Is Africa the New Frontier of Sovereign Wealth Funds?

April 02, 2015 by Loch Adamson

Africa's SWF Boom Fails to Materialize
Save or Spend? The Dilemma Facing Africa's Developing Nations
Africa's Resource Rich Nations Face Competing Demands
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The Finnish Parliament Annex Building, Helsinki

Two years ago sub-Saharan Africa was heralded as the new frontier of sovereign wealth funds. With oil prices accelerating past $100 per barrel, history suggested that we were on the verge of another boom in sovereign wealth fund creation like the one that characterized the mid-2000s. Now, in 2015, that vision has failed to materialize. Sovereign Wealth Center’s Victoria Barbary suggests that this might not be such a bad thing.

It’s a snowy morning in Helsinki at the end of March. Even the native Finns are wrapped up in goose-down coats to keep out the chill as they walk to work. A coat of white covers the city in a picturesque blanket that dampens the noise of the rush-hour traffic. This isn’t the place you’d expect to find parliamentary delegations from resource-rich countries of sub-Saharan Africa and Central Asia, but walking down the street to the new Finnish parliament annex is a group of African MPs decked out in scarves and hats in the bright colors of their countries’ flags, standing out against the white and gray of their surroundings.

The delegates are here for a seminar on parliaments and extractive industries revenue, part of a joint initiative by the Eduskunta, or Finnish legislature, and the World Bank. The goal is to help strengthen parliaments in the developing world. The meeting comes at an interesting time for countries such as Kenya, South Sudan, Tanzania and Zambia, all of which are debating establishing a sovereign fund to manage their new-found natural resources wealth, whether it is from oil, natural gas or copper.

But while a sovereign wealth fund was once seen as a badge of fiscal prudence by the International Monetary Fund, and developing countries still tend to view them as a status symbol, there is now an air of caution that surrounds them.  

Decrepit Infrastructure

Sovereign wealth funds, designed for intergenerational equity transfer, have their roots in the small states of the Arabian Gulf in the mid-twentieth century. When oil was discovered, these countries had tiny populations and little economic activity other than pearl fishing and local trade.  

According to the World Bank Kuwait had a population of only 262,000 in 1960, seven years after the British colonial government established its sovereign wealth fund. In 1975, the year after the Abu Dhabi Investment Board (the precursor to the Abu Dhabi Investment Authority) was established, the emirate’s population was just 211,000. With such tiny economies there were few options other than to save the money they were generating from oil exploration: annual government surpluses from oil revenues were abundant even after generous government spending plans to help develop the local economies.

Today, resource-rich African countries face a different challenge. While they may have vast mineral wealth, they also have large, growing and young populations — over 60 percent of Kenya’s 45 million citizens are under 25 — decrepit colonial-era infrastructure and are in desperate need of upgrading their education and health care systems. According to Donald Kaberuka, president of the African Development Bank, sub-Saharan Africa needs to spend $92 billion a year to bring the continent’s roads, railways, telecoms and electricity distribution up to snuff.

Many of these countries also have debts to pay. In 2013 and 2014, with investors around the world searching for yield, many sub-Saharan African countries were able to borrow on the international markets with debt issued in U.S. dollars or euros. South Africa, Angola, Côte d’Ivoire, Gabon, Ghana, Kenya, Namibia, Nigeria, Rwanda, Senegal, Seychelles and Zambia have been able to raise funds in international debt markets. In December 2014, Ethiopia became the poorest ever country to tap the global sovereign bond market, paying a relatively low yield of 6.625 percent for its maiden $1 billion note. 

Appropriate Projects

But while borrowing costs may currently be historically low for these countries — coupons are generally between 6 and 8 percent — they are still large commitments for poor countries to meet.  

This vast web of competing demands on mineral wealth makes the decision to save difficult for African countries. Given these challenges, is a sovereign wealth fund the right solution for countries with such an immediate need for cash?  

At the World Bank meeting, the advice from experts was unanimous. Without a fiscal surplus arising from commodities’ revenues, it is almost impossible to save. Most of the countries in the room were running deficits. While all the experts agreed that having a sovereign fund, particularly for stabilization purposes, was helpful for governments, amassing such a fund should not mean scrimping today if that investment is necessary for economic development. The best way to benefit future generations of Africans is to invest in today’s young and growing population.

The meeting also suggested that a sovereign wealth fund was not the right mechanism for investing domestically. While the budgetary process is scrutinized by parliaments and which are theoretically held accountable, a sovereign investment vehicle — no matter how transparent — is removed from politics and has an arm’s-length relationship with the government. The challenge then becomes working with the authorities to target appropriate projects, as the IMF asserted in its annual report on Angola last year, while also preventing corruption and nepotism. In short, such nations should spend their resource wealth for the benefit of needy citizens through the existing budgetary process. The World Bank too is averse to independent sovereign investment vehicles being used to finance domestic infrastructure projects on a non-commercial basis.

Some argue that simply having a sovereign wealth fund decreases borrowing costs. It does, but so too does maintaining fiscal discipline. Keeping debt low in the good times makes borrowing easier and cheaper in the hard times.

Citizens’ Trust

Enough economics. There’s a vital political dimension to this debate, which was brought into sharp relief in Helsinki: Voters lack trust in their national politicians. Citizens in many sub-Saharan African countries largely have a local perspective, rather than a national one. Perhaps the greatest challenge discussed in Helsinki was how and whether to accede to demands to distribute mineral wealth directly to the local communities affected by mines and oilfields.

Africans’ lack of trust of their politicians is the result of decades of corruption and nepotism . The continent’s resource wealth has been squandered and inequality has grown. For example, in Nigeria, the value of the Excess Crude Account, a holding pool for the country’s oil wealth, declined by $20 billion between 2007 and 2010. Taking into account subsequent inflows, industry experts estimated that as much as $30 billion was disbursed to state governors, who enjoy little direct oversight, or else frittered away on ineffective infrastructure projects. 

To save money in good times requires not only political probity, but also buy-in by the local population. Even Chile, which saved its copper revenue in its dual sovereign investment vehicles, the Pension Reserve Fund and the Economic and Social Stabilization Fund , found it challenging. President Michelle Bachelet’s approval ratings sank to their lowest levels during the boom when her government refused to spend the proceeds freely. That said, she rocketed back in popularity during the financial crisis, when the state could use the ESSF to implement a major stimulus effort.

The challenge for a new generation of African politicians is to win their citizens’ trust by spending their resource wealth wisely on infrastructure, education and welfare, and develop their economies. The task is tough, but the future looks relatively bright. If the delegations in Helsinki are anything to go by, these countries do not lack talent, and this can only be bolstered as Africans who moved abroad to the U.S. or Europe return to their home countries to build businesses and enter politics. One example: Uche Orji, the CEO of the Nigeria Sovereign Investment Authority .

On the evidence presented in Finland, should bankers be flocking to Nairobi, Lusaka or Dar es Salaam? After a working session, most of the parliamentarians decided they might suggest their resource wealth not be saved in a sovereign wealth fund, and instead be used to better conditions for today’s populations. Those bankers on their way to the finance ministries really ought to cancel their flights.


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