Managing currency volatility is arguably inherent to the practice of investing in most emerging and frontier markets. Exchange rates fluctuate, especially over the long holding periods typical of private equity investments. As global equity markets become increasingly integrated, understanding and managing that currency risk becomes increasingly important, especially in the context of private capital investment in Sub-Saharan Africa.
One region that stands out for its currency stability is the West African Economic and Monetary Union (WAEMU), which utilises the CFA franc (FCFA) as its common medium of exchange. As we delve into how investors can benefit by de-risking their investments in the West African region through strategic partnerships and co-investments with funds operating in the WAEMU region, we believe that it is useful to explore the stability of the FCFA currency in comparison to neighbouring currencies, namely the Nigerian Naira and the Ghanaian Cedi. For a comprehensive approach to impact investing in West Africa, we would like to suggest that partnering with a reputable firm like Brightmore Capital is an essential consideration.
The challenge of foreign exchange instability in Africa
According to the African Venture Capital Association’s (AVCA’s) recent Currency Risk Report, foreign exchange volatility and currency risk remains one of the biggest challenges facing private equity investors in Africa. The AVCA 2021 Annual Private Equity Industry Survey found that 56% of LPs view currency risk as a key challenge when investing in African Private Equity.
56% of LPs view currency risk as a key challenge when investing in African Private Equity. – African Venture Capital Association’s (AVCA’s) recent Currency Risk Report.
Compounding the risk factors and volatility associated with many African currencies, AVCA’s 2023 African Private Capital Industry Survey reported Macroeconomic risks as the primary concern for 66% of GPs and 57% of LPs. 54% of LPs cite unfavourable regulatory environments, most notably the restrictions placed on foreign exchange movements by some intra-country governments, as a concern, as this can affect the repatriation of income from investments.
In the 2021 World To Africa Survey led by Standard Bank, which surveyed 225 global investors and their intermediary providers, 50% of new investors and 30% of existing investors cited FX liquidity and restrictions as a key obstacle “blocking” them from being fully invested or optimised in key African markets. The answer to all these concerns could lie within The West African Economic and Monetary Union.
50% of new investors and 30% of existing investors cited FX liquidity and restrictions as a key obstacle “blocking” them from being fully invested or optimised in key African markets.” – 2021 World To Africa Survey
The stability of the FCFA currency
The West African Economic and Monetary Union, or WAEMU and the Central African Economic and Monetary Union, or CAEMC, consists of 14 countries, that maintain the same currency. WAEMU countries share harmonised macroeconomic policies, as well as a common currency, the CFA franc. Together they represent a geographically and demographically significant share of the African market, accounting for 14 percent of Africa’s population and 12 percent of its gross domestic product (GDP).
The CFA franc zone is actually two currencies: the Central African CFA franc and the West African CFA franc, which are effectively interchangeable. Benin, Burkina Faso, Côte D’Ivoire, Guinea-Bissau, Mali, Senegal, and
Togo comprise the West African Economic and Monetary Union (WAEMU), also known by its French acronym, UEMOA. The remaining six countries, Cameroon, Central African Republic, Chad, Republic of Congo, Equatorial Guinea, and Gabon, comprise the Central African Economic and Monetary Union, or CAEMC.
The CFA franc (FCFA) is pegged to the euro (before which it was pegged to the French franc) and guaranteed by the French treasury. It thus operates within a macroeconomic environment that is markedly different from the other countries in the region. Due to a fixed exchange rate agreement with the French Treasury, the value of the FCFA maintains a notable degree of stability relative to the euro. Investors find this stability enticing, as it significantly reduces exchange rate risk, making the WAEMU region an attractive destination for foreign direct investment (FDI). This confidence in returns and investment predictability encourages economic growth and development within WAEMU countries.
Due to a fixed exchange rate agreement with the French Treasury, the value of the FCFA maintains a notable degree of stability relative to the euro. Investors find this stability enticing, as it significantly reduces exchange rate risk, making the WAEMU region an attractive destination for foreign direct investment (FDI).
The benefits of the FCFA for investment
The franc zone offers a myriad of advantages for both local and foreign investors in the WAEMU region:
Currency stability: The stability of the FCFA enables higher macro-economic stability. The fixed exchange rate system is shielded from fluctuations, providing investors with a low-risk investment environment, secured investment returns and it assists in eliminating the volatility associated with floating exchange rates.
Reduced exchange rate risk: The stability of the FCFA within WAEMU countries minimises exchange rate risk, offering foreign investors a sense of security and predictability.
Inflation control: WAEMU countries have lower inflation and interest rates than non-WAEMU countries. While there are variations between WAEMU countries, these are small, compared with non-WAEMU countries’ inflation rates, which vary widely. This stability is attractive to investors, encouraging long-term investments and facilitating easier exits.
Trade facilitation: Freedom of transfers within the franc zone, streamlines cross-border trade and business transactions within the WAEMU region, bolstering regional trade and economic integration.
Lower transaction costs: Uniformity of the FCFA across WAEMU member states reduces transaction costs associated with currency conversions, facilitating cross-border business operations.
Access to a larger market: With a population exceeding 100 million people, the WAEMU region presents investors with access to a significant and growing market, promoting expansion and increased profitability.
