political risk and trade finance txf conference - nov 2014

www.politicalmonitor.com.au

POLITICAL RISK ASIAECA-DFI Finance in Asia 2014November 2014

WHAT IS POLITICAL RISK?

Political risk outlook 2

Political risk is the risk that derives from both the decisions of government and the broader stability of a political system. It has the ability to impact company valuations and influence long term commercial planning.

Political risk can emerge from any level of government – local, state or national – and at any level of decision making – political or bureaucratic.

WHAT ARE WE FORECASTING?


• Relative likelihood – political risk forecasts provide guidance on the likelihood of any event occurring and the implications for political stability relative to other markets.

• Systemic weakness – political risk identifies those markets that are likely to be overwhelmed by an unforeseen event due to institutional weakness.

• Trends – political risk focuses on trends that speak to systemic issues within a country that have long-term implications.

• Political economy – political risk analyses the way in which power considerations influence economic decisions.

KEY INFLUENCING FACTORS


Environmental

Climate change

Water resources and

pollution

Biodiversity

Energy resources and

management

Bio capacity and ecosystem quality

Air pollution

Natural disasters

Natural resources

Social

Human rights

Education and human

capital

Health levels

Political freedoms

Demographic change

Employment levels

Social exclusion and

poverty

Trust in society /

institutions

Crime and safety

Food security

Governance

Institutional strength

Corruption

Regime stability

Political rights and civil

liberties

Rule of law

Regulatory effectiveness and quality

Accounting standards

Government finances

REGIONAL TRENDS

YOUTHFUL POPULATIONS OFFER SIGNIFICANT ECONOMIC UPSIDE


BUT GIVING YOUNG PEOPLE JOBS IS CRITICAL TO POLITICAL STABILITY


RISING FOOD PRICES ARE A CONSTANT SOURCE OF POLITICAL RISK


THE DECLINE IN OIL PRICES DOES NOT BENEFIT ALL MARKETS EQUALLY


HOT BUTTON ISSUES

WHAT ISSUES ARE CREATING TENSION IN THE REGION?


• Disputed geography – disputes between China, Japan, South Korea, Philippines and Vietnam over islands and ocean boundaries.

• US pivot to Asia – welcomed by US allies – Australia, Japan, South Korea – but regarded by China as an attempt to constrain it in its own neighbourhood.

• Energy – the pursuit of natural resources and control of the waterways that allow access are a constant source of tension.

• The rise of China – tensions emerging from the above reflect underlying concerns in the region about China’s rise and its political intent.

TENSIONS REVEAL THEMSELVES IN TRADE – trade within & outside of trading blocs (Share of total goods trade, %)


23 24 25 24

47

10 13

73 6865 63

0

10

20

30

40

50

60

70

80

90

100

2000 2003 2006 2012

ASEAN goods trade

Intraregional Trade with China

Global (ex China)

64 66 6459

23 4

5

34 31 32 36

0

10

20

30

40

50

60

70

80

90

100

2000 2003 2006 2012

EU goods trade


Global (ex China)

46 45 42 40

5 8 10 12

49 48 48 48

0

10

20

30

40

50

60

70

80

90

100

2000 2003 2006 2012

NAFTA goods trade


Global (ex China)

Source: McKinsey Global Institute

TENSIONS REVEAL THEMSELVES IN TRADE – Japanese trade with China


COUNTRY ANALYSIS

COUNTRY IN FOCUS –China: HIGH– 43/100

• China’s demographic dividend has been banked

and the country is now entering a period in which

its population will decline and age. This will result

in demand for increased social services while

there will be less working age people to fund

those services.

• Nearly 15% of China’s population officially lives

below the poverty line. Unofficial figures suggest

the number is closer to 30%.

• China’s one-party rule and intolerance of dissent

removes legitimate avenues to express

grievances pushing those tensions underground

or into illegal and potentially violent protests.

• China ranks 80th on the Transparency

International global Corruption Perceptions Index.

The country is experiencing strong year-on-year

growth in public protests largely related to official

corruption.


COUNTRY IN FOCUS –India: MODERATE– 38/100

• India’s low external debt, relatively low levels of

inequality, youth unemployment below the regional

average and robust electoral process all support a

moderate risk profile for India. Furthermore, the

proportion of household budgets spent on food and

fuel has declined markedly overly the last 2 years.

