Africa’s MICs - High interest rates are not compatible with state enterprise divestiture
Inflation in Africa’s largest middle income countries is primarily the result of cost push inflation. This is because Egypt, Nigeria and South Africa are all highly dependent on imports. With the significant devaluation of the Egyptian pound, the Nigerian Naira, and the South African Rand in 2022, with currency depreciation ranging from 30 to 100 percent, this has significantly increased the cost of imports, thus propelling inflation.
This year, the first African startup conference took place in Algiers. In trying to foster a private sector with the capital to privatize state enterprises, they are crucial to the mechanism. (Creative Commons)
Rising prices in these MICs is primarily the result of cost push not demand pull inflation. Yet, the Central Bank’s of South Africa, Nigeria and Egypt have all responded to surging inflation by raising interest rates to levels ranging from 18 to 30 percent.
Interest rates this high won’t just hurt consumers who will spend less on everything like new cars and homes, it will determinately affect private sector development. If you have well thought out investment codes, this will do little to promote private investment when the cost of borrowing averages out at 25 percent. What type of business can make an annual return of over 25 percent to justify this cost of borrowing? This cost of borrowing is now not just exuberant for start-ups, it prohibits existing businesses trying to expand and grow.
This is particularly true for private equity firms (PEs). PEs specialize in acquiring equity or ownership stakes in firms that are not publicly traded. PEs tend to buy large public firms with the objective of making quick returns. The underlying basis of a PEs profit is to find undervalued assets that have the potential for improvement, and can create higher profitability in the short term.
However, high interest rates deter PE acquisitions because their takeovers are often done using debt finance. When interest rates are high, PEs need to find firms that have steady cash flow for an acquisition to make sense. But, state enterprises in most African MICs typically have very low rates of return, and thus lack the cash flow a PE would be seeking. Accordingly, firms in the acquisition business are very sensitive to high interest rates which will work against any government attempting to privatize a large number of state enterprises.
So, when it comes to privatizing state assets, there are two possible scenarios. A government can either sell state assets in a low or high interest rate regime. When a government chooses to privatize when interest rates are high, this makes the risk of divestiture failing high as well, or it makes it more likely that state firms will sell for pennies on the dollar. If these MICs received advice to raise interest rates to fight inflation, and to sell state assets at the same time, and if they listened, they will likely regret both.