The political instability of 2016 was less a blip and more a foretaste of things to come as the world enters a new era of political risk under the shadow of the Trump presidency, Brexit and a more assertive China.
That’s the downbeat message form global risk consultancy Verisk Maplecroft in its just-released Political Risk Outlook 2017, produced for multinational corporations (MNCs) and finance institutions, and drawing on predictive analytics, risk indices and forecasts from over 30 of the group’s experts.
This year’s report suggests that the upheaval of 2016 was not an outlier, but a paradigm shift in political risk that will create greater uncertainty for investors worldwide. The Government Stability Projection (GSP) predicts that all regions are more likely to experience a decrease in government stability over the next three years, with investors in developing markets most susceptible to negative shifts.
The Middle East and North Africa (MENA) and sub-Saharan Africa are seen as most exposed, with a respective 46% and 41% probability of deterioration for the average country.
However, businesses and investors accustomed to the traditionally stable markets may have to adapt most. According to the group’s projection data, Brexit has left the UK, a “longstanding bastion of policy and regulatory certainty”, facing a 69% chance that the stability of its government will deteriorate by 2019.
France, Germany and Italy also display highly uncertain outlooks, but the trajectory of risk in these countries could move either way, depending on the success of far-right parties and their populist agendas in upcoming elections.
“Governments facing heightened instability are prone to erratic policy-making, which can undermine investors’ trust in key institutions of the state,” said Verisk Maplecroft’s head of analytics, Guy Bailey. “While the outlook is not unremittingly bleak, the outputs of the model suggest that 2016 was not a one-off-investors should brace for more shocks.”
Western Balkans: A crisis in waiting?
The Western Balkans could provide one such upset; a region ripe for destabilisation by Russia states the report. The most likely focus of any such effort is Bosnia Herzegovina, with one of Europe’s most negative risk profiles in the GSP.
The report suggests Russia has the means and motive to target the European Union (EU) and North Atlantic Treaty Organisation’s (NATO) ‘soft underbelly’ as it seeks to contain further Euro-Atlantic integration. The Kremlin wields significant influence over the government in Serb-dominated Republika Srpska, a constituent entity of Bosnia and Herzegovina.
With Moscow’s encouragement and backing, the republic could act on its threat to proclaim independence. Bosnia is rated ‘high risk’ for issues such as the rule of law and corruption, so the government’s weak institutions would struggle to limit the damage caused by such a move.
While the chances of this remain low, a push for secession would fundamentally alter the political, economic and business landscape in the Western Balkans and nullify the 1995 Dayton Agreement, increasing the likelihood of armed conflict across the region.
Volatility to mark the Trump era
The election of Donald Trump as US president constitutes the most significant victory of anti-establishment political forces outside the UK’s Brexit vote, says Maplecroft. It expects the White House to be characterised by multiple competing power centres and impulsive decision-making that will raise the US political risk profile and inhibit a predictable operational environment.
Trump’s brand of economic nationalism will be framed by tax and regulatory relief and heavy protectionism, while the US’s trade relations and political risk ratings look set to deteriorate. His vow to reverse the decline in manufacturing has manifested in broadsides against individual firms, namely those with operations in Mexico. As this become the norm, the stock of those companies will likely experience intensifying volatility.
The administration will also take radical approaches, including the rigorous enforcement of trade rules and targeted tariffs on specific imports. This could spark reciprocal actions from major trading partners such as Mexico and China and engender a protectionist wave through the global trade regime. The degree of disruption to business will depend on how extreme the policy path is
Mexico will bear the brunt of any protectionist measures, which are likely to push the country towards recession. Trump’s “belligerent rhetoric” will also strengthen anti-US sentiment south of the border and provide a lifeline to left-wing oppositions in Mexico and South America’s two largest economies.
The wave of optimism that dominated Brazil and Argentina’s political shift towards more moderate leadership in 2016 is quickly dissipating. The report warns that the risk of disruption to business is increasing in both countries and if US policies contribute to slowing the economic recovery, a revival of left-wing populist parties in these markets can’t be ruled out.
