When politics and policy collide
10 October 2016
Political risk has significant implications for economic growth and market sentiment. While such risk has traditionally been more associated with emerging markets, it has become increasingly apparent in developed markets in the aftermath of the global financial crisis.
Consequently, Standard Life Investments has established an in-house process for examining political risk. The aim is to identify how these risks contribute to policy uncertainty and the subsequent potential for reduced economic growth.
The system categorises risks as either institutional or cyclical, before identifying the precise factors that create a risk to investments. Developed markets most commonly exhibit cyclical risk in the form of elections, and we have isolated three factors that amplify the risk that these cyclical events carry.
- Populism – the increased popularity of anti-establishment parties and policies
- Fragmentation – the move of political systems from two party to multi-party regimes, as seen in Spain
- Polarisation – a hardening of ideological divisions across parties and electorates, as seen in the US
These factors bring added policy uncertainty and the potential for aftershocks following political events in developed markets. By understanding how politics and policy measures are intertwined, we can test the likely effects of political events on investments.
Stephanie Kelly, Political Economist at Standard Life Investments commented “Our approach to political analysis is based on the view that one of the key mechanisms through which political risk is transferred to the investment outlook is through policy uncertainty. The theory suggests that policy uncertainty can reduce growth prospects for an economy because corporate investment slows and consumers delay spending on big ticket items.
“During our analysis of political risk, we assessed the impact of policy uncertainty on a number of major economic and market factors; the results indicate that such an uncertainty shock is usually associated with lower GDP growth, as well as downward pressure on national equity markets and the outlook for interest rates.
“Given that policy uncertainty has a tangible effect on economic and market indicators in developed markets, understanding the political dynamics and structures that drive this uncertainty is crucial.”