A summary of the report
In the early weeks of 2019, much of the world’s attention was focused on Latin America. In Brazil, President Jair Bolsonaro took office at the head of an administration that looked ready to move the country as far to the right as Lula da Silva had moved it to the left a decade earlier. In Peru, yet another new president was battling corruption, this time with some degree of success, while in Ecuador the current president was struggling with the legacy of an absent predecessor now wanted on criminal charges. Argentina remained dominated by economic challenges, while Colombia’s new president was watching his popularity plummet after just a few months in the job. Overshadowing all this, of course, was the situation in Venezuela, a country which ended January with two presidents and genuine fears of a bloody confrontation over who should govern.
Against this background, the inauguration of Andres Manuel Lopez Obrador, widely known as AMLO, as the president of Mexico in December 2018 was a relatively small event. AMLO had won the presidential election last July by a landslide while his National Regeneration Movement (Morena), only founded in 2014, swept to majorities in both houses of Congress. The scale of his victory threatened to eclipse the country’s three traditional parties for a generation, while giving him a mandate to rethink the direction of Mexican politics.
The five-month gap between his election and inauguration gave AMLO time to assemble his team and hone his policies for the single term of six years that Mexico’s constitution allows its presidents. The conciliatory tone in the aftermath of his election was promising for those who hoped to see the pragmatic streak in AMLO that was evident, at least sometimes, while he was mayor of Mexico City between 2000 and 2005. During the 2018 campaign, his use of rhetoric that bordered on populist had been balanced by signals to the business community that an AMLO presidency would not be radical. His campaign manager was avowedly business-friendly, and six months before the elections AMLO had unveiled a largely moderate cabinet-in-waiting that included well-known academics to head both the economics and the finance ministries. The choice to head his NAFTA negotiating team, with previous experience at both the WTO and IMF, was widely welcomed.
However, during the campaign and afterwards, there was always a palpable degree of tension between the moderate stance of many of those surrounding AMLO as the presidential candidate, and the more radical stance of Morena and its supporters.
An early cause for concern among the business community was AMLO’s approach to Mexico City’s new airport. In August, after the election but before taking office, he said that he would consult the public on whether the 13-billion-dollar project should continue or be scrapped. He spoke while campaigning about the cost involved and the potential for corruption in such a large project, talking up a cheaper option that would ease chronic congestion at the capital’s existing airport by linking it to a nearby military airfield via rail. But at the same time, his economic team strongly indicated that an AMLO administration would indeed continue with the new airport, not least because a third of the construction was complete and the cost of cancellation would be more than five billion dollars. The business community was left with the sense that a public consultation was a way to give AMLO political cover for a pragmatic decision to approve the new airport. The polling data certainty suggested that it was broadly popular.
The consultation process took place in October and involved voters from across the country indicating whether they favoured building the new airport or an upgrade to the existing site. The issue aroused little interest, there were technical glitches with voting equipment, and the eventual turn-out was just 1% of eligible voters. Moreover, the whole undertaking was not legally binding. But of those who did vote, 70% rejected the new airport and AMLO swiftly announced that the project would be mothballed.
The impact was immediate. The peso fell against the dollar, opposition parties accused AMLO of manipulating the vote, and investors in the project indicated that they would push for redress. Two of the main rating agencies downgraded the country largely on AMLO’s handling of the airport issue. More generally, the idea that well-established infrastructure projects might now become subject to constitutionally questionable ‘people’s votes’ was a major blow to an investor community that was just coming to terms with the idea of an AMLO presidency.
Within a week of the airport vote, AMLO announced another consultation exercise, this one on a proposed rail line linking popular tourist sites across five states that had already attracted substantial interest from private investors. With the Maya Train publically backed by AMLO, who announced the start date for its construction at the same time as he announced the consultation, the project was duly approved in November on another low turnout. But the prospect of such consultations being called by the president at any stage of a project has seriously dented the new administration’s credibility.
Having been reached through a process that failed to comply with existing public consultation legislation, the decision to cancel the airport was a demonstration of AMLO’s willingness to risk alienating investors in order to make a political point. The way in which the decision was taken also undermined his economic team, suggesting they have insufficient influence within the administration to maintain the moderate course that they have been describing to investors both within and outside Mexico. While AMLO has insisted that the government will repay all debts and meet all contractual obligations associated with the airport cancellation, this will be a challenge as the bonds involved were originally meant to be repaid from airport taxes. Government finances, already stretched by AMLO’s agenda, may struggle to meet the cost.
