The Strategist

10 main risks for the world economy

06/05/2018 - 15:12

Despite the accelerating growth, the world economy has been facing the highest level of risk in recent decades, say experts from the Economist Intelligence Unit (EIU), an analytical division of The Economist. Protectionism, territorial disputes, terrorism, the growing number of cybercrimes and even the threat of nuclear war are the incomplete list of the geopolitical, financial and operational risks that businesses are facing.

Some of these risks are related to the largest economies of the world (USA, China, EU), others are global in nature. The EIU ranked potential destabilizing events according to the risk effects: their impact on the global economy was assessed on a scale of 1 to 25. The risk effects take into account probability of an event, from very low (0-10%) to very high (more than 40% in the next two years), and its impact: a change in annual GDP growth rates of 0-0.1 pp compared to the baseline forecast with very low impact, by 2 pp or more - with a very strong (growth in positive scenarios, a fall - in negative).

1-2. A prolonged fall in major stock markets is destabilizing the global economy (the risk effects: 15): the average probability, a very strong influence. Development of the world economy is moving into a new phase, where increasingly more central banks will wind down monetary incentive programs and raise interest rates, the ultra-low level of which stimulated the boom in the stock markets. This has greatly increased uncertainty for market participants, and was reflected in a sharp jump in volatility in February after a long calm "bullish" period. A prolonged decline in the stock markets will undermine consumer confidence and lending, as the financial situation of banks will worsen.

1-2. The decline in world trade as a result of US protectionist policy (the risk effects: 15, like in the previous case): the average probability, a very strong influence. The US can withdraw from the North American Free Trade Agreement (NAFTA) and restrict imports from China, which will provoke a trade war. The growth of protectionism will have serious consequences outside the US and China: it will negatively affect prices and availability of American and Chinese products in the supply chains of companies from other countries. Consequently, investment and consumer spending will be reduced, growth of the world economy will be undermined.

3-5. Territorial disputes in the South China Sea will lead to clashes between countries (the risk effects: 12): the average probability, strong influence. China should become a "leading world power" and have "first-class" armed forces by 2050, the congress of the Communist Party of China decided in October 2017. The growth of its activity in the international arena is accompanied by a decrease in the role of the United States, which, in particular, ensure transport routes availability. Territorial disputes in the South China Sea are a serious reason for disagreement between China and a number of Asian countries. Due to armed conflicts, there may be disruptions in supplies through regional chains and sea routes. 

3-5. The growth rate of the world economy will exceed 4% (the risk effects: 12): the average probability, strong influence. Risks are not exclusively negative. Further increase in business activity in a number of large and developing countries can substantially stimulate growth of world GDP. Growth above 4% has not been noted since 2010. Accelerated global growth will not only help slow-growing countries, but will also facilitate long-term reorientation of China's economy. Higher demand will support commodity prices, further improving economic situation in its exporting countries.

3-5. A large-scale cyber-attack would undermine activities of state bodies and companies (the risk effects: 12): the average probability, strong influence. F and power of cyberattacks is increasing (in 2017, the loudest cases were the WannaCry and Petya attacks), and there is a risk that hackers will tear down state or corporate networks or will be manipulating them for a long time. A variety of actors are waging cyberwars, from governments or sponsored groups to scammers and criminals. Economic losses can be significant if cyber-attacks seriously restrict work of government agencies or damage physical infrastructure.

6-8. A serious and long-term economic downturn will begin in China (the risk effects: 10): low probability, very strong influence. Rapid growth is likely to continue in 2018, but there are questions about how long China may delay measures to reduce its ever-increasing debt, which eventually provokes a financial and economic crisis. If the credit bubble bursts and real estate prices begin to fall, it may be difficult for Beijing to maintain control over the economy. A serious deterioration in the situation in China will hit raw material prices and foreign companies, which are increasingly dependent on demand in China.

6-8. Large-scale military operations on the Korean peninsula (the risk effects: 10): low probability, very strong influence. The progress of the DPRK in the development of nuclear weapons and ballistic missiles that can reach the territory of the United States increases the degree of risk in the conflict that has not ceased for more than 60 years. 

Donald Trump took a much tougher stance towards North Korea than Barack Obama. Some politicians in the US are calling for a preemptive strike against the DPRK, which is likely to respond using conventional weapons and, possibly, short-range missiles. For South Korea and Japan, the consequences will be terrible.

6-8. Conflicts in the Middle East will escalate into direct confrontation between large countries, which will hit the world energy markets (the risk effects: 10): low probability, very strong influence. The long feud between Saudi Arabia and Iran worsened during the war in Syria and Yemen; the kingdom also organized the blockade of Qatar.
Turkey is increasingly drawn into the conflict in the region. In the worst case, the confrontation between the various players will grow into an armed conflict, the Strait of Hormuz will be blocked, along with the supply of oil, a spike in prices will hit the world economy.

9. Oil will become much cheaper if the implementation of the OPEC + agreement (the risk effects: 9) breaks down: the average probability, the average impact. The agreement of OPEC and Russia on the limitation of oil production is valid until the end of 2018, the parties promise to step out of it gradually. But the growth of political tension in the Persian Gulf may weaken desire of the countries of the region to cooperate in rebalancing the oil market.

If Russia comes out of the agreement for some reason, the deal can also be considered to be canceled. The market can return about 1.8 million barrels a day, provoking a fall in prices. It will hit the US and Canada, undermining investment and the oil-producing countries, and also can provoke a debt and political crisis in Nigeria and Angola.

10. Many countries will leave the Eurozone (the risk effects 5): very low probability, very strong influence. The risk of Greece's exit from the Eurozone in the medium term has not disappeared, and economic problems in Italy in the absence of structural reforms over time can provoke attempts to leave the block. 

The crisis-ridden countries leaving the Eurozone will lead to a strong devaluation of their currencies and the inability to service the euro-denominated debt. Banks will suffer huge losses on government bond portfolios. All this can push the world economy into recession.