EURASIA GROUP: Here Are The 10 Greatest Risks To Global Stability

The Eurasia Group is out with its annual Top 10 Risks of 2014, and it seems that for the first time since 2008, geopolitical fears top economic ones.

“The realities of a G-Zero order, a world of geopolitical creative destruction without global leadership, are evident,” Eurasia Group writes in its report. “There are tensions between China and Japan in the East China Sea, elite-level executions in North Korea, Russia flexing its muscles in neighbouring Ukraine and beyond, and everyone fighting with everyone else in the Middle East (some things don’t change). All of which is changing the geopolitical map quite aside from the role of the world’s only superpower.”

So here are the top 10 things to keep you up at night. All are quotes from the report.

1. America’s troubled alliances

There is, however, a notable decline in US foreign policy. Some of this is structural — too many increasingly influential countries with which to coordinate effectively; a distracted Europe led by Germany (with geo-economic and bilateral sensibilities) rather than a more geopolitically aligned UK and France; and emerging markets, particularly Russia and China, more willing to challenge US preferences abroad. Some of it reflects changes in the US domestic landscape: Voters now offer less support for an ambitious foreign policy, and growing income inequality persuades large numbers of Americans that they don’t benefit from US engagement abroad. Some of the issue is specific to the Obama administration, with a tactical and risk-averse approach to foreign policy along with a weak (and not well-trusted) second-term foreign policy team. Add in a handful of significant missteps — regarding Syria, the response to the NSA/Snowden affair, and the need for domestic focus on congressional infighting and the Obamacare rollout fiasco — and you have the makings of a perfect US foreign policy storm.

2. Diverging markets

Voters in six of the largest emerging markets — Brazil, Colombia, India, Indonesia, South Africa, and Turkey — will go to the polls in 2014 to choose lawmakers and presidents. In all six countries, the incumbent party will have ruled for a decade or more. But since coming to power, few incumbents will have faced an electoral cycle as bruising as this. The emerging market world is lurching into a new cycle of political challenges as slowing growth, sputtering economic models, and rising demands from newly enfranchised middle classes create heightened uncertainty. And as recent protests in Brazil, Turkey, Colombia, and even Russia have shown, frustrated expectations among new middle classes can quickly find expression in the streets.

3. The new China

The biggest risks economically are in the financial sector, where the leadership recognises significant problems with bank solvency and is likely to proceed with removing moral hazard in the banking system to lay the foundation for tougher liberalizations over the coming years. To do that, they must make clear what is guaranteed by the government and what isn’t, which requires more tolerance for outright defaults on bad loans. Beijing hopes it can smoothly navigate a transition to a normalized banking sector, but that will be difficult without triggering a larger credit event. Yet politicians are becoming more tolerant of these risks, and with key officials involved in financial reform such as Wang Qishan and Zhou Xiaochuan set to retire in 2017, these changes will be among the regime’s most front-loaded.

4. Iran

We believe that the P5+1 (the five permanent members of the UN Security Council plus Germany) and Iran will probably reach a final deal (60% chance). Iran’s economy is in dire straits, and November’s interim agreement offered scant sanctions relief. Tehran is incentivized to remain flexible and agree to an end-state deal that would provide a real economic boost. The probability of a deal creates significant risks in itself, especially given sharper tensions between Iran and Saudi Arabia, the expanding proxy war in Iraq, and the negative impact of a steep decline in oil prices on petrostates (more on that with risk #5). But that other 40% is still a very big number, and it’s worth looking at what happens if diplomacy fails.

5. Petrostates

The unconventional energy revolution has already had important geopolitical implications. It created supply space that allowed sanctions to take half of Iran’s oil exports off the market without an economically damaging increase in prices, and it made deepened engagement with the US look more attractive to China’s new leaders than it did to their predecessors.Over the past few years, though, disruption events have offset much of the effect of volume growth, limiting the impact on producers. In 2014, this will change, with an acceleration of spare capacity growth, bearish price pressures, and heightened competition among producers more generally.

6. Strategic data

The internet will fragment even more in 2014, national champions will become more dominant actors in data-driven sectors in many of the world’s key economies, and costs of doing business for competitors that are, or hope to be, global will increase. As cyber-security becomes a bigger vulnerability, and cyber-mastery a greater economic opportunity, these inefficiencies are set to grow.

7. Al Qaeda 2.0

In the past two years, as the center of gravity of political mobilization shifted from North Africa into the Gulf and the Levant, we have witnessed a powerful resurgence of Sunni extremism and the Al Qaeda brand. The failure of democratic transitions across the region is reinforcing Al Qaeda’s narrative that Western-style democracy is not suitable for the Muslim world. More importantly, the Syrian conflict has turned into a powerful magnet for jihadist recruitment, not unlike Afghanistan in the 1980s and Iraq following the ouster of Saddam Hussein. The extremist message is gaining traction across the Levant and in North Africa as well.

8. The Middle East’s expanding unrest

Stabilisation in the Middle East is highly unlikely in 2014. The Russian-brokered deal that imposes international control over Assad’s chemical weapons stockpile has removed the war in Syria from Western headlines, and the restoration of baseline stability in Egypt by military head Abdelfattah el Sisi has shifted focus from that arena as well. However, the Middle East, gripped by instability for the past three years, has yet to reach bottom.

9. The capricious Kremlin

The implications of an all-powerful leader with a shrinking support base and a flair for the unpredictable are worrisome. Policy has already become more erratic and lacking in strategic vision. Disciplined monetary and fiscal policies are offset by other more retrograde moves: the recent decision to merge Russia’s best business-oriented court with the heavily politicized supreme court, for example. Or Putin’s bid to grant the investigative committee, run by a loyalist, freedom to pursue tax cases against businesses. Or the sudden dismemberment of Russia’s state-owned (but reasonably professional) news organisation Ria Novosti to be replaced by a more tightly controlled outfit run by an ultra-nationalist friend of the president. And though the technocratic elites are grumbling, Putin isn’t yet listening. During 2014, as the economic picture remains grim, Russia’s investment climate will suffer from greater policy unpredictability.

10. Turkey

Among emerging markets, stability in Turkey is especially vulnerable from a range of directions. In particular, Turkey is facing serious spillover effects from the ongoing civil war in Syria and a reemergence of the Kurdish insurgency; and Erdogan’s increasingly emotional and aggressive behaviour threatens to further unhinge market and investor confidence.

Red herrings:

1. U.S. domestic politics: “This year will be much less politically volatile, with further upside market implications.”

2. Europe: “Although anti-European parties are gaining traction politically, they are still not in a position to challenge for power or even determine ruling coalitions except in a couple of countries.”

3. Syria: “The country’s nearly three-year civil war will persist, but there’s not a chance that Syria will become a larger global security or market risk this year.”

4. North Korea: “The odds of all-out conflagration on the Korean peninsula remain low-ish for 2014. Kim and the remaining elites around him are aware that a major conflict would destroy their country.”

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