Methodology

Africa’s economic potential is widely recognised but often misunderstood. The potential reward from operating a successful business on the continent is easy to comprehend, but the idiosyncratic risks that each country poses is a different story altogether. Many corporations have rushed into these frontier markets with the aim of leveraging first-mover advantage, only to exit that market a few years later with a severely dented balance sheet. NKC’s in-depth macroeconomic and political research and its granular risk assessment provide a unique toolkit with which companies can assess a country’s business environment and detect potential risks before they become a reality.

Economic Risk

Our distinct risk measures provide a unique framework in which we communicate our latest economic forecasts and translate how these figures affect the business environment. Each risk measure comprises a collection of indicators that drive that specific risk, weighted in proportion to the importance of each driver. The indicators are a combination of data-based scores, performances in prominent global economic/political indices, and subjective scores assigned by country-specific analysts. Each score reflects the extent to which that indicator represents a risk going forward, with the aggregation providing a score out of 100, with 0 suggesting no risk and 100 implying maximum risk. A brief description of each economic risk indicator follows:

• Economic Policy Risk: The extent to which government policy hampers business operations and the risk of adverse policy adjustments. This score measures risks associated with monetary, fiscal, exchange rate, and regulatory policy.
• Economic Structure Risk: An assessment of the structural vulnerability of an economy. This considers projections regarding debt ratios, growth drivers, external balances, and the financial structure.
• Liquidity Risk: The risk that forex constraints prevent profit repatriation and the funding of imports. This risk looks at key forex reserve metrics and the ability to source hard currency.
• Market Demand Risk: The risk of a deterioration in demand conditions in the country. This reflects NKC’s baseline economic growth forecasts, wealth levels, and historical demand volatility.
• Market Cost Risk: The risk that the cost of operating a business in the country will increase. These scores take into account our baseline forecasts for wages and inflation, input costs, and policy effectiveness in containing price growth.
• Exchange Rate Risk: The risk of a depreciation in the value of the currency. These scores are based on our baseline currency forecasts, fundamental evaluation, current and capital account positions, as well as the policy stance.
• Fiscal Finances: The risk that government finances will become unsustainable. These figures incorporate our baseline projections for key fiscal metrics, fiscal policy orientation, and aid dependence.
• Financial Sector Soundness: The risk of instability in the domestic financial sector. This considers the health of domestic financial institutions, the range and efficiency of monetary tools, and government’s involvement in the banking sector.
• Balance of Payments Risk: The risk of an external funding crisis. These scores reflect a country’s current account position and the outlook regarding various funding channels, including external debt, forex reserves, and foreign investment.

This comprehensive methodology allows for comparisons between countries on each risk measure. The risk structure graph also puts a country’s performance into context by comparing it to the median of the 10 best performing countries and the 10 worst performing countries in that measure.

Political Risk

African states tend to be politically less stable than states in other regions, owing to the legacies of the colonial era and the Cold War. This political instability has significant effects on the economic and business environments, and for this reason political research has always been a key part of NKC's overall risk analysis.

Our political risk assessments draw on data from a number of authoritative sources to create two indices. The first index measures structural risks which are risks that do not change rapidly and form the broad context in which power is contested and exercised. The second index measures institutional risks which could be described as institutional quality – institutions help mitigate risks that emerge from the political structure. Thus, even a country with factors that make it politically risky in theory can have lower risk thanks to strong institutions.

Structural Risk: an index comprising data related to 12 factors, including: average conflict fatalities per 100,000, ethnic fractionalisation, demographic pressure, and poverty rates.

Institutional Risk: an index consisting of data related to six factors, including: rule of law, level of democracy, duration of current regime, and level of corruption.

These risk measures ensure that our assessments are objective and that risk is comparable across both time and countries. However, the data used is by its nature historical, while political risk assessments need to be forward looking. This is where our third measure of risk – Analyst’s View and Forecast – makes the vital difference. Analysts complete a structured assessment of risks that a country might face in the short - to medium term. This score and its implied trend are added to our overall risk assessment to incorporate our analysts' experience. This ensures our assessment is an accurate guide to how political risk will evolve in the near future.

Overall Economic and Political Risk Assessment

The various economic and political risk measures are aggregated to formulate an overall country risk score. Our assessment of economic and political risk is not comparable to the credit risk ratings issued by international ratings agencies as we do not rate the attractiveness of sovereign debt instruments, but rather express a view on overall macroeconomic and political country risk.