Political risks ease in China and Iran but worries deepen over Brazil

Anti-corruption reforms and the lifting of sanctions have eased political risk in China and Iran, respectively, according to Aon Risk Solutions’ 2016 Political Risk Map for emerging markets.

The firm, which is the global risk management business of Aon, did say, however, that other states are struggling to counteract the economic risks being driven by weak commodity prices.

“For the first time in the last three years, the Aon Political Risk Map reflects more countries with reductions in political risk than increases, an encouraging sign of the impact of political and economic reforms,” said Karl Hennessy, president of Aon Broking and chief executive officer of Aon’s Global Broking Centre in London.

“Despite increases in economic risks stemming from low commodity prices, improvements in political stability have occurred. However, weakness in the global economy could yet cause significant increases in political risks within countries and spill-over effects into others states.”

Over the last year, anti-corruption measures have contributed to a decrease in political risk in China, according to the Aon Risk Solution. Nonetheless, it said that recent implementation issues and policy uncertainty have clouded the overall outlook.

The rebalancing and slowing of the world’s second largest economy is likely to present challenges for China’s neighbours and key trading partners, according to the report, which could experience higher political and economic risks as the pace and composition of growth changes.

Recently there have been signs of an improvement in the communication of policy, but risks remain, particularly around the building up of further leverage in the Chinese banking system, according to the data.

The outlook for many emerging market economies will be based on whether politicians are able to implement pledged reforms to attract more investment at a time when weaker global trade and economic growth is increasing competition for capital, according to Aon Risk Solutions.

“So far, many of the structural reform plans have disappointed, weakening growth and reducing resiliency to shocks. Two in the spotlight this year are India and Indonesia, who have stronger balance sheets than many peers, but who have been struggling to implement policies. Doing so would help alleviate political risks,” it said.

In Iran, the implementation of the international Joint Comprehensive Plan of Action (JCPOA) loosening international sanctions, prompted a reduction in the country’s political risk rating in 2016 from a very high level. With uncertainty around the extent to which the country’s Revolutionary Guards and others with vested interests will play a role in the economy, the operating environment remains unclear. A stronger government position could lead to Iranian intervention elsewhere in the region and perpetuate regional political risk,

“Iran’s re-entry to global markets will increase the supply of oil, and eventually gas, as it gains access to more foreign markets including Europe,” said Rachel Ziemba, Managing Director of Research at Roubini Global Economics. “Iran has a more diversified economy than many Middle Eastern and African peers and has done more to adjust to lower oil prices.”

Topping the list of political risks facing emerging market investors in 2016 is the impact of oil prices in already fragile oil-dependent countries such as Iraq, Libya, Russia and Venezuela. The 2016 Aon Political Risk Map indicates that countries with more resilient institutions and greater foreign currency reserves will be better positioned to minimise sovereign non-payment and exchange transfer risks, including members of the Gulf Cooperation Council (GCC) as well as Colombia, Malaysia and Kazakhstan. Still, increased security risks in neighbouring countries such as Iraq, Algeria, Nigeria, Libya and Syria are likely to hinder improving risk outlooks for countries that might stand to benefit from cheaper oil, like Egypt, Tunisia and Morocco.

“Oil-producing nations must find substitutes for lost revenues which will put pressure on their corporate sectors at a minimum through tax regime adjustments and at the extreme through initial public offerings (IPOs) of state-owned enterprises,” said Matthew Shires, head of political risk for Aon Risk Solutions.

“With no sign of oil prices returning to previous levels, turbulence in many oil producing states is likely to continue, and could worsen.”

Weaker oil prices are exacerbating exchange transfer risks, according to the report, putting pressure on corporations and individuals seeking foreign currency and discouraging investors. Meanwhile weaker revenues are increasing sovereign non-payment risk.

While only a few countries have sizeable foreign currency debt burdens (Venezuela), government budget gaps are widening, putting pressure on banks, which in turn are perpetuating a credit crunch in the GCC countries, CIS countries and African oil producers. In some of the more vulnerable countries, government arrears are growing, providing further strain on the private sector.

Ongoing conflicts between countries and with non-state actors create heightened levels of political violence and present further risks. The effectiveness of extremist groups in the Middle East and Africa, including ISIS and Boko Haram, taking advantage of porous borders and weak institutions will also be amplified in afflicted countries, many of which are also feeling the effects of low oil prices. Even in countries which look more resilient, increased taxes and higher unemployment are likely to add to political strains making it harder for them to cope with other shocks.

Finally, as Rio de Janeiro readies to host the 2016 Summer Olympic Games, Brazil’s longest recession since the 1930s remains a significant strain on the country’s social resilience. Although many of the drivers of the crisis are political, including the gridlock between political parties which has left fiscal and economic policies in unsustainable limbo, the increase in unemployment and falling wages is challenging both households and companies. For 2016, non-performing assets in state-banks will continue to increase debt and debt service will become increasingly costly while ongoing political deadlock will erode the country’s ability to cope with a range of economic, social and health shocks, including the Zika virus.

“The Brazilian economy is experiencing its most prolonged downturn in recent history as it prepares for Rio 2016,” said Paul Domjan, managing director of Roubini Global Economics.

“Over the long run, the business environment has been weakened by poor economic performance and this could become an even bigger issue for firms operating in Brazil. Brazil’s buffers are being eroded, and even the potential upside from rooting out corruption is bringing significant collateral damage as cases work their way through the legal system.”