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As we begin 2012, political risks dominate global headlines in a way we’ve not experienced in decades. Everywhere you look in today’s global economy, concerns over insular, gridlocked, or fractured politics affecting markets stare back at you. Continuation of the politically driven crisis in the eurozone appears virtually guaranteed. There is profound instability across the Middle East. Grassroots opposition to entrenched governments is spreading to countries such as Russia and Kazakhstan that were thought more insulated. Nuclear powers North Korea and Pakistan (and soon Iran?) face unprecedented internal political pressure.

soon Iran?) face unprecedented internal political pressure. 1 The End of the 9/11 Era 2 G-Zero
1 The End of the 9/11 Era 2 G-Zero and the Middle East 3 Eurozone
The End of the 9/11 Era
G-Zero and the
Middle East
North Korea
South Africa
Red Herrings

Paradoxically, political risk has become so fashionable that its effects are now frequently overstated. Those 2012 political handovers in countries totaling some 50% of the world’s GDP? They’re not such a big deal this year, whether the democratic elections in the United States and France or managed authoritarian transitions in China and Russia. Moreover, seri- ous challenges to national decision-makers doesn’t mean that governments are all poised to buckle under pressure. The eurozone isn’t heading toward fragmentation (one of the most consistently over-exagerated risks out there). The American economy is more resilient than many believe. And a Chinese hard landing? Not if Beijing can help it—and it can—in 2012.

So the big challenge, for risk analysts and for corporate decision-makers and investors, is

in carefully weighing the risks in a world of ever-increasing information, data, and commentary

(much of it noise). Our top risks of 2012 are meant to provide you with tools, signposts, and our best judgments on where all these stories are heading—and on how some stories that you’re not reading about elsewhere might prove more important than people think. The most important macro theme for 2012: The world’s key political decision-makers will be focused heavily on questions of domestic economic stability at the expense of international security concerns at a moment when politics is having unprecedented impact on the global

economy. This conflation of global politics and markets defines the formal end of the 9/11 era,

a moment when decision-makers sought to isolate globalization from international security concerns. The end of the 9/11 era is our top risk for 2012.


TOP RISKS 2012 1–THE END OF THE 9/11 ERA The end of 2011 marked the


TOP RISKS 2012 1–THE END OF THE 9/11 ERA The end of 2011 marked the formal
TOP RISKS 2012 1–THE END OF THE 9/11 ERA The end of 2011 marked the formal
TOP RISKS 2012 1–THE END OF THE 9/11 ERA The end of 2011 marked the formal


The end of 2011 marked the formal close of the 9/11 era—the killing of Osama bin Laden, the withdrawal of US troops from Iraq, and an end date for the war in Afghanistan. In 2012, we begin to put the global war on terror behind us. These are positive developments for the economy. But for most, what’s replacing it is of greater concern and far more impactful. It was a truism of globalization—economics drives the markets, and national security drives geopolitics. Banks hire economists and worry primarily

about the private sector; the government hires political scientists and concerns itself mainly with the public sector. No longer. The culmination of a number of discrete events and longer-term trends turns the page on this formula as we enter a world where politics and economics overlap almost entirely. The war on terror is being subsumed

by fears for the global economic balance. This is not a conventional or unconventional weapons threat. It’s not a balance of terror or an individual terrorist. The new night- mares are of spiraling deficits, the eurozone crisis, and economic relations with China. These have become the primary risks to na- tional security, though there are clearly other ongoing security concerns for the US. That’s clearest for the country that still matters most, the United States. During his first

three years in office, President Barack Obama eschewed an overarching foreign policy strat- egy. In part, that was driven by the country’s overwhelming focus on domestic economic headaches. But as long as bin Laden was still at large and the end- games in Iraq and Afghanistan remained uncertain, these inherited concerns dominated the administration’s foreign policy agenda. The death of bin Laden, the withdrawal from Iraq, and ac- ceptance that Afghanistan is not amenable to counterinsurgency