• Around 30% of business investment derives from

Indian firms indicating confidence in the domestic

economy.

• However, a number of key risks are present. While

youth unemployment is proportionally similar to

other nations at 10.5% the raw number of young

people unemployed is in the tens of millions.

Combined with a population in which 30% are under

the age of 15 and around 60% under the age of 30

this creates the potential for civil unrest amongst a

volatile component of the community capable of

expressing public dissent.

• The percentage of Indians living below the poverty

line is approaching 30%.


COUNTRY IN FOCUS –Indonesia: MODERATE– 36/100• Indonesia’s outlook has improved significantly

over the last 12 months dropping from a VERY

HIGH to MODERATE risk.

• Despite some controversy and claims of

corruption the peaceful transition from one

democratically elected president to another is a

testament to the growing strength of

governance institutions.

• External debt is around half the regional

average and the level of domestic business

investment in the economy is relatively high and

growing. Both inequality and food security

rankings are better than the regional average.

• Ethnic and religious tensions simmer in the

regions. While the government has subdued

terrorist groups, underlying issues of youth

unemployment & rising inequality remain fertile

hunting grounds for extremists – youth

unemployment is twice the regional average.


COUNTRY IN FOCUS –Myanmar: EXTREME– 83/100

• The Government of Myanmar has a poor track

record of reporting key data sets, which counts

heavily against the country in risk scores.

• Nearly one-third of the population live below the

poverty line; twice the regional average.

• Myanmar is one of the worst performing countries

on corruption and transparency indices.

• The country has low levels of investment from

domestic firms.

• The absence of free and fair elections and a large

proportion of the population under the age of 30

with poor employment prospects are a potential

source of social and political discord.

• Despite a long history as the rice bowl of the

region the country’s agricultural output has

declined over recent decades and ranks poorly on

food security indices.


COUNTRY IN FOCUS –Philippines: VERY HIGH RISK - 64/100

• Large proportion of population under the age of

25 and a high youth unemployment rate exposes

the country to considerable turmoil. Youth

unemployment rate is currently higher than 17%

and more than 35% of the population are under

the age of 15.

• More than one quarter of the population live

below the poverty line and over 42% of

household budgets are dedicated to essential

foodstuffs indicating sensitivity to any price

shocks.

• Less than 20% of business investment derives

from domestic firms.

• The Philippines fairs poorly on the Transparency

International corruption perceptions index – 36 /

100

• External debt is less than half the regional

average.


COUNTRY IN FOCUS –Thailand: MODERATE– 33/100• Thailand ranks as one of the safest countries for

investors on the Asia Political Risk Index, which

has surprised some analysts given recent

events.

• However, the country has a number of

underlying strengths the first of which is a track

record of not allowing political crises to interfere

with business having experienced 18 coups

since becoming a constitutional monarchy in the

1930s.

• Most importantly for the country is a very low

level of youth unemployment and relatively low

levels of poverty. The fact that such a large

proportion of the country’s youth are engaged in

employment limits the risk of political discord

becoming social discord.

• Thailand also has relatively high levels of

domestic investment signaling local confidence

in the business outlook.


ELECTIONS (ACTUAL AND HOPED FOR)

COUNTRY IN FOCUS –Japan: LOW– 5/100• Prime Minister Abe’s decision to call an early

election is a demonstration of how political

events can emerge in even low risk countries.

• Abe led a coalition of his Liberal Democratic

Party and the New Komeito party that had a

majority in both houses of parliament. This

suggests that the decision to call an election

was more about re-asserting his authority in the

LDP than seeking a new mandate for economic

reform.

• Japan has a number of well documented

economic challenges; notably excessive

government debt, low growth and a constant

risk of deflation.

• However, its underlying social and political

accord remains firmly in place. Japan has

relatively low levels of youth unemployment, low

susceptibility to rising food prices, relatively low

levels of inequality and it ranks well on

corruption indices.


IN FOCUS – Hong Kong• Events in Hong Kong have had little impact on

the risk outlook for the city with the political risk

spread remaining in negative territory; one of

the best rated areas in the Asia region.

• This suggests that markets do not believe the

recent protests will result in long term social and

political discord and that there are few

implications for business investment.

• However, the protests are a reminder that

political issues can emerge quickly and

unexpectedly.

• And as with most political risk issues a number

of underlying tensions are creating discontent,

which has found expression in concerns about

governance.

