Economic anxiety meets political fragility | Top 5 Risks | RiskMap 2020
Top 5 Risks
4 Economic anxiety meets political fragility
For the intimate but increasingly tense relationship between politics and economics, 2020 brings little promise of relief or rapprochement. Countries with reasonably robust political and economic basics will withstand what is likely to be a year of stagnant growth, absent a severe local or global shock. But countries facing serious political challenges will find the sluggish economic outlook an unwelcome source of stress – a weak economy increases the chances of further political instability.
The difference between the two types of country is slim. Companies will need to know where their most vulnerable markets are, and whether 2020 will put them under potentially transformational pressure.
Control Risks’ strategic partner Oxford Economics reports that 2019 was the weakest year for global GDP growth since the 2008 financial crisis. It does not believe a recession in 2020 is inevitable. Nonetheless, GDP growth is expected to slow in the early stages of next year. Any pick-up in growth in H2 is likely to be grinding, in contrast to the healthy rebounds that followed the two previous mini slowdowns in the current expansion.
Although major central banks have stepped in to provide insurance policy cuts to keep financial conditions accommodative, this is unlikely to deliver any substantial acceleration in GDP growth. Interest rate cuts and quantitative easing (QE) are inadequate offsets to heightened geopolitical uncertainties. More generally, the effectiveness of interest rate cuts in stimulating activity has diminished, due to the low starting point for interest rates and bond yields.
On balance, over 2020 as a whole, global GDP growth is expected to average around 2.5%, in line with 2019’s outturn. Indeed, a weakening sustainable rate of GDP growth means that sub-3% global growth is likely to be the new normal, and there is no guarantee of any meaningful pick-up in 2021.
A further, fairly broad-based slowdown in growth is anticipated in the advanced economies next year. US GDP growth is expected to slow particularly sharply, from 2.3% this year to 1.6% in 2020. Meanwhile, we expect eurozone GDP growth to edge down from 1.2% this year to 1.0% in 2020, despite a more promising outlook for the cornerstone German auto industry.
The US Federal Reserve is likely to cut interest rates once more next year, though this is unlikely to counteract the effects of waning US fiscal stimulus, heightened trade tensions and weak corporate profits. Yet the causes of the country’s febrile atmosphere are not primarily economic. The country is in throes of the 2020 presidential election campaign and the impeachment process. Both political exercises will be protracted, controversial and tense. Confidence in US political institutions – including the belief in the sanctity of the electoral process – is being undermined amid intense partisan pressure and external threats.
Nonetheless, the US has experienced political upheaval before and come out the other side. In 2020, politics and economics will combine to inflame an already irritable body politic, but they will not destabilise the country beyond its (increasingly brittle) breaking point.
The EU’s resilience will be severely tested in 2020. Its ability to respond to the current downturn has been weakened by a lack of conventional monetary policy space and self-imposed rules that limit fiscal loosening. This has been exacerbated by continuing shifts in the politics of several member states. Coalitions have become larger and more unwieldy as a result of growing political fragmentation, while attempts to keep populist and far-right parties out of government are forcing ideologically distinct parties into awkward collaboration.
The rise of anti-establishment parties and the proliferation of more heterogeneous, less cohesive coalitions mean governments have less room to coordinate actions at the EU level. If they’re not held hostage by individual coalition members, many are fearful that acting in the long-term interest of the bloc – which may differ from short-term domestic priorities – will see them punished at the ballot box. Cooperation on economic issues such as fiscal policy and monetary union finds scant support in these circumstances.
With the patience of electorates increasingly stretched, and trust in established political parties severely weakened, some member-state governments may lack the political capital at home to compromise in the event of an EU-wide crisis. That EU governments faced with a crisis will manage to reach the required unanimity on most major decisions is an increasingly shaky assumption.
For business, the risk is that this instability and prolonged indecision will fail to convince international markets that Europe is on top of its economic and political challenges. If markets lose confidence and start doubting the stability of the Eurozone again, access to capital could become a challenge, with the result that companies whose financial fundamentals are not strong could suffer.
China, emerging markets
Amid the gloomy outlook, emerging markets are a relative bright spot in the global economy. But this moderate pick-up in growth is largely down to a select group of economies, including Brazil, India and Turkey, gaining some momentum after an especially disappointing 2019.
Despite the announcement of a “phase one” US-China trade deal, we expect China’s GDP growth to be the slowest since 1990. The government will take some action to support, but increased tolerance for slower growth and concerns about the negative effects of stimulus will limit the extent of policy easing. China will relinquish its position of the past decade or so as the global spender of last resort.
Economic pressure in China will translate into political pressure, reinforcing the trend of tighter domestic control and increased appetite for external confrontations. However, this pressure will not include any serious threat to Xi Jinping’s position, despite periodic rumours he is likely to dominate the political scene well beyond the next leadership turnover in 2022.
Moreover, a modest dip in GDP growth – remember, 6% growth in China creates the equivalent of a new G20 country every year – will not inflict much damage on the Asian economies in China’s orbit. Those countries benefit most from a strong Chinese economy, but they benefit from other dynamics too. For example, with the US-China trade war alerting companies to the costs of political risk, some manufacturers are moving (or mirroring) part of their China capacity elsewhere in the region. While there is certainly no exodus of multinationals from China, this trend has provided significant stimulus to economies in countries including Vietnam and Thailand.
