2020’s sting in the tail: Political instability will rise in 88 countries
Political Risk Outlook 2021
by James Lockhart Smith and David Wille,
Political systems across the globe were battered in 2020. But what comes next could shake the foundations of stability in a swathe of countries as the Covid-19 crisis enters its final act.
countries are likely to experience more instability by 2023
Our 2-year Political Stability Index projections for 130 countries (simulation models which generate 10,000 potential outcomes per country) are bleak. Almost three-quarters of these countries – ranging from much of the developed world to leading emerging markets, such as India, Brazil and Saudi Arabia – are likely to experience more instability by 2023. Depending on where and how hard it strikes, this could at best gum up policymaking, make the investment environment less predictable, or erode countries’ ESG profiles. At worst, instability could disrupt all but the most resilient firms, force governments into default, and block crucial trade and commodity flows.
Foundations of government legitimacy under stress worldwide
As Figure 1 shows, we project instability to increase in 68% of the 130 countries in our projections dataset. The risk will be largest for 23 nations likely to experience a significant decline of over 0.5 in their score on our index, including Brazil, Saudi Arabia, the Philippines, Ukraine and several eastern European emerging markets. Our models suggest that most of these countries are also at higher-than-normal risk of experiencing lefttail destabilisation (see Focus box).
The central driver of risk will be fading legitimacy of governments and intensifying civil unrest, as those in power struggle to engineer economic recoveries, answer for the human toll of the pandemic, or fall victim to internal political divisions (see Figure 2). For the small number of countries expected to improve, such as Belarus, civil unrest will simply be subsiding after a turbulent 2019-2020, in most cases without demonstrators’ underlying grievances being addressed. China, which moved fast enough against the virus to reopen quickly and had enough economic firepower to mitigate the pandemic’s global macro impacts, is a rare exception.
Emerging markets: short on funds
One key culprit for this global increase in political risk is 2020’s extraordinary credit binge by leaders desperate to keep their economies afloat – 84 countries in our dataset saw exceptional increases in their debt-to-GDP ratios of at least 10 percentage points last year. As shown in Figure 3, our data suggests that moderate borrowing has benefited wealthier emerging markets such as Poland, Hungary and Thailand. And unsurprisingly, developed markets borrowing in their own currencies have little to fear from the bailiff. However, if some debt is good, more isn’t better. The other high or upper middle income emerging markets which borrowed the most last year will now be markedly more exposed to political risks.
A key signal for this eventuality is a significant decline in our Public Debt Index, such as that witnessed by Argentina, South Africa, Romania – and Russia, where the Kremlin has so far opted to both borrow and scrimp more rather than draw down strategic fiscal reserves. Here, servicing higher debt burdens will have the highest potential to drive discontent by constraining social spending and fiscal stimuli. And that’s without even factoring in the risk of any abrupt change from central bankers in developed markets. Though not currently our base case, it would trigger a major withdrawal of capital across emerging and frontier markets.
Democratic governance: muddling through
But if developed markets have little to fear from 2020’s credit spree, our data suggests democracies will, on average, see more uniform declines in stability, as shown in Figure 4. Their leaders have a tougher job – at least in the immediate term – of managing the politics of a crisis that is having a highly regressive impact on health and livelihoods. Many have done so badly in curbing the spread of Covid-19 that public trust in government has diminished significantly. This applies across many countries, including DMs, but will impact political risk most in the weaker or newer emerging market democracies, which feature heavily among the 23 nations with projected declines in their Political Stability score of 0.5 or more.
Our data indicates that some emerging markets have benefited from measured borrowing, while excessive debt has generated significant political risk headwinds for others
That said, the widespread but modest declines in score we project for DMs suggest that wealthier free countries will probably emerge from the crisis bruised, but without permanent injury. The US will likely even rebound slightly, spared for now despite emerging from one of the most disorderly transfers of power in its history. Possible exceptions include the most indebted Eurozone suspects Italy, Spain and Greece, as well as the UK, which faces severe economic pressures, and centrifugal political challenges, stemming from Brexit and its chaotic management of the pandemic.
How our political risk projections quantify likely outcomes and tail risks
Our Political Stability projections, derived from a composite of our Government Stability and Civil Unrest indices, generate full probability distributions of future risk – 6 months and 2 years in the future – benchmarked to our index scales. That means we forecast not just the most likely outcomes, but also the worst- and best-case scenarios, as shown in the example of Saudi Arabia’s 2-year Political Stability projection in Figure 5. Peering into the murky left tails – closer to the worst-case scenarios than the mean – sheds more light on what could go wrong, and why. In normal distributions, outcomes cluster around a central mean and rapidly become less likely the further they move into the tails on either side – to the extent that only 2.27% of outcomes occur two or more standard deviations to the left of the mean. However, as with many of the complex ESG and political risks that we at Verisk Maplecroft assess, outcomes two or more standard deviations to the left – which we define in this piece as left-tail destabilisations – are more likely than normal assumptions indicate. More than 70% of countries have so-called ‘fat tails’ in our latest 2-year projections, with probabilities of left-tail destabilisation significantly above 2.27%. Many also have exceptionally long tails, indicating high levels of uncertainty and greater potential for abrupt shifts in risk.
Authoritarian countries: the sting in the tail
Firms and investors with exposure to seemingly calmer authoritarian countries – many of which are staples of emerging market debt portfolios and supply key global commodities – should generally worry most about left tails. We expect risks to be highest in the Gulf.
Markets are pricing Saudi Arabia, Kuwait, Qatar and Bahrain favourably thanks to their perceived comparative advantage in low-cost fossil fuel production, credit risk profiles and their ability to repress civil discontent. Yet, our index projections show their fragility.
of Saudi Arabia, Kuwait, Qatar and Bahrain facing left-tail destabilisation in our Political Stability Index Projection over the coming two years
As shown in Figure 6, each receives at least a 4% probability of left-tail destabilisation in our Political Stability Index Projection over the coming two years – among the highest in our dataset. This stems from the lack of effective mechanisms for channelling discontent, which makes dramatic bouts of civil unrest more likely over the long term. Saudi Arabia stands out with a 4.9% probability of seeing a drastic decline in political stability by 2023-Q1. The kingdom ranks second-highest risk in our dataset after Azerbaijan in terms of the combined probability and magnitude of such outcomes.
We’re unlikely to see a traditional emerging market debt crisis, and its political consequences, at least without a major hike in developed-world interest rates. Nor should we expect the funeral of liberal democracy, even as the last MAGA hats are swept from the Capitol. But investors and firms still face a toxic brew of mounting political risks, albeit one that is survivable for those with diversified cross-national exposures. Watch out for non-contagious instability in the most indebted emerging markets, especially weak democracies, and the further erosion of political institutions in some European countries, potentially even the US. And don’t overlook the elevated risk of left-tail destabilisation in major authoritarian political systems. We might be done with 2020, but 2020 isn’t done with us.