Accountability and transparency: Mutual “surveillance” is an implicit result of being in a monetary union, safeguarding member countries from irresponsible governments that juggle interest rates or print money.
In comparison with neighbouring currencies (Naira and Cedi)
In contrast to the FCFA’s stability, neighbouring countries such as Nigeria (utilising the Naira) and Ghana (utilising the Cedi) have experienced significant currency fluctuations. This is in part due to economic factors, including oil price volatility, fiscal deficits, inflation and political instability, but it is also worthwhile noting that both these currencies are government owned and managed.
While the Central Bank’s target range is 1% to 3% for WAEMU, current interest rates in independently monitored states such as Nigeria, sit at 24% and Ghana at 30%. Since 2007 the Cedi has lost over 90% of its value. These fluctuations create uncertainties for investors and elevate risk levels when investing in these countries. The instability and volatility of non-WAEMU states highlights the attractiveness of the FCFA’s stability.
De-risking investments through partnerships in the WAEMU region:
While acknowledging the challenges, private equity investment in Africa is viewed as a manageable risk– not a deterrent! According to respondents of AVCA’s March 2022 Currency Risk Report, the risk is still worth the reward. In fact, according to AVCA’s 2023 African Private Capital Industry Survey, LPs hold a positive long-term outlook, with 52% believing that private capital in Africa will be more attractive than other emerging markets in five years, with 48% of LPs considering it more attractive than developed markets.
To mitigate the risk, private equity investors in Africa have adopted risk management strategies: 72% opt to invest and operate in regions more resilient to currency volatility, like WAEMU, and over 83% of GPs and 69% of LPs opt for natural hedges such as portfolio diversification across different sectors and geographies as a preferred strategy for managing currency risk in Africa.
To fully leverage the stability of the FCFA and minimise investment risk, partnering or co-investing with funds in the WAEMU region can be a very prudent approach:
Diversification: Diversification mitigates currency risk. Partnering with local funds in the WAEMUregion enables investors to diversify their portfolios, across investment stages, vintage year, sectors and geographies, yet remain within the stability of the WAEMU’s regulated environment.
Risk Sharing: Collaborating with WAEMU funds allows investors to share risk at the project and portfolio levels, cushioning potential losses against unforeseen market fluctuations.
Access to local expertise: Local funds and impact investment firms like Brightmore Capital, possess intimate knowledge of WAEMU’s regulatory environment, business practices and cultural nuances, guiding investors through challenges and identifying profitable opportunities.
Political stability: The region’s political stability, coupled with strategic partnerships, fosters an environment conducive to sustainable economic growth and protection of long-term investments.
Currency hedging: Although the FCFA’s fixed exchange rate arrangement provides stability, investors can employ currency hedging strategies for additional protection against exchange rate fluctuations.
Why partner with Brightmore Capital?
Over 54% of AVCA’s 2023 Currency Risk Report respondents reported relying on fund managers’ knowledge of target countries and sectors to mitigate the effects of currency volatility. Brightmore Capital is that solution, perfectly positioned to navigate the complexities of impact investing in West Africa…
Investing in West Africa presents a wealth of opportunities, but it requires a profound understanding of the local landscape and a commitment to creating a positive social and environmental impact. Over 54% of AVCA’s 2023 Currency Risk Report respondents reported relying on fund managers’ knowledge of target countries and sectors to mitigate the effects of currency volatility. Brightmore Capital is that solution, perfectly positioned to navigate the complexities of impact investing in West Africa:
Local expertise: Diversification requires in-depth knowledge of a region. As an impact investment firm based within and focusing on Francophone West Africa, Brightmore Capital has extensive knowledge of regional markets, industries, regulations and socio-economic dynamics.
Impact-focused investment strategy: Partnering with Brightmore Capital ensures alignment with a company dedicated to creating meaningful and sustainable impact in Francophone West Africa, benefiting local communities while enhancing long-term investment viability.
Risk mitigation: Our experience in the region enables us to identify and mitigate potential risks, safeguarding investments and increasing the likelihood of success.
Deal flow and pipeline: We have an extensive network and local presence which can offer a robust deal flow and a strong investment pipeline, providing investors with diverse opportunities for portfolio diversification.
Regulatory and compliance support: Brightmore Capital’s expertise in compliance and regulatory matters ensures adherence to local laws and reduces compliance-related risks.
Impact measurement and reporting: Impact investing necessitates an understanding of the tangible social and environmental benefits of investments. Brightmore Capital’s commitment to impact measurement and reporting allows investors to track their contributions to achieving global sustainability goals.
Local partnerships: Building strategic partnerships with local stakeholders is integral to making successful investments in Francophone West Africa. Our established relationships can open doors to new opportunities and foster mutual understanding.
Investing in West Africa through the stability of the FCFA currency presents a unique opportunity for investors seeking to unlock the region’s vast potential. By partnering with reputable impact investment firms like Brightmore Capital, investors can leverage local expertise to mitigate risks, increase returns and align their investments with meaningful impact, positively transforming communities and contributing to the sustainable development of West Africa. The WAEMU region, with its stable currency, political stability, and growing market, offers a promising destination for impact investors looking to create a lasting difference while achieving financial success.