This is an excerpt from the upcoming book, Grow Rich in the New Africa, which is released in March 2012. With the downgrade of nine euro zone countries at the end of last week, this piece speaks directly to the changing risk profiles of developed and developing countries which leave a number of economies in Africa winners and a number of Western markets losers.
We are living in a world that is changing very quickly. The breakdown of socialism and planned economies in Eastern Europe has dramatically transformed the economic landscape of the world and led into the process of globalization. The former systems of two superpowers, the United States of America and the Soviet Union, and two competing political and economic systems is no longer in place. What we have now is a multipolar world, which we shared about in Redefining Business in the New Africa, with new dominant players gaining momentum and influence, such as China, India, Brazil, Russia, and South Africa (also known as the BRICS countries). Rising commodity prices are benefiting resource-rich countries.
The most dramatic change can be observed in the world financial system. Since the subprime crisis and the default of Lehman Brothers, its stability is deteriorating quickly. Now, we are facing a sovereign debt crisis of most countries of the developed world. The crisis of the Euro zone, in particular, has the destructive power of derailing the whole financial system. The possibility I alluded to early in 2011 in Redefining Business in the New Africa, and for which many told me I was wrong, has become a likelihood with discussions among European nations to allow the existing union to break up and form another.
Investment and business risks are rising tremendously. It is increasingly hard to measure and value risk properly. So-called safe havens in the financial industry are vanishing as sovereign bonds and major currencies are at risk and legislative changes dry up some offshore financial centers.
Currencies that were considered as being stable are about to lose their reputation as anchors of stability. This is not only true for the euro, which is set to break up in 2012 as one or more countries might be forced to leave the Euro zone, but also for the Swiss franc that is now tied closely to the euro. The US dollar as the number one world currency is increasingly vulnerable because sovereign debt has reached a level that is not sustainable. The same is true for Japan and the yen.
A growing number of renowned financial experts are heralding the end of the financial system as it is now in place. There are clear signs that support this gloomy view. Greece is about to collapse. Interest rates of Italian sovereign bonds have recently crossed the level of 7%, which is considered as a line that must not be crossed – otherwise the country would no longer be able to serve its huge debt.
Also, Portugal and Ireland are in dire crises. Spain is in acute danger as well. The national economy of the UK is heavily dependent on the financial industry, which makes it vulnerable in case of a financial collapse. The big banks in France and Germany are lacking equity; some of them might have to be nationalized in case of major problems with sovereign bonds of some southern European nations.
This negative outlook is confirmed with Standard & Poor’s downgrading the U.S. AAA crediting rating it has held for decades last year and downgrading nine Euro zone countries – Austria, Cyprus, France, Italy, Malta, Portugal, Slovakia, Slovenia, and Spain – in January 2012. Italy’s credit rating is now at the same level as Kazakhstan’s and Portugal’s credit rating is considered junk status. Investment risk in developed nations has increased dramatically over the last five years.
If you take a look at the interest rates that are remaining at absurd low levels that are not reflecting the inherent risk adequately, you must come to the conclusion that the vast majority of market participants are not yet realizing how big the risk really is. Let me ask you a question, “Would you be ready to lend money for 10 or even 30 years to someone who will never be able to pay back his overall debt, whose income is constantly lower than his expenses, and whose currency will probably be devalued before the loan’s redemption?” – probably not. As an example, the European Union expected China to help them but China has shown no inclination in this current environment to do so.
However, all owners of treasury bonds issued by the United States and Japan are doing exactly this. The current yield of 10-year US treasury bonds is 2% while Japanese bonds are yielding 1%. This is considerably less than the inflation rate. So, the real yield is negative. If you invest capital in such financial instruments, you are losing wealth each year.
It is high time to set out for new frontiers. If the profitability of businesses and yields of the capital markets in your home country is too low, you have to look for higher returns elsewhere. In other words, you should diversify your assets and sources of income. Africa is an excellent region in which to do so.
In past years, I spoke to many people about the tremendous opportunities that Africa has to offer. A few of them where already invested in the capital markets or involved in doing business in African countries. Some of them were planning ahead for entering Africa markets. But most of them are still afraid of making a positive decision and taking action. Whenever I asked these people for their reasons, they answered that the risk was too high. In many cases, prejudices or bad experiences in the past played a major role.