strategies have created the Hillary Clinton moment in US foreign policy. Secretary of State Clinton has developed a doctrine founded on economic statecraft and a shift in US foreign policy priority toward Asia, despite continuing instability in the Middle East. Asia is the engine of global economic growth; it is also where the long-term credibility of US commitments faces the big- gest potential challenge from a competitor (China). It is therefore of the highest geopolitical importance. That (accurately) reflects an environment of both risk and opportunity in Asia. Just as economics is driving geopolitics, politics is now mov- ing markets as never before. The role of politics in global markets is hardly new, but before 2008 the overlap was defined and lim- ited. Only in emerging markets was politics the primary economic driver. Only in these countries were natural resources especially susceptible to resource nationalism and interstate conflict. Elsewhere, markets were driven mainly by economic fundamen- tals. Geopolitics was primarily a matter for those concerned with national security, not with the Nasdaq. That’s no longer true, for three reasons: 1) Emerging markets are now the primary drivers of global economic growth; 2) Developed

states are in structural crisis, and political decisions are an increas- ingly important determinant of their economic trajectories for the first time since the end of World War II; and 3) An overarching rebal- ancing is needed between developed and developing states. How quickly and how successfully that rebalancing occurs is primarily a question of political will and political capacity. In short, for the first time in the era of globalization, 2012 re- flects the full global convergence of politics and economics. This will fundamentally drive investor sentiment toward risk aversion, as investors focus on the obvious lack of strong and effective political leadership in virtually all of the

major players. Intriguingly, it will lead to an overestimation of political risks in several important cases, especially the eurozone, the US, and China. Our red herrings this year are much more important than usual, because baseline expectations for those risks have become exaggerated. Concern about macro risks will erode

confidence in an improving American economy, exacerbate concerns of eurozone crisis, and enhance worries that emerging market growth might prove wobbly. Cau- tion will remain an overarching investment principle—lending continued support for the dollar, a reluctance to rebalance portfolios dramatically toward the growth economies, and

a greater desire to stay in “safe havens” such as cash and gold. At the end of the 9/11 era, politics is driving the global economy,

while economics drives geopolitics. All of this is playing out against

a volatile G-Zero backdrop of global leadership in short supply.




TOP RISKS 2012 2–G-ZERO AND THE MIDDLE EAST The G-Zero—the inability/unwillingness of major powers to


TOP RISKS 2012 2–G-ZERO AND THE MIDDLE EAST The G-Zero—the inability/unwillingness of major powers to take
TOP RISKS 2012 2–G-ZERO AND THE MIDDLE EAST The G-Zero—the inability/unwillingness of major powers to take


The G-Zero—the inability/unwillingness of major powers to take on new risks and burdens—will become more obvious around the world in 2012. But the Europeans have the means to solve their own problems, however haphazardly; Asia faces even bigger struc- tural challenges, but they’re longer term. In other regions—Latin America, Eurasia, even Africa—the geopolitics aren’t as turbulent. Thus, once again, the Middle East is a special case: unresolved

religious, sectarian, and ethnic tensions; the continuing absence of

a viable regional security framework; and in the midst of continuing protests, old autocracies at risk and enormous challenges facing newly “democratic” regimes. Nowhere will the G-Zero have more serious and immedi-

ate impact than in the Middle East. In the aftermath of the Arab Spring, the United States finds itself with dramatically reduced regional influence. The demise of Hosni Mubarak, Washington’s main Arab

ally, tensions with Israel, Riyadh’s increasing skepticism about American intentions, and

a firm desire to avoid reengagement in Iraq

make a big difference. The US is not about to exit the region, but declining US leverage creates a gap in external political engage- ment, economic support, and security pro-

