Responsibly Financing Africa’s Missing Middle

Author: Alexander Raia, Managing Director of Cauris Finance

Small and medium-sized enterprises (SMEs) play a major role in all countries. But their impact is particularly critical in emerging and frontier markets, where they are the backbone of economies. In Africa, SMEs are engines of economic growth, providing essential goods, expanding employment opportunities, and contributing to national income. 

Indeed, it is difficult to overstate SMEs' essential and outsized economic role across the continent. Africa’s 125 million formal and informal SMEs (inclusive of micro-enterprises) account for more than 25% of the world’s total SMEs. In Africa, SMEs represent 90% of all private sector businesses, generate 80% of job opportunities in many sub-Saharan markets, and supply 80% of all consumer goods sold on the continent. In addition, SMEs contribute between 20% and 40% of the national GDP in some African countries, and these numbers are higher when informal SMEs are included.

SMEs also play a key role in reducing poverty and inequality because they provide job opportunities for people with limited formal education or formal skills. Often, they are among the only entities stimulating economic activity in rural areas with the highest poverty rates. 

Africa is currently undergoing rapid and transformative demographic shifts. By 2050, the continent’s population is projected to reach 2.5 billion. Urbanization is set to triple, with 50% of Africans expected to live in cities by 2030. Additionally, by 2034, Africa will host the world’s largest working-age population, estimated at nearly 1.2 billion people. These demographic changes present significant opportunities, but only if countries can generate the growth and jobs that provide people with economic agency and economic security. SMEs will play a crucial role in meeting these demands, supporting sustainable development and fostering economic resilience.

Although SMEs are Africa’s most powerful unit of change, they also comprise the continent’s oft-cited “missing middle,” too big to be served by microfinance institutions alone and too small for many traditional commercial banks. The SME financing gap in sub-Saharan Africa is estimated at $331 billion, and it continues to expand despite significant efforts from both public and private capital providers. Access to credit is a critical challenge—and arguably the most critical challenge—facing African businesses today. Yet African SMEs have historically borne a disproportionate share of the continent’s market failures, most notably in terms of limited access to local currency financing. 

A wide array of investors in Africa provide hard currency in lieu of local currency financing. This includes development finance institutions (DFIs), private credit funds (like us, at Cauris), and even individual investors whose financing reaches African SMEs through direct deals or intermediaries. Understandably, investors often prioritize hard currency to safeguard their investments. Hard currency financing can mitigate their own exposure to currency risks or may be a requirement dictated by their own investors. This preference often stems from the perceived stability and predictability of hard currencies, such as the US dollar or euro, which are less susceptible to the volatility experienced in many African currencies. Additionally, hard currency financing can offer investors more straightforward financial reporting and easier cross-border fund transfers, making it an attractive option for funds with global mandates or diverse investor bases.

However, while hard currency lending can provide stability for lenders, it can pose significant challenges for borrowers. Exchange rate volatility can drastically increase repayment obligations, especially in African countries and in other emerging and frontier markets around the world where currency depreciation is common. Both acute and chronic depreciation can turn otherwise manageable debts into unmanageable financial burdens, posing severe, even existential threats to SMEs. This financial strain can disrupt cash flow management, hinder growth plans, and even lead to insolvency for businesses that are unable to absorb the increased costs. For SMEs operating on thin margins, such fluctuations can divert essential resources away from business development, innovation, and expansion. Ultimately, the risks associated with hard currency debt can amplify the already challenging financial landscape SMEs face.

The risk throughput of hard currency lending is particularly acute in Africa, where currency volatility is a frequent and well-documented challenge. African countries are especially susceptible to currency shocks due to their status as net importers, which heightens their exposure to external economic fluctuations and exacerbates currency depreciation cycles. These vulnerabilities are often compounded by global economic disruptions, trade imbalances, and reliance on imported essentials. When global commodity prices rise or geopolitical events disrupt trade flows, African economies that depend on importing goods such as food, fuel, and industrial materials face increased costs. This puts pressure on foreign exchange reserves, leading to currency depreciation as demand for foreign currency outstrips supply. Additionally, many African countries rely on exports of a limited range of commodities, making their economies highly sensitive to changes in global demand and price volatility. This structural dependence creates a cycle where external shocks further weaken local currencies, increasing the cost of imports and deepening economic instability.

