by Rory Kutisker-Jacobson, fund manager of the Allan Gray Africa ex-SA Equity Fund

It was an eventful and volatile first quarter of 2024 in African markets. Deteriorating current accounts, fiscal deficits and a shortage of hard currency have effectively forced market liberalisation on many currencies.

In Nigeria, despite allowing the currency peg to weaken more than once in 2023, the dam walls were effectively broken in the first quarter as the exchange rate moved to a market determined one, and a backlog of over US$7 billion foreign exchange forwards was cleared by the central bank. In 2023, the naira weakened by 49% versus the US dollar. This trend continued in the first three months of 2024, with the currency falling another 44%, before strengthening slightly to end the quarter 33% weaker, year-to-date.

In Egypt, it was a similar story. In January 2023, the Central Bank of Egypt allowed the currency to weaken by roughly 20% to approximately EGP31/US$, before keeping the currency largely pegged at that rate for the balance of the 2023 calendar year. As part of its commitments to secure an upgraded US$8-10 billion International Monetary Fund (IMF) programme and a significant investment commitment north of US$30 billion from the United Arab Emirates, the country allowed the currency to float freely in early March 2024. As the pent-up demand for capital flows out of the country has been clearing, the currency weakened by a further 35% over the quarter.

In Zimbabwe, following the reintroduction of the US dollar as a legal means of exchange in 2022, the local currency had become increasingly obsolete on the ground. Our understanding is that north of 80% of domestic transactions are now conducted in US dollars. Notably, many of the counters listed in Zimbabwe have begun paying US dollar dividends and have reverted to, or committed to reverting to, reporting their financials in US dollars. Post quarter end, the government formerly abandoned the existing currency and introduced the ZiG, a new currency that in theory is a currency backed by reserve assets in the form of foreign currency reserves, precious metals and other valuable minerals. Time will tell whether locals and investors embrace this new currency or continue to trade in US dollars.

We view all of these developments as overwhelmingly positive. Capital controls not only distort pricing, discourage foreign investment and reduce sentiment, they also suck the lifeblood out of young economies that are dependent on the import of foreign goods and services to grow and further their economic development. Allowing their currencies to float freely and be market determined (or US dollars to be used as a medium of exchange in the case of Zimbabwe) introduces short-term volatility to asset pricing and domestic inflation but should be very beneficial to economic growth over the medium to longer term.

From a returns perspective, the past decade has been a lost one in Africa. Over 10 years, the MSCI Emerging Frontier Markets Africa ex-SA Index has generated an annual return of -3.1% per annum. Investors would have fared much better by avoiding Africa altogether.

Does this mean investors should expect similar returns over the next decade and therefore avoid Africa? We do not know what the future holds, but to paraphrase Warren Buffett, investing based solely on past performance is like driving while looking into the rearview mirror.

What we do know is that valuations in Africa today are much lower than they were a decade ago. Currencies are much weaker, and sentiment is incredibly depressed. While far from a forecast, Kenya’s recent performance offers a glimpse of how small changes in sentiment and expectations can have a material impact, given starting valuations. In 2023, the Kenyan shilling fell by over 20% versus the US dollar, and the local Nairobi Stock Exchange (NSE) was down 21% in local currency (-38% in US dollars) as the market grew concerned about the government’s ability to refinance its US dollar debt. In January 2024, Kenya secured a new package from the IMF and have been off to the races ever since. The Kenyan shilling has strengthened by 19% versus the US dollar and the NSE has rallied 25% in local currency for a US dollar return of almost 50% in the quarter.

We remain cautiously optimistic about the future return potential of select businesses in African equity markets.