Global Risks 2016 [Looming Economic Crises, Growing Instability in the Middle East, A Nuclear East Asia & Lots More...]

From my blog https://globalinsightsblog.wordpress.com/

I know these annual global risks assessments are typically done at the end of the preceding year or at the start of the current one. Seeing that 2016 has started on a roller-coaster adventure ride, I hate to admit that we may have many surprises in store for us this year. And so, I couldn’t resist coming up with my own list of political, security, economic and financial risks that may hit us in 2016. In no particular order, here they are:

1. The Re-emergence of the Arab Spring

It has been a few years since the first signs of an Arab Spring emerged that eventually saw ground-up movements topple autocrats and dictatorial leaders across the region. We could see those sentiments revived this year. Oil-dependent Middle Eastern economies may be adversely hit by this downturn of the commodity-cycle and if their citizens feel the brunt of these economic consequences, and without appropriate platforms to express their frustrations and make their voices heard (including through elections), we could see discontent brewing in some of these countries. With the Saudi Arabian royal family having its own internal power politics, the country could be one of the candidates to soon see internal conflict.

2. Middle East Instability 

Sanctions against Iran have been lifted and one may think that could bode well for stability in the Middle East. However that may not be the case if the events this year are an indication thus far. In early Jan, Saudi Arabia executed Saudi-born Shia Islam cleric Nimr al-Nimr, which saw the Saudi embassy in Tehran attacked and ransacked by Iranian protestors. The incident led to the Saudis severing all diplomatic ties with Tehran. Incidentally, that was in the same month that broad Western sanctions were lifted against Iran, fueling Saudi royals’ fears of dealing with a resurgent Iran, which it has had run-ins with for decades now. The rivalry between both countries has already transcended into power play in OPEC, where Iran recently refused to support a Saudi-backed deal to freeze oil production levels, and in Lebanon, where the Saudis and Iranians are embroiled in a petty proxy contest. Iran recently voted in a reformist government and is probably more focused on cashing in on economic deals following the lifting of sanctions rather than engage with Saudi Arabia in any open conflict. But if the Saudi domestic political situation worsens, Riyadh may find it strategic to use Iranian provocations as a distraction. Who knows what such unnecessary provocations may lead to? My sense is that we will start seeing both countries square-off on a number of volatile issues from here on.

3. Europe: Trouble, trouble 

This is not a happy year for Europe. From dealing with the migrant crisis to the potential Brexit, Europe’s list of woes just keeps getting longer. Add to that the recent terrorist attack in Paris, which makes the risks of imminent threats from domestic elements even higher. The migrant crisis could lead to a Europe where some countries have open borders and others closed. This will erode the very basis of the establishment of modern Europe, where the Schengen Agreement, signed in 1985, led to the creation of open borders without passport controls. With Britain’s exit from the European Union looking increasingly difficult to avoid, the validity and relevance of a unified Europe hangs in the balance. A political backlash could be in store for many European leaders, not least a certain German chancellor, whose popularity slide continues to be nothing short of spectacular. It remains to be seen if fragile European economies, barely recovering themselves, are able to cope with large political and economic shocks, assuming that any instability will spook investors as well.

4. Economic Crisis & Thrifty Governments  

Crisis or no crisis? Economists and corporate leaders appear divided. If the Davos meetings were anything to go by, then most leaders are optimistic that the global economy will be alright. Or at least it’s their job to say so. Besides China and the oil price slump, both of which I discuss below, the one crucial factor that could plunge the global economy deeper into stagnation is the (in)ability of economic honchos in key governments to accurately identify the reasons for slow growth and consequently, and more importantly, to apply the necessary and effective solutions. Take monetary policy for example. How long more is it going to be before policy-makers around the world realize that monetary policy action has failed to fully pull all affected countries out of the global crisis in 2008-09? Low interest rates have not led to higher growth. And the lower interest rates are, the less likely you can continue to depend on monetary policy to stimulate growth. I will discuss this paradox in more detail in a subsequent post. But for now, governments need to start spending and break away from this high-savings and low-investment environment. A round of expansionary fiscal policies can kick-start the global economy. Anything less and we could see the slump worsen.

