From the CEO – December 2022
The closing of a year and the beginning of a new one always warrants forecasts or warnings about what to watch for over the next 12 months. We are occasionally asked to isolate our top five or 10 risks for the year, to which we usually offer a pass since we provide a range of forecasts and supporting data to over 140 countries monthly. Themes run throughout these projections. And my discussions with clients on these topics tend to take directions and cover material that are unique to each clients’ circumstances.
In any event, there are several geopolitical developments we are watching that have arisen from our data series. They tend to be multifaceted, develop over some time, and given that our ICRG forecasts have been shown through independent studies to be predictive of risk events, they occupy a unique space in the industry.
I will say that China’s recent dropping of its zero-covid policy, and the impact of the surge in infections is alarming. Much press has been devoted to the possible consequences of the rise viral infections in the country, from supply chain interruptions to the spread of new variants. The ultimate death toll from the change in policy has been estimated in the millions, and we are now told that there has been a peak in infections in urban areas with a surge to follow in rural settings. China has said that it would ‘hit back’ at nations (such as the US, Canada, India, Italy, Japan, etc.) that have placed restrictions on its travelers for what it terms ‘political goals.’
Our risk data has shown a downward trend in China’s risk profile since the middle of 2021, with some of the more notable changes coming via the metrics dealing with ‘Internal Conflict,’ ‘Socio-economic Conditions,’ and ‘Government Support/Popularity.’ As I mentioned in a note to a Swiss client during the November protests, the dissent has as much to do with the impact of the zero-covid policy as it does with the longstanding quest for greater public responsiveness from the Chinese authorities. There is a history of such protests in the country, and Xi’s popularity has suffered.
As such, the change in covid restrictions was necessary for China to return to the ‘wider world,’ as it were, with all the obvious economic benefits and geopolitical advantages that it implies. During the lockdowns, commercial and industrial activity
unsurprisingly shrank, and consumer confidence was in the tank. China has a problem with youth unemployment that sits just under 20%.
On the geopolitical side, the ending the lockdowns has coincided with further articulation of China’s position vis-à-vis Russia’s invasion of Ukraine, and a ‘new era’ in relations between Beijing and Riyadh, for example, complete with new trade deals and cooperation over digitization and space exploration.
A more visible and aggressive China looks in store for 2023.
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Meanwhile, the New Year was greeted with some somber forecasts by the IMF as the agency announced that one-third of the global economy will be in recession this year. About a half of the EU is expected to fall into this camp, and China’s economy – given the authorities’ abandonment of the zero-covid policy and the coming onslaught of infections – will suffer in the short-term, with spillover effects reaching other parts of the world.
On a brighter note, given its relatively robust labor market, the US might escape the worst of the slowdown, but this situation would do little to help bring down inflation to the point where the Fed shifts to a more relaxed monetary stance.
None of this bodes well for the emerging market asset class, which saw its worst performance last year since 2008. To be sure, some countries in the asset class will do well – see our ICRG composite scores in Table 1 for relative improvements in political risk – and indeed others, such as Chile, India, and Mexico were on track (in November) to record (yoy) ETF asset growth.
In this environment, one area that will be exceptional from an investor’s perspective is the use and value of ESG data. Emerging markets generally hold relatively good valuations. But there is a dearth of solid ESG data that can isolate the attractive markets from the less so. The ICRG data – and select risk metrics – offer such an opportunity and are increasingly being incorporated into the portfolio selection and management practices of the world’s largest institutional investors. Clients should consult ICRG risk metrics affecting various socio-economic variables, forms of internal conflict, corruption, ethnic tensions, and overall quality of democracy.
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We are extremely pleased to announce that we are closing in on our 45th year in business!! No other geopolitical risk rating and forecasting agency holds that title and it speaks volumes to the quality of the data produced each month by our team around the world.
Our new book Quid Periculum? Managing Political Risk in an Age of Uncertainty, co-edited and co-authored by Peter Marber (Harvard/Aperture Investors) is now available! The book includes such diverse topics as risk forecasting techniques, reliability measures, the impact of political risk on asset prices and sovereign debt workouts. Also featured is a special roundtable discussion by some of the world’s leading voices in the field on the future of political risk, who combine to address some of the challenges presented by globalization and COVID-19.
Finally, ICRG and related PRS data continue to be the gold standard of all geopolitical risk data among the scholarly and research communities. A recent IMF Working Paper used our ICRG data in part to help determine whether the composition of the sovereign debt investor base affects the probability of a fiscal crisis. Inter alia, it was found that an increase in the share of non-official debt is associated with a lower likelihood of a fiscal crisis, while an increase in the share of non-resident debt is associated with a higher probability of a fiscal crisis.
In a separate study on how the underlying dimensions of political risk affect excess returns in equities, it was found that ICRG’s ‘Government Stability’ risk metric produces a negative hedge in the all-country sample used. ‘Socio-economic conditions’ produces the highest positive hedge return. ‘Ethnic’ and ‘Religious Tensions’ contribute a positive hedge return of 5.6% p.a, of which 6.7% p.a. is related to emerging markets. A similar trend is detected for ‘Religious Tensions.’
Thanks for your continued support and all the best in 2023.
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