A summary of the report
Among the three factors to emerge from the individual country profiles in this edition of the Willis Towers Watson Political Risk Index, two are familiar while one comes as something of a surprise. The first which we have seen previously involves global oil prices and the extent to which US sanctions on Iran are likely to push prices higher. The other is the state of the dollar and the related level of US interest rates, which can influence how much investment flows towards or away from emerging market economies. The new factor is related to the recent elections in Brazil.
As many of the forty countries covered in the Index are either significant exporters or importers of oil, price fluctuations can have a substantial effect on policy options. Oil prices look likely to retain their relatively elevated levels for the remainder of 2018. The price of Brent crude rose above 80 dollars per barrel in September for the first time since November 2014, largely on the decision by OPEC and its partners not to increase production when US sanctions limited international access to Iranian crude sales in November. OPEC production had risen by 430,000 barrels per day (b/d) between January 2018 and September 2018, when the decision was taken at a meeting of producers in Algiers, with half of that increase coming in August as both Iraqi and Libyan production moved sharply higher. However, this is still substantially below the promise made in June to increase production by 1 million b/d and output from Saudi Arabia and Venezuela has since fallen.
The decision not to ramp up output elsewhere, to replace Iranian production made unavailable by US sanctions, is significant because estimates of the amounts involved have continued to rise. Initial expectations were that some 300,000-700,000 b/d of Iranian crude and condensate exports would be affected as countries, mainly in Europe, acceded to Washington’s insistence that their purchases of Iranian crude must end. However, as the sanctions deadline came closer, traders, banks and oil companies raised estimates of how much production would be removed from world markets to between 1.0 million and 1.5 million b/d.
With prices already above 80 dollars per barrel, forecasts that they will rise above 100 dollars in 2019 are becoming more common. Part of that higher price factors in the probability that it will be left to US production to replace inaccessible Iranian output. Although US crude production continues to increase and is expected to reach 11.50 million b/d in 2019 from 9.35 million b/d in 2017, the concentration of production around the Gulf of Mexico highlights the potential for global supplies to be affected by hurricane damage to US refining infrastructure.
Both Tehran and Washington are taking a hard line on sanctions, and neither will find it politically easy to move back from their respective positions. Although the restrictions on crude sales are likely to persist into 2019, the resultant price spike is expected to occur within the context of a relatively bearish medium-term outlook. Emerging market currency depreciation will add to the rising cost of importing oil, keeping demand growth in 2019 at a figure of 1.4 million b/d. Other factors that are becoming more important in dampening demand growth are the 3.5 million passenger electric vehicles (EVs) already on the world's roads, which together displace just over 200,000 b/d of oil demand, and policy measures to ban certain plastic products which would reduce oil demand from the petrochemicals sector by a similar amount.
Meanwhile, although the dollar’s recent weakness has provided some relief to indebted emerging markets, more expected rate rises from the Federal Reserve are likely to strengthen it once again. A dollar liquidity squeeze stemming from the twin effects of a sharp rise in Treasury issuance and the unwinding of the Fed's balance sheet would pull capital out of emerging market economies. This could also potentially lead to longer-term pressure on the dollar if bond investors start to fret about the deterioration of the US fiscal and current account balances. In the near term, however, a more hawkish Fed still poses a significant risk to emerging market assets, particularly if expectations of further monetary tightening spark a renewed rise in the dollar.
The new factor with the potential to have an impact on short-term prospects for countries in the Index involves Brazil’s presidential election. In the first round of voting, held in early October, far-right candidate Jair Bolsonaro, a retired army captain and seven-term congressman, came within 4 percentage points of outright victory. He won some 46% of valid votes, against 29% for Fernando Haddad, who was standing in for the imprisoned former President Luiz Inacio Lula da Silva as the Workers Party (PT) candidate. Congressman Jair Bolsonaro scored a strong victory in November to become Brazil’s president.
Bolsonaro, running for the small Social Liberal Party (PSL), began very much as an outsider in the presidential race, staking out territory distinctly to the right of Geraldo Alckmin of the much larger PSBD, which is the traditional party of the centre-right. Many observers initially gave him little chance of making the second-round runoff, partly because Brazilian voters were not expected to be receptive to his uncompromising and sometimes divisive message, but mainly for a more practical reason involving access to free airtime for election broadcasts. These free slots are distributed by a formula that reflects the backing that each candidate can muster in the lower house of the legislature, where Bolsonaro has few allies. As a result, he received very little free air time during the official television campaign period while Alckmin was awarded almost half the available slots.
