Review of key rating changes in this edition of the Index
By Dr. William Arthur, Manager, Oxford Analytica
Review of key rating changes in this edition of the Index This edition of the WTW Political Risk Index covers the second half of 2023, assessing the many political risks facing foreign investors in the emerging world. The overarching sense that emerges from the 61 entries that form this index is of a world that is still struggling to deal with the aftereffects of the massive government interventions undertaken to try to mitigate and control the COVID-19 pandemic.
As readers of the Index will remember, widescale societal and business lockdowns were put in place during the pandemic. The effects of these lockdowns were not necessarily obvious at the time but became increasingly so as lockdowns stretched into the months. Governments were forced to take on huge levels of public borrowing to pay for furlough schemes, since people could not legally work in many cases, and for emergency vaccination programmes, as well as other counter-cyclical and health measures.
This debt, of course, must now be serviced and paid down, and this is a controlling factor in the spending decisions that many governments are making today. Paying down the debts will mean a combination of more borrowing, seeking to refinance the debts, raising taxes and cutting state spending.
But, as this edition of the Index highlights for many countries, herein lies another risk. Cutting spending and increasing taxes, without necessarily having new infrastructure or social programmes to show for it (since the objective is debt servicing), raises the risk of popular discontent. In its mildest form, this can mean peaceful protests and complaints to legislators. But in the extreme, protests can turn violent.
In these cases, governments will have to decide whether to back down, or to meet the protests – be they violent or not – with their own state-sponsored policing resources, which could use violence themselves. Backing down can be de-escalatory but the debt problem then remains.
Some countries in this Index face the debt problem more acutely than others. Various economies, such as some in Africa, were trying to sustain difficult levels of debt long before the pandemic. The problem they now face is that global interest rates are rising, to control inflation that was itself partly an effect of massive pandemic-related spending, and this is driving up debt servicing costs.
In such cases where there is debt distress, various governments are seeking the helping hand of multilateral lenders such as the International Monetary Fund. But help from these lenders comes with conditions beyond an interest payment. Requirements can include the reduction of subsidies, for instance on fuel. Such actions themselves then dictate government spending priorities and whether governments will face (or conduct) political violence, and whether governments and public entities will default on their debts.
The difficulty, too, is that the global surge in inflation is not being driven purely by the aftereffects of the COVID-19 pandemic: the ongoing war between Russia and Ukraine has dramatically affected global supply chains, especially for the essentials of food and fuel, which rose in price, partly due to competition for imports. More recently, poor harvests have led some of the world’s largest rice exporters to impose controls, which may create a surge in prices in yet another staple foodstuff.
As if that were not difficult enough, during the time in which this version of the Index went into production (October 2023), war has broken out between Hamas and Israel. Hundreds have been killed already in the early days of fighting, and Israeli forces have conducted operations within Gaza. The conflict has very deep historical roots, and while policymakers are well aware of the risks of escalation, none of the participants have an obvious exit strategy that avoids escalation.
For now, Israeli forces are mounting their counteroffensive, but the risks to civilian life are high and there is a clear danger off long-running conflict emerging. Indeed, the same is entirely possible in the case of the Ukraine war, albeit for different reasons and with a different historical context – which, by the time this Index is published, will likely have continued for two years.
An additional concern is that Iran could decide to use this moment to try to assert more control in the Strait of Hormuz, or that the US or Israel may retaliate against Iran. If such events were to happen, there is ample risk of rising global oil prices. In that case, global inflation rates can be expected rapidly to pick up, which would worsen the already difficult issues of high global interest rates and associated debt unsustainability.
Perhaps one, somewhat tacit, positive is that these energy risks may drive progress further and faster in the emergence of effective green technologies and decarbonisation. To be sure, the second half of 2023 has seen considerable debate about whether the pace of net-zero climate goals should be moderated, to help shelter consumers from rapid spikes in the cost of fossil fuels, but the ultimate decarbonisation goal appears in most countries unquestioned.
Yet herein lies another risk: the controversy over net-zero goals and their costs to consumers (for which, in democratic countries, read voters) is yet another potential source of political instability: there are various important elections coming up in 2024 and it is entirely possible that many governments will be severely weakened or fall entirely, partly based on generalised inflation but also the drive towards net-zero and the associated rising costs for energy users.
In that case, new administrations will take time to settle into office and enact their agendas. However, they may find that debt servicing pressures, allied with potentially rising interest rates and inflation, plus supply chain disturbances, effectively limit their policy options.
Looking further ahead, a developing risk – which is already evident and has been seen before – is that US-China relations deteriorate. If so, that will see more tit-for-tat sanctions and further disruption to supply chains. This will also see competition between Beijing and Washington for influence over the rest of the world.
