Looking out across a largely rural population of Kenyans the bulk of whom get by on less than a dollar a day as subsistence farmers and vendors, many a bank might turn west or east or anywhere that would be elsewhere. But Kenya’s Equity Bank looked a bit closer and saw an opportunity.

“You look at the customer and what they have been doing,” said Gasper Jumwa, Equity’s trade finance manager. “You know they have a history of planting, they have a history of farming, so you need to help them buy the seeds.”

Naïve? Quite the contrary. When it comes to securing loans to people with nearly nothing, the bank’s team says it’s a matter of knowing their customer.

“You know what is the catch?” says James Mbogo, Jumwa’s assistant manager. “The matrimonial bed. Nobody will let his matrimonial bed be sold. That is the catch. They will make sure the loan is liquidated before the bed is auctioned.”

Jumwa says it’s on the back of tiny transactions like these that Equity Bank has been able to grow into one of Kenya’s largest in a few short years, with profits for the first half of this year 194% what they were during the same period a year ago.

But, while their means of securing a loan may be innovative, Equity Bank certainly isn’t alone in recognising the potential of the farmer.

In many ways the surge in commodity prices around the globe has put African farmers centre stage, touching off deadly riots in Senegal and exacerbating famine in the African horn.

But the crisis could also be an opportunity for a continent where large tracts of land lie fallow. The hunger for commodities among investors in the Middle East and Asia has overwhelmed their perceptions of risk in East Africa and the Horn, and has pumped fresh resolve into the region to tackle its infrastructure challenges.

A recent Indian investment in an Ethiopian sugar project is one case in point.

“This year India’s Exim Bank moved in to provide around US$640mn out of the [Ethiopian] government’s US$1.3bn projected spending,” comments OB Sisay, deputy Africa analyst with Exclusive Analysis. “I think it is a trend you are going to see a lot more of. The UAE and other Arabic investors are looking to increase food production, not just sugar, but right across the board.”
Infrastructure hurdles
While Equity may have hit upon a means of financing a small and fragmented soft commodities market, by working from the ground up, financing is but one of the hurdles local producers will have to overcome in order to compete on an international scale. The largest of those is inadequate infrastructure. Without improvement in that sector the country will remain a net importer of not only manufactured goods, but also agricultural products.

According to Sisay, the new scarcity of soft commodities means investors are increasingly willing to build infrastructure to get at them.

“The infrastructure growth is going to be pushed by the commodities growth,” Sisay comments: “If India and the Chinese and the Russians come in, one of the key sweeteners they are offering African governments are infrastructure products.”
And there is little doubt that nothing could be sweeter on a continent where great potential continues to languish in backlogged ports and at the wrong ends of treacherous roads and sleepy railway lines.

For many producers in East Africa and beyond, it is still easier to trade with the Europe, the Middle East and Asia than across borders a few hundred kilometres away.

“It will cost five or ten times as much to get the goods from where they’re produced to the port as it will to get them from the port to wherever they are going,” remarks Peter Jones, chief executive officer at African Trade Insurance Agency (ATI).
For its part ATI has been supporting road construction and the roll out of a fibre optic backbone in the region.

But there’s still a long way to go. According to a 2006 report by the World Bank, Africa would need to make an annual investment of US$20-25bn over the following 10 years in order to bring rail, road, telecoms, electricity and water sanitation in line with Millennium Development Goals for 2015.

Spearheading top priority regional projects is the New Partnership for African Development, or NEPAD, an African Union programme working in partnership with the United Nations and African Development Bank. Support from the private sector will be crucial.

“Traditionally we’ve relied on donor funding,” said Lynette Chen, chief executive officer at the NEPAD Business Fund. “But, as the commercial sector grows, there definitely will be a lot more economic returns for the private sector.”

In Kenya, where the new government has launched an initiative to give infrastructure investment highest priority, some local bankers see a construction boom in their future.

“Look at the ambitious plans that Kenya has,” said Samson Waka, senior manager of trade finance at Kenya Commercial Bank. “There is going to be massive reconstruction. For people who want to invest in that activity, the place to be is Africa.”
Western banks involved in commodities finance are watching closely. But they are tentative.

