The challenge of private equity investment in low-income countries

The boom times may be over for emerging market businesses looking for money. After a steady rise in private investment in low- and middle-income countries, over the past several years, the trend is now reversing. That’s especially true when it comes to private equity investments, according to Bill Sonneborn, global director of disruptive technology and funds at the International Finance Corporation, the World Bank’s private sector arm. Private investment across Asia, Latin America, Africa, Central, and Eastern Europe, and the Middle East totaled about $208 billion in 2022, a drop of 22%, according to data from the Global Private Capital Association, a membership group of investors across those regions. Although despite the decline, it was still the second-highest amount on record in terms of the amount invested. The trend was driven by a 30% drop in the dollar value of private equity investments, and a 33% decline in venture capital investments. Other types of financing saw an uptick, including infrastructure investment and private credit, lending from nonbank financial institutions. Global economic conditions are unstable and could worsen, which makes investors more nervous and has caused them to pull back or delay any plans to enter these countries. And although an increased focus on impact investing has encouraged financial institutions to look at investing in the global south, many of the big firms still haven’t been able to make their model work in these geographies. That puts more pressure on IFC and other DFIs to help build these markets and use their tools to make the case to these hesitant investors, Sonneborn said. Changing priorities Three years ago, traditional private equity investors were starting to dabble in lower-income countries alongside the likes of IFC. But now, things have changed. The combination of COVID-19, the Russian invasion of Ukraine, and the resulting economic fallout has “caused those green shoots to wither and die,” Sonneborn told Devex. The pandemic shut down economies, hurting businesses and leading governments to borrow more. As a result, sovereign debt challenges have emerged. Meanwhile, the war in Ukraine drove increases in food and energy prices. Rising United States inflation is making money more expensive as interest rates rise. As a result, investors have become more fearful and it will be harder for businesses in lower-income countries to raise money to grow. IFC works to build up investment industries in many of these countries, but Sonneborn said his organization has seen things go back to how they were five years ago when development finance institutions, or DFIs, were the dominant or only investors. The impact revolution As financial institutions have become more focused on impact, and environmental and social factors, there was a hope that these trends would drive more money to low- and middle-income countries. But that hasn’t happened so far, Sonneborn said. Mainstream investors are still focused on financial returns. They see less risk in investing impact-focused money in inner cities in the U.S. for example, than in places such as Nigeria, where the currency has steadily been losing value, he said. And some of the mammoth U.S. private equity players including KKR, Carlyle, Bain, and Blackstone tried investing in Africa but now steer clear. Sonneborn knows firsthand — he used to be CEO of KKR Asset Management. While KKR once made an investment in Ethiopia, hired a head of Africa, and thought it would build a private equity business there, it fairly quickly closed up the operation. The firm, and many like it, raise huge funds that want to invest $500 million at a time. They don’t believe that there are enough African companies that need or can handle the size of investments needed. But it’s not just a challenge in Africa. Bad experiences in Latin America, including a corruption scandal in Brazil, have also made some of them skittish to invest there, Sonneborn said. In the venture capital space, things are a little different. That sector is known for early-stage, longer-term, riskier investments, and some of the big firms are starting to make some investments in less developed countries. Infrastructure investment is also growing in those markets. But even Global Infrastructure Partners, home to former World Bank President Jim Yong Kim and former IFC chief Jin-Yong Cai, still won’t invest in Africa because its private investors have opposed it, Sonneborn said. Planning for the future Nonetheless, Sonneborn believes that the big players in international investment won’t stay away from these markets forever. As they get even bigger and look to spend impact-oriented money, they’ll have to expand their geographic footprint, he said. IFC and other DFIs need to make the case that the fund managers and businesses they support in these countries can be an attractive investment in terms of both risk and return, Sonneborn said. “When we’re able to do that, then lightning will strike and we will be able to step away and say our job is done, we actually created the industry in this country.” At that point, the DFIs can move to even more challenging places to invest and try to build up capital markets in those countries. A key component to doing that successfully will be getting local sources of funding, such as pension funds or other institutional investors, to invest in their own countries. DFIs can help educate them about proper due diligence processes or bring them in on investments so they can get more comfortable, he said. IFC is also using its investments to help push the funds that it supports to broaden its geographic footprint to smaller, lower-income countries, particularly in Africa, Sonneborn said. It can also use blended finance in the form of guarantees or grants, to help lower currency and investment risks. Using this money to bring some of the world’s largest investment firms along could be tricky business though. Sonneborn said IFC would need to be careful, transparent, and provide a lot of evidence if it were to use those limited concessional funds to get big companies to invest. It would need to prove they wouldn’t have otherwise invested and that IFC was not “providing them some public good from taxpayers to increase their carried interest and allow them to buy another Hamptons home,” he said.