Top Geopolitical Risks for 2018

It took about a decade for the world economy to recover from the Global Financial Crisis (GFC) in 2008. And according to both the World Bank and International Monetary Fund, the global economic growth in 2017 was more broad-based with both developed and developing economies growing. As a result, there are signs that the global economic growth will be more sustainable in the future.

 

However, the global economic recovery still faces many risks that may potentially sap the economic growth in the short and medium term. Unlike in 2016 and 2017, when the world economy was still facing many 'unknown-unknown' risks, the main geopolitical risks in 2018 are mainly 'known-unknown' risks. These are mainly events that occurred in the past couple of years and their consequences will continue to be felt in the coming year. 

 

Trump Administration and America First

During his first year in office, the United States (US) President Donald Trump has in fact been quite "moderate" in his policies, when compared to the strong nationalistic and populist rhetorics he made during his presidential campaign. This is probably because of the moderate voices within his administration. However, from Trump's tweets and declarations, there are signs of increasing conflicts and disagreement between him and senior members of his administration like the Secretary of the State Rex Tillerson, National Economic Council Director Gary Cohn and Chief of Staff John Kelly among others. There are risks that with an administration in turmoil, Trump may take further action to keep pushing his America First policies. These may eventually have a negative impact on the US economy. 

 

Over the past year, President Trump has adopted a completely different approach in the American foreign policies. There had been many incidents where American allies and major trade partners, like Australia, Germany, Japan and others, were taken aback by his actions and declarations. All these actions are not only undermining America's ties with its allies and partners, but also sapping its influence on the world stage. If Trump keeps on pursuing his America First policies, it will mean that America under Trump will be retreating from the world. Its allies and trade partners will be alienated and they will have to trek on a new path without the global leadership of the US.

" Unlike in 2016 and 2017, when the world economy was still facing many 'unknown-unknown' risks, the main geopolitical risks in 2018 are mainly 'known-unknown' risks. "

America-lead protectionism and trade war

 

Since his presidential campaign, President Trump has been focusing on the large trade deficits of the United States with the world. Last year, he has been ranting about this issue several times and has been urging his administration to find solutions and rectify the situation. During his visit in Europe for the G7 summit last May, he criticized Germany for its massive trade surplus with the US. When he met the Japanese Prime Minister Shinzo Abe last November, he urged the latter to take concrete actions to rectify the trade imbalance between Japan and the US. Similarly, at the APEC summit in Vietnam, he declared that he would look after the interests of America First and ranted about the trade imbalance and that many countries are having unfair trade practices with America.

With Canada and Mexico, Trump is pushing for a renegotiation of the North American Free Trade Agreement (NAFTA). With South Korea, the US-Korea Free Trade Agreement (KORUS FTA) is being reviewed. Last August, he instructed the US Trade Representative Robert Lighthizer to look into the trade practices of China and initiate an investigation under the Trade Act of 1974’s Section 301. It will seem that in 2018, Trump will take a more confrontational approach to the trade issue by erecting barriers to trade. This will not only have an impact on global trade, but there are risks that these actions may lead to a trade war with many countries. 

European Union and Brexit 

Last December, the British Prime Minister Theresa May managed to have a breakthrough in the Brexit negotiations with the European Union (EU) by moving the discussions to the trade part. However, it looks like an impossible task to have a trade deal with slightly more than a year left, before the United Kingdom (UK) officially leaves the EU. Hence, Theresa May is also negotiating for a two year transition period after the UK leaves the EU. However, Michel Barnier, the EU Chief Brexit negotiator, is putting forward many conditions for this transition period. Moreover he is very firm that this transition should end on 31st December 2020. Consequently, there are still many uncertainties on the Brexit negotiations and a trade deal does not seem anywhere close. 

Both the EU and the UK need to manage carefully Brexit. On the one hand, if the UK does not have a very comprehensive free trade deal with the EU, overall trade and investment in the UK will be impacted; thus affecting its economic growth as well. On the other hand, not only the EU will be affected with its UK trade, but also, the final outcome of the Brexit negotiation may have an influence on the rise of nationalism and populism in the EU. If Britain is seen as having a good Brexit deal, it may encourage other European countries to break off. But if the EU is being viewed as too harsh on the UK, it will spur on the nationalists and populists in Europe.

Nationalism and Populism dividing Europe

 

The positive outcome of the Brexit referendum in 2016 was a wake-up call to the European establishment about the popular resentment against the state of affairs in Europe. Brexit was not only the result of the people feeling alienated by the European Union policymakers, but also about the will of the people to take back control of their own national interests. This wave of nationalism and populism swept through Europe. Although pro-EU leaders were able to win elections in France and Netherlands, German Chancellor Angela Merkel suffered a setback with the far-right political party, Alternative for Germany (AfD), making big gains in the elections. There are still many European elections, where the far right nationalist and populist parties may make bigger inroads in the future.

The economic stagnation in Europe since the GFC in 2008 as well as the recent waves of mass migration from Africa and the Middle East have greatly contributed to the rise of nationalism and populism. Hence, the European Union needs to reform so that it is not being viewed as a massive bureaucracy, that is mainly pushing down policies to the various national governments. More needs to be done to make all EU members, particularly those East European countries, feel part of the union. Otherwise, Brexit may become an impetus for others to break off from the EU as well.

Economic slowdown and reform in China

Since 2010, the economic growth in China has been on a gradual decline. The Chinese government supported its growth through a mixture of fiscal and monetary policies. The financial institutions were encouraged to lend more to companies for capital investment. In the process of stimulating and supporting the economic growth, many asset bubbles within many sectors as well as massive overcapacity within the industrial sector were created. Moreover, in trying to boost its export, the People's Bank of China unexpectedly devalued the renminbi by 3% in 2015. This subsequently rattled the financial markets and caused massive currency outflow that put even more downward pressure on the yuan in 2016. 

 

It was during the 18th National Congress in 2012 that the current Chinese President Xi Jinping took over power and had to deal with the slowing down of the Chinese economy. Being the world second largest economy, it was no longer easy as previously to manage and reform the economy. For instance, in 2014, China accumulated more than $4 trillion in foreign reserves, but due to massive capital outflow in 2016, China had to use $1 trillion to support its currency. Moreover, over the past few years, to maintain its economic growth of about 6% to 7%, China's debt increased massively, resulting in its credit to gross domestic product (GDP) ratio reaching more than 250%. While the mandate of President Xi has been renewed during the 19th National Congress, he will face enormous challenges in reforming the state owned enterprises as well as the overall economy. 

" Being the world second largest economy, it was no longer easy as previously to manage and reform the economy. "

Conclusion

Unless there are major global macro events affecting the world, the risk of China mismanaging the massive overcapacity in its industrial sector as well as its overall economic reform seems to be low. The biggest 'known-unknown' risks will be about President Trump and the course of action taken for his America First policies. Overt he past year, it looks like that Trump's actions can be unpredictable and whether these are strategic moves to boost further the American economy remains to be seen. Brexit and politics in the EU need to be closely monitored so that appropriate risk mitigating measures can be taken in time. Overall, if there is no major negative event, the global economy should firm up and continue on its growth path.

2018 will definitely bring about many surprises that may affect the global economy. By and large, most of the geopolitical risks have been shaped by events over the last couple of years. Although some of these risks may have a major impact in the world, they are not major unknowns that investors will not account for in managing their risk exposure. As for companies, they will also need to implement relevant strategies to proactively respond to these potential events.

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