How Covid-19 impacts on Political Risk

by Evelyne Legaux on 02-06-2020

Prior to the Covid-19 pandemic, clouds were already accumulating in the political risk sky with the rise of nationalism & populism in many parts of the world, the US-China trade war & unclear US trade policy, an expected 2.6% rise in insolvencies in 2020, the challenging UK-EU trade deal negotiations, weather-related disasters and the ongoing refugees & migrants crisis in particular.

Some blue spots in the sky were still visible however: global growth was expected to stabilise in 2020, and several Emerging Markets countries with dynamic consumer demand & investments combined with stable political institutions, were offering a positive economic prospect for international trade & development.

This though was without the Covid-19 global outbreak and its many collateral effects that plunged the entire sky into darkness at the blink of an eye! Beyond the drastic effects on economies, the pandemic-related lockdown measures taken by most governments around the world are also having a significant impact on political risk.

Therefore, it is more important than ever before for companies to incorporate political risk into their wider risk management strategy & governance.

Initial Impact of Covid-19 on Political Risk

Being subjective in nature, political risk may crystallise at various levels: economic, regulatory, societal, political or geopolitical. The Covid-19 related risk is no exception to this:

• With the most severely impacted countries facing the deepest economic recession in 2020 since the Great Depression, the first obvious impact is the widespread risk of default on sovereign debt despite liquidity easing measures adopted by Central Banks, as the cost of fighting the virus along with financial rescue & social support packages implemented by governments around the world put a significant strain on public finances. Such risk is already materialising in Emerging markets (Pakistan, Iran, Argentina or Ecuador to name a few…) with many countries applying for assistance from the IMF.
• Collateral to this would be the risk of currency inconvertibility / non-transfer. Countries with weak public finances &/or low hard currency reserves (e.g. Argentina, Lebanon or Egypt) may be tempted by FX control measures to support their own local currency and restrict cross-border financial outflows. As a result, any local financial assets owned by multinational companies may be trapped while collecting trade debt from local customers may become impeded.
• Some countries may introduce export restrictions of essential goods such as pharmaceuticals, medical supplies, food or agricultural products thus organising scarcity of same for the rest of the world or positively discriminating geographies against others. Recent measures taken on exporting PPE & other essential medical equipment have demonstrated how protectionism can affect geopolitical relations.
• The recent exceptional oil price plunge, if prolonged, would have significantly stressed public finances in most oil exporting countries, with an acute impact on countries that are either highly dependent on oil revenue &/or already carrying a high level of public debt. Such situation would have led to further countries seeking international liquidity aid and could even trigger political instability in the Gulf region.
• Civil unrest over prolonged lockdown measures causing excessive job losses, restriction of freedom, supply shortages, mental health issues, etc… or over discontent at how public authorities manage this pandemic crisis, has been erupting in several countries (USA, Brazil, India, South Africa, Germany, etc…) and may turn violent thus creating security issues and escalate further.
• The risk of political instability may also arise from political leaders becoming infected by Covid-19 themselves and incapacitated overnight in exercising their duties! Such risk may also be triggered where local authorities would take advantage of the public health crisis to impose anti-democratic & unlawful measures such as undue control of people movements or freedom of press restrictions (e.g. Hungary or Latam region), thus leading to mass demonstrations and a potential change of regime.

Looking ahead: what does Covid-19 have in store for us?

Longer term, the potential implications of this pandemic on political risk remain largely unknown. This said, a number of questions come to mind:

• How deeply will the current crisis hit the most vulnerable geographies and sectors? What will be the extent of financial support provided to them by the IMF, other international bodies & public authorities? How far will FX control policies go?
• How will the US & China play the pandemic crisis in terms of their strategic relationship and on the geopolitical scene? We already see that China is taking advantage of it to further tie Hong-Kong to mainland China…
• How stable is the crude oil market? Will Saudi-Arabia & Russia find common ground to continue support oil prices and avoid damaging erratic variations?
• How stable is the European Union (EU) political construction going forward?
• How will people respond to economic recovery measures in those countries most hardly hit by the virus &/or most vulnerable economically?
• How will this crisis impact on rising nationalist waves? Are populist leaders likely to gain growing support & impose new policies in their respective country? This pandemic revealed the limits to an excessively interdependent world, and anti-globalisation movements might emerge stronger from it with adverse consequences on multinational companies.

How best to manage Political Risk in the Post-pandemic era?

Business owners or leaders should assess how their company’s activities are impacted by political risk, and develop an approach to best prepare & mitigate it.

• Many functions such as Business Strategy, Sales, Supply Chain, R&D, Finance, Treasury or HR are typically affected in different ways. It is therefore increasingly compelling for companies to determine where the management responsibility for political risk resides at senior leadership level, and ensure that the individual or function in charge can work cross-functionally to coordinate strategies across all stakeholders.
• Once clear responsibilities have been established, companies should carry out an impact assessment of how exposed to political risk each functional area is or might be under various business scenarios, and validate their perception of political risk with external expert sources.
• Companies should also consider factoring in political risk into their enterprise risk management (ERM) systems & processes.

        And like for any other types of risk, insurance remains another critical tool for companies to mitigate their exposure to          political risk. Being highly dependent on a robust re-insurance market, insurers so far continue to honour their long              term commitments and underwrite political risk despite Covid-19 related exacerbation. Companies should therefore              work with their brokers & insurers to ensure that the changing factors of political risk are covered under the terms &              conditions (T&C’s) of their policies.

• With regards to governance, companies should develop an action plan aiming at raising awareness & understanding of political risk within their organization, enhancing topical communications & ensuring cross-functional collaboration.

Conclusion

The Covid-19 pandemic has provided the business world with the perfect opportunity to remember that managing political risk requires a company-wide approach and should be at the heart of their operations. Companies integrating political risk into their own culture will be better positioned to mitigate its impact & improve their resilience in the face of further pandemic or other types of crisis to come.