vision at a time of remarkable geopolitical volatility. No major player from outside the region will step in to fill this vacuum. NATO’s intervention in Libya is not a precedent; it’s the end of an era. This leaves three regional actors—Turkey, Saudi Arabia, and Iran—as the major remaining players in the new Middle East game. Newly self-confident and assertive, Turkey presents itself as the new Islamic model for modernism, democracy, and economic dynamism. Saudi Arabia, by contrast, wants to expand the influence of the Gulf Cooperation Council (GCC) to counter American pressure for rapid reform, especially within the region’s monarchies. Iran assumes that Washington’s withdrawal is Tehran’s gain—and believes its own rhetoric that the Islamic Republic inspired the Arab Spring. In 2012, the disengagement of outsiders, the aspirations of regional powers, and the spreading unrest in the broader region come together in the challenge to Bashar al Assad’s minority- Alawite regime in Syria and the US withdrawal from Iraq. There are key differences between these two countries, but in both we see rising Sunni assertiveness, the reemergence of extremist groups, and sharp tensions among Iran, Turkey, and Saudi Arabia. Iran sup- ports the existing governments in Damascus and Baghdad; Turkey and Saudi Arabia, unlikely allies, are cooperating to counter Tehran and support Sunni aspirations. Actors outside the region have little

Sunni aspirations. Actors outside the region have little appetite for intervention, and there is virtu- ally

appetite for intervention, and there is virtu- ally no prospect of regional cooperation to resolve these issues. In Syria, there’s little chance of mean- ingful negotiations between Assad and the opposition, never mind active outside support for removing him from power. Given this lack of leadership, the Arab League process will grind on, extending the regime’s life without producing a credible resolution to the crisis. Frustration with this




impasse could trigger a regional confron- tation, with Iran backing Assad and the Saudis and Turks backing the rebels. In Iraq, greater sectarian conflict is now filling the vacuum left by the withdrawal of American troops. Earlier trends toward mutual accommodation have reversed, and Sunni-Shia tensions are again on the rise. Instead of opposing the Kurds’ bid for autonomy, Iraqi Sunnis are now pushing for their own autonomous region. Iran, Saudi Arabia, and Turkey each look for more influence. Al Qaeda is back in the game. Until recently the most exciting investment story in the Middle East, Iraq’s stability itself now hangs in the balance. That’s a growing danger for Israel, as well. The Arab Spring has generated a surge of populism across the region, roiling Israel’s relations with Egypt, Jordan, and Turkey. Meanwhile, Israel has less confidence in support from its international allies—even the United States. Ally fatigue, a growing feeling of isolation, and Iran’s bid to move its nuclear program into bomb-resistant underground facilities make an Israeli strike on Iran more thinkable (though still unlikely), especially in the face of Tehran’s provocations. It also undermines efforts at further negotiations with the Palestinians, opening up pros- pects for more violence—both within Israel and with Lebanon. The Middle East will provide other potential conflicts in 2012. The G-Zero will complicate efforts to bring a new government together in Libya, save a failing state in Yemen, and limit proxy

TOP RISKS 2012 conflict in Bahrain. Egypt merits its own risk (listed below). The only


TOP RISKS 2012 conflict in Bahrain. Egypt merits its own risk (listed below). The only recent
TOP RISKS 2012 conflict in Bahrain. Egypt merits its own risk (listed below). The only recent

conflict in Bahrain. Egypt merits its own risk (listed below). The only recent case in which outside actors have accepted serious risks and burdens to settle a conflict in this region came with the NATO assault on the Qaddafi regime in Libya. That was only possible because Qaddafi had alienated just about everyone else in the region. In 2012, there are no more Qaddafis in the Middle East. Paradoxically, that’s part of the problem.



part of the problem. 3–EUROZONE: THE MUDDLE IS THE RISK The major financial upheavals of recent

