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The Growth of Political Risk Consciousness in Investing

Many analysts saw the U.S.'s downgrade by Standard & Poor’s as a political rather than an economic problem. It has higlighted a recent trend investing towards a greater focus on analyzing political risk, according to Stuart Rothenberg, editor of the well-followed Rothenberg Political Report.

What could be more predictable than the behavior of politicians? cynics might ask. But lately even the most hard-core septics, on both sides of the Atlantic, have been at times shocked by developed-country leaders’ odd antics regarding such unfunny matters as debt, public spending, bailouts and deficits.

The upshot is that political risk, which is as old as the Pharaohs, has assumed an anxiety-producing new prominence — become the joker in the deck of risk cards — and begun to change the way investors think about risk.

Stuart Rothenberg, editor of the well-followed Rothenberg Political Report, asserts that “political decisions are increasingly affecting markets and economic growth.” It’s no surprise that major investment banks, including UBS, now routinely ask government affairs experts to participate in conference calls with investors.

What crystalized the new political risk-consciousness in the U.S. was of course the debt-ceiling contretemps and Standard & Poor’s closely related decision to downgrade America’s credit rating from AAA to AA+. S&P senior analyst David Beers said the stand-off on Capitol Hill over raising the national-debt limit and slashing the deficit pointed up a degree of uncertainty “that is incompatible with an AAA rating.”

“I was struck by the emphasis in the S&P analysis on politics,” says Rothenberg.

But is the concern about the supposed new perils of political risk in the West warranted? After all, the U.S. remains a top-notch credit.

In fact, however, much more fundamental factors than pre-election political jockeying are intensifying at least the perception of political risk. For a start, Western governments tend, for better or worse, to be a much bigger force in their economies than they once were. In the U.S., for instance, “the entire healthcare regulatory process is based on political inputs, not on the marketplace,” maintains Raghuram Selvaraju, a healthcare analyst with New York investment bank Triartisan Morgan Joseph. “The failure to recognize the political risks in the regulatory process can deeply affect decision-making and the investment process.”Moreover, the basic nature of developed-country political risk seems to have changed overnight. Most sovereign financial analysis in the past was based on a country’s “ability” to pay, explains Tom Vogel, a partner with New York consulting firm Rachlan Strategic Communications. But the S&P’s decision rested on the U.S.’s “willingness” to pay. That, says Vogel, completely changed the analytical metrics. Always an explicit factor in evaluating emerging markets, political risk now applies overtly to the U.S. and Europe. “You don’t make decisions based only on economic and financial data, because you can always be undercut that with political caveats” says Vogel, who has written extensively on sovereign risk in emerging markets.

Of course, political involvement in an economy cuts both ways. Almost all of today’s fastest-growing economies, such as China and India, exhibit a pronounced political tilt that should in theory make for exaggerated political risk. In China, says William Kaye, a managing director of Hong Kong investment bank The Pacific Group, Beijing sets the economic agenda down to allocating the last silicon chip. But as long as that process functions well, no one is going to make a big deal about its political character, contends Kaye, and in China “the political system works.” For the time being, anyhow.

Once, evaluating political hazards was just one component of the overall risk-assessment exercise, concludes Rothenberg. What should have everyone worried today is the “outing” of political risk: the tendency for businesspeople and politicians alike to blame politics for every conceivable shortcoming of the economy. That, too, poses real risks.

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