The 10 Biggest Risks The World Is Facing In 2012

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Major obstacles await investors in the year ahead, with “political risks dominat[ing] global headlines in a way we’ve not experienced in decades,” according to Eurasia Group’s President Ian Bremmer and Head of Research David Gordon.And with the news media jumping to discuss the effects of every headline, they write in a report out this morning, the biggest challenge for investors will be determining which risks are relevant and which are not.

They spell out the 10 big issues you should be watching for this year—and the four you should probably ignore.

#10 Venezuela: A No-Win Election

October 7's election is already shaping up to be a tight race between the cancer-afflicted Hugo Chavez and an uncertain opposition candidate. But regardless of who wins, the fallout is grim:

Economic policy remains unchanged with a Chavez victory, with a bit more room for adjustments such as a currency devaluation. As a result, economic conditions will steadily worsen. Chavez would also try to further tighten his grip on power, something that could threaten stability and undermine any chance for a rebound in the investment climate...

But if the opposition wins, Venezuela's short-term outlook will be even bleaker. The new government would have to manage a very difficult transition, given the country's deep economic distortions. It would be hard not to provoke substantial social unrest as Chavez's work is pushed into reverse. And the Chavismo political bloc would still control most of the country's state apparatus.

Source: Eurasia Group

#9 South Africa: Populism Ascendant

An election late in the year will magnify political dissonance, and that certainly will do no good for markets. At a time when South Africa is trying to show its economic ascendancy, pandering to popular sentiment in order to hold onto power will do little good for growth.

Tensions will be visible in the February budget as the treasury battles with slower-than-anticipated growth and revenue. Competing spending priorities (fiscal stimulus for the economy that includes a $100 billion infrastructure package, higher public-sector wages, and social grants for 30% of South Africans) will prove politically difficult to negotiate and could force slower fiscal consolidation. Worse, the mid-year ANC policy conference will raise populist pressures further--with resolutions seeking to reaffirm a policy shift to the left. These will include at least some support for the nationalization of mines, which will generate a lot of headlines even if it is unlikely to be adopted.

It's not an all-out disaster; there are limits to the populist trend. But 2012 is likely to inflict lasting damage on policy-making and institutions, and it's almost certainly a lost year. That's not the best way for South Africa to join the BRICS club--not that it really belongs.

Source: Eurasia Group

#8 Egypt: A Transition In Trouble

Increasing tension between the ruling military council and Islamist and Secularist protestors could result in 'political disintegration' in 2012, jeopardizing the rough but 'managed' transition analysts had been hoping for. Deepening division between popular representatives that are a product of the reform movement and the military elite could result in a complete meltdown that would kill the tourism sector and cut off aid from abroad, not to mention Egypt's place in the regional balance of power.

The ruling supreme military council is becoming both more rigid and more aggressive. It perceives the activists as a threat and seeks to ignore their demands in order to limit change. But despite its informal partnership with the powerful Muslim Brotherhood, the military appears incapable of marginalizing the rejuvenated alliance of Islamist and secularist protesters without resorting to violence. That will undermine the popularity of the military and harden the resolve of the protest movement--polarising politics at a critical time.

Source: Eurasia Group

#7 China: Regional Tension

China continues to drive growth in Asia, but continuing tensions between China and the United States could muddle the situation across Asia. Increasing provocation in the form of threatening foreign policy announcements from the Chinese central government could force all of Asia's global players to take sides, hindering economic growth.

There is already high risk that Beijing will produce unpleasant foreign policy surprises this year, given rising nationalism in the country, its ongoing political transition, and the leadership's unwillingness, and perhaps inability, to resolve internal debates about China's role in the world. Beijing will therefore be more apt to meet provocation with provocation in months to come, using both its naval and its economic power. A harsh Chinese response to an incident at sea involving an American ally would provide a significant test for the Obama administration, which would then face election-year pressures to project toughness, adding to already significant tensions on other issues.

Source: Eurasia Group

#6 Pakistan: Turmoil Spillover

This could be the most unstable year for Pakistan since Bangladesh seceded more than 40 years ago. Domestic political instability, an economic crisis, and the departure of the U.S. from Afghanistan all put the country's future up in the air.

From the report:

In 2012, Pakistan will face its most severe challenges since the Bangladesh succession crisis more than 40 years ago. Domestic instability is growing as tensions between civilian and military leaders simmer, extremists continue to expand their presence in core regions of the country, and a severe economic crisis leaves government unable to provide essential public services. The unravelling of ties with the United States adds to the anxiety. Pakistan is not headed for state failure, but the risk of severe political instability and even more direct military interference in government is on the rise.

Source: Eurasia Group

#5 North Korea: Implosion Or Explosion

Uncertainty about the state of affairs inside North Korea makes this the fifth-largest political risk right now. Kim Jong-un has not been adequately prepared for the challenges of power, there appears to be little appetite for reform, and conflict over who pulls the strings is likely to manifest at the highest levels of government. While Kim Jong-un may keep his title, behind-the-scenes power struggles will dominate.

Kim Jong-un may remain in place, but he is very unlikely to actually run the country. Those around him and other stakeholders--almost certainly encouraged by China--will have decided that this is the best outcome for the moment. In coming months, we should not be at all surprised to see provocative external acts meant to prove that the government is firmly in place and not to be trifled with.

