Political risk should be the number-one concern for investors

The elephant in the room: Investors should keep more of an eye on political risk when making decisions

Political risk has always been an important element of investment decision-making.

Yet with concerns about the Chinese and US economies fading, and the European economic recovery on track, attentions are turning more exclusively to political factors.

In Europe, the election of Emmanuel Macron has removed the risk of France leaving the EU, but it has not eliminated European political risk altogether, given the onset of elections in Germany in September, and in Italy by next spring.

Germany, France and Italy are among the 84 countries worldwide that have elevated political risks – lower political scores in Euromoney’s survey – compared with a year ago, and there are 91 showing higher political risk on a longer-term, five-year historical basis.

Unsurprisingly, one of the biggest concerns is North Korea, losing 10 political risk points over the past five years, and now scoring a measly eight points out of a possible 100 – matching Haiti – as failing efforts to dismantle its nuclear weapons programme have brought regional conflict closer.

This is causing uncertainty for other countries in the firing line – invariably South Korea.

“We have not faced the risk of conflict with such potential repercussions for a very long time,” says Magdalena Polan, senior economist with Legal & General Investment Management (LGIM).

“Investors have also been focusing on political risk, given the series of elections in the major European countries and the general increase in political uncertainty following the US elections and the Brexit vote.”

Other countries with higher political risk trends include Turkey where president Recep Tayyip Erdogan is forcing constitutional change to turn the country from a parliamentary democracy to a more authoritarian, presidential-style system in the wake of a failed political coup.

There are vastly reduced scores for a range of other higher-risk investments, including Barbados, Burkina Faso, Chad, Syria and Venezuela, among others.

Larger emerging markets, such as Brazil, Malaysia, Russia, South Korea and South Africa – the latter worsened by the latest political manoeuvrings – are all causing concern.

And there are numerous advanced industrialized markets with downgraded scores, too, including Greece, Poland, the UK and US to give investors pause for thought.

“For large asset owners, such as pension and insurance investors, political risk is as important, if not more, than purely economic or structural metrics,” says M Nicolas Firzli, director-general of the World Pensions Forum (WPF) and advisory board member of the World Bank Global Infrastructure Facility.

“This is especially true for long-term investments: long-dated government bonds, private equity, real estate and infrastructure assets,” he adds.

On specifics, corruption risk has increased for 44 countries during the past year, becoming a huge problem in Malta as a growing scandal enveloping the prime minister and other officials forces a snap election in June, and considerable embarrassment for European leaders with the country hosting the rotating presidency of the EU during the first half of 2017.

Graft has worsened in Brazil, Montenegro, Azerbaijan, Nigeria and in numerous other countries, often where the risk-factor scores were already low. This has an impact on the cost of doing business, it creates reputational damage, and it impacts on fiscal balances and donor engagement.

Institutional risk, climbing in 54 countries, is another key factor affecting decisions for UK and US investors, in Turkey especially, and across parts of central and eastern Europe.

Information access, and the transparency of governance and public contracts, has worsened in 54 countries. Among them are Montenegro and FYR Macedonia, as well as the US, Israel, Poland and Hungary.

Regulatory and policymaking concerns are rising in 41 countries, particularly across sub-Saharan Africa. The risk of government non-payment/non-repatriation is a growing risk in 52 countries, again dominated by African borrowers where liabilities have grown enormously as the positive effect of the multilateral debt relief effort a decade ago has dissipated.

Finally, government stability is a problem for 43 countries spread liberally across the industrialized and developing worlds, from Germany and New Zealand to Bermuda and Benin.

And it might not stop there.

Although some countries will become less risky as elections are held and the political outlook becomes clearer, for others the situation might only get worse.

On Europe, LGIM’s Polan says: “Much is still ahead of us. German elections and, importantly, the elections in Italy – another large eurozone country where populist parties have gained larger support.”

WPF’s Firzli states: “Macron’s recent victory in the French presidential election may well mean a reinforcement of the neo-con corner in Berlin and Brussels: those who want to punish Britain (hard Brexit) and chastise the peripheral marches of the EU empire (Poland, Hungary and, soon, Italy) can count on the Frenchman’s enthusiasm for open-society liberalism backed by harsh economic and commercial sanctions for recalcitrant nations.

“I’m afraid this will only serve to further alienate voters in Warsaw, Budapest and Rome, fanning the flames of populism at the worst possible time for the EU.”

And beyond Europe there are numerous other issues for investors to contemplate, not least because populism is a trend extending globally, as the election of Rodrigo Duterte in the Philippines demonstrates, and the rise of ‘people-power’ in Hong Kong and Taiwan.

So as the global economy improves, and world trade thrives, in 2017 it is political risk that is still the elephant in the room.

This article was originally published by ECR. To find out more, register for a free trial at Euromoney Country Risk.