US Fed Rate Cuts Set to Reshape Global FDI Flows—Impact on Kenya and East Africa

The US Federal Reserve’s decisions on interest rates reverberate across global financial markets, influencing foreign exchange dynamics, liquidity, and Foreign Direct Investment (FDI) flows.

On September 18th, 2024, the Fed opted to lower interest rates by 50 basis points (bps), an unusually big cut indicative of the US Central Bank’s confidence that it is winning its battle against inflation.

While some view this move as an election-year tactic to boost voter confidence through economic optimism, the rate cut opens significant opportunities for emerging markets, including Kenya and East Africa.

Relationship between US Fed Rates and global FDI flows

There is generally an inverse relationship between the Federal Reserve’s interest rates and the flow of FDI globally. When US rates decrease, investments in US-based assets yield lower returns, prompting investors to explore higher-yield opportunities in foreign markets.

Conversely, when the Fed raises rates, capital flows back to the US as higher domestic returns become more attractive. This shift directly impacts emerging economies, which rely heavily on FDI to spur economic growth.

Implications for Kenya and East Africa

With the US rate cut, economies across East Africa could potentially see a rise in foreign investment if local conditions are conducive to capital inflows. Here are some of the likely scenarios:—

Capital Inflows to Emerging Economies: A lower interest rate environment in the US makes domestic investments less attractive, prompting investors to seek higher returns in emerging markets. Kenya, along with other Eastern African nations such as Tanzania, Uganda, Ethiopia, and Rwanda could see a rise in investments.

Devaluation of the US Dollar: An increase in FDI outflow typically weakens the US dollar, making foreign assets more affordable for international investors. Kenya’s manufacturing sector stands to benefit significantly if positioned strategically, potentially creating thousands of jobs. At the same time, a weaker dollar will ease the stress of repaying foreign-denominated debt, making debt servicing more manageable for the Kenyan government.

Elevated Investor Confidence: A Fed rate cut is typically interpreted as a sign of looser monetary policy, increasing global liquidity and encouraging investors to take on more risk. This is particularly beneficial for developing markets such as East Africa, where global investors are on the lookout for untapped opportunities. Kenya, with its relatively stable democracy and consistent economic growth, can position herself well to attract foreign investments under such conditions.

Long-Term Infrastructure Opportunities: The reduced global borrowing costs, driven by lower US interest rates, enhance the appeal of long-term investments in large-scale infrastructure projects. Key initiatives such as the US-backed Nairobi-Mombasa expressway or the Private Special Economic Zones (SEZs) are likely to gain more foreign investment as a result, helping to drive regional development.

Local challenges and competition from Asia markets

While the US Fed rate cut creates favourable conditions for foreign investment, East African economies, face a dual challenge: addressing internal obstacles to attract FDI while competing with the more attractive Asian markets.

Over the last couple of years, the overall FDI inflows to developing Asia remained steady at $663 billion, accounting for roughly half of global FDI, whereas Africa attracted only 3.5 percent of global FDI inflows, with $45 billion​ (as per Lloyds Bank Trade)​.

However, while the external environment may be favorable, East African countries must first overcome internal obstacles and contend with competition from other emerging markets, particularly in Asia. Here’s how I think they can do to compete favourably:—

Political stability and governance: Political stability is crucial for investor confidence. While generally stable, the region has experienced electoral tensions in the past and this can dampen investor confidence.

In contrast, many Asian economic powerhouses such as Singapore and South Korea, offer predictably stable political environments, reinforcing their attractiveness to global investors.

To compete effectively, Kenya must prioritize transparency, establish a consistent governance framework, and strengthen the rule of law.

Regulatory and Legal Framework: A clear and efficient regulatory framework can make or break FDI attractiveness. Excessive bureaucracy, legal ambiguities, and delays in processing investments can frustrate foreign investors.

In contrast, Asian markets offer streamlined processes, transparent regulations, and investor protections that make doing business easier. For example, countries such as Vietnam and Malaysia are known for their business-friendly policies, making them prime destinations for foreign investors.