Latin America is experiencing considerable political volatility, with mass public protests in Chile, Bolivia and Ecuador, to say nothing of Venezuela’s seemingly bottomless downward spiral and a lurch to the political left in Argentina.
Any additional economic pressure in many of those countries would bring simmering discontent to a boil. That, we believe, could send some countries in the region toward the left end of the spectrum, political real estate many assumed was now abandoned in Latin America.
We do not predict a new “pink tide” in South America, in part because 2020 is not a major election year on the continent. Nor do we anticipate a complete collapse in governing parties, even in South America’s most fragile states. Instead, we see the left discrediting incumbent right-wing governments and pinning on them the blame for downturns caused by the global slowdown and – crucially for resource-rich South America – a drop in commodity prices.
Here is what it will mean for investors: anti-business rhetoric, animosity and opposition, particularly in rural areas, will soar. Communities will demand more from business, particularly when tight budgets mean governments are unable to meet pressing social needs. These issues are particularly acute in Bolivia and Colombia, where low levels of social spending have sparked outrage among indigenous communities. Finally, the security situation in places like Colombia and other countries that are host to non-state armed groups depends on a robust economy. Governments that cannot fund their security services will feel restrained in their ability to guarantee their citizens’ safety.
The weight of foreign currency debt
So what of countries where the overall picture for the time being is robust, but debts in foreign currencies have reached crushing levels? Egypt comes to mind. The country remains an attractive destination for foreign direct investment – its economy is growing, and foreign currency reserves are at record highs. That said, it has a USD 12bn loan from the IMF and sizeable borrowings with the African Development Bank and the European Bank for Reconstruction and Development. This is on top of substantial loans from friendly regional governments. Public and private non-payment concerns loom large in Egypt, and a shock to the global economy – and FDI flows – could have a serious political impact.
Even in an environment that suppresses open political expression, Egypt in 2019 saw substantial social unrest as protesters took to the streets to push back against endemic corruption. It is not difficult to envisage developments that could bring protesters back onto the streets again if the economy turns sour. Although President Abdel Fattah al-Sisi has the support of parliament, with loyalists effectively providing a rubber stamp, a further decline in public support for his leadership could well be on the cards in 2020.
Companies seeking a counter-cyclical relationship between politics and economics will find some relief in Africa. This stems from its relative isolation from international financial markets: most of Africa’s challenges to foreign investors come from security and integrity risks across the continent, rather than from global economic shocks. In fact, when many international markets struggle, money tends to flow into Africa.
South Africa, the country most connected to global markets, is broadly seen to be in recovery mode, both economically and politically. The country held an election in 2019 and its democratic institutions are robust. It will not see an unanticipated change in leadership, though President Cyril Ramaphosa’s ambitious reform programme faces considerable opposition. In the event of a sharp downturn, we would expect the populist wing of the ruling African National Congress to turn on the public taps and spend.
Despite large imbalances in some financial markets, global economic and financial balance sheet vulnerabilities are overall less alarming than in 2008. Indebtedness issues in China have clearly grown over the past decade, and are likely to constrain growth. But policymakers there have scope to respond to a substantial softening in growth, and the risk of a hard economic landing remains low. Overall, a substantive global economic slowdown would be more likely to resemble that seen during the 2000 dot-com bust rather than the 2008 global financial crisis.
The scope has grown for looser fiscal policy, particularly in advanced economies, to be a positive game changer for the global economy. But while low rates have increased fiscal space, few governments seem prepared to embark on an imminent and aggressive fiscal loosening. And the chances of co-ordinated action are slimmer still. Growth would probably need to significantly undershoot our baseline view to deliver a significant fiscal policy response.
While our baseline view is that a global recession – defined as GDP growth falling below the annual rate of population growth of 1.1% – will be avoided, the risk of recession has grown. We attach a 30% probability to such an outcome in 2020. A resurgence in trade tensions, a sell-off in financial markets or policy errors are the most plausible trigger for significantly weaker GDP growth.
Ben May is a Director of Global Macroeconomic Research at Oxford Economics and is involved in the production and presentation of the company’s global macroeconomic views, with a leading role in our coverage of the advanced economies. Ben joined Oxford Economics in April 2014. He has over 15 years’ experience as a macro economist in the public and private sector and has over a decade’s expertise covering the Eurozone economy. Before joining the Global Macro team, Ben worked on the Eurozone team at Oxford Economics. In addition to his work covering broad Eurozone issues he was also responsible for research on the ECB and Germany. Prior to joining Oxford Economics, Ben spent over six years at Capital Economics and was responsible for the coverage of the southern Eurozone economies throughout the Eurozone crisis. Before that, he spent seven years at the Bank of England, working in three divisions of the Monetary Analysis area of the Bank, which provides research and analysis for the Monetary Policy Committee. Ben has a BSc in Economics with Statistics from the University of Bristol and an MSc in Economics from University College London.