institutional investors and institutional strengthening.

As part of FSD Africa’s new strategic approach, our Capital Markets team will now focus on five priority countries: Ethiopia, Ghana, Kenya, Morocco and Nigeria. We will also double-down on early successes, building green bonds markets in Ghana, Kenya, Nigeria, Morocco, and the Southern African Development Community (SADC) region. We are proud of our results to date, and of the strong relationships we continue to build with a broad array of decision-makers, innovators, and opinion formers in Africa’s capital markets ecosystem. We offer our partners a fresh way of working – underpinned by our agility, deep knowledge of the continent, ability to deliver world class support and willingness to take risks. We are also based in Africa – close to the partners we work alongside and uniquely positioned as a neutral and trusted convener in a fast-evolving marketplace. We hope you enjoy reading about our work. We are always looking for new opportunities to deliver: so, if you would like to learn more, please be in touch. The final section of this note introduces you to our Capital Markets team, and it would be great to hear from you.

At FSD Africa, we believe the role of Africa’s capital markets has never been more critical.

Yours sincerely
EVANS OSANO

Challenges to debt sustainability and financial market development posed by COVID-19 and the war in Ukraine

While chronic fiscal and current account imbalances that arose well before the Covid-19 pandemic placed limits on the ability of country authorities to respond to unexpected shocks, this did not prevent authorities in four of the focus countries

– Ethiopia, Ghana, Kenya, and South Africa – from adopting counter-cyclical fiscal measures that led to the accumulation of high levels of public debt.

This study shows that while all countries are exposed to liquidity and solvency risks, the most important risk to be monitored is the risk of an external debt distress. Ethiopia, Ghana, Kenya, and Nigeria face high levels of liquidity risk associated with their external indebtedness, and the risk of debt distress during the next decade in Ethiopia, Ghana, and Kenya is considered high. The availability of foreign exchange required to fund the current account deficit and external debt service is constrained by low public revenues (Ethiopia, Ghana, and Nigeria) and large trade deficits (Ethiopia, Kenya). At the same time, prospects for alleviating liquidity pressures in the short to medium term are limited, as they depend on structural changes aimed at reducing current account deficits. Indeed, it is anticipated that these pressures will become even more acute in 2022/2023 due to a combination of three factors – historically high levels of public debt, rising market interest rates and downward pressure on many emerging market currencies – which have caused the cost of external borrowing on commercial terms to become prohibitive.

Prior to the pandemic, given the limited depth of their financial systems, Ethiopia, Ghana, and Kenya had already accumulated unsustainable levels of public debt. Computational simulations

show that over the coming decade the level of public debt to GDP in Ghana, Kenya, Nigeria, and South Africa will stabilise, although in Ghana, Kenya, and South Africa this will happen at historically high levels, resulting in high debt service burdens and constraining fiscal space for new public investments. An important lesson highlighted by Covid-19 and the Ukraine war is the extent to which debt vulnerability derives from exposure to external creditors both in terms of the ability of sovereign borrowers to honor their external debt service obligations, and in terms of high debt service obligations which can lower economic growth prospects in the medium to longer term.

A comparative analysis shows that Nigeria and South Africa, Sub-Saharan Africa’s two largest economies, are in a less precarious situation than the other three countries. Nigeria entered the Covid-19 crisis with a lower level of public debt while South Africa’s deep domestic financial market makes it possible to absorb higher levels of public debt.

However, Nigeria and South Africa need to address specific risk exposures. Due to low fiscal revenue mobilisation, Nigeria’s total debt service absorbs a high share of government revenues, thus exposing the government to liquidity risk. Even with its more developed taxation system, South Africa is also exposed to liquidity risk because the ratio of total debt service to revenues is high. While foreign investors impose discipline on macroeconomic management, which should ultimately benefit the South African economy, reliance on foreign portfolio investment in domestic government debt exposes South Africa to risk, due to the ‘vagaries’ of foreign portfolio investors.

Landscape of climate finance in Africa

The African continent presents a massive investment opportunity for investors to advance climate solutions in the coming decade according to a new report. However, a set of barriers to finance have stifled requisite investment to date. The report provides a framework for how innovation in financing structures can leverage strategic deployment of public capital to ‘crowd-in’ private investment at levels not yet seen.

With a dynamic entrepreneurial environment, the African continent presents a massive investment opportunity in the coming decade. However, climate finance in Africa falls short of what is required to implement regional Nationally Determined Contribution (NDCs), with climate finance needs eight times higher than amounts currently invested.

Barriers to finance related to financial market depth, local governance, project characteristics, and enabling skills and infrastructure have led the private sector to play a marginal role in African climate finance to date. Barriers can be acute or chronic and are highly context-dependent in the relevance and intensity, differing by geography, sector, and sub-sector.

