Risk. Reinsurance. Human Resources.

Political risk continues to increase in emerging markets, with more countries recording deterioration than improvement. However in Q2, only two countries were downgraded for overall Country Risk ratings:

Philippines (Medium -> Medium High) Micronesia (Medium Low-> Medium)

No countries risk icon scores experienced sufficient positive improvement to warrant an upgrade in their overall Country Risk Ratings.

Countries worthy of a mention that experienced a general deterioration in their individual risk icon scores are;

Armenia, which has seen an increase in its exchange transfer risk due to spill-overs from the Russia/Ukraine crisis and weaker domestic growth.

Brazil, where government intervention in key sectors has increased along with recent political scandals have reinforced persistent corruption.

Nepal’s weak infrastructure and low government effectiveness has left it unable to cope with a series of earthquakes. Although some of its economic risks have eased, (including exchange transfer) supply chain disruption and the country’s weak quality of infrastructure will leave it reliant on foreign funds for rebuilding.

Meanwhile, a range of commodity-reliant countries are experiencing weaker export revenues, which is increasing government exposure to financing shocks. Any measures introduced to combat these vulnerabilities could be very negative for economic growth. Sovereign non-payment risk scores continue to be affected by the low oil price which continues to weaken the external financing conditions of key producing nations. In response, government intervention in the economy has increased in Russia and Kazakhstan.

Aon Risk Solutions | Political Risk

Q2 2015

Summary

Political Risk Quarterly NewsletterComplementing the annual Political Risk Map, Aon’s political risk newsletter is developed in partnership with Roubini Global Economics, an independent, global research firm founded in 2004 by renowned economist Nouriel Roubini. The newsletter is released on a quarterly basis and provides insight into levels and types of political risk in non-EU and -OECD countries.

In this Issue2 Regional overview of political risks

3 In the spotlight this quarter- Brazil and Latin American risk

3 Country risk rating overviews

4 Key contacts

Political Risk Newsletter | Aon Risk Solutions | Q2 2015 2

Regional overview of political risksAsia Although Philippines and Micronesia were the only two countries to have their country risk rating downgraded this quarter, in general, political risk continues to increase in Asia. Lower fuel prices continue to support local consumers and governments. The reduced cost of fuel subsidies allows government spending on other items, such as social and physical infrastructure. The recently elected governments of India and Indonesia struggle to push through new reforms needed to encourage long-term investment and to remove obstacles to foreign investment. In India, key rural stakeholders are blocking land reform, while in Indonesia an increase in populist pressure has led to reforms being put on hold and increased the cost of foreign currency transactions. Thailand continues to struggle to implement an effective investment strategy as differences between rural and urban areas undermine new projects. With the king’s health deteriorating, the country is exposed to the risk of succession issues. Slow growth in China has led to an increase in investment overseas such as the Asian Infrastructure Investment Bank, which aims to absorb excess commodities and labour. Increased government intervention in the local economy risks further undermining the position of foreign investors.

Eastern Europe and CIS The ongoing chaos in Ukraine continues to weigh on political risk in the region. It seems more likely that the conflict will remain frozen. The risk of a sovereign credit event has risen, given its IMF programme mandates Ukraine to negotiate debt restructuring with its key creditors to reduce debt service costs. We have been highlighting Ukraine’s solvency issues for some time and would expect that not only sovereign debt, but also private sector external debt will need to be restructured. With key creditors focused on maturity extensions not reductions in principal, the risk of a disorderly restructuring or missed payment has increased. Europe and U.S. are likely to maintain existing sanctions against Russia until at least 2016, but are reluctant to increase sanctions pressure given the risk of counter-sanctions and economic costs. Armenia, Georgia and Moldova, all EU applicants, remain exposed to possible counter-measures from Russia, which could reduce trade and increase government intervention in the economy.

Latin America Although no country experienced an overall change in country risk rating, regional economies continue to suffer from weaker commodity prices. Countries differ in their commodity exports, but for the most part they have become more reliant on China, and weaker export revenues as a consequence of the slowdown in China have necessitated tighter fiscal policies. Some Caribbean and Central American countries are beneficiaries of the cheaper commodity prices as they are fuel importers, while revenue weakness has reduced the influence of Venezuela on some of its regional peers.

Middle East and North Africa Political risk continues to rise in the region, as extremist groups (notably, Islamic State) continue to take advantage of weak institutions in Iraq, Libya, Syria and Yemen. These extremist groups could continue to undermine the security of neighbouring countries, such as Egypt, Jordan, Morocco, Saudi Arabia and Tunisia, as well as their European neighbours through terror attacks. Gulf Cooperation Council countries continue to have ample financial resources to maintain spending plans at home and abroad. Proxy conflicts do however remain a risk to their security. A final nuclear deal with Iran, if agreed by negotiators, could reduce local political risk as it removes some hurdles for foreign investment and paves the way for stronger growth and exports. The framework agreement alone does not prompt any changes in country risk rating, but a final deal could bring improvements over time in some economic indicators, including exchange transfer risk and sovereign non-payment risk. Changes in the country risk rating would be very dependent on the Iranian government’s policy choices, including how it chooses to spend any increased access to foreign assets, what terms it offers to foreign investors in key sectors, how (if at all) its relationship with the dominant military changes, and how it addresses debt issues in the banking system.

