From the CEO – June 2022
‘Uncertainty is the refuge of hope.’
—Henri Frédéric Amiel
As we move firmly into the summer months, most of what is shaping geopolitical risk involves questions of the extent of a global economic slowdown and whether central banks’ monetary policies will be scaled back from their current tightening phase.
Since the outset of the year, the concern of business and investment has been about just how far the world’s major central banks will go in tightening monetary policy in response to inflationary pressures that most of the world hasn’t seen in 40 years. For example, minutes from the Fed’s meeting in June underscored the notion that top official thought further tightening was necessary as inflation continued to rise. The ECB is set to raise rates in July for the first time in over a decade.
Yet the atmosphere has changed in recent weeks as there are clear signs the US manufacturing sector is slowing, as well as business activity in the eurozone. Indeed, I suggested earlier in the year that the prospect of recession was becoming very real in the US, compounding higher prices for goods and services. Recently, Bloomberg Economics polling put the likelihood of a recession next year at 38%. More widely, Nomura Research has some of the world’s major economies, including the UK, South Korea, Japan, Australia, and Canada all contracting over the next year. The prices for major commodity items – with a few exceptions – have all fallen over the past month.
Not surprisingly, there are signs that investors have reduced their expectations of how far the Fed will go in raising borrowing costs. Futures market suggests that the Fed will raise the benchmark rate to 3.42% by the early part of 2023 – which is down from the 3.9% factored in last month. The yield on the 10-year note stands at 2.9%, down from 3.5% in mid-June. The two-year note – which is more sensitive to monetary policy changes in the US – has recently fallen 8 basis points since May, standing at 2.8%.
There are suggestions now in the US that fiscal policy could help reduce price pressures via higher taxes and less government spending. Such efforts could include reducing mandatory spending and some tax breaks currently in operation. But I suspect that apart from some piecemeal changes that might not have much of an impact on inflation, by the time such policy adjustments come into effect the current economic environment could be much different.
Turning to emerging markets, the effect of inflation on our ICRG risk data has been quite pronounced since the end of 2021, with higher risk found in levels of Internal Conflict, Socioeconomic Conditions, and Government Stability.’ Feeding into a range of economic and financial risks contained in the ICRG rating system, debt moratoria in places such as Sri Lanka and Zambia were not surprising.
However, apart from some elevated levels of political risk, much of the emerging market universe covered by ICRG is not in terrible shape. Current account deficits are not unruly; forex reserves are in relatively good shape; currency valuations are appropriate in the vast number of cases. Most interestingly, given their weaker currencies earlier in the year, the central banks of many emerging market economies began their tightening cycle well before the Fed, and now have less work to do to tame price pressures. Indeed, when looking at the ICRG inflation tables for the 140+ countries covered – apart from clear standouts such as Venezuela and Turkey – inflation seems more pronounced in the world of developed economies.
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Turning to the June ratings, some highlights stand out. In Argentina, the $44bn deal with the IMF saw the first wire of $3.9mn hit the coffers of the central bank, while the overall creditworthiness of the Bahamas is being questioned.
In Europe, legislative elections in France saw Macron lose his working majority as parties on the left and right of made some major gains. Inflation is up, driven by energy and food costs. The same price pressures are being felt in Italy, as coalition tensions rise and unions strike over military aid being send to Ukraine. Bond yields are trading up again.
Democracy got a shot in the arm in Kazakhstan as a country-wide referendum on various reforms received overwhelming support. And while Russian defaulted on $100mn in USD/EUR payments, French and Italian banks are most exposed to the country’s paper, with outstanding claims of some $20bn.
In Africa, Angola is now the continent’s largest oil producer, while civil liberties continue to be repressed. Tanzania is having problems relocating groups of Maasai, as gains in the LNG sector mount.
Indonesia has resumed exports of palm oil, as the country signs a trade pact with the UAE. The Philippines elected a new government, with consumer confidence levels being boosted on the back of the new regime and by the end of covid mobility restrictions. The central bank there is raising interest rates amidst a slump in the peso.
Finally, in the Middle East, rate hikes in Egypt continue amidst surging inflation and a jobless rate of just over 7%. Forex levels are shaky given the effect of the war in Ukraine and import demand. Protests in Morocco continue over higher prices, while fertilizer production could heighten the country’s geopolitical importance.
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PRS has entered early-stage discussions with several leading North American and European business schools to create something truly unique in the AI/data driven geopolitical sector that will benefit both academics and firms alike. As I’ve mentioned on many occasions: political and country risk can only be truly meaningful if it can be quantified over time and across jurisdictions; when it can yield exceptional empirical findings; and when it can be applied to the behavior and protection of assets. On the latter, our work with the schools looks to be paired with a leading NYC/London-based AI trading platform so the ICRG data can offer more select trading positions on a range of asset classes.
We have also received considerable demand for our recently-released new addition to our popular Researchers’ Dataset series – one that offers clients a more granular look at the political risk components of the ICRG, supported by 20 years of monthly data. The new series works as an excellent complement to the other data bundles announced this year affecting ESG, corruption, and internal/external conflict. Scores of academic studies have been conducted using these series, providing unique insights in asset volatility, government responses to the pandemic, and many more. Contact us for more information.
June was another fruitful month for new and returning clients, ranging from some of the world’s top universities to the largest institutional investors throughout the US, Europe, the UK, and the Middle East and Asia. Our data are now regularly featured in the research of the IMF, Bank for International Settlements, and various central banks, such as the Bank of Italy.
Our ICRG political risk scoring changes were very robust in June, affecting over 100 countries (of 141) and over 125 individual political risk metrics!!
ICRG and related PRS data continue to be the gold standard of all geopolitical risk data among the scholarly and research communities. For example, given concerns over central banks’ ability to tame inflation, a recent study using ICRG risk data considered the inflation targeting experience of emerging markets as ‘an effective monetary policy framework to promote changes in the currency composition of their international debt.’ It was found that ‘inflation targeting led to a 3-6 percentage point reduction in the foreign currency share of international debt in targeting countries when compared to non-targeting countries.’ (https://lnkd.in/gmPnf9S8)
Additionally, as tighter policy rates, higher financing costs, and slower growth/recession prospects are on the minds of many, a case study on Bangladesh – using ICRG and WGI governance data over the period 1989 to 2016 and a nonlinear regression – found that ‘up to certain threshold level of institutional quality, the interest rate differential reduces while economic growth stimulates net capital flight (NCF). Additionally, up to a certain threshold, the level of corruption and interest rate differential lower NCF while beyond that level no effect exists. However, none of those independent variables affects NCF whenever the role of government stability threshold is considered.’ (https://lnkd.in/gFKjprGJ)
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