Innovation in financing structures is required to overcome these barriers, but there is no one-size fits all approach. Investors must tailor strategies based on the geographic and sectoral context of a given investment, deploying combinations of financial instruments based on their effectiveness in addressing specific risks to overcome investment barriers.

The report provides a framework for how these instruments and strategies can be efficiently deployed to overcome barriers to finance and capitalize climate solutions in Africa. Some instruments can be deployed narrowly to address acute barriers to finance such as deploying guarantees to address early-stage construction risk.

Financial sustainability and regulatory proportionality of African capital market regulators

In Africa, capital market regulators are tasked with a dual mandate – both developing and regulating the market. This raises the difficult question of how a regulator might play a dual role, including determining the right strategic focus, activities and capacity to do so effectively. This is particularly important in resource-constrained economies where the regulator operates with a limited team and budget. Its functions must be delivered with constrained financial resources and managed in a way that is proportional to the market context.  The White Paper on Financial Sustainability and Regulatory Proportionality of Capital Market Regulators in Africa proposes an analytical framework to assess the state and stage of a country’s financial market, which guides how the capital market regulator should implement its mandate, focus areas and engage policymakers on appropriate funding models.

In addition, limited resources call for careful identification of regulatory gaps that need to be bridged by capital market regulators to enable them to achieve both their regulatory and developmental mandates.  Gleaning from institutional capacity assessments that we have supported in eight regulators in Africa from 2015 to 2022, the Institutional Capacity Assessment Toolkit for Capital Markets Regulators in Africa is a reference guide to equip regulators in systematically identifying their capacity gaps and developing appropriate institutional strengthening programs to address them.

Insurance supervisors’ responses to COVID-19

The importance of insurance has been amplified in the face of the Covid-19 pandemic

The Covid-19 pandemic constitutes one of the largest shocks to the African continent in recent times; in 2020, GDP contracted by 2.1% across Africa, costing the region at least $115 billion and pushing 30 million Africans into extreme poverty (AFDB, 2021; World Bank, 2020). Beyond this negative impact, the pandemic has also amplified the importance of the insurance sector’s role in the development of and support of the resilience of businesses and individuals. Insurance can help manage risks and transfer funds to individuals and businesses when unexpected crises like Covid-19 hit, and it can aid in economic recovery by enabling capital to flow into investments and lending practices.

Covid-19 disrupted and exacerbated weaknesses within the insurance sector

Despite being part of the solution, the insurance sector itself has also been affected by the pandemic. Research conducted by FSD Africa, Cenfri and the Oanisation of Eastern and Southern African Insurers (OESAI) in mid-2020 found that the pandemic affected insurers’ operations, negatively impacting their ability to launch new products, conclude new sales, collect premiums, service existing customers and process and pay claims.

The operations of insurance regulators were also significantly disrupted

In seeking to fulfil their core mandates of market stability, consumer protection and (in some cases) insurance market development, insurance regulators across sub-Saharan Africa (SSA) have had to perform a balancing act between offering regulated entities regulatory relief during a challenging time and monitoring vulnerabilities in the market closely. Research conducted in 2020 by FSD Africa and Cenfri found that different regulators chose to prioritise different sides of this trade-off. Some insurance regulators eased up on their usual regulatory requirements in an attempt to enable regulated entities to enhance their capacity to respond to Covid-19. Oers placed greater emphasis on the set of issues arising from the pandemic, such as the potential for the face-to-face nature of insurance business in their markets to spread the virus. Despite these challenges, the research also found that opportunities emerged for regulators to enhance market efficiency and stability through digitalisation and careful market consolidation, as well as improve the efficiency of their reporting and supervision processes through new solutions, such as regulatory technology (regtech) and supervisory technology (suptech).

Assessment of long-term impacts to identify how to build back better

Covid-19 is far from over. A year on from when the previous study was conducted, our current research takes stock of the ongoing impacts through a future-looking perspective, to assess which regulatory responses have (or have not) been effective and to identify what the imperatives and opportunities for regulators are to support stable, sustainable and growing insurance markets. The aim of this research is to shed light on the actions needed to ensure the resilience and stability of African insurance markets in the medium- to long-term, while also encouraging market development, growth and inclusion. Furthermore, understanding which regulatory responses to the pandemic were most and least effective can provide important guidance for regulatory authorities on how to respond to the next systemic crisis – be it a pandemic, a significant cyber incident, a major natural disaster or widespread political protests or riots.

Ethiopia jobs protection facility learning brief

In 2020, we partnered with FCDO Ethiopia and KfW (on behalf of BMZ) to implement an emergency jobs protection facility for manufacturers in various industrial parks in Ethiopia. The main objective of this intervention was to ensure continuity of employment for workers and the post-Covid sustainability of Ethiopia’s textile and garment manufacturing sector.

