Currency risk hampers impact investment in southern Africa

22nd September 2017 Steve Hoare

While countries such as Angola and Zimbabwe offer particular challenges for impact investors, fund managers reveal that there are plenty of opportunities in the SADC region beyond South Africa provided institutions can mitigate foreign exchange risk. 

In terms of impact investing, South Africa dominates the SADC region of 15 countries. Investment by international development finance institutions (DFIs) in South Africa totalled US$9.7 billion, according to the Global Impact Investing Network (GIIN) report The Landscape for Impact Investing in Southern Africa, more than the entire DFI investment across the 11 other countries surveyed where total investment came to US$7 billion.

The survey collected all known data up to mid-2015 on impact investments i.e. on investments made with an intention to provide a measurable social or environmental benefit as well as a financial
return. The data show that non-DFI investment in the region’s dominant economy South Africa totalled US$4.9 billion against US$830 million for 11 other SADC countries, just under 17 percent of the total figure for South Africa.

When you consider that domestic South African DFIs invested USD$14.4 billion across 6,800 transactions with South African companies, it becomes clear that South Africa is leagues ahead in the impact investing space. But as fund managers and the report suggest, there are opportunities opening up across the region.

Notes: Average deal sizes may not equal displayed capital disbursed divided by deal sizes. Capital disbursed rounded to nearest million, except where less than 1 million (rounded to nearest 100,000). Average deal sizes rounded to nearest 100,000. Excludes domestic South African based DFIs.

Stuart Bradley, joint managing partner, Phatisa

A case in point is Mauritius-based African impact investor Phatisa. “We don’t touch South Africa,” says Stuart Bradley, the firm’s joint managing partner. Phatisa manages the US$246 million African Agriculture Fund, which closed in 2011 and is fully invested in nine companies. The bulk of the money came from DFIs such as AECID, FMO, OPIC and AFD. It is in the process of raising another US$300 million for a second Phatisa fund to invest in food security across Africa.

Nairobi and Lusaka, its founding partners are not South African. They gained their experience in institutions such as CDC Group, Diageo, Norfund and Unilever in countries such as Zambia and Kenya. With so much capital and private equity in South Africa, Phatisa is happy to remain in the markets it knows best.

“The rand also creates challenges,” adds Bradley. “We are a dollar fund and the rand has taken a severe beating since we set the fund up six years ago.”

Michael Fischer, regional office director at DEG, Germany’s DFI, who is also based in Johannesburg, highlights agriculture as one of the region’s biggest untapped opportunities but he also recognises it as one of the most difficult areas to finance and also to operate in.


Michael Fischer, regional officer director, Southern Africa, DEG


“Just because you have some land and a hosepipe, that does not make you a farm,” says Fischer.
They are looking for capital from DFIs and other international players but Fischer believes DFIs cannot be the majority owner in, for example, a beef production plant in Congo.

“Our ability to run a farm is probably the same as your ability to run a farm,” Fischer tells me. “If you do not have a strong operational leader with enough money and resources behind it you will not get those projects off the ground.”

He believes the industry should look at smaller scale projects with SMEs funded by local institutions.
Stuart Bradley, managing partner, Phatisa Bradley at Phatisa would agree. He highlights the case of Goldenlay, a poultry business in Zambia in which the African Agriculture Fund is invested. Eggs are the cheapest source of high quality protein per gram in Zambia, but the country is a net importer of eggs and chickens. You might see chickens in almost every yard but this is a simple matter of demand outstripping supply.

Since Phatisa invested in the company in 2012 through a leveraged management buy-out, Goldenlay has increased production from 250,000 eggs a day to 500,000. It has increased its maize and soya production to feed the chickens and it has created jobs for 5,000 soya outgrowers to assist with this. Furthermore, only 16 percent of the eggs are sold in formal retail outlets. According to Phatisa, Goldenlay’s increased output has boosted the income of rural market traders– often women–by some 60 percent.

“It has been a really impactful investment,” concludes Bradley.

The firm has its own method of measuring impact using an SROI (social return on investment) methodology to create a definition of true value beyond financial return. SROI uses monetisation methods to put a financial value on key indicators such as job creation, environmental management, governance policies, skills development, women and SME empowerment.

This is a bespoke system that is in development. Other organisations have their own tools. DEG has tools, which it has been developing over the past 15 to 20 years. Proparco has its own impact assessment tool, which it is constantly improving but remains a work in progress. Proparco is working with GIIN Non-DFI direct investments by sector and other DFIs to improve impact monitoring but a standard method of measurement has yet to emerge.

“I am a strong believer in practice more than theory,” says Denis Sireyjol, regional head for Southern Africa at the French DFI Proparco. “We should have a standard tool but I think we can only reach a standard tool by merging our own tools rather than asking an external organisation to invent one from scratch.”