• House prices, education costs and employment

prospects are core concerns for protesters and

their supporters and anger about these issues

has been latent for many months.


To find out more contact:

Damian Karmelich Steve Cusworth

Partner - Sydney Partner - Melbourne

p. +61 407 772 548 p. +61 417 178 697

e. [email protected],au e. [email protected]

About Political Monitor

Political Monitor is a political risk research and advisory firm. Our analysis provides

insight into the implications of political risk for commercial valuations, asset selection,

investment decisions, strategic planning and operational decisions.


mailto:[email protected],au

mailto:[email protected]

DISCLAIMER & COPYRIGHT

Disclaimer

Information in this document is subject to change without notice and does not represent a commitment on the part of Seller.

Seller does not warrant the accuracy, completeness or timeliness of any of the data and/or programs (“Information”) available within the report.

The Information is provided “as is” without warranty of any kind, express or implied, including, but not limited to, implied warranties of

merchantability, fitness for a particular purpose, title or non-infringement.

In no event will Seller or its affiliates be liable to any party for any direct, indirect, special, consequential or other damages for any use of or

reliance upon the Information found within the report, or on any other reference documentation, including, without limitation, lost profits,

business interruption, loss of programs or other data, even if Seller is expressly advised of the possibility of such damages.

The disclaimer is in addition to the specific terms and conditions that apply to the products or services offered by Seller.

Copyright

Copyright © Political Monitor Pty Ltd 2014. This document is copyright and contains confidential information that is the property of Seller. Except

for the purposes of executing or applying this report, no part of this document may be copied, stored in a retrieval system or divulged to any

other party without written permission. Such rights are reserved in all media.

Intellectual property rights associated with the methodology applied in arriving at this document, including templates and models contained there

in, reside with Political Monitor Pty Ltd, excepting client information it contains that is demonstrably proprietary to the client or covered by an

agreement or contract defining it as such.

No part of this report may be reproduced, transmitted, stored in a retrieval system, or translated into any language in any form by any means,

without the written permission of Political Monitor Pty Ltd.

© Political Monitor Pty Ltd 2014. All Rights Reserved . ACN 166 162 572.


APPENDIX 1 – POLITICAL RISK SPREADS• The Political Monitor political risk spread is a proprietary score that quantifies the component of a

country’s sovereign risk spread (the difference between yields on 10 year US Treasuries and

comparable debt in respective countries) attributable to political factors such as stability of

government, judicial independence, corruption, poverty levels, food security and a range of

demographic factors such as the size of the population under the age of 30.

• The political risk spread allows investors to make a clearer distinction between the different types of

risk that influence sovereign yields. This approach means investors can distinguish between political

risks and more general economic risks when assessing country specific investments.

• The scores are refreshed daily for countries where publicly available data on bond yields are

available. They are general in nature and do not take into account the capacity of individual firms to

manage and mitigate political risk in each market.

• Political Monitor provides political risk spreads for 15 nations across Asia and 7 in which Australia’s

major mining companies have operations.


APPENDIX 2 - ECONOMIC & INVESTMENT IMPACT OF POLITICAL & SOCIAL INSTABILITY – DOES IT MATTER?• Political risk is the second ranked concern for publicly traded companies … "Looking ahead, investors

continue to be wary about the effects of systemic risk, politics and regulation on the world's markets and

how they'll perform.” (BNY Mellon, Global Trends in Investor Relations, 2014).

• In general political instability results in:

• (a) lower economic growth (Aisen & Veiga, 2013)

• (b) reduced private sector investment (Alesina & Perotti)

• (c) increased inflation levels & volatility (Aisen & Veiga, 2008).

• The economic effects of political & social instability remain for an observable period of 2 – 3 years. The key

determinant of whether the effect of instability ceases at that point is the speed with which countries

implement reforms & improve governance (Bernal-Verdugo, Furceri & Guillaume, IMF Working Paper,

2013).

• An increase in economic policy uncertainty foreshadows a decline in economic growth and employment in

the following months (Baker, Bloom & Davis, EPU).

• The International Monetary Fund (IMF) estimates the economic loss to Libya, Egypt, Tunisia, Syria, Yemen,

and Bahrain in 2011 at USD$20.56 billion as a result of political and social conflict.


political risk and trade finance txf conference - nov 2014

Economy & Finance