How Political Risk Influences Economic Risk

Navigating Risk Ratings and Politics in the Global Economy

The sharp decline in economic conditions in the wake of the 2007-08 global financial crisis prompted extensive country risk rating downgrades among the 132 countries Dun & Bradstreet’s economists cover. Similarly, economic factors drove wholesale country risk rating downgrades in Asia Pacific following 1997’s regional financial crisis. As economies recover from the recession, we’ve seen gradual improvements in these ratings. But it’s not always the economy that influences shifts in our risk ratings: we look at many other elements, including political risk.

What is Political Risk?

Definitions of political risk can be broad, as ‘political’ decisions can affect not just the political outlook but also the economy, the commercial environment, and internal/external security. Our economic experts look at risk holistically, combining multiple data sources with economic factors to understand the essential nature of risk. Political risk is broad and multi-faceted. In this context, political factors that affect Dun & Bradstreet’s executive economists’ risk ratings include:

  1. Government policies: Policies created by the government affect the economic and commercial environment; for example, risks will fall after a trade and investment agreement is signed with another country, or when moves are made to address corruption, while risks will rise if the state takes greater control of the commodity sector or if there is political interference in central bank policies.
  2. Political system: The rating environment can change based on changes in a political system, including the outcome of elections – which could herald a different economic agenda – or the rise of populist parties. Moves towards a more democratic system will improve the risk outlook, but increased authoritarianism will elevate risk.
  3. Powerful interest groups: Unelected but powerful interest groups can skew policy-making in their favour, negatively affecting the business environment.
  4. Decentralisation: Moves toward independence in a specific territorial area can raise risk levels (for example, the Kurdish referendum in Iraq has heightened political risk in Iraq, Syria, Turkey and Iran). Sometimes, however, a negotiated increase in autonomy for a region can see risk fall; no single model fits all contexts and countries.
  5. Radical groups: The presence of radical groups that are not prepared to act within the country’s laws will have a negative impact on the risk rating.
  6. External threats: Increased political tensions between countries will raise risk, while improved relations will lower it.

The Significant Impact of Political Risk Globally

There is considerable room for the complex interplay of political events and policy decisions to affect Dun & Bradstreet’s risk ratings. Indeed, in the period covering 2012 to end-September 2017, political risk considerations were responsible for one-third of our risk rating changes (77 out of 231). When we include rating changes prompted by a combination of economic and political factors, ‘politics’ accounts for 117 (over 50%) of the changes made during this period.

How Political Risk Affects Upgrades and Downgrades in Ratings

Political influences affect the likelihood of upgrades and downgrades differently: since the start of 2012, political factors, either solely or in combination with economic events, have accounted for a far higher proportion of downgrades (86 out of 146) than upgrades (31 out of 85): 58.9%, compared with 36.5%. This trend has been particularly pronounced in 2017, with all 11 downgrades this year being made due to political factors (nine solely because of politics, and two stemming from the politics/economics combination). In contrast, of the 14 upgrades, only five were rooted in political factors, whereas nine were the result of improving economic conditions; this partly reflects the gradual strengthening of the global economy after years of weak growth following the 2007-08 global financial crisis.

Countries Recently Downgraded due to Political Risk

The countries that have been downgraded because of political factors in 2017 are Poland, Romania (twice), Albania, Iran, Qatar, Bahrain, Chile, and India. In addition, Oman and Jordan were downgraded amid a combination of political and economic factors. This indicates that political uncertainty has become more widespread; in 2011, for example, the vast majority of ‘political’ downgrades were in the Middle East and North Africa (MENA) region. More positively, Uzbekistan, France, Albania, and Macedonia have been upgraded for political reasons, while Iceland was upgraded because of improved political and economic conditions.

Regional Differences in Political Risk

Breaking down the findings by region highlights significant disparities. The MENA region, which includes 19 (14.4%) of the 132 countries we cover, accounted for 41.9% of the political downgrades, followed by Western and Central Europe (WCE) with 30 countries (22.7% of our coverage universe), which accounted for 23.3% of the political downgrades. By comparison, other regions were less prone to political difficulties; Latin America (15.9% of the 132 countries), Eastern Europe and Central Asia (EECA, 12.1%) and Asia Pacific (17.4%) each accounted for 9.3% of the political downgrades, while Sub-Saharan Africa (SSA, 15.9% of the countries) was responsible for 7.0% of the political downgrades.

In terms of political upgrades, the same two regions were the most active in prompting rating changes, with WCE leading the way at 29.0%, followed by MENA (25.8%), EECA (19.4%), Asia-Pacific (12.9%), SSA (9.7%) and Latin America (3.2%). North America, which comprises only Canada and the US, did not have politically-related upgrades or downgrades in the period under study.

The political reasons for the changes in WCE risk ratings have primarily centred on the structural political weakness of the EU, the rise of anti-EU populist parties, and the Brexit vote in the UK. In contrast, MENA has been hit by the after-effects of the Arab Spring (since late 2010), the Iranian nuclear issue, and, in 2017, increased tensions between Saudi Arabia and Iran, between Washington and Tehran, and between the Quartet (Saudi Arabia, the UAE, Egypt and Bahrain) and Qatar.

Political Risk will Influence Economic Risk in 2018

Looking ahead to 2018, downside risks to our growth forecasts and the business environment remain heavily influenced by political factors. In the US, partisan politics is threatening the consensus over raising the debt ceiling, while the important NAFTA agreement between the US, Mexico and Canada is also under pressure. In Latin America, Venezuela – a key oil producer – is lurching towards authoritarianism and the threat of civil war, while government policies are not addressing key issues (such as corruption) that undermine the business environment.

Across the Atlantic, even the politically stable democracies of Europe face challenges: the Brexit discussions are undermining the outlook in the UK and the EU, while the rise of populist parties has heightened political risk more widely. Further east, in the EECA region, the war in Ukraine is undermining the regional security situation, while Turkey is drifting towards authoritarianism and has adopted increasingly fractious relations with many countries.

Meanwhile, the MENA region’s business environment is being undermined by a number of factors: divisive civil wars, increased tensions between the US and Iran, a dispute between the Quartet and Qatar, and, latterly, the Kurdish independence vote. In Sub-Saharan Africa, socioeconomic tensions are rising in several countries, including South Africa and Kenya.

Finally, the most worrying (but not necessarily the most likely) political risk is in the Asia Pacific region. Here, the North Korean crisis continues to attract headlines, while radical Islamist groups are present in a number of countries, including Pakistan, Indonesia, Bangladesh and the Philippines.

The Importance of Political Analysis in Managing Risk

This complex web of contexts and developments highlights the multi-faceted nature of the political factors that influence our country risk ratings. It also reinforces how vitally important it is for customers to continually monitor political risk in the countries where they operate and in which they have supply chains.

Given the interplay of domestic and international politics, customers must also consider that the political factors in play in countries where they do not have a presence can also impact on their business activities. Analysis of domestic and cross-border political developments remains an essential source of insight for potential changes in risk.