Managing currency risk

Proparco is an investor in Phatisa’s African Agriculture Fund and it is also an investor in Agri VIE 2, a development capital fund for sub- Saharan Africa as well as SADC countries such as Mozambique,
Michael Fischer, regional officer director, Southern Africa, DEG Tanzania, South Africa and Zambia. These funds enable Proparco to access smaller companies they would not normally find.

Indeed, Sireyjol highlights the discovery of good projects as his biggest challenge but it is not the biggest challenge facing all overseas investors, which is currency risk.

Denis Sireyjol, regional head for Southern Africa at the French DFI Proparco.

“DFIs need to find a way to increase their share of local currency funding,” says Sireyjol. “Even our offer in local Denis Sireyjol, regional head, Southern Africa and Indian Ocean, Proparco
DFI direct investments by sector currency is too expensive. There is a lot of homework to do on this issue.”

Sireyjol says many different ideas are emerging on how to deal with currency risk but few are putting the ideas into practice yet. For example, DFIs could borrow local currency from a local bank in the short term and then the DFI could re-lend the currency for a long term.

“Short-term currency loans are not expensive but long-term ones are expensive. So maybe we could help with that,” says Sireyjol.

Another idea is to issue bonds or work on the local capital markets so the DFI can gather local currency and then on-lend to its clients.

“All these ideas work theoretically but they require a lot of work in the capital markets and with regulators.

We should be doing it. The IFC is doing it a bit more than other DFIs. It is the way forward,” concludes Sireyjol.

Michael Behan, the Africa portfolio manager at US-based non-profit social investment fund Root Capital, agrees that his biggest challenge is lending in local currency.

“This is where there is the most unmet demand,” says Behan. “These are very soft currencies, which are depreciating very strongly against the dollar.”

Like Phatisa, Root Capital is bullish on Zambia and its agriculture sector but Behan points out that the Zambian kwacha depreciated 28 percent against the dollar during 2016.
Root (like most other impact investors) holds its capital in hard currency–generally US dollars. It
has to trade its dollars for the Zambian kwacha to lend in that currency. It is a very expensive market as there are not many banks willing to do it.

“Businesses are making their money in the kwacha. If you were lending them dollars, their loan would become 28 percent more expensive. We have to protect them from that FX [foreign exchange] risk by lending to them in the kwacha. But by doing so, we are then taking on that FX risk and we have to price it,” says Behan.

There are solutions. These currency markets are not market- driven. Behan says he has to trade with banks at an inflated price because of the illiquidity in the market.

“Until these currencies can stabilise, all of this local currency lending is cost-prohibitive,” Behan continues. “It is irresponsible to lend at those rates to agricultural SMEs. That presents one of the strongest cases for some type of mechanism to absorb that FX risk.”

One thing Root Capital has done to allow it to trade in these markets is to create an FX Trust, which was capitalised by Germany’s development bank KfW and which serves as a reserve to absorb some of the FX risk so it is not passed on to the borrower. The African Development Bank is also considering issuing local currency bonds, which would be appropriate for local commercial banks holding their balance sheets in that currency.

Taking funds beyond South Africa

One country that does not have this problem is Zimbabwe. In 2009, the government adopted a multi-currency regime, which permitted the US dollar, the South African rand and the Botswanan pula to be used as legal tender. US dollars are the dominant currency, which most people use.

“It brings a lot of stability and has done away with inflation,” says Chai Musoni, chief executive of Zimbabwe- based Vakayi Capital. “It made things work again. On the negative side, our reserve bank cannot print dollars and at the moment, we have a squeeze on liquidity because dollars are in short supply but overall the impact has been quite good.”

Foreign investors have greeted the lack of exchange rate risk positively but other investors such as Phatisa remain wary of the ongoing political risk under President Mugabe’s regime. But the likes of DEG, FMO, Swedfund and Proparco are back after a period away.

Given the land rights issues, few will touch agriculture but Vakayi’s main areas of focus (energy, education, healthcare and low-income housing) provide opportunities for impact investors.

As the figures at the beginning of this article attest, South Africa is the region’s powerhouse. It can also act as an inspiration and a direct exporter of impact. Sireyjol at Proparco cites the Agri VIE fund as an example of a fund that was South Africa-focused in its first incarnation but plans to spread throughout Africa with Agri VIE 2.

Similarly, Enko Education is Proparco’s first education sector investment in South Africa and the investee plans to replicate its model of cheaper private schools for the middle classes across Africa.
Outside of South Africa, about 80 percent of retail is through informal markets. These are barely microbusinesses. To have an impact on these citizens far from urban centres, working with local funds and local banks is essential.

The SADC region clearly has its challenges but the good news is that impact investors from the African Development Bank and the IFC through to Phatisa and Vakayi, which was only set up in November 2016 and is yet to close its first deal, are working on the solutions.

“All the DFIs have small initiatives [on currency risk] but we need a global approach in all the countries,” concludes Sireyjol.

Leave a Reply

Your email address will not be published. Required fields are marked *