Across the continent, many nations experience regular currency devaluations driven by structural economic vulnerabilities and external pressures. In fact, more than 20 African currencies have faced significant double-digit depreciations against major global currencies over the past decade, underlining the recurring, nearly endemic nature of these financial stresses. For example, in West Africa, the Nigerian naira devalued by more than 50% over a 12-month period through September 2024.  In East Africa, the Kenyan shilling experienced a 30% depreciation against the USD in 2023. These are not isolated events. Many African nations have experienced pronounced weakness against the US dollar in recent years, including Angola, Burundi, Congo, the Democratic Republic of Congo, Egypt, Ethiopia, Ghana, Malawi, South Africa, Zambia, and Zimbabwe among others. 

These examples underscore the persistent and severe risk posed by currency fluctuations in Africa, particularly for SMEs that often lack the resources and capacity to effectively manage currency volatility. Does this mean that financing African SMEs with hard currency should be avoided? We don’t think so. However, we do believe that the investor community must be more proactive and innovative in developing strategies and solutions to mitigate the risks associated with currency volatility—solutions that are both widely accessible and affordably priced.

A range of solutions already exist to help manage hard currency risk for both investors and SMEs. Traditional options include hedging through local financial institutions and specialized providers like TCX Currency Solutions and MFX, which offer hedging products specifically designed for emerging and frontier markets. At Cauris, we value our partnership with MFX (and so do our portfolio companies) due to their proven expertise and comprehensive suite of solutions that help mitigate risk for both our fund and the SMEs we support as end borrowers.

We are also encouraged by the expanding range of innovative solutions being piloted and scaled across the continent, particularly on the local currency front. For instance, TLG Capital co-launched Nigeria’s first local currency credit fund earlier this year. Additionally, last year the UK’s development finance institution, British International Investment (BII), established the Growth Investment Partners (GIP) platform in Ghana to provide SMEs with long-term, flexible capital primarily denominated in local currency. These initiatives are promising examples of the impactful solutions that can emerge when stakeholders collaborate and innovate to enhance Africa’s credit ecosystem.

Furthering this trend of innovation, the FX Innovation Workshop hosted by the Legatum Center for Development and Entrepreneurship at MIT and the Kuo Sharper Initiative (KSI) provided a crucial forum for tackling currency volatility challenges. Notably, the workshop centered African SMEs at the heart of all discussions, emphasizing their unique challenges and needs.

By convening a diverse group of African entrepreneurs, investors, DFIs, and thought leaders, the workshop fostered collaboration and the exchange of practical strategies. Participants explored solutions aimed at reducing risk and ensuring sustainable access to financing for SMEs. The energy and enthusiasm at the workshop highlighted the necessity for ongoing innovation and collaborative efforts to create solutions that are not only scalable but also affordable.

We walked away with a deeper conviction that while mechanisms that mitigate currency volatility risk are essential for investors, they are equally vital for the survival and resilience of African SMEs. Mitigating currency risk must be seen not just as an investor safeguard but as an essential strategy for empowering African SMEs. This approach is key to responsibly financing Africa's missing middle and ensuring these essential businesses can fulfill their potential in generating jobs, reducing poverty and fostering continent-wide sustainable development.

About Cauris Finance
Cauris is an Africa-focused impact credit fund. We specialize in supporting socially impactful fintechs that finance African SMEs and entrepreneurs, bridging the critical funding gap in the region’s “missing middle.” With a commitment to inclusive growth and expanding financial access, we prioritize investments that support small businesses, job creation (including for youth), gender equity and climate action.  Cauris integrates cross-cutting gender and climate lenses into its investment approach, championing the empowerment of women, sustainable climate solutions and equitable economic development.