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AFRICA DILEMA WITH FOREIGN PORTFOLIO INVESTORS

By  Dr. Ignatius Odianosen Okosun (Ph.D.).          

 

Foreign Portfolio Investment (FPI) usually encompasses short-term positions in financial assets of international markets and is comparable to investing in domestic securities. FPI allows investors to take part in the profitability of firms operating abroad without having to manage their operations directly. This is a related concept to trading domestically; most investors do not have the capital or expertise required to run the firms that they invest in personally. Foreign portfolio investment differs from foreign direct investment (FDI), in which a domestic company runs a foreign firm. While FDI allows a company to maintain better control over the firm held abroad, it might make it more difficult to sell the firm at a premium price later. This is due to information asymmetry: the company that owns the firm has intimate knowledge of what might be wrong with the firm, while potential investors do not.

Foreign private investment is the main way of doing investment in different countries. It has two components׳ foreign direct investment (FDI) and Foreign portfolio investment (FPI). Lipsey (1999) argues that foreign direct investment (FDI) has more permanent nature than foreign portfolio investment (FPI) and FPI is also known as “hot money”. Therefore, the desire of developing countries is to increase the foreign capital so as to enhance the economic development of the country (Broto, Diaz-Cassou, & Erce-Dominguez, 2011). According to the theory of portfolio investment by Hymer (1976), foreign portfolio investors are attracted by the high interest rate because it reduces the borrowing cost; foreign portfolio investor will invest until the interest rate gets equal all over the world, therefore, it might be said that foreign portfolio investment is affected by domestic interest rate and not by domestic returns. However, this theory’s structure is so naïve when the problems of risk, uncertainty, and volatility are introduced. Therefore, we must consider the risk factor in terms of foreign investment volatility. The term volatility is concerned with the international investors׳ intention to invest for short-term benefits, and they withdraw their investment on uncertain conditions (Kodongo & Ojah, 2012). Thus, volatility refers to the uncertainty regarding the flow of FPI in the country.

Portfolio investors also consider the host country exchange rate along with the interest rate. Devaluation of host country currency motivates the foreigners to invest due to higher return (Bleaney & Greenaway, 2001); the fluctuation in real exchange rate increases foreign investment volatility. Moreover, inflation also affects volatility in FPI. Volatility in FPI is enhanced by the decrease in return and increase in inflation. Agarwal (1997) suggested that home country low return and high inflation motivates portfolio investors to invest in other countries where inflation is low, and return is high. Mody, et al, 2001 favored it by arguing that increase in inflation is linked to declining in foreign portfolio investment. Moreover, foreign portfolio investors are attracted by high returns (Chakrabarti, 2001 and Gordon and Gupta, 2003; Çulha, 2006; Froot, O׳Connell, & Seasholes, 2001). They argue that stock market is an indicator of performance and investor expectations for the host country. Thus, the rise in an index would increase the stock prices leading to higher returns and ultimately lower the volatility in foreign portfolio investment.

The share of FDI in foreign equity flows greater than FPI in developing countries compared to developed countries, but net FDI inflows tend to be more volatile in developing countries because it is harder to sell a directly-owned firm than a passively owned security. Foreign investment in African economies will stretch to a record $80 billion in 2014, as business leaders in developed economies put the recession behind them and Chinese and others from emerging markets continue to show a strong interest in African assets. The United States of America, United Kingdom, and France still lead the foray. The three countries combined held the biggest share of Africa investments in 2012, the latest available data totaling $178.2 billion. The so-called Brics countries; Brazil, Russia, India, China and South Africa collectively held investments valued at $67.7 billion, of which $27.7 billion were Chinese.

The in-depth survey was compiled by the African Development Bank, the United Nations Development Program and the Organization for Economic Cooperation and Development and launched in Kigali at the start of the ADB’s annual meetings. Foreign-investor interest remains fixed on a handful of African nations. However as reported, “the top six recipients, representing one-third of the continent’s population, received the same amount of foreign direct investment as the remaining 48 countries together,” the report said. The top destinations were the continent’s two largest economies, South Africa and Nigeria. While resource-rich African states lured most of the overseas private capital, the report noted ever-more manufacturing and services projects are represented in the fusion. Moreover, of the total foreign direct investment in 2013, (65%) flowed to resource-rich countries, compared with 78% in 2008, as money was increasingly directed to countries without natural resources that presented attractive opportunities in other industries. African investors also continued to boost their presence on the continent, representing (18%) of total investment in new or “greenfield” projects in 2012, up from (7%) in 2007. Unlike their foreign counterparts, who directed most of their attention to the mining sector, investors from the continent preferred financial services, construction and communication projects. Also the report shows that a combination of foreign direct investment, portfolio investment in stock and debt, growing remittances from workers sending money home and improved tax revenue has meant the continent’s overall dependence on foreign aid will continue to shrink as a proportion of its external financing, the report showed. Foreign aid as a proportion of total foreign capital inflows to Africa was set to decline to about (26%) in 2014 from (30%) the year before.

But foreign aid will continue to increase this year, to about $55 billion, and the poorest African nations rely on it to survive. Overall, the continent’s economic growth has been outpacing the world’s, but it is very uneven among countries and regions. Economic output for the whole of the continent is expected to grow by (4.3%) this year and (5.7%) in 2015, but East and West African regional economies are set to grow significantly faster than other regions as reported.