As the economy worsens, other risks may also appear. For one, we are already seeing around the world the rise of politicians and political parties promoting more protectionism and closed borders, jeopardizing the survival of domestic and international liberalism. A less liberal world will be only worse for the global economy. Slower economic growth will also create more discontent and frustration, especially among countries with a large restless and unemployed young population. In some of these countries, where elections are looming, we may see a change in governments but in others, perhaps more dangerously, citizens who can’t express their discontent at the polls, may resort to other means to expedite political change. An uncertain political environment is always a risk to regional and global stability.

5. China & an Asian Currency Crisis 

China is the latest example where the use of the monetary policy as a driver for growth has its constraints. Many optimists brush off the risks of China’s slowing economy by pointing out that the state-controlled economy can simply depend on a boost from a looser monetary policy. China’s ability to lower interest rates further is however restricted by its current position of being confined by the ‘Impossible Trinity’ – an economic theory which states that it is impossible for a country to have all three of a stable foreign exchange rate, no capital controls and an independent monetary policy, all at the same time. What this means is that if China lowers rates to boost growth, the yuan will suffer further downward pressure, which it can do nothing about. If it allows the yuan to further decline, then investors will be spooked and there will be further capital flight from the country. In other words, China has to let go control of either its exchange rate or interest rate if it wants to preserve free movement of capital. Alternatively, if it wants to preserve control over both interest rates and exchange rates then it will have to tighten on capital account opening. Such backtracking of reforms would result in a loss of investor confidence and consequently, outflows of capital. So China has two main policy-options: it either influences interest rates to stimulate growth, allowing its currency to further slide in the meanwhile, or it tries to arrest the flight of capital by propping up its exchange rate and allowing status quo interest rates to allow a more modest growth of its economy. My sense is that it will probably go for the former, opting for higher growth but allowing its currency to slide in hopes that this will boost its export competitiveness. This will also preserve some credibility of its policy-makers in not backtracking significantly of recent reforms. The recent move by its central bank to ease the reserve requirement ratio indicates that it is taking steps to create liquidity in the system to offset capital outflows. Moreover, with expectations of another Fed hike later this year still lingering, the dollar’s rise has been held back leading to lesser downward pressure on the yuan. Thus, any devaluation in the yuan is unlikely to be sharp. Should the US increase rates and the yuan devalue substantially, however, many Asian currencies could come under pressure. More than anything, any further unclear policy moves by the Chinese government could jeopardize growth and cause investor panic across the region. “The only thing we have to fear, is fear itself,” former US president, Franklin Roosevelt, said during the Great Depression. Early signs this year have shown that this risk for exaggerated investor panic still remains and could cause large shocks to our markets, even if to many observers such risks appear remote for now.

6. The Fallout from Oil Prices 

Whether oil prices have bottomed out or not, I am convinced that they will end hit the near $50/barrel levels closer to the year-end. I will explain the reasons for my optimism in another post, but some of them lie above, particularly if any conflict in the Middle East threatens supply. Regardless, record low oil prices could have already done significant damage by then to some oil-producing economies. Nigeria and Azerbaijan are two front-runners to head this list but if things don’t improve, many other economies could join them. The world’s largest crude oil producer, Saudi Arabia, which sees oil revenue account for more than 80% of its government’s coffers, has already had to introduce austerity measures and it could be forced to do more. The IMF predicts that the country’s deficit could be as high as US$140 billion. During the 1986 oil price crash, reportedly 17 out of 25 of the world’s major oil producers defaulted on their debts. Debts levels within these nations increased by an average of a staggering 40% over that period. With a perfect storm brewing now (low oil prices, Chinese economy slowdown, slow growth in the emerging markets and jittery financial markets) the fallout this time round could be much worse. But it’s not just the weak oil producing economies that could be in trouble. Globally, the oil and gas sector’s combined debt is estimated to be at a massive US$3 trillion. Corporates in the sector, especially shale producers in the US, are vulnerable to defaulting on such high debts. High level of defaults and bankruptcies could force banks, who have to write-off bad debts in the sector, to tighten credit. A viscous circle could appear as such a tightening could starve oil & gas companies further, pushing even more towards bankruptcy. A sharper bottoming out of oil prices could save such a scenario from playing out.    