The major financial upheavals of recent decades—Mexico’s peso crisis, the East Asian financial crisis, Russia’s ruble crisis— had one fundamental thing in common: the US Treasury Department played a big role along the road to recovery. That won’t hap- pen in today’s eurozone. Washington will speak loudly but let markets carry the stick, and French President Nikolas Sarkozy learned the hard way that China won’t pitch

in either. Nor is there a solution involving some combination of emerging and devel- oped markets. But Europe is the most advanced and institutionalized region in the world, and the political and economic will to sustain the eurozone, messy as it is, will provide the space for enough European Central Bank (ECB) intervention to get the eurozone through the worst of this, at least in 2012. Alas, there’s still plenty of downside this year. The biggest risk for Europe in 2012 is not eurozone fragmen- tation (a Greece-plus exit of peripherals) or disintegration (Italian and Spanish exit). The real problem is continued incremental- ism. There’s a market view that the eurozone crisis must be

resolved quickly to avoid the collapse of the European project, but Europe’s key politicians don’t see it that way. In Germany,

other core states, and Europe’s ever more powerful institutional apparatus in the European Commission and the ECB, there is

a consensus on the need to do just enough to avoid disaster,

while maintaining market pressure to ensure both sustained commitment to austerity and the political breakthrough required for fiscal union. German Chancellor Angela Merkel is articulating this pathway, and though a source of derision in the English- language press, her pronouncements have provided the closest thing to a signal we’ve seen from Europe, however problematic the strategy might be. The Merkel formula will ensure that the uncertainty and volatility that have characterized the investment and broader economic environment in 2011 will continue well into 2012. As a result, the gradual move toward a sustainable solution—both for

a final bailout and fiscal union—will be more difficult, more costly, and less optimal when it’s finally reached. It will be more difficult because the likelihood of a European recession will only make it tougher to get these plans approved by parliaments—or by voters as various referenda are held. It will be more expensive, because the next round of reform will extend well beyond the sums needed to bail out Greece, Portugal, and

Ireland. It will be less optimal because the current approach, priv- ileging fiscal austerity above all else and turning fiscal demands into tests of moral rectitude, will ensure on- going political turmoil, distrust between the core and periphery, a contraction in growth, and further serious damage to market and


corporate confidence. Over the course of 2012, the euro- zone will continue to struggle to achieve its self-prescribed solution and will most likely avoid a systemic market event. But the long-term risks will not go away. Even if Europe can get there, the underlying economic problems will not have been ad- dressed. And all this uncertainty raises the near-term risk of recession, which can only make matters worse.



Like Europe and the Middle East, the G-Zero hits the United States, but in a way that highlights continuing US advantages. As Europe’s troubles continue to roil markets, America’s safe-haven status trumps concerns with deficits, keeping interest rates down and easing pressure on Washington to deal with long-term fiscal challenges. With economic indicators improving, there’s

TOP RISKS 2012 not as much urgency on this issue as media hype would have


TOP RISKS 2012 not as much urgency on this issue as media hype would have you
TOP RISKS 2012 not as much urgency on this issue as media hype would have you
TOP RISKS 2012 not as much urgency on this issue as media hype would have you

not as much urgency on this issue as media hype would have you believe, and it’s not surprising that a politically deadlocked Washington continues to push off tough decisions until after the

2012 elections. The rubber will hit the road very quickly after the ballots are counted—but on two much narrower issues. There’s little doubt that this will be one of the ugliest presi- dential campaigns in modern US history. Intense partisanship will reinforce the already sour political mood of the country. Con- tinued weak economic performance and Washington’s all-too- obvious political dysfunction will make matters worse. But the election is not the risk in 2012. Despite the loud noise from both ends of the spectrum, we expect an election that is fought over moderates and the center—especially given that the Sturm und Drang of Republican primaries will likely leave Mitt Romney as his party’s presidential nominee. As a result, sharp policy turns after the election are unlikely– over China or long-term deficit strategies—despite the dramatic campaign rhetoric. The United States is structurally bound to seek improved relations with Beijing even as tensions between the two countries increase. And the contours of a long-term deficit deal will have to balance entitlement restructuring with defense spending consolidation and some form of revenue enhancement, though the balance among these elements will depend on the post- election political configuration. So a year