The experience of the airport project has been followed by other developments that worry investors. AMLO and Morena are making cuts in some parts of the public sector to free up resources for social programmes. An early consequence of cutting salaries and benefits for many senior civil servants has been an exodus of experienced officials from important regulatory agencies. A wider impact looks likely to be a centralisation of power within the presidency. Perhaps of most concern is an effective freeze on his predecessor’s main achievement of bringing a degree of liberalisation to the crucial but moribund energy sector. As we watch developments play out in Mexico during 2019, we will be paying close attention to how government action materially affects the environment for business and investment. This is political risk in its rawest form, and a reminder once again that tracking political risk and taking steps to mitigate its potential impact, through insurance or other measures, is a vital part of effective corporate management.
The WillisTowersWatson Political Risk Index has been following most of our forty countries for more than a decade, and we have become used to undulations. Individual categories of risk can move up and down at differing rates within a single country, and the overall direction of risk can shift from year to year as macro factors such as energy prices, interest rates, and electoral timetables have an impact.
But this edition of the Index, the first for 2019, clearly extends the trend that was established over the last two editions of 2018. Taking these three most recent editions together, it is evident that overall risk as measured by the Index is rising. In mid-2018, we still had twenty countries whose scores were falling, denoting deceasing risk, compared to fourteen whose scores were rising, suggesting an increase in risk, However, we noted a narrowing of the gap between the two categories from earlier editions, which seemed to foreshadow the end of a relatively positive period. So it has proved. By our last edition of 2018, the Index had moved firmly into negative territory as eighteen countries posted a rising score while only thirteen saw their overall scores go down. In both cases, there were a total of nine countries with scores that did not change from one edition to another.
In the current edition, six of those unchanged countries have moved firmly into the rising risk column as the negative trend becomes more pronounced. This time, we have 25 countries with rising risk compared to fourteen whose scores go down. The only country that does not go up or down from the previous edition is Ethiopia, and that is only because it was not part of the report. With this edition, it makes a welcome return to the Index for the first time since 2012, taking the place of the Dominican Republic.
The overall score for each country is derived from the ratings for five individual risk categories: expropriation, political violence, terrorism, exchange transfer and trade sanctions, and sovereign default. In this edition, only two categories - exchange transfer and trade sanctions risk, and sovereign default risk – have a preponderance of countries with falling risk, and only by the smallest of margins. For the first three categories, countries with rising risk emphatically outweigh those with falling risk. It is perhaps worth noting here that no country has all of its sub-categories moving in the same direction, with most posting a mix of rising, falling, and stable numbers. These internal dynamics tend to reduce the instances of large or sudden movements once we have applied the algorithm that coverts these individual category scores into a single overall number for each country. As a result, movements of country scores by one or two points in either direction may seem small but represent a considerable degree of change.
Looking at the country scores in this edition, we see that Venezuela is back in the Extreme Risk category with a score of 91 after a brief dip down to 89. In recent weeks, the situation in that country, for so long in the unhappy position of topping our Index, has seemed to move both quickly and slowly at the same time, but change does now seem a realistic possibility. Iran’s overall score is up by three points as the sanctions regime bites hard. Mexico is also up by three as investors clash with the new government and the huge debts of the state oil company threaten the creditworthiness of the federal government, while Indonesia and Senegal rise by two as difficult elections loom. On the positive side, both Angola and Uzbekistan continue to see their scores fall as their new presidents take over from long-entrenched predecessors, while Bangladesh, Brazil and the DRC all post lower scores, at least temporarily, as controversial election campaigns did not bring substantial violence in their wake.
Moving from overall country scores to the individual risk categories in the current edition, the expropriation category has seventeen countries with rising risk, eleven with falling risk, and twelve unchanged. It shows the greatest breadth of change of any of the categories, with scores rising by as much as nine points and falling by as much as three. The nine-point rise was for Mexico, where the early policies of the AMLO administration have already contributed to a credit downgrade and significant concern among investors. The sharp rise encapsulates the sense of shock as what appeared to be a relatively pragmatic approach towards business within the new administration veered in a different direction.
In most editions, a rise of five points would have been enough to dominate the round-up of this category, and the importance of the five-point increase in expropriation risk for both Vietnam and China should not be underestimated. Vietnam’s new cyber security law, which came into effect in January, requires all companies providing internet-based services to hold all their data for Vietnam within the country. It also gives the Ministry of Public Security even greater powers to determine what constitutes acceptable online content. Barely a week into January, the government was already going after Facebook, and foreign participation in the country’s thriving digital sector was under significant threat. In China, the main concern is the possibility of government-directed bureaucratic retaliation against foreign companies as tensions continue to rise between Beijing and North America.
Other areas of concern in the expropriation category include the Algerian government’s intervention in the sale of a private company and the Indonesian government’s assumption of majority control in the main mining company in Papua after protracted and highly politicised negotiations. More positively, Angola and Peru are down by three points as new presidents attempt to remove barriers to greater investment. Thailand is also down by three as the military government continues to amend laws in an effort to increase the prospects for foreign investment in particular sectors of the economy.