Instead, Bolsonaro and his highly engaged supporters ran an extremely effective social media campaign that reached not only the increasing number of more affluent Brazilians who get their news from the internet, but also the many younger Brazilians among whom resentment at the current economic situation runs deep. Although he was not considered the clear frontrunner when he was stabbed during a campaign rally on September 6, the additional media exposure he gained following the attack boosted Bolsonaro’s campaign.
As late as a week before the first round vote, he was expected to lose a second-round runoff to Haddad but his huge margin of victory in the first round put Bolsonaro within touching distance of the presidency. Despite spending decades in Congress, his low profile there allowed him to run as the 'anti-system' candidate at a time of profound crisis in Brazilian politics. Although the country’s mainstream parties have all been deeply implicated in the corruption scandals that have convulsed the country in the last four years, the revelations of the PT's involvement in corruption following years of claiming to be the 'party of honesty' shaped a more general anti-PT sentiment across the electorate. Bolsonaro has managed to capitalise on this more than any other candidate by building support among three distinct and occasionally overlapping groups.
One is made up of social conservatives, including those who came over to him late in the campaign in reaction to a series of anti-Bolsonaro rallies organised by women in major cities across Brazil just days before the vote. They have responded to his combination of attacks on the PT with a conservative approach to social issues. A second is made up of economic liberals who blame the PT’s interventionist policies for the country’s economic problems and welcome Bolsonaro’s talk of reducing the state’s role in the economy. Bolsonaro has successfully recognised that, although the centre-right has traditionally held back from pushing free-market economics in Brazil, support for economic liberalism has gained significant ground in recent years.
Finally, in a country with a murder rate of around 60,000 per year, Bolsonaro's promise to take a hard line on public security has proved a vote winner now that a significant proportion of the electorate believes the country needs new and tougher policies to tackle crime. His proposals in this area include lowering the age of criminal responsibility to 16 from 18 and giving citizens more leeway to arm themselves for self-defence.
Bolsonaro did not need to create a desire for change in Brazil after the political and economic turmoil in recent years. He merely needed to tap into the existing levels of dissatisfaction by offering an alternative to the years of PT rule from the opposite side of the political system, rather than from the discredited centre ground occupied by the PSBD.
As we have seen elsewhere, not least in the US and UK in 2016, a desire for change within an electorate that feels neglected or ignored can lead to an electoral lurch in the opposition direction. Bolsonaro’s campaign shows once again how powerful an effective social media campaign can now be, even in countries where traditional campaign advertising is still assumed to be crucial. The extent to which developments in Brazil will affect wider investor perceptions of political uncertainty in emerging economies, and particularly the potential speed of political change, remains to be seen. But it does perhaps suggest the need to understand political dynamics within individual countries even as one notes the development of broader trends.
Although the previous edition of the Index was still indicating an overall fall in general political risk across the forty countries covered, we noted with some concern the narrowing gap between the number of countries with falling scores and those whose scores were rising. The split then was twenty countries with a lower score, indicating a decrease in risk, and fourteen whose rising scores denoted increased risk. Only six had scores that did not move.
That trend has not only continued in the current edition but has moved the overall Index firmly into negative territory. This time, we have eighteen countries posting a rising score, only thirteen with a lower risk and nine that are unchanged. In most cases, the country scores have changed by a relatively small amount but the upward trend in risk is clear. The overall score for each country is derived from the ratings for five individual risk categories: expropriation, political violence, terrorism, exchange transfer, and sovereign default. In this edition, all but terrorism show more rising scores than falling. However, it is perhaps worth noting that no country has all of its sub-categories moving in the same direction, with most posting a mix of rising and falling numbers, and this usually acts as a check on large and sudden movements in either direction. In the current edition, the expropriation sub-category shows not only a preponderance of rising scores, but also a degree of volatility in the numbers. Seventeen countries show increased risk, while only ten are falling. Significantly, half of the countries had scores that moved by two points or more. In some countries, the numbers are high but the scope of the businesses under threat is limited. Angola is up four points as the government of President Lourenco targets companies associated with his predecessor’s family, while Ukraine falls three points as the government in Kyiv scales back similar efforts to overturn questionable privatisations by the previous regime.
Both Colombia and Zimbabwe are down by three points after their recent election results, while Mexico is up by three for the same reason. AMLO’s expected victory in the July elections was reflected in the score last time but there is still scope for additional concern as his energy team assembles. By contrast, while it is something of a surprise to see expropriation risk in Venezuela down by four points, the dire economic situation forcing the government into a difficult process of de-nationalisation.