Sub-Saharan Africa Political risk trends across Africa have diverged, with relatively stable risk outlooks in East African nations, but some signs of increased tension in Southern Africa. West African nations continue to bear the brunt of lower commodity prices, (Nigeria in particular) which reduce the government’s ability to stimulate the economy, though the relatively peaceful election is a positive sign. The new government faces several challenges, including increasing party and regional cohesiveness and cutting spending in the wake of softer oil revenues. Signs that Ebola has been eradicated from Liberia and may be ebbing in Sierra Leone and Guinea will reduce pressure on institutions in those countries, which will need to be rebuilt and strengthened in the coming years to increase their resilience. Extremist groups such as Boko Haram and others with links to Islamic State remain a source of uncertainty for West and Northwest Africa. Strikes and other social pressure are undermining South Africa’s growth and policy implementation, while increasing some of the pressure on migrants.

Political Risk Newsletter | Aon Risk Solutions | Q2 2015 3

In the spotlight this quarterBrazil and Latin American risk

Latin America faces many headwinds to growth that have been increasing political risk and challenging foreign investors. Across the region, lower oil prices have reduced government revenues, which have prompted cuts to government spending in Mexico, Colombia and Venezuela, with public investment and the capital spending of commodity companies among the hardest hit.

Brazil’s policy outlook is particularly challenging. The past years of excessive government intervention in the economy have created an environment where corruption thrived and the private sector cut investment. The country has been hit by a series of simultaneous economic shocks, corruption scandals and inflation, all of which are exacerbating the ongoing recession. Meanwhile, the economic policy team are engaging in fiscal adjustments which should slow the increase in debt.

Higher interest rates, lower public investment, government arrears and weaker growth will undermine asset quality. These trends may increase the risk of corporate defaults, requiring investors to choose their counterparties carefully. The impact of the Petrobras scandal on investment will be compounded by the fallout from corruption probes at other major companies including the electricity company and the railroads. It is possible that the revelation of these corruption scandals and new anti-corruption measures could pave the way for stronger rule of law and an improved regulatory environment, although progress is likely to be slow.

Chile, Colombia, Mexico and Peru, all commodity producers, have stronger institutions and generally have more policy space. All also share a higher level of government involvement in the economy.

An increase in security issues (FARC in Colombia, drug war issues in Mexico and a decline in popularity of the Chilean government), may make it more difficult to implement planned reforms.

The next six months brings elections in Argentina, which could pave the way for a more market-friendly policy stance, encouraging investment. In Argentina, any new government will face a tough decision regarding whether to settle with the ‘holdout’ creditors from the debt exchange in order to access credit markets again. In the short term, the government will be able to muddle through without reaching a deal and has secured sufficient funds to engage in pre-election populist spending. However, this will come at a further cost to the Argentine economy, which continues to experience high interest rates and tight credit conditions. We expect modest policy improvements at best, and the cost of the past restrictive policies suggests the adjustment will be difficult.

Country risk rating overviewsDeteriorations in country risk rating: Micronesia: the combination of a typhoon and a weaker economic outlook was responsible for an increase in Micronesia’s country risk rating. Its balance of payments have deteriorated, while government intervention in the domestic economy is increasing, which will undermine the outlook for foreign investment. In particular deadlock on land reforms has delayed investment plans from local and foreign private investors. Typhoon Maysak was a reminder of Micronesia’s vulnerability to natural disasters, as it lacks the institutional capacity to cope. Even setting these supply-chain disruptions aside, Micronesia is not growing, which will leave it more reliant on regional partners for growth.

The Philippines: Higher inflation and natural disasters are putting pressure on the economic outlook and investment climate. Nonetheless, the Philippines has one of the strongest balance sheets in Asia and is less exposed to weaker Chinese demand than many regional peers. A slowdown in economic activity in the GCC, U.S. and rest of Asia could temper the important remittance flows the country receives.

Risk. Reinsurance. Human Resources.

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About Roubini Global Economics Roubini Global Economics (RGE) was founded in 2004 by Professor Nouriel Roubini. Through his national balance

sheet approach to analysing economies, Nouriel Roubini foresaw the coming US housing crisis and was eager to

bring the same approach to analyse the rest of the world. Now numbering nearly 100 staff around the world,

RGE’s mission is to produce macro analysis beyond the consensus view to influence investment decisions around

the world. RGE works with clients in a series of different ways, from macro strategy subscription product, to bespoke

work, multi-client conference calls, direct access to analysts, and the licensing of its systematic country risk analysis

tool. For further information on Roubini Global Economics, please visit www.roubini.com.

Matthew Shires Aon Crisis Management Head of Political Risk matthew.shires@aon.co.uk

Prateek Singh Head of Political Risk Analytics prateek.k.singh@aon.co.uk

David Awit Roubini Global Economics Account Manager david.awit@roubini.com

Key contacts

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