– By Sudip Basu
Pace of change from geopolitical risks
Let’s take the first geopolitical risk event. Within six months of Covid detection in China, eight hundred thousand dailies were recorded globally and within the first twelve months, that number shot to four million daily cases in January 2021 bringing to a grinding halt economic activity, causing GDP shrinkages, massive dislocation, unemployment and extreme poverty.
The second geopolitical risk event was a massive reduction in interest rates by the Central Bank led by the US Fed where Fed Fund rates dropped to historic near zero within three months of the pandemic and duly followed by Central Banks around the world. This was then followed by a huge injection of liquidity for Financial Institutions and citizens to bolster local economics and lending standards were relaxed to ensure that delinquencies were minimised.
The third geopolitical risk event was Global inflation which started in the first quarter of 2021, roughly nine months after the Fed Fund rate cut and massive injection of liquidity, and within a year reached the peak of 9% during May 2022 for the US, a level not seen post the Seventies. This was further inflamed by the rampant supply chain disruption due to the invasion of Ukraine by Russia and the post-Covid market opening stresses.
The fourth geopolitical risk event is the rise of interest rates by Central Banks around the world since mid-2022 to tame the inflation levels causing lending rates to rise across the world with 10Y UST trading at 5% in November 2023, another two-decade high record causing a slowdown in major economies of the world with possible global recessionary outlook.
In all these four risk events, the pace at which the impact unravels was fast with the result that businesses were caught off guard and without a remedial plan in sight.
Globalisation index
With all the talk of deglobalization, the DHL Global Connected Index shows a secular increase in all the pillars of Globalization. Information flow shows the strongest growth followed by Trade, Capital and People. The People trend was dramatically impacted by Covid and is unrelated to Deglobalization and expected to bounce back. Hence despite the trade sanctions on China, Iran, and Russia and the Brexit event, Globalization continues to witness secular growth albeit at a slower pace. Countries and businesses are finding ways and means to do business despite sanctions and those that are getting impacted are the ones who are not suitably mitigating geopolitical risks.
Geopolitical uncertainties
What are the big risks that are staring at us in 2024? The US & Russia Presidential Elections. What if Putin & Trump are voted into office. What if the US becomes embroiled in fractious domestic issues and support for Ukraine weakens and stance on Russia softens? The Palestine-Israel conflict enlarges and polarises the Arab world and diverts US attention. Russia, Iran, and China’s axis strengthens, China adopts more aggressive postures on Taiwan & East Asia and Russia’s advances on Ukraine start threatening Central Asian & East European neighbours and the US continues to look the other way. These uncertainties take away the focus on climate change and decarbonization targets fall woefully behind leading to radical climate shifts.
As evident from the World Uncertainty Index, global uncertainty driven by geopolitical risks has only been accentuated. And it is unlikely that the worst is over, and we will now see an era of calm. Hence while Globalization may proceed, the risks from geopolitical events are bound to increase and therefore the need to manage Geopolitical Event Risk increases many folds.
Managing risks in era of geopolitical instability
As is evident from above, Geopolitical and Macroeconomic Risks have a strong correlation. It’s difficult to think about one without the other. Businesses need to think along four pillars of impact. These are risks to the Supply Chain, Capital and Capital Markets, Clients & Employees.
Supply Chain disruption was evident during the post-Covid period. Container Freight, Container availability, and Port Congestion have played havoc on the global supply chains. Raising Interbank lending rates has sent bond yields soaring, significantly raising the Cost of Capital and therefore impairing the ability to raise capital for businesses wanting to do so. Inflation is running high in many parts of the world causing social and economic disruptions and impacting markets. Political sanctions, Tariffs and Non-Tariff barriers are impacting trade and movement of goods and services. And onset of climate change is already making life difficult for people to live and work in many parts of the world, leading to poor health and productivity issues.
Scenario planning becomes key to Geopolitical Risk Management (GRM). Businesses must have a Base and Downside Scenario with a stated set of assumptions supporting both. Against these stated scenarios, a Risk Mitigation action plan to protect the four pillars must be in place. Periodically, the scenarios must be tested for ground realities and the Risk Mitigation plan revised accordingly. Ideally, GRM should be embedded in the Enterprise Risk Management Framework and follow the ERM methodology.
(Sudip Basu is President, Group Risk at Hinduja Group Ltd.)
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