In another sign of an overall rise in risk, in this edition more countries have a rising score than a falling one in the sub-category covering political violence. While the gap is relatively small, with fifteen up and thirteen down, falling scores in this category are not always encouraging. As we have noted before, they can sometimes reflect a government that is becoming more repressive rather than a society becoming less agitated.
Egypt’s score falls by a further two points this time as the heightened security that preceded the presidential election earlier this year tightened rather than relaxed in the months after the vote. Thailand is down by four points after the military government’s determination to enforce its ban on all political activity was made plain by its efforts to prevent opponents from marking the anniversary of the coup that brought it to power. More positively, both Angola and Ecuador are down by three points as changes at the top of the governing parties ease political tensions, while Mexico and Pakistan are down by the same amount following completion of significant electoral campaign periods. Among those countries with a rising score, Bangladesh is up four points as the government adds a heavy-handed response to student demands for more job opportunities to its ongoing campaign against the country’s main opposition party. Brazil’s political violence score rises again in this edition as the final stages of the presidential campaign added the threat of clashes between rival supporters to concerns about the possibility of more clashes between strikers and security forces. Although the three-point rises for the Dominican Republic and Senegal both come from a low base, in each case they are related to the potential for popular protests over a specific issue and reflect the risk that a clumsy response from inexperienced authorities could raise tensions.
Even the terrorism sub-category has reversed the downward trend that was evident in the last two editions. Although almost twice as many countries post falling scores than rising ones this time, we now have eight countries showing rising scores rather than six last time. Most of these are doing so from a low base amid a rise in general rather than specific concerns, but the three point rise for Venezuela and the two point rise for Indonesia both reflect significant recent activity. Among the countries with falling scores, both Algeria and Egypt continue to make progress in holding back efforts by Islamist groups to gain a foothold in urban areas, while Bangladesh has now gone two years without a significant attack on foreign nationals. Despite continuing trouble in Chechnya, it is also eighteen months since a terror attack took place in a major Russian city and, happily, the World Cup was held without incident. Saudi-led operations in Yemen have reduced the immediate terrorist threat to the kingdom, although this may change in the longer term.
The category covering exchange transfer and trade sanctions reflects the same dynamics, with the encouraging trend from the previous edition now reversed. This time eighteen countries have rising scores and only twelve are falling, compared to eleven up and eighteen down last time. The very sharp rise of nine points for Turkey reflects not only the recent lira crisis but also the potential for a further fall as President Erdogan’s idiosyncratic approach to economic policy and the bilateral escalation of trade tariffs with Washington both continue. Russia is up by seven points as new US sanctions related to the Skirpal poisoning incident in the UK begin to bite and a second round of more stringent measures against them in November. The implications are hurting not only the rouble but the wider economy as well.
Elsewhere, Myanmar is up by four points on a weakening currency and the prospect that dwindling European patience with the government’s handling of the Rohingya crisis is hastening the imposition of meaningful sanctions, while India and Ghana are both up by three points following the slide of the rupee and the cedi respectively. More positively, Colombia and Ukraine are down by two points after a period of relative stability, although the latter still has a ‘high’ risk rating in this category. Iran, the only other country rated ‘high’ here other than Venezuela, has gone up by another two points ahead of further US sanctions in November.
As usual, the sub-category covering sovereign default risk is among the most static, with more than half of the countries seeing no change to their score in this edition. But even here, the balance between those countries with changing scores has turned negative. Last time, eleven countries had rising scores while sixteen fell; this time, twelve are up and only seven down. Turkey again stands out, rising by eight points on a burgeoning budget deficit and the substantial amount of foreign debt that becomes due soon, but South Africa, Mexico, and the Philippines are all up by two points.
Among those with falling scores, Egypt is complying with the IMF’s exacting conditions while Nigeria is making progress in paying down high yield debt. The two countries showing greatest risk of sovereign default, Venezuela and Zimbabwe, both have scores that are unchanged, meaning that Venezuela remains firmly in the ‘extreme’ risk category with no sign of progress in restructuring what is now more than 65 billion dollars of foreign debt.
Although we have already had a number of significant elections during 2018, including those in Mexico, Pakistan, Turkey and Zimbabwe, there are still more to come. Among them are conclusion of the parliamentary contest in Bangladesh that is expected to return the Awami League for another term, and the much-delayed presidential election now expected at the end of December in the Democratic Republic of Congo. The first months of 2019 promise parliamentary and presidential elections in Nigeria and the increasingly slim possibility of legislative elections in Thailand.
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 Political Risk Index, and look forward to bringing you the next edition.