Country Risk: Has politics become the number-one problem for investors?

The importance of political factors to the assessment of a sovereign’s overall risk profile should not be overlooked. Political risk has increased in 116 of the 186 countries over the past two years, according to Euromoney’s Country Risk Survey, with 28 sovereigns witnessing double-digit falls in their political risk assessment scores. The Arab Spring and the eurozone crisis are key protagonists of course, but there are other causes, and with varying effects. Monitoring and evaluating political changes have become crucial for investment strategy, Jeremy Weltman reports.

Measuring political risk may be more fraught with difficulty than dealing simply with the raw numbers of economic data, but that should not relegate it to the background. Indeed, political risk is not only an important constituent of a sovereign’s country risk profile, alongside economic and structural indicators, it has become the main issue for many countries.

This has been demonstrated in recent days by developments in Italy and in the failure to seal a new EU budget for 2014-20, because of the intransigence of the UK. There are of course many other examples.

Although political risk may be difficult to quantify, Euromoney’s Country Risk Survey provides a useful guide. Economists and other country-risk experts are asked to qualitatively assess six political factors in all – those that are deemed most relevant to the investor environment. They include: government non-payments or non-repatriation, corruption, information access/transparency, institutional risk, the regulatory and policy environment, and government stability; factors that are often interlinked and can upset the fiscal dynamics, creditworthiness and investor image of a country.

Of those sovereigns to have seen the largest attenuation in their political risk in 2012 (see chart), Syria, perhaps unsurprisingly, leads the pack. We have omitted Antigua and Barbuda as an outlier – it is a small country with an already low score and limited coverage.

Currently ranking 161 on ECR’s Global risk data table, Syria, unrated by all three of the main agencies (Fitch, Moody’s and S&P), but regularly assessed by ECR, has seen its political risk assessment score fall by 6.6 points, to 20.4, this year, as the internal political strife and civil warfare have intensified.

Not far behind, though, is Argentina, now down to 111 in the global rankings, and another country whose political risks have intensified. Rated CC by Fitch, B3 by Moody’s and B- by S&P, the unpredictable policymaking of the Buenos Aires government led by president Cristina Fernández de Kirchner, with its desire for resource nationalism, a lack of respect for property rights and opaque statistics, creates an uncertain playing field for foreign investors. Picking a fight with the UK over the Falkland Islands (Malvinas) has hardly instilled confidence in the political leadership either.

These problems have been variously picked over by ECR and its contributors over the past few years, and the country’s political risk score has fallen by 11.8 points during that time, nearly double the 6.6 point drop in its economic assessment score. Noticeable is the two-point slippage in the score for the regulatory and policy environment. But with falls almost as large for institutional risk, information access/transparency and government non-payments/non-repatriation, all of Argentina’s sub-factors are now scoring less than 3.0 out of 10.

Eurozone woes are political in nature

Other countries with heightened political risk this year include Greece and Slovenia. Greece, languishing at 112th place on the ECR scoreboard, still burdened by its enormous debt problems, despite being given additional debt relief and two more years to reduce government spending, has seen many street protests and strikes since the crisis began. Its debt burden, forecast to be as high as 124% of GDP in 2020 even if the austerity programme is kept on track, highlights the complexity of its risk profile.

Politics is central to the debt resolution and in turn this has implications for creditors, of which France is the most exposed, accounting for 10% of Greece’s €327 billion of total liabilities. Greece currently scores just 42.6 for its political profile, some 17.3 points below the level prevailing two years ago and almost exactly half the score that Germany receives from ECR’s experts.

“The government is viewed more positively in Greece, but policy execution is still a problem,” says Nicholas Spiro, managing director of Spiro Sovereign Strategy. “Creative solutions must be found to trim the [Greek] debt and avoid the one clear outcome – official debt write-downs resisted by its creditors.”

Spiro goes on to state that political risk “has now taken centre-stage as the number one issue in Europe, but it is difficult to price. We are in uncharted waters.

“The eurozone debt market panic may be a thing of the past. The European Central Bank’s outright monetary transactions (bond-buying) programme has been the game-changer. But the positive signalling effect has also led to a degree of complacency, particularly with regard to a banking union. Without market pressure there is a sense of drift.”

Contrasting with the comments recently made by French resident Francois Hollande, who confidently asserted that the euro crisis was “behind us”, Spiro states:

“The crisis isn’t over. Its debilitating effect has been staunched, but qualitative political drivers are still lurking. We don’t yet have a political Frodo Baggins to address the problems. The eurozone crisis has just mutated into a political crisis.”

Slovenia, another country with emerging problems, demonstrates how political deadlock can damage the investor environment, and the importance of ECR’s multi-factor approach in teasing out the relevant concerns – which involve the perceptions, sometimes gut feelings, of experts.

Not all of Slovenia’s political risk profile has deteriorated. Since 2010, three of the sub-factors (non-payment/non-repatriation, corruption and information access/transparency) have improved. However, resistance from the opposition to the government reforms (notably its banking sector resolution programme), and recent street protests – amid pension reforms and budget cuts – are weighing heavily on Slovenia’s risk profile. Its scores for government stability, institutional risk, and the regulatory and policy environment, have all been downgraded since 2010.

