Political Risk: Time to Access the Present Realities and Look for Cover

As the clash between the two biggest economies in the world unfolds and individual countries are forced to take sides, we are reminded of political upheavals of times gone by – restrictions in free trade, espionage, artificially staged crises, and sabotage to name a few.

There is also a larger uncertainty surrounding the entire Eurozone. Be it new twists to Brexit, a slowdown in Germany, the perpetual crises of Greece and Italy, or instability in Turkey – all these have left the Eurozone in jitters.

According to the World Economic Forum’s Global Risks Report 2019 (the Report), rising geopolitical and geo-economic tensions are one of the most urgent risks of 2019. The Report indicates that the world’s ability to foster collective action in the face of urgent major disasters has reached a crisis level, with worsening international relations hindering action across a growing array of serious challenges.

The Report, which incorporates the results of the annual Global Risks Perception Survey of approximately 1,000 experts and decision-makers, points to deterioration in economic and geopolitical conditions and warns that growth in 2019 will be held back by continuing geo-economic tensions. In fact, 88% of respondents expect further erosion of multilateral trading rules and agreements. Not surprisingly the Report names the top three short-term risks as:

(a) Economic confrontations/frictions between major powers.

(b) Erosion of multilateral trading rules and agreements.

(c) Political confrontations/frictions between major powers.

If economic headwinds pose a threat to international cooperation, efforts will be further disrupted in 2019 by rising geopolitical tensions among major powers, according to the Report. Eighty-five percent of respondents to this year’s survey said they expect 2019 to involve increased risks of “political confrontations between major powers”. The Report discusses the risks associated with what it describes as a “multiconceptual” world order – one in which geopolitical instabilities reflect not only changing power balances but also the increasing salience of differences on fundamental values.

Let’s look at the key challenges of key players and their possible impact.

1.    USA
Once a strong supporter of free trade, US President, Donald Trump, is struggling with the Democrat-controlled congress and implementing his pre-poll promises on the domestic front. Further, his government’s approach towards global trade to protect American jobs and business has not gone down well with the US’s traditional trading partners. The new tariffs in 2019, sanctions on China, the arrest of an Huawei executive, aggravating the relationship with Iran, inconclusive meetings with North Korea, and excluding India and others from the Generalized System of Preferences trading program, signal a broad and escalating global trade situation.

What to expect:

• Greater domestic and international tensions. 
• High risk of global trade wars. 
• Spillover of global trade tensions on unrelated economies.
  
• Some exacting unilateral political decisions could have a major impact on world trade order and sovereign alignments.

2.    Brexit puzzle
The painfully long and turbulent Brexit deal process has kept everyone guessing. After the exit of the Theresa May led government, the outcome is still uncertain.

What to expect:

• Business is already impacted, from large corporates to small restaurants. Expect more economic uncertainty and disruption.
• Doubts are now being cast on overall political stability and unity in the region, with severely strained relationship between Britain and  the EU and Eurozone.        

3.    Germany 
Germany is witnessing a policy paralysis as Chancellor Angela Markel’s government, once hailed as engine for the Eurozone, has lost the trust of industry. Power struggles between conservative and centrist factions have led to a leadership vacuum within the Christian Democratic Union.

What to expect:

• Possible collapse of a grand coalition.
• Risk of a weak government in the future leading to more indecisive policies and general slowdown in economy and welfare measures. 

4.    Middle East
Iran’s nuclear deal has collapsed and a direct Iran-US and Saudi Arabia conflict looks possible. Israel has opened a new front in Lebanon, while new Palestinian uprising is clearly visible. Kurds are again pushing for statehood.  With everyboby pulling in different directions, Libya, Syria and Yemen peace processes have failed miserably. 

What to expect:

• Renewed tension and possible confrontation between Iran, US, Saudi and Israel.
• New embargos and sanctions.
• Arms race, clandestine wars between various factions, heightened Shia-Sunni conflicts.

5.    Russia
Ukraine separatists have renewed their combat and Russia is meddling with surrounding regions. The relationship between the USA and Russia is frosty and the US has withdrawn from the Intermediate-Range Nuclear Forces treaty. The EU and the US have imposed sanctions on Russia.

What to expect:

• Ukraine conflict to continue simmering, making business difficult.
• Tensions in Eastern Europe, especially over Syria are something to watch.
• World order change as Russia warms up to China.   

6.    South China Sea
The trouble in South China is intensifying and could result in China getting into military conflict with US/Vietnamese/Japanese forces. The US’s high level of support for Taiwan has just added fuel to fire, increasing vigil and patrols.

What to expect:

• Regional cooperation could be at risk, making investments highly risky.
• There could be a situation where Asia, already under pressure from US-China trade war, splits and realigns its respective interests.
• This conflict could again produce a bi-polar world.    

7.    Italy
The Italian government led by Giuseppe Conte, has been on a tax cutting and social spending spree. At 132% debt to GDP ratio, the Italian economy is already a worry for the Eurozone. A universal income scheme will cost Italy 17 billion Euro and a flat 15% tax rate on income will cost 80 billion Euro and with more such social schemes, Italy’s costs have become too big for the European Central Bank to bail the country out.

What to expect:

• Political paralysis and/or early general elections,
• Business to become costly due to the price of labour.
• Possible increase in bankruptcies and defaults.
• Sovereign default on long term debt/projects.  

8.    Turkey  
Already in recession due to excessive lending, high inflation and widening current account deficit, Turkey President Recep Tayyip Erdogon’s belief that an interest rate hike is akin to terrorism has prevented the central bank to take measures to reset the economy. The Turkish currency is in free fall.  

What to expect:

• Hundreds of defaults and bankruptcies.
• Three to four years of hardships before Turkey comes back..

9.    North Korea
North Korea has never been a business friendly economy, but is capable of disrupting the trade balance of the region.    

What to expect:

·         A strong ally to China, North Korea can play a major role in any disruption if trade war escalates, either by way of controlled skirmishes with South Korea keeping USA busy, or ruffling the feathers of other surrounding nations.  

The above analysis shows the need to be prudent and pragmatic about the world’s outlook, and demonstrates the need to have strong risk management plans in place. Many companies have diversified their risks among economies based on their ratings and have created provisions to ensure minimal catastrophic shock.   

In a globalized world, investors, financial institutions and corporates need to protect their overseas interests against a wide range of political risks. Often an organization’s  assets and income sources are exposed to potential loss from unpredictable events such as foreign government action, political uprising, currency inconvertibility and non-transfer, or sovereign payment default, and this is when they need protection on the ground to safeguard their interests. This is where a political risk insurance can also come in handy.

What is Political Risk Insurance?

Political risk is the probability of disruption to the operations of multinational enterprises by political forces or events, whether they occur in host countries or result from changes in the international environment.

  Types of policies:

• For contractors, non-payment insurance.
• For investors, investment insurance.   

Coverage:

• Non-payment due to commercial default of principal or because of political risk.
• Loss of debt/equity in investment in a country due to political risks.

Scope of coverage:

• Confiscation of assets.
• Expropriation or deprivation of promised facilities by a government.
• Nationalization of assets.
• Deprivation or forced occupation and appropriation of property, equipment or assets. 
• Embargo or, prohibition of commerce and trade with a certain country.
• Forced abandonment of assets.
• Selective discrimination.

This is a completely customized solution, so an experienced political risk product professional can advise on appropriate coverage.