“Increasing Chinese investment in infrastructure is very exciting,” said Karel Valken, global head of agri-commodities at Rabobank. “For us as a bank to step in it is a little early.”
Political risk
After Kenya’s political crisis this winter a heightened perception of political risk in the region prevails.

“Short term our outlook for Kenya is quite negative,” said Tom Christie, Africa economist with TKTK. “Our forecast for Kenya is 3% down from 7-10%. That is really a result of constraints caused by political upheaval earlier in the year, which has had a negative effect on outputs.”

And Kenya’s viability is crucial to that of the East African region.

Photos of men brandishing crude weapons and burning tyres somewhere in Africa may not seem like particularly novel news items. But, when pictures cropped up this winter, investors took notice. Because those youths weren’t just anywhere, they were in Kenya, which meant that those roads weren’t just any roads but the roads linking the bulk of East Africa to the sea and vital trade routes to the east and west.

Indeed, news of Kenya’s post-elections crisis threw into doubt the country’s image as a dependable if rickety engine for the East African economy.

“If Kenya had collapsed then it would have had a huge and very significant effect on the landlocked countries that need to get everything through Kenya,” said Jones of ATI. “What it did was it demonstrated very clearly not just to the outside world but to Kenya and East Africa that political risk still does exist, that political risk is real.”

Now though, eight months after the first riots broke out, there are signs that, even as the violence crescendoed and the faith in political leaders crumbled, the country’s financial institutions barely seemed to tremble and it held its advantage as a shipping destination.

“Although our forecasts for Kenya are negative at the moment, I think the country still does have a relatively good infrastructure for the region both in terms of its geographical location, with Mombasa being a regional port, and having a financial system that is sophisticated,” said Christie. “If power sharing is sustainable and can create a lasting peace, I think investors will come to the country in a greater number than 2008.”

Kenya’s banking sector is robust. Capital adequacy and the ratio of nonperforming assets fell considerably to around 11% last year, according to Christie.

In April, the country saw the largest initial public offering in East African history – so eager were investors to claim a stake in the homegrown Safaricom, the country’s leading mobile network operator, that the IPO was oversubscribed by 532%. In August, both Equity and Kenya Commercial Bank (KCB) announced substantial increases in net profits, with the Central Bank of Kenya reporting the sector’s profits during the first four months of this year were 35% higher than the same period last year. That same month Standard & Poor’s bumped its outlook for Kenya from stable to good.

Roadblocks are long gone and rail lines, parts of which had been destroyed by angry rioters after the announcement of results for the presidential elections, are once again functional.

“It is opening up again after the trouble that was in Kenya,” said Donavan Oliphand, managing director for Southern Africa with Drum Resources, a collateral management company based in London that also ensures smooth transportation of goods in Sub-Saharan Africa. “The rail lines are starting to operate again and things are moving freely.”
Trade barriers
Most agree the best shot at growth sub-Saharan African economies have will be through regional cooperation and trade.

“Africa is thinking about the future,” said KCB’s Waka. “We need to remove our own restrictions here, trade amongst ourselves in this East African region. The market is huge. We believe that if we expand and we integrate more we will do much better.”
But regional barriers to trade remain formidable.

Though a dozen regional economic bodies exist across the continent, there is still a long way to go. It’s not just that distances to the Middle East and beyond have been more effectively bridged than those within the continent. A deficit of trust between countries has at times stilted the flow of trade.

“50% of the benefits to Africa out of the Doha round would come from the removal of internal barriers,” said Jones of ATI. “So, theoretically, they could take 50% of the benefit just by agreeing amongst themselves to remove the barriers but that’s huge.”
Nowhere is the vulnerability of integration efforts to domestic politics more evident than in the case of Kenya’s sugar licenses.

Sugar has always been controversial in the region – from last year’s racially tinged riots in Uganda to a temporary block on imports and exports of the commodity this summer in Kenya.

In June, Kenya’s agricultural minister, William Ruto, abruptly cancelled all licences for the import of sugar, accusing traders of evading license fees and taxes, and undermining domestic production. Shortly thereafter, all but two export licenses were cancelled for similar reasons.

Those close to the business suggest Ruto’s reasoning was sound. The Common Market for Eastern and Southern Africa (COMESA), has granted Kenya special permission to impose a quota of 200,000 tonnes on tax-free sugar imports. That’s just enough to plug the difference between local production and demand, without displacing local producers. In recent months, though, it became evident that more than that amount was making its way past Kenya Revenue Authority officials at the port in Mombasa.