To compete, therefore, Kenya and its neighbours must simplify regulatory processes, cut red tape, and ensure that foreign investors are protected by a strong legal system.

Infrastructure Gaps: Despite progress in building roads, ports, and energy infrastructure, Kenya and other East African nations still face significant gaps. Large-scale investments in transport, logistics, and energy infrastructure are necessary to enhance the region’s appeal.

Meanwhile, Asian nations have already made significant strides in building world-class infrastructure, from ports to high-speed rail, making them more appealing destinations.

High transportation costs make Kenyan products more expensive than their Asian counterparts. Public-private partnerships (PPPs) play a crucial role and must be encouraged in addressing these gaps by mobilizing private capital for development.

Human Capital Development: Investors are increasingly looking for markets with skilled workforces. East Africa has a young population, but there is often a mismatch between the skills available and what foreign companies need.

Investing in education, vocational training, and technical skills development is essential to build a competitive workforce that can meet the demands of FDI-driven sectors such as technology, manufacturing, and services. In contrast, many Asian countries, particularly India and China, have heavily invested in education and vocational training, making their labor markets more attractive to investors.

Developed Financial Markets: Asian economies, such as India and Singapore, boast well-developed stock exchanges with high liquidity, providing investors with diverse and secure investment opportunities. The depth of financial markets in Asia, combined with strong regulatory frameworks, allows these countries to absorb large volumes of capital, leaving countries like Kenya at a disadvantage.

In contrast, Kenya’s Nairobi Securities Exchange (NSE) has struggled in recent years, with limited liquidity and no major IPOs in almost a decade. This stagnation makes Kenya less attractive to Foreign Institutional Investors (FIIs) seeking liquid and dynamic markets.

Focused Strategy: Leveraging Kenya’s Unique Geographical Value Proposition (uGVP): To maximize FDI, Kenya must adopt a focused strategy centered on its unique geographical value proposition (uGVP). Rather than reacting to external trends or foreign agenda, Kenya should develop a clear, data-driven plan that targets high-potential sectors such as manufacturing, agriculture, and renewable energy.

By leveraging deep data analytics, Kenya can identify gaps in global value chains and position itself as a key player, offering substitutes or complementary products in areas where it has a competitive edge.

This approach will ensure that investment efforts are aligned with Kenya’s strengths, attracting investors to strategically chosen projects and sectors, leading to sustainable economic growth.

Proactive Investor Outreach and Well-Packaged Bankable Projects: A key advantage Asian economies have over many African nations is their proactive approach to attracting foreign investment. Governments in Asia, particularly in China, India, and Singapore, actively engage in headhunting investors by presenting well-packaged, bankable projects that cater to global investment trends.

These projects are often accompanied by comprehensive risk assessments, clear timelines, and attractive incentives, making them highly appealing to investors, and are presented to potential investors by seasoned professionals and not government officials.

East African countries, on the other hand, have been less aggressive in pursuing foreign investors and often wait for investors to come to them. To compete, Kenya and its neighbours must adopt a more proactive approach, identifying and packaging high-potential investment projects while ensuring that these opportunities are effectively marketed to the international investment community.

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Fed Rate Cut a strategic opportunity for Kenya

The recent US Fed rate cut presents a strategic opportunity for Kenya and East Africa to attract more FDI. However, critical reforms are required to compete with more established regions such as Asia.

Kenya should leverage its unique geographical value proposition (uGVP) and focus on specific high-potential sectors, particularly manufacturing, which offers strong growth prospects and the ability to create large-scale employment, thereby enhancing the spending power of the population.

To support this, improving infrastructure through PPPs will be essential, especially projects like the Nairobi-Mombasa expressway to reduce logistic costs. Furthermore, revitalizing financial markets, particularly the NSE, by improving liquidity and encouraging more listings, will help attract institutional investors.

By proactively reaching out to qualified investors with well-packaged bankable projects, Kenya and its East African neighbours can position themselves as competitive alternatives to Asia, driving economic growth and job creation in key sectors.

The author, Mahesh Punia, is a practicing geo-economist and Head of Advisory at Andersen Kenya