in which the United States does little of consequence and looks much better than its developed country peers is a year of low US political risk, right? Right. Until November. Then things get dicey. The contours of long-term deficit reduction are pretty clear, but there are enor- mous uncertainties in the short term. About $5 trillion worth of tax and savings deci- sions ($3.8 trillion of Bush tax cut expiration, $1.2 trillion of automatic sequesters) must

be made during the eight weeks between the elections in early November and the end of 2012. Firms and investors will face uncertainty about their taxes, gov- ernment contracts, and the impact of these policies on economic growth through the course of the year. With an election that’s likely to be tight until the very end, there will be few signals along the way about how these questions will be resolved—though we can expect plenty of noise. Businesses and investors will be forced to wait on the sidelines for resolution or expose themselves to significantly disparate outcomes. That’s problematic for investor confidence and a damper on economic growth.



on economic growth. 5–NORTH KOREA: IMPLOSION OR EXPLOSION Don’t be fooled by stories of how smoothly

Don’t be fooled by stories of how smoothly the transition is pro- ceeding in Pyongyang. The first rule of analyzing North Korea— it’s the world’s most opaque regime and no one really knows what’s going on inside—has not changed. Maybe things really are going smoothly. Maybe they’re already off the rails. We do know that North Korea is a nuclear power, that provocation is its traditional foreign policy tool of choice, and that North Korean col-

lapse is the likeliest way to bring American and Chinese soldiers face to face in an unpredictable and dangerous security environment. That’s why it is precisely the inability of outsiders to evaluate what’s re- ally happening in North Korea that creates so much risk there. Will North Korea become history’s first leaderless nuclear power? Kim Jong-il’s 28-year-old third son Kim Jong-un has been named successor, but only after a


TOP RISKS 2012 hastily arranged transition and with no meaningful experience in government. Kim Il-sung


TOP RISKS 2012 hastily arranged transition and with no meaningful experience in government. Kim Il-sung took
TOP RISKS 2012 hastily arranged transition and with no meaningful experience in government. Kim Il-sung took

hastily arranged transition and with no meaningful experience in government. Kim Il-sung took more than two decades to prepare the ground for Kim Jong-il to succeed him, and it still took years for the “Dear Leader” to consolidate power. Kim Jong-un will have to do more with much less. To be sure, there is no North Korean political spring waiting to

bloom. There will be no demonstrations, no opposition. It’s a totali- tarian state. There’s no reform, no apparent demand for change, and a massive (when they fall, they fall hard) outpouring of emotion ongoing. Just as with the death of Mao and Stalin, those bases are covered. But Kim Jong-un is no Deng Xiaoping or Nikita Khrush- chev, and security from within the circle around him is an entirely different matter. It’s like what they say about family firms: The first generation builds it, the second hangs on to it, the third destroys it. And there are already warning signs in North Korea that the third time will not be the charm—the quick announcement of events to roll out the new leader revealed that they weren’t adequately pre- pared, and a number of high-ranking political figures have died lately in car accidents in a country notably short on cars. In short, the preparations for transition were hurried and violent—and the transition is now in motion. Kim Jong-un may remain in place, but he is very unlikely to actually run the country. Those around him and other stakehold- ers—almost certainly encouraged by China—will have decided that this is the best outcome for the moment. In coming months, we should not be at all surprised to see provocative external acts meant to prove that the government is firmly in place and not to be trifled with. Alternatively, we could pick up signals of infighting at the highest levels of government. Those within the leadership who fear a fall from favor have clear incentives to derail the process of consolidation of power. That won’t happen openly or immediately.