Alternatively, we could pick up signals of infighting at the highest levels of government. Those within the leadership who fear a fall from favour have clear incentives to derail the process of consolidation of power. That won't happen openly or immediately. (As they used to say in the British special forces, in a hostile environment you shoot the first person who moves. There's a serious first mover disadvantage in a totalitarian transition). But the initial calm may not last long, and it's almost impossible to predict exactly what sort of political risk the elite might produce. As we've seen in recent months, another belligerent international act could be just the thing to provoke a state of crisis and rally North Korea's power brokers to the regime.

Source: Eurasia Group

#4 United States: Right After Elections

Though that G-Zero ineffectiveness will also affect the U.S. for much of the year, after elections 'things get dicey.' Probable uncertainty leading up to then could hinder economic growth and stunt investor confidence.

Bremmer and Gordon write:

Firms and investors will face uncertainty about their taxes, government contracts, and the impact of these policies on economic growth through the course of the year. With an election that's likely to be tight until the very end, there will be few signals along the way about how these questions will be resolved--though we can expect plenty of noise. Businesses and investors will be forced to wait on the sidelines for resolution or expose themselves to significantly disparate outcomes. That's problematic for investor confidence and a damper on economic growth.

Source: Eurasia Group

#3 Eurozone: The Muddle Is the Risk

Because there is no U.S. Treasury to save Europe, the political and economic situation across the pond will remain volatile throughout the coming year, even though they predict the European Central Bank will ultimately step in and save the day. That's because European leaders' staunch refusal to take strong, short-term action will make fixing Europe's problems 'more difficult, more costly, and less optimal.'

From the report:

Over the course of 2012, the eurozone will continue to struggle to achieve its self-prescribed solution and will most likely avoid a systemic market event. But the long-term risks will not go away. Even if Europe can get there, the underlying economic problems will not have been addressed. And all this uncertainty raises the near-term risk of recession, which can only make matters worse.

Source: Eurasia Group

#2 G-Zero and the Middle East

Bremmer and Gordon point to G-Zero--'the inability/unwillingness of major powers to take on new risks and burdens'--and its influence on political volatility in the Middle East as the second greatest political risk in 2012.

They write:

The Middle East will provide other potential conflicts in 2012. The G-Zero will complicate efforts to bring a new government together in Libya, save a failing state in Yemen, and limit proxy conflict in Bahrain. Egypt merits its own risk (listed below). The only recent case in which outside actors have accepted serious risks and burdens to settle a conflict in this region came with the NATO assault on the Qaddafi regime in Libya. That was only possible because Qaddafi had alienated just about everyone else in the region. In 2012, there are no more Qaddafis in the Middle East. Paradoxically, that's part of the problem.

Source: Eurasia Group

#1 The end of the 9/11 era

The end of 2011 marks the end of the 9/11 era, 'a moment when decision-makers sought to isolate globalization from international security concerns.'

Concerns about terrorism have transformed into concerns about global economic instability. Bremmer and Gordon write:

2012 reflects the full global convergence of politics and economics. This will fundamentally drive investor sentiment towards risk aversion, as investors focus on the obvious lack of strong and effective political leadership in virtually all of the major players. Intriguingly, this will lead to an overestimation of political risks in several important cases, especially the eurozone, the US, and China. Our red herrings for this year are much more important than usual, because baseline expectations for those risks have become exaggerated.

Source: Eurasia Group

Red Herring #1: Political Transitions

Elections are ahead for four countries that 'represent about nearly half of global GDP and four-fifths of the UN security council'--the U.S., China, Russia, and France--not to mention Mexico, Venezuela, Kenya, Taiwan, and perhaps Egypt.

But regardless of the headlines that will come out of these events, there won't be many surprises, at least right away. Bremmer and Gordon note, 'Whatever risks come with these outcomes will arrive in 2013 and beyond.'

Source: Eurasia Group

Red Herring #2: Eurozone breakup

Bremmer and Gordon call a partial or complete euro area dissolution 'the single most overrated risk of 2012.'

Here's why:

The political will to maintain the eurozone remains strong among all the major political parties in the core eurozone states, almost across the board in the European periphery and, just as importantly, among eurocrats in the ever-growing European bureaucracy. To be sure, this could change over time. We'll see what happens if Europe's leaders totally fail to restructure the institutional machinery of the eurozone. But that's not a story for this year.

Source: Eurasia Group

Red Herring #3: China's Hard Landing

While there are signs that China's economy is overheating and the banking sector has severe structural problems, there are simply no clues that 'a major financial blow-up or a sharp contraction in 2012 that takes Chinese economic growth down to 5% or even lower' is in the cards.

There's no chance that the government will fail to pull out every stop to prevent a meltdown--or even a serious bump--especially in the middle of a major political transition. The Chinese banking and financial system is a mess, but it's also a fundamentally closed system. In a closed system, preventing such a crisis becomes a matter of fiscal capacity and political will. There will be no shortage of either in 2012. In short, China has more of what it needs to kick the can down the road than any other country out there, and in a challenging 2012 environment, look for Beijing to use it.

Source: Eurasia Group

Red Herring #4: Mayan Apocalypse

Just isn't happening. And if it does, well, sorry.

Source: Eurasia Group

So about one of those big risks...

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