Identifying investment opportunities in Africa’s fragile and conflict-affected states
7 September 2022
Seeing opportunities through challenges
The designation of a country as a fragile and conflict-affected state (FCS – also known as FCAS) can be a major deterrent to investment in Africa as the label generally connotes high levels of business risk. We regularly see clients excluding countries on the basis of fragile state status at the outset of projects mapping opportunities in Africa.
However, investment – both development finance and private sector investment – in FCS can offer significant opportunities for risk-adjusted returns and positive impact, generating profit but also bringing development and reducing fragility. Nevertheless, fragile states are often blind spots in investment portfolios due to the tendency to ‘screen out’ countries with an FCS designation at an early stage. In this Perspective, we share our thinking around investment opportunities in FCS in Africa for both development finance and private sector opportunities.
Understanding the FCS designation
The World Bank classifies FCS on the basis of assessed institutional/social fragility and the presence of violent conflict (calculated on the basis the number of conflict-related deaths relative to the total population). The World Bank’s list is updated every July. Other international institutions also have their own fragile states lists with nuances in definition, such as the Fragile States Index.
In July’s revised publication, the World Bank’s List of Fragile and Conflict-affected Situations 2023 designated 20 African countries as FCS: eleven conflict states (Burkina Faso, Cameroon, CAR, DRC, Ethiopia, Mali, Mozambique, Niger, Nigeria, Somalia, and South Sudan) and nine institutionally and socially fragile states (Burundi, Chad, Comoros, Republic of Congo, Eritrea, Guinea-Bissau, Libya, Sudan, and Zimbabwe).
Africa’s contributions to the list are unchanged this year, with African states making up over half of the list (54% in the 2023 list). It also means that over one third of African countries are designated as fragile or conflict-affected.
Challenges to investing in fragile and conflict-affected states
FCS have complicated and unique issues but share common contexts and patterns to why investment opportunities in FCS can be dismissed as too high risk. Social and institutional challenges are the foundation of fragility: violent conflict, poor governance, an absence of the rule of law, fragmented economies and a range of social issues. These factors make it difficult for new markets to develop and grow, while also leaving investments vulnerable to significant market uncertainty and external shocks.
Weak political and economic institutions in FCS increase unpredictability. Navigating the political situation at the level of national politicking and local government interests can be difficult. Political structures can be weak, democracy is fragile and political stability is lacking. At the macro-level, weak governance minimises safeguards against political interference, while economic hardship can limit consumer demand, even in the face of pressing needs. At a micro-level, in FCS we have seen there can be greater desire for political involvement in investments or projects, particularly larger scale investments or in particular sectors, such as infrastructure or natural resources.
Security remains the glaring challenge to investment in conflict-affected areas. Insecurity poses a risk to assets and personnel, as well as the continuity and safety of transport links, access to power or other productive assets. The social contract with local communities, and between local communities and host governments, can be more fragile in FCS, with insecurity complicating local community relations and community attitudes towards a given project.
Fragile states often have weak legal frameworks and poor governance. This undermines the rule of law and legal safeguards for investments, as well as facilitating corruption (with the latter often an important, if sometimes overlooked driver of conflict). With poor institutional governance, adherence to international standards or best practices can be harder to achieve in certain sectors.
Opportunities to de-risk fragile states
Against such a complicated operating environment, risk intolerance is understandable. Underlying risks can lead to higher costs, delays, and integrity considerations. To outweigh the perceived disadvantages, investment opportunities in a fragile state often demand a higher rate of return to merit funding, especially in contrast to environments and opportunities with fewer contextual risks.
The requirement for higher returns can be a major hindrance to scaling up private sector investment, especially if investors are not looking for exposure to FCS specifically. Private sector investors are also deterred by the risk of competitor free riding: early movers de-risk new markets at a cost to themselves, reducing barriers to entry for later entrants. This can diminish the long-term sustainability of returns if competitors come in.
In this context, there is a real opportunity for development finance institutions (DFIs) to play a role in opening markets in fragile states. Typically, we have seen DFIs as first movers, a major de-risker and enabler for further investment in FCS. Pathfinder investment brings confidence and momentum, growing an ecosystem around certain sectors. DFIs can not only influence perceptions but also offer collaborative projects.
For private entities long term availability at scale may be dependent on other companies entering the market. Likewise, DFIs are not just looking at investments in single companies but at broader market segments. In this context, intervention points are needed across a sector to see a market grow. For sustainable growth in FCS private sector activity, investment by DFIs in FCS cannot be isolated – multiple market segments require funding or multiple DFIs should be present.
There is a growing awareness of the historical level of neglect towards fragile states and of the need for greater cooperation within the DFI world. For example, in December 2021, the DFIs of the G7 countries launched a combined platform to support investment in fragile states, the Africa Resilience Investment Accelerator (ARIA). It is hoped that such collaboration will de-risk opportunities by pooling DFIs and path the way for greater coordination in development finance efforts in FCS.