7. The Threat of Terror Deepens

In the first 3 months of this year, we already had terrorist attacks in Indonesia, India, Iraq and Turkey. Terrorist ideologies have leveraged on the pervasive use of social media to influence, infect and recruit ‘soldiers’ from all around the world. Much of this focus has been to recruit terrorists for attacks in their respective home countries, making it challenging for authorities to pre-empt and avert such attempts as they need to act quicker to respond to local threats. This is especially as governments around the world have to deal with their citizens, who were involved in insurgencies overseas, coming home. With several high-profile events this year – the Rio Olympics and the European Championships in Paris – the threat of an attack may be much more pronounced. The attacks in Paris late last year hint that Europe is a soft target while two attacks in less than 6 months in Southeast Asia (Bangkok and Jakarta) shows that the region is very much on the radar of terrorists. What is worrisome is that the attacks in Paris could be a dress-rehearsal for a more coordinated attack across a host of European cities at the same time. It could be a big blow to a Europe that is already grappling with other issues.

8. South China Sea of Trouble 

For one, I don’t think that anyone currently involved in the South China Sea disagreements are looking for any war or conflict to occur. Whether that is China, Philippines, Vietnam or even the US, which is increasing its presence in these waters. But that is not to say that an accidental incident, at a point when tensions are high, cannot lead to a more aggressive confrontation between China and any of these parties. China, with a slowing domestic economy, may look to create distractions so as to maintain its power at home and the South China Sea may prove to be an easy theatre for it to do so. Moreover, with the tribunal on the Philippines’ arbitration case against China set to announce its decision in May, China, in a bid to flex its muscles, may increase its activity in the disputed waters. I suspect we will see tensions in the South China Sea rise and fall during the course of the year, at times threatening to blow out of proportions and thus sending countries in the region into panic mode and investors into a frenzy.

9. A Nuclearized North East Asia 

It is not just the South China Sea that sees China involved in a growing security dilemma. Tensions in North East Asia, exacerbated by North Korea’s questionable nuclear threat, could see the likes of South Korea, Japan and even Taiwan, develop their own nuclear capabilities. China is of course irked by these calls for its neighbours to develop their own nuclear deterrence, with its foreign minister recently warning South Korea that its adoption of the THAAD missile defense system is a serious security threat to China and hinting that Beijing will not take such a development lightly. The US fancies building a multi-layered missile defence system in the region. These factors could see a nuclear arms race building up in North East Asia. And then, there is the irrational North Korea as well, who could fire their missiles when you least expect it.

10. States vs Corporations

The recent public spat between Apple and FBI in the US over privacy matters is a reminder of the rise of the corporate as being more than a business enterprise. With more business leaders, such as Apple’s Tim Cook and Facebook’s Mark Zuckerberg, flexing their muscles in advocacy and taking on governments, this trend poses a new public policy challenge to states around the world. How do governments manage these corporations? The tech companies and their bosses in particular are arguably more in touch with people now through their products and services, and have bigger constituencies and revenues than some governments themselves! The Apple vs FBI case has shown that a significant amount of public faith has moved from governments to corporations, and that is where the challenge lies. With the rebalancing of trust, governments may start to see their moral authority to govern more in question. And to make matters worse, some cyber-savvy loyalists may decide unilaterally to side their favourite corporations and take on governments on their accord, placing government cyber-security very much a high risk factor going forward. Ever imagined the likes of Google and Facebook being the governments of the world in the future? 2016 may see that trend becoming clearer.