(As they used to say in the British special forces, in a hostile environment you shoot the first person who moves. There’s a seri- ous first mover disadvantage in a totalitarian transition). But the initial calm may not last long, and it’s almost impossible to predict exactly what sort of political risk the elite might produce. As we’ve seen in recent months, another belligerent international act could be just the thing to provoke a state of

crisis and rally North Korea’s powerbrokers to the regime. In the worst-case scenario of rapid govern- ment collapse, US and South Korean forces would move north to secure North Korea’s nuclear sites, while China would likely send forces across the Yalu River to block any flood of refugees and restore basic security, creating the potential for unintended conflict

given the absence of any joint US-China contingency planning. After all, the United States and China remain on opposite sides of the security divide in Asia, a problem that will only get bigger in 2012 (see risk #7).



in 2012 (see risk #7). 6–PAKISTAN: TURMOIL SPILLOVER In 2012, Pakistan will face its most severe

In 2012, Pakistan will face its most severe challenges since the Bangladesh succession crisis more than 40 years ago. Domestic instability is growing as tensions between civilian and military leaders simmer, extremists continue to expand their presence in core regions of the country, and a severe economic crisis leaves government unable to provide essential public services.

The unraveling of ties with the United States adds to the anxiety. Pakistan is not headed for state failure, but the risk of severe political instability

and even more direct military interference in government is on the rise. Pakistan also faces mounting threats from across its borders. American soldiers will begin the handover of Afghanistan’s security to local troops this year. By Novem- ber, about 33,000 US personnel will have left the country. The security vacuum left behind will become the Pakistani military’s primary




immediate concern as Afghan refugees flow into Taliban-occupied areas of the country. Should the Taliban further consolidate ter- ritory in southern Afghanistan, those areas could become safe havens for Pakistani Taliban who are challenging Islamabad’s authority in the tribal areas. The American withdrawal will also fuel fears inside Pakistan that Washington is effectively “handing off” informal leadership in

TOP RISKS 2012 Afghanistan to India, allowing Pakistan’s long- time rival to encircle the country.


TOP RISKS 2012 Afghanistan to India, allowing Pakistan’s long- time rival to encircle the country. Pakistan’s
TOP RISKS 2012 Afghanistan to India, allowing Pakistan’s long- time rival to encircle the country. Pakistan’s

Afghanistan to India, allowing Pakistan’s long- time rival to encircle the country. Pakistan’s perceptions are reinforced by India’s large development and diplomatic presence in Af- ghanistan, which will continue (and potentially increase) after the US withdrawal. Pakistan is hedging its bets on Pashtun groups in Afghani- stan that have a higher likelihood of control- ling any future government in Kabul. India is focused on strengthening its historical ties to

northern alliance groups. As it tries to extend its economic reach into Asia, India will find itself drawn more deeply into the South Asian geopolitical morass, po- tentially provoking a proxy war that spells trouble for the region. The looming security failure threatens prospects for South Asian economic integration—and just at a time when greater col- laboration is needed to meet growing energy, consumption, and production demands.

today: For many countries in the region, China’s economic development is a source of lucrative new business opportunities, but they want to avoid becoming too economi- cally or politically dependent on Beijing. In 2012, we’ll begin to find out if this delicate balance can be maintained. US-Chinese relations already have their

share of tensions, especially over cyber- security issues and indigenous innovation/ state capitalism. These problems will make regional tensions more difficult to manage. No one wants a security confrontation that would undermine economic growth, but the enhanced US security presence in Asia emboldens China’s neighbors to take on more assertive policy positions with China,

especially on strategic issues. Countries such as Vietnam or the Philippines—both entangled in boundary disputes with Beijing

in the South China Sea—could decide that closer defense ties

with Washington provide the cover needed to push back against perceived Chinese advances. Either government could create a maritime confrontation that (they hope) might draw in the United States, tilting the balance of force in territorial disputes to their advantage. This (mis)calculation would raise a host of risks for the Asian security environment and for global markets in 2012. There is already high risk that Beijing will produce unpleasant foreign policy surprises this year, given rising nationalism in the country, its ongoing political transition, and the leadership’s unwill- ingness, and perhaps inability, to resolve internal debates about China’s role in the world. Beijing will therefore be more apt to meet provocation with provocation in months to come, using both its naval and its economic power. A harsh Chinese response to an in- cident at sea involving an American ally would provide a significant test for the Obama administration, which would then face election- year pressures to project toughness, adding to already significant tensions on other issues.






