From the CEO
Over the past four decades of leading the field of political and country risk, PRS has been especially aware of not confining the value destruction of political risk only to emerging or frontier markets. Developed markets, for example, the Western democracies of North America and Western Europe, have carried with them their own peculiar risks to local and international business. But they were usually located around events internal to the political economy of the country and were rarely influenced (at least directly) by external events.
To be sure, a possible exception would be risks induced by various swings in the commodity cycle during the 70s and 80s, and again over the last decade as prices for various items (e.g., oil, gold), lifted the currencies of commodity-based economies in relation to the US, giving rise to asset bubbles (e.g., real estate, shares of some resource extraction firms). Global supply and demand conditions later changed and prices reverted to their historical norms, with all the ‘shaking out’ that such events entailed.
At any rate, looking at our risk ratings and forecast scenarios over the past several years, it appears to nobody’s surprise that developed economies are indeed playing a significant role in political risk. The US is a recent case in point.
Earlier this year in our outlook for America in Modern Trader’s special “The Issue with Forecasting,” (www.moderntrader.com) we were clear about the uncertainty surrounding President Trump’s policy agenda, and we were on point when we said that investors were confident in Trump’s economic proposals as being good for economic growth. However, laden in these comments was the notion that should the president’s policy agenda falter, the boost that Trump’s election has given the broader markets would be short-lived.
This is now the case: Last week the president’s health care reform bill effectively collapsed and now many are quite fearful that other pro-growth policies on which Trump campaigned, such as tax reform, could be foiled by disunity within the Republican Party and by divisions within Congress. Indeed, PRS thinks that tax reform – to the extent that it can be achieved – will be much more modest than initially proposed by Trump, and other campaign proposals, such as building a larger ‘wall’ along the border with Mexico (and the costs that go with it, since it’s rather clear Mexico will not ‘pay’ for it, at least directly) will get bogged down. On this latter note, Congress must pass a new budget resolution for next year that includes various reconciliation measures, allowing a bill to pass the Senate with a bare majority (the idea is not to rely on Democratic votes), which may indeed be difficult to achieve since there are elements within the Republican caucus that are uneasy about higher operating deficits.
As it looked like Trump would not have the votes in Congress to carry the bill on health care, the markets have subsequently retreated, the greenback has fallen to levels not seen since the November vote. Global investors have moved into gold and government bonds and measures of market volatility are up. In short, the so-called ‘Trump trade’ is coming under significant pressure to the point that it might be fully unwound. And it is doubtful therefore whether the Federal Reserve will tighten over the year at a pace many assumed several weeks ago.
Looking ahead, PRS sees the following moves in asset prices and in political and country risk assuming the president’s agenda continues to be significantly derailed: A weaker greenback, lower bond yields, a stronger UK pound, yen, and euro, as well as some emerging market currencies that are not grounded in commodity-based economies.
Indeed, a weaker dollar will help with the external debt servicing costs in a range of emerging and frontier markets (clients should consult Table 13 of the International Country Risk Guide for the complete data set on external financing costs as a percentage of real GDP) and, to the extent it helps alleviate some pressure on the government’s coffers, allow spending to be channeled into those policies that work to ease social tensions. Several countries in our universe appear to fall into this category, including Tunisia and Belarus.
This is the sort of thing that captures the attention of many of our clients. As such, I am reminded of a recent call I received from a rather new client – a financier that works as a political risk advisor to a Paris-based private equity group focusing increasingly on parts of Sub-Saharan Africa. Apparently, the financier uses a number of our risk metrics, looking for signs of improvement as an opportunity to ‘get in on the ground-level’ as it were. The conversation consisted of questions and answers: his way of validating his ideas. In looking at the risky countries, the financier tries to spot discrepancies between price behavior (assuming the country in question has a relatively liquid shares market) and easing political and country risk. This is similar strategy that PRS has employed for some time.
Looking at our risk ratings this month, several countries saw their risk profiles improve. Haiti, for example, has consistently risen in our composite risk table since the president, Jovenel Moïse, assumed office in February with his right-leaning Parti Haïtien Tèt Kale holding a majority in parliament. A prime minister and cabinet have been chosen, but the political system remains mired in deficiencies, including a rather high degree of graft.
Similarly, Mexico, which crossed into the ‘High Risk’ category in August of 2016, received a slight reprieve as consumer confidence staged a partial rebound and the peso (which we suggested was rather oversold several months ago) strengthened against the greenback as President Trump’s policy agenda looks increasingly like it will be stifled in the months ahead.
Turning to those countries where the risk profile has deteriorated, firms in Papua New Guinea have reported difficulties accessing foreign exchange, and in the Philippines, where FDI inflows remain uneven, export receipt are sluggish, and as the president backs stronger measures against mining firms, advocated by the environment ministry and related civil society groups.
Argentina’s risk profile also suffered a setback this month as we expect incidents of unrest to surface given the run-up to the next election and that the economy is improving.
And in Belarus, bank lending has eased and pockets of protests have been reported. Although the economy has shown signs of improvement of late, we expect the various political risk to have an impact on government cohesion and policy making going forward.
Clients should note that some 50 countries had their political risk profiles adjusted this month, affecting just over 50 individual risk metrics.
As is the case almost monthly, researchers at the IMF used our data to investigate various economic phenomena. This month, our corruption scores were used to explore the impact of fiscal decentralization on fiscal policy performance in a range of developed and emerging markets. The study found that a larger share of decentralized expenditure is associated with a stronger fiscal balance; however, fiscal decentralization can lead to more pro-cyclical fiscal policy, suggesting therefore that the design and pace of fiscal decentralization must be fashioned to the specificities of the economy. (https://www.imf.org/en/Publications/WP/Issues/2017/03/24/Fiscal-Decentralization-and-Fiscal-Policy-Performance-44759)
Clients should be aware that we will be attending this year’s SALT conference in Las Vegas in mid-May (www.saltconference.com). Speakers include Dr Ben Bernanke, David Cameron (former British prime minister) and Dr Mark Mobius (Executive Chairman, Templeton Emerging Markets Group). With so much of political risk dominating the markets this year it will be a great opportunity to meet with our clients and to discuss their ideas for the year ahead.
Thanks for your continued support, and please contact us if we can be of any assistance.