The trend towards greater risk is most apparent in the political violence category. Here 21 countries post rising scores with just nine falling, compared to 15 and 13 in the last edition. Algeria, Indonesia and Senegal all see their scores up by four points as each one contends with the possibility of election-related violence. The expectation is that these scores will go down once the election period has passed, but the elevated numbers convey the heightened risk at present even in a country like Senegal, which rarely features in this section.
The positive side of the ledger always requires a degree of caution in the political violence category because a falling score can sometimes result from an increase in government control rather than a reduction in political tensions. This is the case in Bangladesh, where the government’s crackdown on its opponents ahead of the December elections has continued into 2019 despite another landslide victory. The fall of four points for Brazil is more encouraging, although it represents more of a lull than a trend. Both President Bolsonaro and his opponents anticipate a new wave of protests on a wide range of issues later in the year if he is able to push through some aspects of his policy agenda. Falls in Angola and Peru are better indicators of positive government action to reduce political dissatisfaction.
Countries with a rising risk of political violence include Kazakhstan, where violence in the mining sector was one of the factors behind the recent increase in the minimum wage; India, where this year’s general election is sharpening religious and caste differences; Ecuador, where the failure of former president Rafael Correa to register a new party in time for the local elections in March could see his supporters protest at their exclusion; and Colombia, where rising prices have already triggered significant protests.
In the last edition, it was the terrorism risk that bucked the negative trend, but that is not the case now. Fifteen countries saw their scores for terrorism go up, indicating higher risk, with only nine posting lower scores. The range of movement here tends to be lower than in the first two categories. However, Kenya is up by three points following the Al-Shabaab attack on a hotel complex in Nairobi in January and Colombia is also up by three in anticipation of renewed terrorist activity from the ELN now that the Duque government has finally broken off peace talks. In terms of falling scores, China is down by two points as Beijing continues to tighten its control in Xinjiang while Turkey is also down by two as the lengthening period since the last serious incident indicates the effectiveness of the security forces. The risks associated with Islamist extremist groups, whose members may have developed operational experience elsewhere or may increasingly be of home-grown origin and hard to detect, remain a significant issue in a number of the countries covered by the Index.
Of the eleven countries showing increased risk in the category covering exchange transfer and trade sanctions, Iran is the clear leader. A rise of six points reflects the extent to which the re-imposition of US sanctions in August and November 2018 are damaging an economy already weakened by years of disrupted trade. While Venezuela is only up by four points, its new score of 92 puts it firmly in our Extreme Risk category. Argentina is up by two points as interest rates, now at a level that is surely unsustainable, are used to shore up the peso ahead of elections in October.
Among the countries with falling scores, Russia is down by two points as further sanctions in the coming months look unlikely despite its seizure of Ukrainian naval personnel at the end of 2018. Thailand is also down by two as Brussels lifts its threat to ban imports from its poorly regulated seafood sector. Brazil, Turkey and Ukraine also post lower scores, although in each case the drop may well prove brief.
The sovereign default category is also closely divided, with thirteen countries posting higher scores and fifteen with lower scores. Mexico takes the headline here with a score that is up by four points, a sizeable and relatively rare jump for this category. Having already seen a downgrade linked to the cancellation of the new airport being built for Mexico City, the worry now for the new AMLO government is the debt of state-owned oil giant Pemex, which is now the most indebted oil company in the world. The possibility of losing its investment grade from all three main rating agencies is very real and, with the government now guaranteeing much of the Pemex debt, the threat to the federal government’s borrowing ability is rising. Countries whose high debt-to-GDP ratio is an increasing cause for concern include Argentina, Gabon, and Zambia. Sizeable budget deficits are an issue for the Philippines, while a lack of interest in recent treasury bond sales and the withholding of some foreign aid are together pushing Tanzania towards our High Risk category. Even the good news here is hedged around with caution. The DRC is down three, although only on the expectation that western donors will respond to the country’s controversial election result by offering greater economic assistance to the new government. Ukraine is down by three points now that the IMF has approved a stand-by line of credit, but it faces a very tough repayment schedule later this year. Uzbekistan is down by four having received its first investment grade ratings ahead of which should be a successful issue in the next few months, but the extent of new and existing Chinese loans could prove a medium-term problem.
Finally, a word about upcoming elections. Last year saw several crucial elections. Some brought new and sometimes controversial leaders to power, while others further entrenched long-time regimes. This is another big year for elections, and in the next few months we expect to see presidential elections in Algeria, Indonesia, Nigeria, Senegal and Ukraine, in some cases in conjunction with legislative elections. We will also see legislative elections that will determine the complexion of the government in South Africa, the Philippines and, perhaps most significantly, India.
In the coming weeks, we will continue to monitor the factors that affect political risk in these countries as well as all the others in the WillisTowersWatson Political Risk Index, and we look forward to bringing you more of this unfolding story in the next edition.