Following the conclusion of the Facility, we also undertook a review of the programme’s performance in line with specific objectives on behalf of the funders. This learning brief summarises the findings of the report and highlights the challenges, lessons and impact of the programme.

Market Failure Analysis: IPO’s in selected African stock exchanges (2014-2019)

We undertook a study with RisCura to identify, explain and address the root causes of “market failure” relating to Initial Public Offerings (“IPOs”) on African stock exchanges.

The study takes a robustly comparative approach, drawing out common challenges and recommended solutions from deep individual analysis of seven stock exchanges, ranging from West Africa to East and Southern Africa and some Francophone countries.

Challenges

The study identified multiple causes for the ‘market failure’ witnessed to date, with responses differing according to geography as well as to the respondents’ role, or vantage point, within the ecosystem and wider economy.

These factors can be grouped into three broad categories:

Solutions

The study uncovered positive and proactive recommendations for cross-cutting solutions which, taken together, have the potential to transform the performance of IPOs on African exchanges.

Three high-priority changes were identified as important and necessary:

Beyond these structural and ‘infrastructural’ solutions, there is also a clear need for ‘softer’ reforms and initiatives in the form of enhanced advocacy, awareness-raising and information-sharing.

Download the summary of this study to read more about ‘market building’ challenges and recommended actions for consideration.

How “Sustainable Futures” apply to FSD Africa’s projects and how FSD Africa seeks to measure change

The future of Africa is highly dependent on the use and allocation of resources. Economies and livelihoods in Africa are linked to the environment and natural resource use, and how benefits are distributed.

Enabling a sustainable future requires that interventions designed to meet the current needs of one group of people do not adversely affect the ability of other people to meet their own needs, now and in the future. Equally, enabling a sustainable future requires that interventions designed to achieve critical environmental outcomes (such as net-zero carbon emissions or halting biodiversity loss) take account of the people who will be most affected: a just transition. It also requires interventions to build, protect or improve critical networks and institutions that promote economic justice and environmental protection, including advocating for others to do the same.

This means respecting and valuing natural capital, social capital and human capital in the drive to grow economies and understanding and mnaging any trade-offs.  It means also recognising that financial capital can and must play a role in supporting people and the environment as economies grow, but has no value in itself.

In 2020, FSD Africa, explored how the concept of ‘sustainable futures’ applies to the way FSD Africa selects and designs its projects. Firstly, FSD Africa targets investments in natural, social and human capital that enable a sustainable future.  This includes providing finance for climate mitigation or adaptation or for biodiversity;  supporting interventions that address corruption; and training men and women with skills for the future.  Secondly, FSD Africa applies a sustainable futures lens to all its projects to identify and mitigate social and environmental risks and to support those left behind.

FSD Africa’s ‘sustainable futures’ efforts are designed to support the entire enabling environment for financial systems in order to reduce inequality and to drive greater equity and fairness for future generations. By pursuing inclusive and sustainable economic growth and access to basic services for all, FSD Africa intends to reduce inequality, enhance social systems and preserve natural care that no-one is left behind.

Financing Africa’s urban opportunity – the why, what and how of financing Africa’s green cities

Africa’s urban challenges are complex. Cities need tailored, endogenous solutions which work for their residents. It also means that the scale of projected investments to drive compact, connected and clean urban development is varied and depends on country-specific characteristics, as are the challenges of financing these investments.

This report addresses financing Africa’s green urban transition; highlights urban opportunities; makes the economic case for sustainable urban infrastructure investment; and outlines financing solutions for low-carbon urban development applicable to the whole region.

With case studies from three African countries, this report shows how investment in compact, clean and connected, urban development could accelerate growth across the continent and secure more resilient and prosperous lives for their residents.

Journey to a new Digital Finance Professional

The development of digital finance tools and systems is a key pillar of inclusive finance. One of the key challenges facing the penetration of digital finance in Africa is digital finance capacity and knowledge gaps among professionals and policymakers in financial institutions and governments across the continent.

In 2016, FSD Africa partnered with the Digital Finance Institute (DFI) to address this challenge. Through this five-year partnership, we supported the pilot and scale of the institution’s flagship professional program – Certified Digital Finance Professional (CDFP).

Since then, we have been able to achieve some of the below milestones:

As a result of this work:

  1. Capacity in digital finance professionals and services providers has increased.
  2. Institutional capacity for digital finance regulation has increased in both regulators and digital finance providers.
  3. Digital finance policies, regulations and directives have been developed or adapted by DFI alumni.
  4. Cross-Sector collaboration has increased resulting in new country-based initiatives on policy, product, customer needs and inclusion.

This partnership leaves the sector with a specialised capacity building utility company (Digital Frontiers), an e-learning school focused on building capabilities and skills aligned to the SDGs (Digital Frontiers Institute), a services business (Gateway), and the formation of a new global Alliance that represents the Inclusive Digital Finance Profession.