Why emerging countries are trembling at the knees

Ignacio de la Torre. Professor. IE Business School

14 June 2011

The uprisings in the North of Africa are basically the result of the rising price of food, which is pushing emerging countries further into poverty, and raising levels of geopolitical risk.

A few months ago, Egypt was considered as a safer country than Spain owing to the risk price for both countries´ credit default swap (CDS). In November, around 300 base points were required of Spain for its risk price to cover the possibility of sovereign default. Much less was required of Egypt: 200 base points. However, as a result of the uprisings, the figure required of Egypt today is 400 base points. And the figure required of Spain is 150. In other words, Spain is now less of a risk than Egypt.

What is behind this paradigm? As pointed out by the Financial Times columnist Gillian Tett last week, if the liquidity risk, credit risk and default risk were rediscovered between 2007 and 2009, the events in Egypt have brought back to the table a risk that has always been ignorantly ignored by financiers: the geopolitical risk.

The best example is that one month before the First World War, when the diplomatic crisis was at its height and pre-war mobilisation was evident, financiers paid maximum prices for the bonds of the countries that were about to go to war, as shown at the time by the British historian Niall Ferguson.

Why has the geopolitical risk reappeared? The response lies in food prices. Although the official inflation figure stands at around 3% in Spain, the actual weight of the food basket on a poor person is much greater than on anyone from the middle classes. Given the sharp rise in food prices in recent months, a poor person´s inflation is much higher than the 3% suggested by statistics. In emerging countries, as there is a small middle-class and huge masses of population in a situation of poverty or near poverty, the social tension generated by food prices is huge. As in many cases there are no democracies to channel the discontent or a strong middle class to provide social stability, the situation can lead to general uprisings such as those seen in Tunisia and Egypt. Indeed, as the Wall Street Journal pointed out last week, in Egypt foodstuffs account for 40% of the "average" basket of the CPI and in China, the figure is 30%. Similar percentages can be found in other countries in the Middle East, Pakistan (a nuclear power) or the Ukraine (also with nuclear capabilities). In the OECD, the weight that corresponds to foodstuffs is 8%. One possible solution lies in a planetary revaluation of emerging currencies historically linked to the dollar, in comparison with the North American currency and, therefore, indirectly with the euro and the yen. This would reduce the prices of emerging countries´ imports and lower inflationist tension. In exchange, Western countries would increase their market share of exports, which would affect the powerful lobby of export companies in emerging countries, which would have to react with redundancies, which, in turn, would give rise to further social tension.

2011 will be the year in which the geopolitical risk again becomes a key factor in the fixing of asset prices in emerging countries. In the USA and Europe, the economic recovery will come with end-of-year rate increases, which will lead to the repatriation of Western funds from emerging markets. We will witness a dichotomy: significant economic growth in emerging countries that is most probably accompanied by a correction of their financial markets (a dichotomy that has already been in place in China for a few years). The process will be speeded up by rising inflation in emerging countries and the consequent aggressive rate increases.

With high wheat and soya prices, a population that has often been at boiling point, with extremely high levels of youth unemployment, inequality at unpresidented levels (they can be measured by the Gini coefficient), a level of corruption that stratifies social classes and new media that expose the inequality, corruption and spontaneous mobilisation, there will be more uprisings and more regimes will fall. The collateral damages will be strategic points that may be affected by these possible events (Saudi Arabian oil, Egyptian gas pipelines, the Strait of Hormuz, the Suez Canal, etc.).

As Alexis de Tocqueville pointed out in his Democracy in America, every human being wants and fights for his freedom and equality. That process began in the West in 1776. In many authoritarian emerging countries it has yet to arrive, but history is unstoppable.

That is why emerging autocracies are trembling at the knees.


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