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19 May Why a Post-COVID-19 World Needs Impact Investment
By Bert van der Vaart, SEAF co-founder and CEO
While the COVID-19 crisis continues to spread on a scale never before seen, many in international development and impact investment should start thinking of what comes next. The economic consequences of the COVID-19 crisis for the emerging and frontier markets are already prohibitive. It is furthermore clear that few if any of these economies can simply “go back to work” when the Virus has been sidelined. Rather, we expect to see significant changes in the roles of governments, global supply chains, and the nature of interdependence. These changes present impact investors unique opportunities to make a substantial contribution.
Together with my colleagues at Small Enterprise Assistance Funds, I’ve been privileged to invest in high impact, small-and-medium enterprises (SMEs) in underserved markets since 1989. Since our beginning, we have raised more than $1.2 billion and made 460 investments in 30 emerging and frontier market countries.
Zooming with my colleagues across the globe these last few weeks, I have become convinced that the world of impact investing must change post-COVID-19. More than ever, I am convinced that in that season of change and disruption, impact investors can help rebuild economies around the world. These are my predictions for a post-COVID outlook:
Most governments will need foreign investment to restart their economies.
Given the huge fiscal cost to developed markets of the COVID crisis, governments in the emerging and frontier markets will need to work with aligned private sector investors to avoid a debt crisis and the potential for “zombie” growth in the future. A major response to COVID-19 everywhere has been for governments to enforce lockdowns, which in turn requires them to subsidize companies and pay monthly stipends to residents not working. As a consequence, sovereign debt levels are rising everywhere, in many cases from an already sizeable base. Many banks and companies have pushed debt repayments back, which helps in the short run but also compounds overall levels of debt. Since most countries cannot simply print paper to finance these stabilizing payments, the net effect is a large increase in liabilities with relatively little hope of a strong recovery when it is deemed safe to “restart” the economies.
Equity and quasi-equity investments will be vital in the emerging and frontier markets in the aftermath of COVID-19.
Equity investments will be necessary for the major infrastructure changes countries will implement, from online services for health and education to increased internet bandwidth, more resilient agribusiness value chains, or rural electrification. Such investments are much more likely to be in areas consistent with the UN’s Sustainable Development Goals (“SDGs”) than traditional investments such as minerals or tourism.
There will be a shift away from global supply chains to regional resilient supply chains.
Virtually all of our countries have experienced large supply shocks after China shut down its economy to slow the spread of the coronavirus. With the shutdown, a wide range of supply and demand items provided by China for its global supply chains came to a halt. From lithium batteries for solar energy companies in Guatemala or scheduled Chinese tour groups’ visits to Vietnam — everything stopped for eight weeks or more. Even though much of China is working again now, to avoid future vulnerability, we believe there will be an increasing emphasis placed on resilient supply, which will be expressed by governments and companies insisting that at least a substantial portion of their supply needs must be satisfied locally or regionally. Not only will regional economies reduce their vulnerability to global supply shocks, but this shift will also provide new jobs that will fuel local economic growth. SEAF has found that every $1 invested in SMEs brings $12 of interdependent economic activity to local communities.
Defaults are likely.
Without economic growth created by SMEs, we are likely to see slow growth, “zombie” companies working to repay their large debt overhang, and a potential wave of emerging market debt defaults, sovereign and to banks.
So how should impact investors prepare?
We believe more investment opportunities will exist focusing on regional geographies rather than those with global aspirations. Certain sectors will be far more interesting than others (I can expand on this in another post).
We believe emerging markets that are closer to major markets will do better — for example, Central America and the Caribbean near the US and Canada; the Maghreb next to Europe; the Levant (Jordan) and Turkey close to the Emirates and Saudi Arabia, as well as to Europe; and Vietnam and Bangladesh — close to Australia, Japan and to some extent South Korea. Wealthier countries will look for reliable partners closer to home. SMEs in these proximate emerging markets will become more competitive across a host of industry sectors, including health tourism, digital advertising, and business processing outsourcing, light manufacturing (especially using 3D printing technology or other relatively customized runs), and agribusiness value chains.
These aren’t theoretical notions for SEAF. Our investment outlook is based on the belief that resilience around the world will require SMEs to grow their payrolls, develop new supply chains, and grow to scale.
Engaging in this shift to local and regional economic resilience will require investment by parties who care about achieving such development, and not just for the maximum short-term profits — in short: a post-COVID world will need Impact Investors. These investors must be trusted locally. We have already seen demand from local governments and our DFI friends for SEAF to manage equity and working capital facilities to effect such local growth and transition in the post-COVID-19 world. We think other impact investors will be increasingly involved as well.
COVID-19 will likely be a defining world crisis for years to come. Impact investors can and must help SMEs in the emerging and frontier markets grow and reposition — otherwise, many of the gains made in the emerging markets over the past 30 years may be undone.