However, this is about to change. More and more companies and investors are not only thinking about entering African markets, but are already putting together implementation teams, founding legal entities, opening liaison offices, and working with local representatives.
I think it is safe to state that more companies will follow those early adopters as soon as more convincing success stories are told. However, whether you choose to wait to hear more success stories or not, the international risk climate has changed in Africa’s favor.
New risk perception paradigms
The paradigms of risk perception are shifting fast as the following tables demonstrate.
|The old paradigm||The new paradigm|
|European countries and the U.S. include low macroeconomic risk as debt levels seemed to be sustainable and the long-term economic uptrend was intact, only interrupted by some short-lived periods of cyclical recession.||The probability of a double-dip recession in the United States and troubled European countries has risen considerably. In an adverse financial environment, even a depression is possible that might last for several years. Balance sheet recessions are more difficult to manage and to overcome than cyclical recessions because debt reduction and deleveraging takes some time.|
|Commodity and energy prices go up and down in minor swings, yet remain predictable and controllable, thus offering a stable business environment.||Commodity and energy prices have entered a major secular bull market that will continue for a long tim, as populous emerging markets like China, India, Brazil, and many prospering frontier markets will heavily invest in infrastructure in order to narrow the huge gap with the developed countries.|
|Developed countries are more prosperous, more stable, and less indebted than developing nations.||Developing countries are growing faster than developed countries. Most of them are less indebted than developed countries. Many of them are becoming more stable in economic, financial, and political terms.|
Valuable sources for measuring macroeconomic risk are:
- United Nations organizations, e.g., UNSTAT, UNDP, UNCTAD, UNIDO, and UN-HABITAT
- International Monetary Fund (IMF)
- Organization for Economic Cooperation and Development (OECD)
- World Trade Organization (WTO)
- World Bank
- Local and bilateral chambers of commerce
- National organizations
|The old paradigm||The new paradigm|
|Western European countries, most Eastern European countries, and the U.S. are safe.||The sovereign debt crisis and the banking crisis in the western world cannot be easily solved. Each possible way out is very painful. There is an imminent threat of imposing one-time wealth taxes (also known as confiscation), nationalization, solidarity payments (newspeak for transferring wealth from good performing countries to defaulting countries), and other draconian measures.|
|Developed countries are more prosperous, more stable and less indebted than developing nations.||Developing countries are growing faster than industrialized nations. Most of them are less indebted than developed countries. Many of them are becoming more stable in economic, financial, and political terms.|
|Before the Euro currency was introduced, European national economies were mostly stable. This was also true during the first decade after the Euro was established as a common currency.||The European Stability Mechanism (ESM) that will be introduced into European and national laws in 2012/13 represents a shift toward an autocratic, centralized political system. Investors and business owners should be prepared for unconventional political decisions leading to unwelcomed results.|
|The old paradigm||The new paradigm|
|Africa is high risk. Africa is seen as a single, high-risk investment target rather than as a continent consisting of many different nations offering great varieties of risk exposure.||A better understanding of African markets leads to a more detailed approach of measuring and anticipating political risk. The trend towards more democracy and good governance in Africa is fully intact.|
|High predictability of political decisions and actions in Western, developed countries.||Low predictability of political decision and actions. This is not only true for many European countries, but also for the MENA region, including Egypt, Libya, and Tunisia.|
|European countries enjoy sophisticated democratic political systems and are considered as safe places for doing business and making investments. The level of economic and financial freedom is very high.||The European Union is increasing its political power by issuing thousands of new laws and regulations and imposing control mechanisms, although various bodies of the EU are lacking democratic legitimacy.|
|Middle East and North Africa (MENA region) are relatively stable. Although the Israeli-Palestinian conflict cannot be solved, and Iran is threatening the region, most players and decision-makers are known and somewhat predictable. Egypt was a stabilizing factor in that game.||Following sudden and unexpected revolutions in Tunisia, Egypt, and Libya, as well as dangerous situations in Syria, Iraq, and Iran, the whole region is destabilizing. The political shift in North African countries toward Islamism removes the stabilizing factor regarding Israel. The breakout of a regional armed conflict with Iran as a centerpiece is a likely scenario. Even a full-scale war in the Persian Gulf is a possibility.|
So, it is obvious that risk is everywhere – US, Europe, and emerging markets. In today’s environment, the risk profiles between developed and developing economies are evening out with some emerging markets looking better than developed markets.