Institutional investment will be important for underpinning Africa’s capital markets

The region’s banks remain largely well-capitalised, liquid and profitable, notwithstanding higher borrowing costs and domestic debt risks. Financial sector growth, liquidity, stability and intermediation will help anchor institutional investor confidence – which will underpin domestic capital markets at a time of tighter monetary conditions.

Institutional investment into emerging and developing economies (EMDEs) is important, and yet remains relatively limited due to a number of hurdles, including regulatory barriers and home bias. Institutional investment (from sovereign wealth funds, pensions and insurance companies) has grown in importance. Multinational development banks and development finance institutions have played an important part in this. Inclusion, exclusion or re-classification within global investment indices – such as the S&P Dow Jones (S&P DJI) and MSCI indices – is more than symbolic; they can catalyse investor interest and inward investment that otherwise may not materialise.

On the flip side, exclusion or re-classification risks could exacerbate tight liquidity. Foreign institutional investors, including pension funds, sovereign wealth funds and insurance companies, are increasingly taking a more global approach to their investment allocations. However, liquidity concerns are at the forefront of their risk management and diversification strategies. Some often have mandates to invest only in MSCI-listed countries. In a higher rate environment, the removal or downgrade of a country from major investment benchmark indices – whether in emerging or frontier markets – can result in funds liquidating or reducing their positions, potentially exerting downward pressure on a country’s asset prices.

This dynamic not only increases market volatility but also limits and negatively affects governments’ and corporations’ ability to raise capital. For Africa’s larger economies, such as Nigeria, Egypt and South Africa, which have bigger capital markets and are particularly sensitive to these changes, the collective impact on the continent’s investment climate, fiscal sustainability and developmental trajectory can be significant. In Asia’s economies too, post-crisis recovery contexts such as Sri Lanka’s are similarly affected.

Notably, Sri Lanka has shown encouraging signs of recovery, with improvements in domestic liquidity in its foreign exchange market; the greater ease of capital repatriation prompted S&P DJI to lift its restrictions. Inclusion in investment indices such as the MSCI and S&P provides countries with a degree of validation and visibility for international investors that may otherwise not have been the case – particularly during times of heightened uncertainty. While the criteria for inclusion vary by investment index, they broadly encompass ease of (i) accessibility, (ii) domestic liquidity and (iii) financial stability. When Nigeria was downgraded in 2023 from the MSCI Frontier Markets Index to standalone status, due to persistent foreign exchange restrictions, it experienced a sharp drop in equity inflows.

• Nigeria’s liquidity challenges exemplify the challenges faced by some African economies’ in managing external shocks. Since March 2020, the country has faced liquidity issues in its foreign exchange market, and in the management of its currency reserves. This has, in part, led to capital repatriation concerns and a widening gap between official and parallel exchange rates. However, the Central Bank of Nigeria’s recent reforms for market-driven naira pricing have boosted investor confidence. Ensuring stability and liquidity in the naira market is essential to underpin the investment ecosystem and Nigeria’s inclusion in the broader investment indices.
• Kenya has experienced persistent currency market issues that have, in part, caused delays in investors’ ability to repatriate capital. However, the addition of listed companies augurs well for investor confidence. Elsewhere, in Sri Lanka and Bangladesh, market accessibility challenges, have also led to concerns about index replicability, liquidity and investability. The closure of BlackRock’s iShares Frontier and Select Emerging Markets ETF underscores some of the broader liquidity concerns.
• Ghana remains vulnerable due to a combination of debt distress, currency volatility and repatriation risks. The country’s 2022 debt default and subsequent 2023 IMF programme have highlighted the importance of long-term sovereign creditworthiness for investment index inclusion. Furthermore, Ghana has had periodic currency reserve shortages, especially during periods of oil price shocks. As with Nigeria, this could stand to be significant for its economic outlook for institutional investors, as it has already seen a notable depreciation of the cedi. Both countries’ currency reserves are vulnerable to oil price swings, particularly Nigeria’s (Figure 1).

Figure 1: Nigeria’s reserve position and the WTI oil price