HAVE THEIR SHARE OF TENSIONS 7–CHINA: REGIONAL TENSION Despite a laundry list of regional and sub-regional

Despite a laundry list of regional and sub-regional institutions, the basic contours of economic, political, and security integration in Asia remain very much in flux. In recent years, China has driven the economic growth story, raising concerns among others in the region that greater strategic balance is needed. It’s no surprise then that 2011 ended with a number of suc- cessful Asian security initiatives for the United States. An agree- ment with Australia’s government adds 2,500 US marines in Darwin. There will be new coastal combat navy ships in Singapore, and Indonesia purchased 24 new F-16 fighter jets. These moves are disquieting for Beijing, but they highlight the realities of Asia



For most of 2011, it looked like Egypt was on track for a messy but managed political transition, one that would meet at least some of the expectations of both the Islamist and secular political forces

while retaining a “supervisory” role for the military. That’s hardly

a revolution, but not a bad outcome either. Yet in 2012, even the

managed transition is at risk. The ruling supreme military council

is becoming both more rigid and more aggressive. It perceives the

activists as a threat and seeks to ignore their demands in order to limit change. But despite its informal partnership with the powerful Muslim Brotherhood, the military appears incapable of marginalizing

TOP RISKS 2012 the rejuvenated alliance of Islamist and secularist protesters without resorting to violence.


TOP RISKS 2012 the rejuvenated alliance of Islamist and secularist protesters without resorting to violence. That
TOP RISKS 2012 the rejuvenated alliance of Islamist and secularist protesters without resorting to violence. That
TOP RISKS 2012 the rejuvenated alliance of Islamist and secularist protesters without resorting to violence. That

the rejuvenated alliance of Islamist and secularist protesters without resorting to violence. That will undermine the popularity of the military and harden the resolve of the protest movement—polarizing politics at a critical time. That’s why Egypt faces the possibility of political disintegra- tion this year, as anger builds between military and civilian politi- cal forces, both Islamist and secular. The Muslim Brotherhood and the Salafist Nour party are not headed toward any kind of formal alliance, but Islamist forces will dominate the new legis- lature to an extent that the military high command may simply reject, especially if the Islamists use their new clout to dominate the writing of a new constitution and back a presidential candi- date that the military dislikes. If so, the generals’ understanding with the Muslim Brotherhood could come apart with the military trying to impose a cabinet largely comprised of technocrats and Mubarak regime insiders. That outcome would be bad for Egypt’s base-line stability, its economic recovery, and its broader regional role. The fallout would be especially damaging for Egypt’s all-important tourism sector and the flow of aid from abroad. It could also spill instabil- ity into the region, given Egypt’s central importance for the Arab Spring and its historic role as an Arab bellwether.



An uneasy political balance between populism and pro-growth elements has defined South Africa’s policy environment since the transition to majority rule in 1994. In 2012, a bitter struggle for leadership of the ruling African National Congress (ANC) will at least temporarily tip that balance. Growth will be the loser—and at a time when the eurozone crisis already weighs heavily on South Africa’s trade and its currency.

President Jacob Zuma and the ANC’s top leaders face reelec- tion at the party leadership conference in December. Zuma has disappointed many former allies, and while a united anti-Zuma front has yet to emerge, that’s not positive news for markets and investors. One of the biggest question marks is the fate of sus- pended firebrand ANC Youth League leader Julius Malema, and a central part of Zuma’s strategy to sideline Malema will be to co-opt at least some of his populist message. Other sources of dispute include the balance between central and provincial governments; the role of labor unions in the ANC; control of the intelligence apparatus; and the use of corruption investigations against Zuma’s suspected rivals. ANC stalwarts such as Kgalema Motlanthe enjoy broad party support but may fail to mount an open challenge at the party conference. Zuma will likely be reelected party president, but this will not be the product of widespread party support but of intensifying factional, generational, and even ethnic divisions within the ANC. That’s hardly a recipe for a strong and stable Zuma administration, undermining South African governance in 2012 and beyond. These tensions will be visible in the February budget as the treasury battles with slower-than-anticipated growth and revenue. Competing spending priorities (fiscal stimulus for the economy that includes a $100 billion infrastructure package, higher public- sector wages, and social grants for 30% of South Africans) will prove politically difficult to negotiate and could force slower fiscal consolidation. Worse, the mid-year ANC policy conference will raise populist pressures further—with resolutions seeking to reaffirm a policy shift to the left. These will include at least some support for the nationalization of mines, which will generate a lot of headlines even if it is unlikely to be adopted. It’s not an all-out disaster; there are limits to the populist trend. But 2012 is likely to inflict lasting damage on policymaking and insti- tutions, and it’s almost certainly a lost year. That’s not the best way for South Africa to join the BRICS club—not that it really belongs.

