Not so long ago, political risk was mostly regarded as a hazard in emerging but not developed markets, except perhaps for trading in oil and other commodities sourced from perceived “dangerous” places. But since the crash of 2008, political news has fast become a key driver in developed markets. Investors in the world's most advanced economies are having to adapt. “Political risk everywhere”, proclaimed the title of a Goldman Sachs research note this month. “In G7 economies, people used to think you could just concentrate on the numbers,” said Commerzbank head of emerging markets research Michael Ganske. “Now that has changed. You just can't ignore the politics.” Ganske says his colleagues covering mainstream economies now increasingly ask his team for their insight on Western Europe. The euro zone debt debacle, China's face-off with the United States over currency and trade, and London-based BP's disastrous oil spill are all examples of political risk to assets in developed countries. The global financial crisis boosted the market impact of politics in several ways. It created short-term dependence on government stimulus that in turn focused market attention on sovereign risk, highlighted global imbalances and the rise of emerging powers, particularly China, and fueled populism and unrest worldwide. Whether fringe euro zone countries such as Greece and Spain default depends on how far they can reduce spending and continue to access international markets. That leaves investors asking two questions: can governments push through required cuts despite domestic resistance, and will core Eurozone states, particularly Germany, underwrite the debt if necessary? Neither have easy answers. “The European spike is going to be with us for a few years yet,” said Ian Bremmer, president of political risk consultancy Eurasia Group. “The austerity required is long-term and requires a level of coordination that rises above the institutional weaknesses of the euro zone.” Euro zone research notes are now dominated by talk of Spanish union negotiations, German local elections and the viability of ruling coalitions - all issues financial analysts covering the region largely ignored until recently. Quicker than ever Political events in countries of particular investor focus, such as a violent demonstration in Greece in May that killed three people, can affect markets worldwide. The sheer uncertainty is undermining the euro. At the same time, markets are intruding into the region's politics more than ever before. Few politicians believe voters would reward them for a bond market crash. How to address non-euro zone member Britain's record deficit and placate bond markets dominated a May election campaign, set the timetable for the coalition negotiations, cemented an improbable center-right coalition and has driven budget cuts. “There is a heightened sense that markets will move on news more quickly than ever,” said Jeffrey Garten, professor of international trade, finance and business at Yale School of Management. “This, of course, is a trend that accelerates itself, as everyone anticipates what everyone else is doing.” The rise of political risk is not confined to Europe. For investors focused on the global economy, US-China tension particularly over Beijing's currency peg has long been key. China's decision to allow greater currency flexibility helped feed a global market rally earlier this week and was officially welcomed by the United States, but President Barack Obama is under growing domestic pressure to take a tougher line. With mid-term elections looming in November and the economy still subdued, US politics is taking a more populist tone. That is seen fueling more aggressive action against banks and particularly BP for the duration of the oil spill crisis. Bank shares have been buffeted by political events since before 2008, with investors looking at how much government support is available and how harsh regulatory and punitive measures might be. BP's Gulf Coast experience - together with mining tax hikes in Canada and Australia - remind investors in extractive industries that developed countries can be just as tough to deal with as emerging nations for foreign firms. Indeed, some analysts argue political risk is in some ways less deceptive in emerging markets. Questioning entire structure? “All countries are risky,” said Ashmore head of research Jerome Booth in a research note. “Emerging markets are those where this risk is priced in. Developed countries are where investors do not perceive their own risk.” Any suggestion of emerging markets were truly decoupled from developed ones was shattered after the Lehman failure. Emerging stocks lost more heavily than their mainstream counterparts - although they also bounced back faster. But Commerzbank's Ganske says investors have become more discriminating. A decade ago, this year's violence in Kyrgyzstan might have prompted a rise in risk aversion across the region. Instead, while it slashed the stock market value of several small western mining companies exposed there, there was little knock-on effect on Kazakhstan or other Central Asian states. Compared to many emerging economies, Greek debt now costs much more to insure in the credit default swaps market, its credit rating is lower and bond yields higher. “Until last year, investors would have classed Polish debt in one risk category and Greek debt in another because it was euro zone,” said Ganske. “But now, they are looking at the real underlying credit risk.” Some analysts suggest the new focus on developed world politics might only last a couple of years before markets refocus their attention and governments go back to sustainable spending. Others suggest it could be much longer. “My sense is that we have not been through this since the 1974 oil embargo, when the world really seems to be in the process of unprecedented economic change and western governments were helpless,” said Yale's Garten. “For the most part, the period since World War II has been pretty steady until now. Sure, there were crises but no one was really questioning the entire political structure. Now they are.”
