Market players shouldn't let the financial crisis distract them from evaluating political risk. Keep an eye on these geopolitical hot spots
Will the global financial crisis ensure that politics matter less than usual for the performance of markets this year? Some observers argue that domestic and global stimulus efforts will drive market outcomes in 2009. That may be true, but politics and politicians will play enormous roles in these processes—and several geopolitical hot spots will generate market-moving events of their own.
Let's start with the financial crisis. In countries large and small, policymakers are now crafting responses to the financial crisis and proposing new rules for financial flows and foreign investment. Following the Group of 20 summit a few weeks ago, leaders of member states pledged to coordinate their plans. But that's unlikely to happen. Instead, politicians from Washington to New Delhi will work first to satisfy the immediate needs of their constituents—and patrons. The big risk: overregulation. In the name of protecting those on whom their political fortunes depend, officials may well create obstacles to the free flow of capital that could weigh on foreign investment and global growth for years to come.
Thus, politics (and not market-savvy economic analysis) will drive the global economy more directly (and less efficiently) in 2009 than at any point since World War II. That's the biggest danger for markets this year.
But it's not the only one. Geopolitical hot spots, from Pakistan to Venezuela, threaten to roil the markets as well.
South Asia and the Middle East
South Asia appears to be especially turbulent. Security problems in Pakistan continue to spill across borders into Afghanistan and India. President Bush has warned President Obama that his greatest challenge will be to protect the U.S. homeland from another large-scale terrorist attack. Chances are good that the planning for any such attack would originate within the lawless provinces along Pakistan's border with Afghanistan, where militants enjoy safe haven. The November terrorist attacks in Mumbai were launched from Pakistan—a possible warning sign of more to come.
In the Middle East, 2009 will also be a critical year. Iran's nuclear program is a potential flash point. Whatever the latest rhetoric from Western capitals, U.S. and European policymakers have begun to accept that a nuclear Iran is all but inevitable. But the Israeli government doesn't see it that way and is under fierce domestic pressure to continue a confrontational approach toward Tehran.
Adding to the explosive mixture is this year's tense political season in Iran. A presidential election is due in June. The country's hardliners are increasingly unpopular, largely because 70% of Iranians, too young to remember the 1979 Islamic revolution, resent the regime's oppressive rule. Gasoline rationing and 25% unemployment don't help. Still, whenever public attention turns toward the nuclear issue, the hardliners enjoy broad domestic support. That's why the Iranian government will answer real or perceived Israeli threats with its own hostile challenges. Meanwhile, Iran is likely to continue with its program of uranium enrichment even as it shrugs off overtures from the Obama Administration. That raises the risk of direct conflict with U.S. forces in southern Iraq and the Strait of Hormuz.
What about Iraq? There, the Democratic congressional leadership will expect President Obama to keep his pledge to begin the full withdrawal of U.S. combat troops over the next 16 months. The new Administration also has pledged to pull U.S. troops from Iraqi cities and towns by June. But it's far from clear that Iraq can maintain recent security gains as U.S. forces depart and militias like Moqtada al-Sadr's Mahdi Army come out of hiding to fill the vacuum. Watch for more trouble there.
Russia and Ukraine
Then, of course, there's Russia. Politics have taken an interesting turn in Moscow, fueled partly by the impact of the global financial crisis on Russia's real economy. Signs are growing of major unrest across the country, even though Prime Minister Vladimir Putin and President Dmitry Medvedev boast popularity ratings above 80%. For the first time in years, anti-government demonstrations were held in 30 cities across Russia in December.
Expect more turbulence this year. The economic slowdown is creating downward pressure on the ruble, sharply undermining consumer confidence, and causing factories to close in far-flung cities and towns. Russia's political elite, ever risk-averse, won't tolerate large-scale demonstrations. And with anti-American and anti-Western sentiment on a low boil across the country, Russia is likely to adopt a more confrontational approach to Western governments and investors.
Next door, Ukraine will also continue to generate headlines—not all of them a result of that country's tortured relations with Russia. Among the most vulnerable of Europe's economies to the global financial crisis, Ukraine is also suffering from the never ending rivalries dividing President Viktor Yushchenko, Prime Minister Yulia Tymoshenko, and opposition leader Viktor Yanukovych. Throw in the potential for Russia to make trouble, and Ukraine is a risk to keep watching.
Even in its own hemisphere, the new Administration faces geopolitical problems. In Venezuela, strongman President Hugo Chhávez has decided to roll the dice, investing an enormous amount of his political capital in a referendum he hopes will abolish presidential term limits. The vote is planned for February. If Chhávez loses—and it looks as if he will—he may well renounce his commitment to genuine democracy and push his country further toward authoritarianism. That would plunge Venezuela into even deeper turmoil.
While all these potential crises simmer, market players may be at higher risk than usual this year as the financial crisis distracts them from evaluating political risk. That's dangerous: When political risks aren't properly valued, their impact is more disruptive. So prepare for a rocky ride in 2009, with plenty of surprises along the way.