Global instability set to rise in Trump era

Political Risk Outlook 2016

Far from being an exception, the instability of 2016 was merely a foretaste of things to come as the world enters a new era of political risk under the shadow of a Trump presidency, Brexit and a more assertive China.

The Political Risk Outlook 2017 draws on our predictive analytics, risk indices and forecasts from over 30 of its political, economic and country experts. Produced for multinational corporations and finance institutions, the report provides key insights into the primary risks impacting geopolitics and the global investment landscape.

Shockwaves of 2016 put stability of global markets on shaky ground

Our new dataset projecting government stability out to 2019 suggests the upheaval of 2016 was not an outlier, but a paradigm shift in political risk that will create greater uncertainty for investors the world over. The Government Stability Projection predicts that all regions are more likely to experience a decrease in government stability in the next three years, with investors in developing markets most susceptible to negative shifts. According to the data, the Middle East and North Africa (MENA) and sub-Saharan Africa are most exposed, with a 46% and 41% probability of deterioration for the average country, respectively.

However, it is businesses and investors used to the traditionally stable markets of Europe that will have to adapt most. 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 – one of the highest risk profiles for any country in Europe. France, Germany and Italy also display highly uncertain outlooks, but the trajectory of risk in these countries could go either way depending on the success of far-right parties and their populist agendas in upcoming elections.

Average probability of change in Government Stability Index Projection score for 2019, by region

“Governments facing heightened instability are prone to erratic policy-making, which can undermine investors’ trust in key institutions of the state,” states 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 waiting to happen?

One of these shocks could arrive in the Western Balkans, a region ripe for destabilisation by Russia, states the report. The most likely focus of any such effort is Bosnia Herzogovina, which exhibits one of Europe’s most negative risk profiles in the Government Stability Projection.

We believe Russia has both the means and motive to target the EU and NATO’s ‘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 the encouragement and backing of Moscow, the republic could act on its threat to proclaim independence. With Bosnia rated ‘high risk’ for issues such as the rule of law and corruption, the government’s weak institutions would struggle to limit the damage such a move would cause.

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.

Trump era to be defined by volatility in global trade and US policy making

The election of Donald Trump as president of the United States constitutes the most significant victory of anti-establishment political forces outside the UK’s Brexit vote. On the evidence so far, we expect 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. In line with this expectation, scores for the US in our Tax Burden Index and Regulatory Burden Index are anticipated to improve under Trump’s tenure, while its position in the Trade Relations and Political Risk indices looks set to worsen.

Trump’s vow to reverse the decline in US manufacturing has manifested in broadsides against individual firms, namely those with operations in Mexico. As this becomes the norm, the stock of these 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, like 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 take 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 in 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. our Civil Unrest Index shows that the risk of disruption to business is increasing in both countries, and if White House policies contribute to slowing the economic recovery, a revival of left-wing populist parties in these markets can’t be ruled out.

China to ratchet up influence in Asia-Pacific with landmark trade deal

Outside of the Americas, our 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 is able to conclude the Regional Comprehensive Economic Partnership (RCEP), a free-trade agreement between 16 Asia Pacific 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.

Regulatory standards across RCEP states

Unlike the TPP, the RCEP will lack a transformative effect on the business environment of participating states. Our Efficacy of the Regulatory System Index shows considerable variance 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 remains potential flashpoint for interstate disputes

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. Our Interstate Tensions Model, which predicts disputes that involve military threats and displays or use of force, but stop short of war, lends credence to this scenario. The South China Sea is identified by the model 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. Our model 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

  • We see 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 following Brexit; and the potential for ‘currency wars’ if China allows the yuan to fall more sharply.
  • Sentiment analysis, tracking UK / EU dialogue on Brexit, reveals the ‘mood swings’ in the current relationship, implying that negotiations could descend into rhetorical trench warfare, which would 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 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.
  • 2017 may 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.