Impact Investing: Ethiopia’s Hidden Opportunity

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The financial crisis called into question ‘business as usual’ and whether global capital markets effectively fulfilled their role of pricing risk and allocating capital. The notion of safe assets is now gone.

The 600 trillion dollars in financial assets globally in 2010 represented claims against a nominal global gross domestic product (GDP) of roughly 63 trillion dollars. In Japan – the world’s third largest economy – 8.5 trillion dollars sits in commercial banks as cash deposits. There will be an estimated 900 trillion dollars in financial assets by 2020, representing claims against about 90 trillion dollars a year of global GDP.

The figures in the world of global finance are so large that even transformational initiatives, such as the total estimated 75 billion dollar cost of Ethiopia’s Growth & Transformation Plan (GTP), can seem like small change.

The challenge, though, has been to orient the world of finance towards consistently adding value to the real economy in ways that are noticeable to average citizens. There are few places where the ways this conundrum will be resolved are more important than in Ethiopia.

Ethiopia is the second-poorest country in the world, with the fifth largest population of poor people – after India, China, Bangladesh and Pakistan. The 2014 global Multidimensional Poverty Index (MPI) – published by Oxford University on June 16, 2014 – classifies 87.3pc of Ethiopians as “multi-dimensionally” poor and 58.1pc as destitute – better only than Niger.

Fortunately, change is gaining momentum in the world of finance as well, and this could help unlock capital resources for the modernisation of emerging markets. Investors are increasingly helping to drive capital towards investments that target both a financial return and some social or environmental outcome: they want to “do good” and “do well” simultaneously with a portion of their portfolios.

These investors are driven by personal interest, deep-seated worries about the future of the planet and interest in low-volatility opportunities and segments of the market that are uncorrelated with mainstream global benchmarks, such as absolute return and capital guarantee products. In the world’s developed capital markets, investors increasingly look for ethical funds, socially responsible investments (SRIs).

It is estimated that SRIs amounted to about 3.74 trillion dollars worldwide in 2011. They are also called impact investments – an emerging investment style, which intentionally pursues a social impact alongside a financial return.

As we move through the first quarter of the twenty-first century, impact investing (also referred to as “social finance”, “social impact investing”, “blended value investing” or “impact finance”) is perhaps the biggest idea to renew the relevance of finance for the real economy and social progress. JP Morgan estimated in 2010 that impact investments could grow to one trillion dollars by the end of the decade.

While this projection is promising, impact investments would represent only 0.1pc of all financial assets by the end of the decade – far from being the silver bullet for addressing staggering need, skyrocketing deficits or uncertain financial markets.

While a small group of early adopters harbour multiple highly elaborate and sometimes contradictory understandings of the concept, institutional investors, government regulators and mainstream financial services firms are all struggling to determine an approach to impact investing that can be implemented at scale. The current world of impact investing can provide part of the answer, but it will not scale fast enough to achieve the results needed, given current growth rates.

A more promising approach is considering the yin and yang of pairing “purist” impact investment with the selective application of impact principles to mainstream capital markets and asset classes.

A harmonisation and mainstreaming approach that we term “impact light” is now, interestingly, underway to benefit both. In the context of its presidency of the then G8 last year, the UK has taken the international lead not only in building a fully-fledged social impact investment market at home – which could provide a template for the modernisation of capital markets along the themes of long-term positive impact around the world – but also working with its G7 and G20 counterparts on cross-border harmonisation and transparency, as well as tasking the OECD to research and help build out the field.

In spring 2013, Impact Economy aided the UK’s efforts and provided the primer for participants of the first G8-level conference on the social impact investment market convened in London by the UK Prime Minister. The companion version of the report, “Making Impact Investible”, has since been translated into several languages and presents a unifying conceptual framework for work underway in several countries.