Potentially, this competition could be useful for poorer, debt-laden countries that may be able to leverage both capitals’ resources for debt relief, concessional loans or grants of aid with watered-down conditions. Even so, much would depend on the public appetite in the host country for overseas spending at a time when inflation, debt and interest rates are causing difficulty at home. (For further discussion of this issue, see the accompanying essay on “The Politics of Sovereign Debt Restructuring.”)
The ‘elephant in the room’ in this edition of the Political Risk Index is arguably China: the second half of 2023 has seen slowing growth in the Chinese economy, leading to concerns for the effects on the rest of the world. Another concern, again already evident, is that China, the United States and its allies could enter into an outright conflict, whether by intent or design.
If that were to occur, there could also be deterioration in relations with the European Union and global governance institutions. Indeed, the challenges are already plain to global governance norms and architecture, which could make it all the more difficult to manage the myriad problems highlighted in the second half of 2023 in this Index, and beyond.
The numbers As ever, this edition of the Political Risk Index focuses on five ‘perils’: expropriation; political violence; terrorism; exchange transfer and trade sanctions; and sovereign default. Additionally, the Index now has a rotating first section for each entry, which changes with each edition to reflect the salient topics of the day. For the H2 2023 Index, this topic was the politics of the debt crisis, a topic that often impacts the five perils categories.
As noted above, not all countries are equally affected by the debt crisis. Frontier markets, in particular, are badly affected, since their access to debt finance is comparatively much more limited than their wealthier counterparts. In addition, frontier markets are less likely to be economically diversified, which limits exports and the ability to bring in foreign exchange. Additionally, and as noted above, there may be heightened risks of disruptive popular discontent breaking out, particularly in authoritarian countries (for more on this topic, see the accompanying essay on “How will the debt crisis impact countries’ political stability?”).
On the other hand, some countries, particularly oil exporters given rising world oil prices (at the time of writing), have been able to use the oil revenues to pay down their debts and expand state coffers with financial buffers. This is true of the Middle Eastern producers for instance, and in some cases, it has been possible to use this additional money to increase state investment activities. An example is Saudi Arabia, which forecasts only a small fiscal deficit in 2023. In contrast, Egypt, for instance, is finding it difficult to keep down rising public debt, and it is not certain that the country will be able to get this debt to below 80% of GDP by the target year of 2027.
In such cases, revenue-hungry governments may turn to the first of the Index’s perils: expropriation . Typically, expropriation for fiscal reasons is done from a position of strength, such as Chile’s recent nationalisation of lithium mining. However, in extreme cases – such as historical Venezuela or Argentina – governments may nationalise at the risk of driving off foreign investment. In the current edition of the Index, Russia appears to have become such an extreme case. There were, however, some rating improvements, including a five-point drop in risk temperature for Colombia and a four-point drop for Kazakhstan.
The second peril is political violence . Belarus saw a fall (improvement) in risk temperature of nine points, partly reflecting the administration’s apparent strength in controlling unrest, while Russia saw a rise of six points. In Russia’s case, the government has pushed back hard against anti-war protests and enacted legislation to penalise the spread of any news it regards as ‘fake’ that is spread about Russia’s war effort in Ukraine or armed forces. Turkmenistan, meanwhile, saw an improvement of nine points, reflecting the passing of some tension within the elite and the return of the former president. Ukraine saw a risk temperature rise of five points, partly reflecting the various counter-offensives and counter-counter offensives underway.
The terrorism ratings are not hugely changed on the last quarter, with most ratings either staying the same or moving upwards or downwards by a few points, to reflect the direction of travel in terms of whether terrorist activity is more or less likely based on long-term trends. However, there were jumps in risk for Kenya and Mali, reflecting militant security concerns. Neighbouring states also face militant concerns, and some of this has necessitated cross-border activities, to try to control the danger. There is also the risk of Russia’s Wagner Group using the unrest and instability in the Sahel for its own gain. In the longer term, the tragic events in Israel may lead to shifts in terrorism risk, but we have not yet implemented any such changes.
Regarding notable exchange transfer and trade sanctions risks, Ukraine fell (improved) nine points, a combination of the central bank’s efforts to ensure there would be no wild currency value spikes, and the likelihood that Ukraine, Poland and Hungary will be able to come to agreement on agricultural and grain trade.
The final peril is sovereign default . Belarus’s rating fell nine points – the country defaulted last year but has since received loan support of different forms from Russia, which has improved the picture. Guyana fell nine points, reflecting a low debt burden and rising levels of international reserves held by the central bank. Indonesia fell eight points, partly reflecting government efforts to keep the currency stable and pay down foreign debts, plus anticipated rises in government income. Uganda fell eight points, partly based on anticipated new income for the government from oil and the positive sustainability of the country’s debt, much of it owed to domestic lenders rather than overseas.
