Rising markets and reviving economies have contributed to the most optimistic business climate in the west since the collapse of Lehman Brothers in September, 2008. But, just as economic risk has declined, so political risk is on the rise, reports ft.com.

The Ukrainian upheavals have created the worst crisis in relations between Russia and the west since the end of the cold war.

The US and the European Union have begun imposing sanctions on Russia. The initial measures involved are limited, but the risks of a tit-for-tat escalation are high – and will be making big western investors in Russia, such as BP, very nervous.

Russia provides a good case-study of the two sorts of political risk that investors have to consider: the macro and the micro. Macro political risks involve large-scale changes – either in the form of internal upheaval or international conflict – which can seriously destabilize the business environment. Micro political risk takes in the sort of events that do not necessarily make world headlines – a change of ministers, a capricious presidential decision, an unexpected court ruling.

In its prospectus for a share offering in London in 2006, Rosneft, a large Russian oil company, had stated frankly: "Crime and corruption could create a difficult business climate in Russia.” Now, investors also have to factor in the risk of an international political crisis.

Julian Macey-Dare, who heads the international political risk business for Marsh, a global insurance broker, says that the classic definitions of political risk centre round the threats of war, or the expropriation of assets.

However, Mr Macey-Dare notes that the nature of the political risks that businesses are worrying about is broadening, both in terms of the kind of assets that need protecting, and the kind of markets that are deemed risky.

The common assumption is still that the riskiest political environments are found in emerging markets and that it is physical assets – such as a mine or a factory – that are most at risk of destruction, or confiscation.

Increasingly, however, it is just as likely to be a non-physical asset – such as a licence to operate, or a debt-holding – that can be placed at risk by an unexpected political change.

Political risks are also no longer confined to emerging markets. On the contrary, the threat of political upheaval in Europe is still one of the main macro political risks facing the world.

At the moment, investors generally seem to assume that the worst of the eurozone crisis is over. The return of confidence is reflected in the fact that countries such as Italy and Spain can now borrow at lower interest rates. Private-equity investors are also on the prowl in Europe. However, it is entirely possible that political events over the next year will reignite the euro-crisis.

Two things in particular need watching. The first is the likelihood of a surge in votes for populist and anti-EU parties in the elections for the European Parliament in May. If, for example, the far-right National Front tops the polls in France – a result that is entirely possible – mainstream politicians will face a crisis of confidence that could transmit to the markets. If the far left wins in Greece, the spectre of a Greek default on its debt could also re-emerge.

The political situation in Italy – which owns the fourth-largest debt stock of any nation in the world – also remains fragile. Many businesspeople are hoping that Matteo Renzi, the energetic new prime minister, will force through much-needed reforms. But the Italian political and social system has defeated many reformers in the past.

And, if Mr Renzi also fails, a sense of political crisis would return to Italy.

The year has also seen a revived awareness of the fragility of emerging markets, with a particular focus on political risk. Put simply, those markets that look most risky are also often those with the most troubled political environment.

So, in Latin America, the current optimism about Mexico is closely correlated to the impressive political leadership of President Pena Nieto. By contrast, the decline in investor confidence about the prospects of Brazil has coincided with the surge in street protests that threaten to peak, during the World Cup, later this year.

Turkey is also an emerging market that is making investors nervous – and, once again, the threat of political upheaval is central to these concerns.

For the past decade, the country has grown rapidly and was widely perceived to be benefiting from the strong and confident leadership of Prime Minister, Recep
Tayyip Erdogan. But he now faces multiple challenges, including recurrent street protests in Istanbul, a corruption probe and a row with the powerful "Gulenist” movement that has split the forces of political Islam.

Given Turkey’s dependence on short-term capital, rising political turbulence could spell economic trouble.

In an ideal world, investors would be able to make calm assessments of the circumstances of individual countries, without necessarily leaping to conclusions about their neighbours.

In reality, a political upheaval in one country can lead to contagious nervousness about an entire group of nations, whether it is "emerging markets” or the eurozone.
That is why political risk is likely to be one of the main threats to the global economic recovery, over the coming year.
1593 reads | 18.03.2014

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