Key messages on the fundamentals driving the magnitude of impact investment supply and demand, as well as four mega trends identified in the research that are shaping the appetite for impact investment, have since been taken up by think tanks around the world, such as the World Economic Forum (WEF), and broadcast widely. Unsurprisingly, the drivers remain the same. Serving massive unfulfilled needs at the five trillion dollar base of the pyramid economy will require unprecedented levels of investment capital. The imperative for radical resource efficiency to promote economic growth by making the material flows of the economy more circular cannot be understated. A shift like this could reduce pollution and greenhouse gas emissions, minimise waste and cut inefficient natural resource use. Plus, a circular economy would offer a multi-trillion dollar business opportunity.

Given demographics and the ability to tax and redistribute, there is no alternative to the modernisation of the welfare state and public service reform in the advanced economies. The 546 billion dollar global virtuous consumer segment continues to rise and favours products and services related to sustainable living and a low carbon footprint. This segment is comparatively small, but provides great product and services and supply chain innovation opportunities that can later go mainstream in consumer markets.

The report also discusses how all actors involved – including foundations, angel investors, financial services institutions and others – can contribute to and benefit from the growing impact of investing industry and makes recommendations for strengthening the industry.

As the recent experience of Ethiopia highlights, advancing Africa is the next big thing – and this progress is already happening. In 2008, Africa counted one billion people with 1.6 trillion dollars GDP and 860 billion dollars combined consumer spending; foreign direct investment in 2010 was 55 billion dollars.

The 2020 forecast is for a GDP of 2.6 trillion dollars and roughly 1.4 trillion dollars in combined consumer spending. And in 2040, when Europe and China will have greyed, we can expect 1.1 billion Africans of working age.

Today, consumer facing industries on the continent already grow two to three times faster than in the developed world. For Eastern and Western companies, early entry into African economies can provide opportunities to create markets, establish brands, shape industries, influence consumer preferences and foster long-term relationships.

Fully seizing the opportunity will mean empowering people on a large scale and ensuring inclusive growth, in addition to the massive capital investment needed. Next to ensuring macroeconomic stability, governments can also help by creating the framework conditions for capital to flow.

Ethiopia is in the fortunate position to be a strategic ally of the main donor governments, with corresponding external budget support and benefits from joint donor and private remittances currently 70pc greater than the country’s total export earnings. The National Bank of Ethiopia (NBE) has achieved a major win by cutting inflation from 33pc in 2011 to single digits today.

Moreover, the country’s banking sector is well capitalised with a capital adequacy sector ratio – a bank’s tier one and tier two capital divided by its risk weighted assets such as credit exposures – well above the eight percent mandated minimum, with non-performing loans in the two to three percent range.

To take advantage of the underlying opportunity and innovations underway in capital markets, the time has come to find ways to initiate the transition from a state-led development model to one where the private sector plays a larger role. Included here is the need to locate ways to cover government deficits beyond central bank financing, and to develop an attractive government bond market.

Africa will play an increasingly important role in the global economy, if the current trends continue. Africa, and Ethiopia in particular, can be important beneficiaries of changes underway in the world of finance as well, provided the continent offers an attractive operating and financing environment.

Pent-up demand will drive growth in Africa for decades to come. Only 15pc of the African population has access to the internet, and only one out of eight Africans currently has electricity. With abundant resources and fast-growing market opportunities, the continent’s potential is undisputed. Devising solutions that simultaneously respond to nonlinear challenges, such as global warming, will be key to driving long term prosperity.

Navigating the transformation of capital markets can yield a handsome benefit as Ethiopia offers over eight million acres of land to commercial farming investors, promotes industrial sectors and provides basic infrastructure to develop four industrial cluster zones. To overcome multi-dimensional poverty, significant progress in education, health and living standards is needed, and this can only be achieved on the back of a modernising and competitive economy.

The opportunities are enormous, but so are the challenges. Investors who want to make a profit while building the Africa of the future are becoming greater in number.

Impact light can shape the future of capital markets. But this cannot truly happen until we identify and execute on the biggest opportunities in this dawning age of impact, and also create the corresponding policy environments now needed.



By Maximilian Martin (PhD)
He is the founder and global managing director of Impact Economy – an impact investment and strategy firm based in Lausanne, Switzerland, with overseas operations in North and South America.
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