The past several years have led to a revamp in the way political risk is perceived by the financial community. It was not a single event that led to this redis-covery but rather a combination of events in multiple locations.
The global economic crisis undoubtedly caused shock waves across the globe, both politically and economically. This was followed by even more destabilising aftershocks. The blame game that ensued between governments and the banks, largely fuelled by public discontent did little to allay fears. Some were blamed for causing the crisis, some for cre-ating the conditions that led to them and others for not foreseeing them. Across the board, individual econo-mies were subjected en masse to polit-ical risks that were either not foretold or ignored. Investors can no longer ignore political risk.
Prior to 2008, political risk rarely featured as a consideration in invest-ment decisions in developed coun-tries and only to a limited extent in developing nations. The extent to which the near absence of political risk contributed to exacerbating the crisis is difficult to assess, as the relationships between politics and economics are increasing complex. However, what is certain is that the crisis and its accompanying events have highlighted the importance of incorporating political risk in invest-ment decisions and more widely to economic outlooks.
Political risk is a very imprecise science. It requires analysts to have deep understanding of what con-stitutes a risk, the likelihood of a risk occurring and the impact on an investment if a certain event were to happen. The ways such assessments are made are country specific. Here is an example. The possibility of a change of government in a developed country like France, for instance, is generally more likely to happen than in a non-democratic one, like Egypt. However, the impact of change in a non-democratic country is accompa-nied by increased political risk (such as civil unrest) that can potentially have far greater consequences than in a democracy.
Country to country
Political risk therefore is not some-thing that can be extrapolated from one country to another. It requires analysts to have first and foremost a deep and current understanding of the political scene in the country being examined. This has led to a flourishing new industry, of mainly region specific consulting bou-tiques that understand and have the knowledge and local networks needed to undertake political risk assessments.
The post-2008 world has ampli-fied the importance of political risk in the developed world, including Europe and North America. There are many examples of this: the effect of austerity and increased unemployment in countries like Greece, Italy, Portugal and Spain on the sovereign credit rating of those nations and fixed income investments.
Political considerations can also impact equity investments through interfering with the regulatory envi-ronment and fiscal regimes. Abrupt political changes that affect equity, fixed income and other types of investments are significantly more likely post-2008 than they were before. Investors need to carefully consider how an investment in what may seem to be a ‘safe’ environment can be impacted by political considerations. It may even be argued that investing in many, if not most, developed countries without a thorough assessment of the political risk is a high-risk strategy.
Besides the global economic crisis, the Arab Spring has also demon-strated why accurate political fore-casting is not only desirable but essential. Questions that arose after the fall of the Mubarak and Ben Ali regimes in Egypt and Tunisia respec-tively have shown how intercon-nected politics and the economies are. Both countries suffered a drop in tourism and other sources of for-eign income. Both were eager to get foreign financial aid.
The aid that was coming would either come from sponsors of the new regimes or from international multilateral organisations like the IMF. In both cases, the loans or grants come with strings attached, often with substantial political implications. Some of those condi-tions included lifting food and other subsidies. This inevitably leads to a drop in the standard of living of large parts of the population and in return an increased risk of further civil unrest. While such conditions can present investment opportunities that may seem attractive, they also carry with them the risk of a cata-clysmic political event that may have substantial impact on investments.
Whether investing in a politi-cally stable or unstable environment, there is little doubt political consid-erations should become an integral part of the decision. It is an exercise that comes at relatively minor cost but has become essential. Ignoring political risk is a reckless strategy that carries economic consequences too big to contemplate.
