Kenya: Why the Yes Vote Will Force a Radical Change in Country's Risk Rating

9 August 2010
Nairobi — Foreign businessmen in Europe and the US who have committed billions of dollars to the Kenyan economy went to bed on Tuesday night with major doubts in their mind.
There was, after all, a high chance that violence would break out if Kenyans voted for the new Constitution and major newspapers around the world had warned their readers over the weekend about this gloomy expectation.
However, they awoke on Wednesday morning to the sobering reality that there would be no violence in Kenya - meaning that they were assigning a punitively high political risk rating to the country.
With Kenyan politics now showing strong signs of stabilising and the country taking significant steps with the passing of the Constitution that could quicken the pace of consolidating democracy, investors will in the next few months be forced to radically reassess their risk models.
It is a path Kenya was expected to pioneer two years ago, but failed with major consequences. Ghana, with its peaceful elections last year, set the pace and Kenya's peace referendum puts it in the league of emerging democracies in Africa.
If the level of global optimism persists, it could see a new wave of rising foreign investment flows into Kenya leading to a major strengthening of the shilling and the emergence of a bull market in the equity and property markets.
This realignment of risk will affect both investment portfolios held by foreign institutional investors and major firms that have either scaled down or held back their involvement in Kenya as the country fell out of favour with politicians in the West because of its bad politics and governance issues.
Over the past eight years, more so after the 2008 political violence, Kenya has ranked consistently among the basket cases in the influential Failed States Index compiled by Foreign Affairs magazine and the Carnegie Foundation's Fund for Peace.
In the 2010 rankings, Kenya dropped to position 13, sitting at the bottom with neighbours Somalia, Democratic Republic of Congo, Sudan and Chad.
This ranking was in the same league as Iraq, Afghanistan and Pakistan. Freedom House, an organisation that specialises in promoting democracy, ranked Kenya among what it calls "partially free" nations.
In the world of a human-rights activists sitting in Washington, there seems to be no difference in perception of whether Kenya in 2010 is a failed state in the same league as Somalia or Afghanistan, but these rankings shape the perception of trustees of pension funds making decisions over whether to put their money in KCB shares or HSBC in Hong Kong.
The questions that are likely to occur when judging the Kenyan situation as an investment case is how much longer Western firms can continue missing out on opportunities as Brazil, India, Russia, China and South Africa, the so-called Brics nations, continue making inroads into the continent.
Why would Bric nations have a better perception of risk when it comes to Africa? A lot of it comes down to the fact that these countries have shared experience in their development path with African nations.
Indeed, some of them have political systems that are not judged as democracies and their managers know well how to operate in these environments.
Political risk ranking is important in a world where investors have to take decisions on where to invest billions of dollars every year based on how they and a small group of rating agencies perceive the political risk in a country.
A poor judgment of risk could see the entire investment lost in conflict countries or conversely, a major investment opportunity missed.
As managers and diplomats from Europe and North America struggle to understand the rapidly shifting political fortunes in Africa, Russia, India and Brazil have capitalised on this uncertainty with their firms investing billions of dollars in Africa.
Firms from these countries have invested close to $100 billion here since 2003.
In the past few months, Bharti Airtel made a splash by buying Zain's mobile phone operations in Africa for $10 billion.
Other Indian firms like Essar and Reliance are also making major investments on the continent.
Chinese firms have been investing heavily in the energy, mining and construction sectors.
However, as much as the adventurism of Chinese and Indian firms has continued to receive a lot of attention, attitudes among Western firms are starting to shift as witnessed in the emergence of a strong private equity sector in sub-Saharan Africa.
According to data compiled by the Emerging Markets Private Equity Association, sub-Saharan Africa attracted $1 billion in the first half of 2010, bringing the total investment in the sector so far to $1.9 billion.
Of the 10 funds that succeed in raising money through mid-year, only three were country-dedicated (two for South Africa, one for Angola).
The balance of funds are focused on regional strategies, most with footprints spanning a handful of markets.
Most are generalist in strategy, but it is expected that the focus sectors will continue to be energy and natural resources, financial services, and consumer goods & services.