South Africa’s economy hit by strikes and affected by the slowdown in developed economies is a drag on sub-Saharan African growth, the report said. The concern echoed the International Monetary Fund’s findings presented that Sub-Saharan African economies will grow by (5.8%) this year and by (5.9%) next year, but the rate is a full percentage point higher if South Africa is excluded from the calculation. The South African economy overtaken in April by Nigeria’s as the biggest on the continent will grow (2.7%) in 2014 and (3%) in 2015. Nigeria’s economic growth will slow slightly, to (7.2%) in 2014 and (7.1%) in 2015, from (7.3%) last year, the report said. Oil theft and poor oil exploration stifle that industry’s potential while heightened turmoil in the country’s northeast is casting a shadow on its financial prospects.

Boko Haram Islamist terrorist group, has been wreaking havoc in north-eastern Nigeria and has stepped up its attacks on civilians since July 2009. The group kidnapping of more than 200 schoolgirls, lead the U.S. and other foreign powers to deploy search missions in the region to help retrieve the students. The Nigerian government’s handling of the situation generated severe criticism. The overall security and political situation have improved in the region, despite persistent pockets of conflict. The Central African Republic and South Sudan have been ravaged by war for months, while Somalia and Libya are also facing financial instability because of internal turmoil.

However, it is absolutely ridiculous to gamble for leverage when you have resources including diamond, gold oil that brings stable income. Businesses have a good reason for using Other People’s Money (OPM) to establish and split the profit with risk takers on the long run. If the business fails, owner of the business is protected from personal liability and shareholders also absorbed a loss. In the case of governments, Africa’s liability multiplies since countries do not fold, even when they default on odious loans.

It is well known that the benefit of stocks and bonds as part of the financial portfolio has its gain in long-term profits. This is where capitals are raised for most projects with the hope that the project would produce the gain for the investors on the long run. The only beneficiaries of a short-term trade, acquisition, and corporate raiders are funded managers and black knights in hostile take-over. They now descend on African countries, to make quick cash or profit in Nigeria. Politicians send loots out while our domiciliary foreign cash account gambles in devalued naira.  Dollar account and loot cannot enhance local development. Instead of relying on whatever we have by making sure our foreign reserve is not drained by foreign portfolio investors, we place faith on FPI intention. It’s pennywise pound-foolish to stake foreign income as collateral loan.  

Awkwardly, each time these foreign portfolio investment fund managers pull their money out of stocks and bonds at a convenient and opportune time, the government is blamed for bad economic policy driving foreign investors away. In the first place, they are not in our countries for local interest and their local partners furnish them inside information on our policies. Foreign rating agencies look after the interest of their partners, not local beneficiaries. Foreign portfolio investors have gravitated towards funds manager seeking their interest for maximum profits around the world. While this is a legitimate pursuit of increasing shareholders’ return on investment, it devastates poor African countries trying to get on their feet by seeking long-term investments for infrastructures and capital projects. It could be a win-win situation if the foreign investors do not seek short-term gain at the expense of their hosts.

Government investment banks have handled most of the capital projects and infrastructure in Africa with low interest loan from international bodies like International Monetary Fund (IMF) and the World Bank. Enormous projects like the Ajaokuta Steel that needed foreign technical assistance and materials became obsolete before production. Smaller projects with “confidence” that FPI were expected to invest in Nigeria resulted in loses of N304bn to foreign divestment in six months. Surprisingly, Innoson Vehicle Manufacturing Company (IVM) products in Nnewi Nigeria have low patronage. For its population, Nigeria has one of the lowest auto manufacturing activities in Africa. Nigeria must plan and implement the auto policy for foreign investors to start from scratch. Morocco, with only two assembly plants, is producing 460,000 units and Egypt, which has 26 assembly plants currently boasts of 325, 000 production capacity, while Nigeria with an allegedly 36 assembly plants only has 15, 000 production capacity.

African countries must trade more with one another to get long-term benefits. It used to be cheaper to fly from West Africa to London than to fly from West Africa to East or South Africa. Well, right now we do more businesses outside Africa than we do within Africa. The reason is simple, our needs and wants have been diverted from our home to Europe and the United States. So we must buy more and trade more outside Africa. Our leaders are cognizant of this, and they have formed regional economic bodies like Economic Community of West Africa States (ECOWAS) and established national airlines that fly across the Continent. With so many airports within our countries, we have many local airlines. So we have made significant advancement, though not sufficient. Many of our airlines are still unreliable and limited, beleaguered by maintenance problems.

Maintenance, service, and material of equipment are the source of incessant money making avenues for foreign companies. Apart from bringing their foreign technicians, the codes to open or operate their equipment are easily controlled from their American or British-based plants or offices. So, when African countries buy top grade medical and manufacturing equipment, local technicians and operators may not be able to service them without remunerating the prescribe fees.  African assurance in local trade must go beyond buying and selling, imported ready-mades and burst into manufacturing finished products admired and patronized at home. It is a volatile issue in Nigeria considering the arguments for and against the devaluation of naira. We went through series of Operation Feed Yourself to Buy Africa, but the discovery of oil as easy foreign income destroyed the incentive to be more productive.

Some Asian countries like Indonesia, South Korea and Japan have designer foreign investment to their cultural values equally to the benefit of both foreign investors and local entrepreneurs. In cases where foreign franchises have been accepted, they adapt the taste and culture of the host countries. A good example is in the food industries where the local menu is different from what one would see in the American or British market.  Most African countries want precisely the foreign taste, style and menu deriding local culture. It should be noted that those businesses that have copied foreign types but diversified into local cultures hoisted a better chance of success because they save a great deal of money in franchise fees and they do not have to depend on foreign goods as their raw materials. We should not be debating this after many years of political without economic independence. Foreign Investment must help bourgeoning industries, not paper profit-draining our foreign assets.

 

Dr. Ignatius Okosun is a researcher, prolific writer on various national/global issues and a social commentator

. From: Toronto-Canada.         Email: odyseries@gmail.com

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