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How does political risk affect capital markets in Africa?

Investor sentiment around the importance of political risk has transformed overtime. Having previously turned a blind eye, companies are increasingly placing these risks at the forefront of their corporate strategy. Given the response of global capital markets to political risk scenarios around the world in 2017, this development should come as no surprise.

Dollar and bond yields reacted to serious concerns about the viability of the ‘Trump turmoil’ in the United States, while the post-Brexit agenda continues to be one of the biggest sources of risk for Britain’s largest listed companies. In Africa, divisions within South Africa’s governing ANC party saw rating agencies relegate the country’s credit rating to junk status, as Mozambique’s jocularly known “tuna-bond” scandal rocked the country’s already spiraling debt and financial crisis.

The damage? A cut in the country’s credit rating to junk status, which triggered a rise in the cost of borrowing in Africa’s most industrialised nation.

Very few countries are actually exempt from such risks, so we should at least find comfort in knowing that we’re all in this together. That having been established, the ultimate question is, how are companies able to manage these risks?

Managing political risk

Just as each country’s history and culture is unique, so too is its political risk landscape and the way in which these risks should be managed. One needs to look no further than Africa for a slew of examples to support this claim. Characterized by its countries’ colourful politics and personalities, prompting headlines to change minute by minute, it’s no wonder that capital markets are so reactive to domestic goings on throughout the African continent.

Take South Africa for example. Zuma’s patronage politics, run under the guise of the so-called “radical economic transformation”, has been described by critics as a smokescreen for state capture, causing personal business interests to flourish in the midst of a recession. As a result, the respected Finance Minister, Pravin Gordhan, recently found himself sacked, causing the rand, which had been one of the best performing emerging market currencies, to plummet by approximately 7% in just one week; it was the first fall since late 2015. And the damage? A cut in the country’s credit rating to junk status, which triggered a rise in the cost of borrowing in Africa’s most industrialised nation.

Once the storm had passed, the rand quickly showed signs of recovery, demonstrating the market’s resilience following Zuma’s somewhat feeble attempt at repairing the damage. For anyone trading in South African markets, the unpredictability has certainly been tricky to manoeuvre. Through an intricate understanding of what drives the key decision-makers and their choice of policies, coupled with a solid grasp of the stakeholder landscape, we at AML have ensured that our clients operating in South Africa and beyond have been able to effectively navigate such risks.

Whether in the public or private sector, it is important to conduct a thorough reputational assessment of those with whom we plan to do business.

Not all markets have been as resilient with respect to their domestic issues. The impact following Mozambique’s debt saga, wherein state owned companies borrowed approximately US$2billion from Credit Suisse and VTB, was momentous. Yields on the bonds soared, and the country defaulted on its interest payments. S&P, Moody’s and Fitch all downgraded the country’s credit rating, making the prospect of commercial borrowing highly unlikely in the short-term. With the recently published Kroll report revealing US$500million of unaccounted for funds, it’s looking increasingly unlikely that there will be an IMF re-engagement, which investors typically view as a safety net. The most salient takeaway from the Mozambique’s debt scandal has been the need to conduct proper due diligence. Whether in the public or private sector, it is important to conduct a thorough reputational assessment of those with whom we plan to do business. AML keeps its clients fully informed of government actors in the jurisdictions where they operate, providing them with tools to better manage these stakeholders, and subsequently, their operations.

Managing risk without a guidebook

Having said that, not all political risks are easy to manoeuvre. Case in point: Nigeria, where traditional currency hedging strategies do not work. This does not fare well for Nigeria, where the Naira has been consistently volatile. The brief uptick in confidence after the postponed election in 2015, which saw Muhammadu Buhari claim victory over the incumbent in a fair and peaceful election, quickly began to erode as the new president took several months to appoint a cabinet and submit a national budget for approval. During the same period, the divergence between the official and unofficial Naira rates resulted in JP Morgan dropping Nigeria from its Government Bond Index for Emerging Markets in September 2015, thereby confirming that the country had entered a recession. In such instances, where traditional currency hedging strategies do not work, insights into the policy forecasts and government agendas are necessary in allowing both multinational and domestic firms to more effectively mitigate their currency risk.

The key to managing political risk is information capital. Despite those whose profession it is to predict financial market trends, there is always a degree of uncertainty, particularly in the African context. However, by maintaining a robust network of high-level political and private sector sources throughout the continent who are close to the deals and decisions that shape policy and affect change, AML has become a trusted advisor for those looking to manage these risks and realise the vast potential of African markets.

 

Ross Alexander will be presenting a keynote at the upcoming FundForum Middle East and Africa, 'What developments are needed to boost both domestic and international in Sub-Saharan African markets, and is the political will there to enact these?'

Find out more about the worlds leading Emerging and Frontier Markets event.

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