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Political Risk at the Helm of Markets

 5 min read / 

The tumultuous status quo of the global economy has birthed a correlation between investor sentiment and political risk like never before. Traders and investors have now become somewhat accustomed to the loosening of central banks’ monetary policies and continued QE programmes over the past year. In today’s volatile economic climate, political factors such as uncertainties in bureaucratic impetus, faltering diplomatic relations and growing intensities in socio-political circumstances have become key determinants in the shaping of market confidence. Whereas such occurrences would have mainly amplified the vulnerabilities of country-specific risks in the past, political drivers are now increasingly adding to the fragility of both the world’s developed and emerging markets.

Beijing’s inability to show conclusive evidence of its claims to move towards consumption and financial liberalisation best explains the growing tensions between political control and fiscal reform. While the government has purported a move away from state investments and a focus on exports, since the bursting of its stock market bubble, its clumsy economic stimuli have done nothing but raise concerns among investors worldwide regarding whether it can manage the fall in share prices, let alone achieve a rebalancing act.

In January, the People’s Bank of China unexpectedly set the official midpoint rate on the renminbi 0.5% weaker at 6.5646. On their part, this was an attempt to support the renminbi’s falling value amidst today’s heavy currency fluctuations. Instead, the massive fall in value, which was the lowest since May 2012, sent shockwaves around global stock markets and undermined investors’ confidence, as they feared it would trigger further competitive devaluations. Furthermore, the $100 billion drop in China’s foreign exchange reserves towards the tail end of January had an adverse effect, as it prompted investors to shift capital out of the yuan by buying dollar-denominated assets.

The confusion caused by such measures can be attributed to pre-existing market turbulence; however, they also highlight the political opposition to reforming powerful state-owned enterprises that still influence the majority of China’s economy. And with global doubts compounding over Beijing’s inefficient economic communications, there is no doubt that Xi Jinping and his party are in the driving seat to influence market confidence for not only China’s sake but also in the interests of global capital flow, such is the importance of China in today’s global economic health.

In the Middle East, the severing of diplomatic ties between Saudi Arabia and Iran has left the falling oil prices in further disarray. Since the lifting of nuclear sanctions by the West in Tehran, OPEC’s two dominant political forces have been on a collision course to gain a bigger share of the declining oil market. The execution of a Shiite cleric, the banning of Saudi goods entering Iran, and unsubstantiated accusations regarding airstrikes in Yemen have led to the worst geopolitical conflict in decades between the two. Considering OPEC’s fantastically opaque policymaking in its oil production, the diplomatic uncertainty has further added to the woes of markets, namely to those that are net importers of oil such as the emerging markets in the Far East.

Since the summer of 2014, oil prices have already dropped 70% in value due to too much supply resulting from the shale gas revolution. With Iran announcing its intentions to produce 500,000 barrels a day in a market that is already oversupplied by over a million, the precarious oil ladder will no doubt have to withstand further tremors. With oil prices being a hugely important factor in determining economic activity, businesses and investors are necessarily keeping one eye on such political developments that affect the continuing oil rout.

The effects of EU’s shambolic attempts to take hold of the refugee crisis have seeped into the financial world. More than a million asylum seekers entered Europe in 2015 for various reasons, exposing gaping holes in the EU’s institutional and legislative arrangements. For member states, this has consequently placed tremendous political burdens in the pursuit to harmonise immigration and asylum policies. Even Angela Merkel’s somewhat sacrosanct status within the EU has come into repute, as her open-door policy has further complicated issues and calls for EU solidarity.

The political malaise resulting from the refugee crisis has manufactured national stages for right-wing parties to gain influence, such as in France and the UK. In turn, this has inevitably led to fractures in the EU’s long-standing commitment to “create an ever closer union”, exemplified by the impending threat of Brexit. With campaigns now well underway in Britain since the turn of the year, the market will growingly enter a period of unease. BDO’s business optimism index, which shows a weighted average of the UK’s monthly business surveys, has reported the lowest levels of confidence in three years. Although significant shifts in market confidence are unlikely until a final decision has been made, there is no denying that businesses and investors have become increasingly wary of how things unfold both in Britain and Europe.

Other political developments such as the 2016 US Presidential Election and ongoing threat of terror deriving from the Islamic State’s activities may emerge as headwinds to economic and financial activity. With this in mind, it is suffice to say that the relevance of political factors is gaining weight in the marketplace. Of course, the relationship between global economic health and financial markets remains; however, political risks are increasingly entering the fray and are beginning to have seismic impacts on market tectonics.

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