Finding success in surprising places
Sharing success stories from investments in FCS has been limited, both for DFIs and for private investment opportunities. Finding success amid the challenges can be an encouragement.
For a recent (and private sector-orientated) example, in mid-July, Bloom – a Sudanese fintech company – raised $6.5 million in seed round founding, including from Visa. This was the latest investment in Bloom, after it became the first Y Combinator-backed startup in Sudan earlier this year.
At this early stage, Bloom is an interesting success story. The company was founded in 2021, with Bloom’s founders bringing experience from former roles at IBM, Goldman Sachs and Barclays. Bloom provides fee-free digital banking and high-yield savings accounts, allowing users to save in US Dollars and spend in Sudanese Pounds. This enables Sudanese consumers to circumvent the country’s weak banking system, inflation and currency devaluation. Bloom made their waiting list public in March, showing that 15,000 people had registered for the app – as of July, over 100,000 were listed on the waiting list. Mobile banking fintech is nothing new, but the interest in Bloom shows that opportunities still exist in more mature start-up spaces in previously neglected markets.
Sudan has not historically been a site for investment opportunity. International sanctions stifled the potential for foreign investment, while, since the removal of Omar al-Bashir in 2019, Sudan has continued to suffer economic hardship and political instability. Sudan only received its first foreign investment in technology in October 2021 – a $5 million investment in e-commerce platform, alsoug. However, investment in companies like Bloom and alsoug show an ecosystem beginning to form, even against a backdrop of uncertainty.
Such investments are representative of the path-finding nature of investing in FCS and the opportunity for private sector to be early movers. With uncertainty over Sudan’s political trajectory, at face value such an investment remains high risk. Bloom has the potential to improve financial inclusion in a country previously bypassed by both DFI and international private sector investment.
Investors – particularly DFIs – have to be willing to be creators and market makers. In the right circumstances, so too can private sector entities. However, for both categories, we would argue, opportunity scoping and deal due diligence requires a broader lens and a different skill set than is required for more established markets.
In FCS, accurate and comprehensive on-the-ground intelligence can be hard to access, out of date, or expensive. Dynamics can change quickly and building volatility into an investment or project remains a major challenge. Developing a capability to gather and integrate in-country insights from a broad range of stakeholders and situations is critical. With our long-established networks in many FCS jurisdictions, we are able to mobilise such insights quickly and efficiently.
FCS designation can be broad-brush and fail to account for sub-national nuances in the operating environment. For example, Nigeria is listed as an FCS and the country contains numerous conflict affected zones (i.e. the Delta, the North-eastern states, the North-west, the Middle Belt and Biafra), but even these designations are broad brush and overlook significant variations in state capacity and security. Similarly, conflicts isolated to a specific region or a country’s periphery should not detract from investments elsewhere in the country, such as in DRC (eastern DRC), Ethiopia (Tigray), or Mozambique (Cabo Delgado). Our core team has deep regional, country-level, sub-national and sectoral knowledge and experience, as well as an appreciation for geographic and historical variation across jurisdictions and sub-regions.
Taking a landscape level perspective
As outlined above, successful investment in FCS will often depend on more than investee management capabilities and immediate market opportunities. The existence of a broader enabling environment and an ecosystem of supportive players, investors and market entrants can be key. Morever, in conflict-affected areas, project impacts and risks may extend beyond the typical footprint of a project and interventions to amplify development impact and managing risks may need to look beyond a project’s ‘battery limits’. Sofala Partners has extensive experience of undertaking ‘landscape level’ political economy evaluations that integrate environmental and social factors, adopting a conflict sensitive lens where required.
Cooperating with local partners or the pooling of investments can be essential for navigating the complex risk landscape of fragile states. Such an approach can de-risk key areas deterring investment in FCS or re-localise the perception of an investment. Understanding and trusting local partners is pivotal to achieving investment objectives and meeting expectations. However, identifying local partners can be challenging, especially understanding the risks such an arrangement and what their interests may be. It is important to look deeper than a potential partner’s reputation and integrity to understand their political and social capital and how they are positioned vis-à-vis other stakeholders.
Sofala Partners and our team of in-country experts regularly support clients across fragile and conflict-affected states in Africa. Beyond projects in more established markets like Nigeria, Ethiopia, DRC or Zimbabwe, Sofala Partners have led a diverse range of projects in FCS across the continent. See our Case Studies here.
In 2022 alone, Sofala Partners has conducted a number of integrity due diligences in Cameroon, Burundi, and CAR, among others, requiring in-country source enquiries. Sofala Partners have also just completed strategy advisory projects in Mali, Mozambique and Republic of Congo. In the past year, we have provided clients with political or sector specific monitoring or advisory in Burkina Faso, Sudan, South Sudan and Somalia. Such projects have been in a range of sectors: agriculture, renewables, health, digital services, telecommunications, and FMCG.
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