China to step up Asia-Pacific influence
Verisk Maplecroft’s analysts believe that Trump’s dumping of the Trans-Pacific Partnership (TPP) trade deal, designed to be a cornerstone of US strategic engagement in the Asia Pacific region, presents China with a golden opportunity to strengthen its regional leadership role in 2017.
If Beijing can conclude the Regional Comprehensive Economic Partnership (RCEP), a free-trade agreement between 16 Apac countries, it would form the world’s largest free-trade bloc. This would represent a significant geopolitical win for China and major setback for US influence in Asia.
Unlike the TPP, the RCEP will lack a transformative effect on the business environment of participating states as the efficacy of individual regulatory systems varies considerably across the 16 potential members of the bloc.
The worst-performing states, most notably China, will not be compelled to strengthen labour rights or environmental standards, or curtail privileges afforded to state-owned enterprises under the RCEP. Regulatory and operational risks in many key Asian sourcing hubs may, therefore, remain significant for years to come.
South China Sea a potential flashpoint
One potential barrier to finalising the RCEP is Chinese president, Xi Jinping’s, need to portray a “strongman image” that may push him to overreact to perceived provocations in the East or South China Seas. This could increase regional tensions and undermine the goodwill needed to conclude the RCEP.
The South China Sea is identified in the report as a potential flashpoint for tensions in 2017, with an 81% chance of a dispute involving China and one of the other nations involved in territorial claims. However, any dispute is unlikely to be so great that it will scupper the deal.
Another key determinant of South China Sea tensions is the role the US will play in the region. The group predicts an 87% chance of a dispute occurring between the US and China. Threats and displays of force, such as freedom of navigation patrols by the US navy, are the most likely scenario, but the use of military force cannot be rule out entirely.
Indeed, it looks increasingly likely that the incoming Trump administration may abandon the current US policy of maintaining a neutral stance on the validity of individual territorial claims, and adopt a more confrontational posture with regards to China’s activities in the region. This is likely to add fuel to the fire and suggests that 2017 may well witness increasing levels of interstate tensions in the South China Sea.
Other risks to watch
Other potential risk areas highlighted by the report:
- Three dynamics that could reverse the decades-long rally in global trade volumes: worsening US/China relations; the shaky outlook for economic integration in Europe post-Brexit; and the potential for ‘currency wars’ if China allows the yuan (CNY) to fall more sharply.
- Sentiment analysis, tracking UK/EU dialogue on Brexit, reveals ‘mood swings’ in the current relationship, implying that negotiations could descend into rhetorical trench warfare and increase the prospects of a chaotic, acrimonious Brexit.
- Donald Trump’s Middle East senior security and foreign policy picks suggest he will take a tough stance against Iran, which could be bad news for companies looking to invest there. The risk of a gradual unravelling of the nuclear deal has increased.
- As president Erdogan tightens his grip on power, Turkey’s business environment will become increasingly politicised. Companies not toeing the government line will be punished with legal charges or face discrimination during tenders.
- The year could spell the end for Africa’s geriatric dictators. Low oil prices, failing economies and intensifying civil unrest are raising the chances of an Arab Spring-type event in Central Africa’s oil producers, including Gabon, Equatorial Guinea and Angola.
When it comes to the relationship between Europe and Britain – uniformity isn’t a word that currently springs to mind. And that’s not just a reference to Brexit. Whilst the Europe and Britain do find themselves in the midst of a political break-up – their monetary policies are also showing signs of divergence.
Europe’s introduction of the General Data Protection Regulation (GDPR) next May will have implications for businesses around the world and US corporates should start getting ready if they haven’t already done so.
The recent NotPetya cyberattack underlined the need for organisations to address their exposure and how to mitigate the risk.
As anticipated, US organisations exited prime money market funds en masse following last year’s SEC reforms. AFP’s latest Liquidity Survey indicates what it will take to encourage them back.