Nedbank, which finances importation of sugar to Kenya, believes the government’s grievances were real and that excess sugar was finding its way onto the market, says John Vowell, director of structured trade and finance at Nedbank.

KCB is involved with export and pre-export finance for domestic but has steered clear of sugar imports.

“As KCB we are not active in it,” said Waka. “In terms of importation we look at it as a political product and we don’t handle it ourselves. As a bank, we keep a professional distance.”

Import and export licences were reinstated in August and COMESA has allowed Kenya to extend the sugar quota for another four years. But sooner or later Kenyan producers will have to compete.

“Initially this is just a stall,” said Sisay of Exclusive Analysis. “If Kenya’s local producers can’t compete, they will not be able to keep a quota that long so they will be forced to withdraw.”

Insurers say the Kenyan government’s move, while not unusual, could possibly affect the price of doing business there.

“The revoking of export licences tends to hit international commodity traders and may increase insurance pricing for transactions in the agricultural sector in that country,” says Elizabeth Stephens, a political risk analyst with Jardine Lloyd Thompson. “It should be noted that Kenya is not unusual in this regard and a number of other emerging market governments have banned exports of certain food commodities to stabilise domestic prices.”

Demand is only going up. Most recently, the government has partnered with Mumia’s, the largest sugar producer in the country, on a US$350mn project that would include the construction of a plant meant to convert sugar into ethanol to be used in biofuel production. Vast plantations set up as part of the project would also be meant to plug the country’s sugar deficit.

For now, though, the project is hung up in court as critics, including Kenyan Nobel Laureate Wangari Maathai, say the project will damage the environment and threaten traditional inhabitants of the sweeping Tana River Delta.

Scaling up
Stalled though it may be, the large-scale nature of the project points in a direction that many producers of soft commodities will have to take if they are to attract financing for the rising costs of inputs like fertiliser, insecticides, seedlings and transport.
One industry that has taken advantage of economies of scale to thrive in the face of violence and rising fuel prices is floriculture. In the wake of elections violence, the industry managed to overtake tourism, long Kenya’s top earner.
So a trend towards investment in large-scale agribusiness makes sense.

“Investors are getting into larger-scale rice farming in lower lying areas that get more water,” said Stephen Muriu, head of global and commodity corporates in the origination & client coverage section of wholesale banking with Standard Chartered Bank, Kenya.

“We see larger teas – the Unilevers and Findleys of this world are staying and actually expanding the tea growing and getting into the flori and horticulture straight to the UK market or flowers to the European or Dutch markets.”
Rising input costs mean finance is very much in demand.

“It’s quite a challenge from the perspective of a bank trying to continually fund that sector,” Muriu said. “It’s a huge sector and it takes almost 50% of the GDP in all the East African countries.”

It remains to be seen whether local banks and producers will be able to capitalise on the trend towards larger scale production.

Equity bank is creating youth funds and “miracle funds” to bundle needs of tiny businesses into one import facility – a new trend for East African markets, which may auger similar facilities for small-scale farmers. But there is a way to go.
“Taking coffee as an example, you have so many smallholders,” said Valken of Rabobank. “The market is very fragmented. As long as these producers are not united in a bigger fashion it would be difficult for international banks to participate.”
Expanding footprints
There is strong evidence that investors with a toe-hold in the region are extending beyond traditional relationships in Kenya, Uganda and Tanzania.

As Burundi’s political climate cools down interest in high quality coffee and tea crops is heating up.

As prices and production rise, Burundi Tea Board is predicting a surge in tea revenues this year to US$13.5mn from US$9.3mn in 2007.

Starbucks has invested in the country’s coffee sector.

“Following the end of the war, the investment climate has steadily improved and recently things have really started to take off. Some of the big players especially in the coffee sector are now coming into the market in Burundi,” comments Simon Cook, a partner with the London law firm Denton Wilde Sapte. “Some new micro-finance regulations were also brought in in the last couple of years which has had a positive effect on investment in SMEs in the trade and commodity sectors. This positive climate is starting to show itself in Rwanda too.”