S&P has warned of a ratings downgrade for Slovenia’s current “A” assessment, amid concerns over investor confidence and funding costs if the reforms are stifled by a possible referendum. Slovenia might then be driven to seek aid from the European Stability Mechanism.

Tumultuous Mena region

But looking over a two-year horizon it is clear that the Arab Spring has had the most important impact on global politics. During that period Syria’s political assessment score has fallen by almost 26 points, beaten only by a 27-point fall for Libya, another country unrated by the agencies, and affected of course by its own revolution.

Libya, ranking 135, has seen its political climate improve this year, following the toppling of Muamar Qaddafi, but, on a lowly political risk score of 26.9 in November, its political environment remains a big concern. This is highlighted by recent ethnic violence between Arab Libyans and the Tabu minority, the still-fragile security situation in Libyan cities and along its borders, a tortuous election process and a weak institutional framework epitomizing a fledgling democracy. All of these issues highlight the multifarious nature of political risk, which ECR seeks to capture through its six main political indicators.

Syria and Libya both belong to a group of 28 countries subjected to a double-digit political risk score decline since 2010 and are among 116 sovereigns ( representing 62% of ECR’s global coverage) to have seen a trend rise in political risk over that period. The global political backdrop has become more biased it seems toward instability, a development that will not have gone unnoticed among bond investors.

Certainly domestic security issues have proved to be a big concern. In addition to Libya and Syria, out of the top 20 countries to have witnessed the largest deterioration in political risk since 2010, many have been affected by warfare, terrorism and/or social – often violent – unrest. They include Pakistan, Egypt, Yemen, Israel and Lebanon, other countries, in North Africa, affected by the Arab Spring (Algeria, Tunisia and Morocco), Iraq, Bangladesh and Bahrain.

The heightened risks seen across the Mena region have not only led to lower scores for government stability, public institutions and the regulatory and policymaking environment, but also for capital repatriation/non-payment, highlighting the increased repayment risk to the region’s investors (see chart). Still, the average sub-factor values hide a wide dispersion of scores, ranging, in the case of repatriation risk, from 3.3 for Yemen, right up to 8.0 (pretty safe) for Israel. In terms of government stability, Qatar and the United Arab Emirates both score 7.1, way above Syria and Egypt on 2.4 each, and Lebanon on 2.8.

Worrying decline in Asia

Asia is another fault line on the increasingly fractious geopolitical global risk map. Several countries have seen large declines in their political risk assessment scores during the past two years, led by the Philippines (down 15.6 points to 43.6).

The country’s lowest sub-factor score is for corruption; it also ranks 105 out of 174 countries in Transparency International’s latest annual Corruption Perceptions Index 2012. But that is only part of the story. The sovereign's risks have increased across a range of political factors, including a substantial drop in the score for the regulatory and policy environment, from 6.3 to 3.9.

The sovereign’s ranking in the World Bank’s Doing Business 2013 report has slipped two places to 138, highlighting the stifling levels of red tape and high costs involved when dealing with local regulations in the Philippines. And the country’s investor environment has been affected by internal conflict between the government and rebel groups, particularly as there have been attacks and further threats made against privately owned mining interests.

The Philippines is also embroiled in heightened tensions in the South China Sea area, which has added to the increased domestic political risks seen in both China and Japan. China’s political risk assessment has been downgraded by 9.2 points during the past two years. Rather than gaining ground as eurozone countries have become more risky, China has slipped in the rankings (to 40th currently). The combination of an unusually uncertain leadership transition and questioning of the Communist regime – with some protests going unreported, amid high corruption levels – has seen China’s government stability sub-factor score fall by 1.5 points to 6.7. Non-payment/repatriation risk has notably heightened, too, with all six political indicators downgraded.

“The transition seems to be well managed and its related risks are now receding,” says Ebrahim Rahbari, an economist with Citigroup. “But there are still a number of issues – so China remains very risky in the medium/long term. A number of communities in China feel left out, with no evident sign of relief, and there are other concerns in the region about territorial disputes, which has macroeconomic relevance for Japan, Vietnam and other countries, particularly in terms of export exposure to China.”

Japan’s political risk score has fallen in equal measure. Once the darling of the investment world (indeed ranked the number one safest sovereign some 20 years ago), Japan is now languishing in 30th place. Its overall political score of 72.4 is still way above China’s 48.7, and its corruption record has improved in recent years, but other aspects of the political environment have lurched in the wrong direction. Institutional risk has slumped 2.1 points, from 8.9 to 6.8. Government stability is down from 7.9 to 6.2 as the country faces an election on December 16. The country’s political risks, as in other parts of the world, are seen as crucial to resolving the debt crisis.

With the opposition Liberal Democratic Party (LDP) currently on course for victory in the parliamentary election, and promising policy stimulus to rejuvenate its moribund economy, Japan has “relatively benign short-term risks, “ according to Rahbari, “but its medium-term fiscal risks will still need addressing drastically.”

From west to east, political risks remain in the foreground, challenging investor decision-making, but with such risks more difficult to quantify than economic data, the views of experts may be the best there is to go on.

This article was originally published by Euromoney Country Risk.