year. That’s not the best way for South Africa to join the BRICS club—not that it
TOP RISKS 2012 10–VENEZUELA: A NO-WIN ELECTION most likely the popular governor of Miranda state,


TOP RISKS 2012 10–VENEZUELA: A NO-WIN ELECTION most likely the popular governor of Miranda state, Henrique
TOP RISKS 2012 10–VENEZUELA: A NO-WIN ELECTION most likely the popular governor of Miranda state, Henrique



TOP RISKS 2012 10–VENEZUELA: A NO-WIN ELECTION most likely the popular governor of Miranda state, Henrique

most likely the popular governor of Miranda state, Henrique Capriles Radonski. But if the opposition wins, Venezuela’s short-term outlook will be even bleaker. The new government would have to manage a very difficult transition, given the country’s deep economic distor- tions. It would be hard not to provoke substantial social unrest as Chavez’s work is pushed into reverse. And the Chavismo political bloc would still control most of the country’s state apparatus. The worst scenario might well be if Chavez dies or is other- wise forced to abandon the race from ailing health. Then Venezu- ela would face a near-term political vacuum and serious instabil- ity, as there is no clear successor within the Chavista party, while divisions within the opposition would intensify. A possible silver lining is that a sick Chavez could find it harder to put obstacles in front of an opposition-led government, but that’s little solace for Venezuela this year.


2012 political transitions

In addition to elections this year in Mexico, Venezuela, Kenya,

Taiwan and (maybe) Egypt, 2012 will see political transitions in the US, China, Russia, and France, countries that together rep- resent about nearly half of global GDP and four-fifths of the UN security council. Yet there is surprising little at stake here for geopolitics and the global economy. Whatever risks come with these outcomes will arrive in 2013 or beyond. The two biggest transitions—in America

and China—will go smoothly. Governance in the United States is constrained mainly by structural factors—an entrenched and powerful private-sector lobby and a system that forces two parties to jostle for majority hold of a Congress that neither can fully control. Despite the rhetoric and the pun-

ditry, the presidential candidates still veer toward the center in two-party, executive- led America (that’s somewhat less true in Congress). And, of course, there’s no actual impact until 2013. In addition, for the rest of the world, there is less to the foreign policy differences in this race than the rhetoric might lead you to believe, at least when it comes to Republican candidates (Romney) with a genuine chance to win. In China, the regime’s greatest political success has been the institutionalization of what is essentially a term-limits system for its entire senior leadership, making transitions, the Achilles heel of authoritarian regimes, much less challenging. In 2012, China will have a new slate of next generation leaders, and without a single strong, charismatic force capable of dominating the policy-

Hugo Chavez underwent cancer treatment in 2011, and his health problems have since generated plenty of market speculation. Is Venezuela finally on the verge of a new and more positive era?

Over the long term, maybe. But for 2012, the outlook is grim both economically and politically—with or without Chavez. The big political story in Venezuela in 2012 is the 7 October presidential election. If Chavez remains healthy, he will probably win what is shap- ing up to be a very tight race. His popular-

ity remains at about 50% despite the coun- try’s many difficulties, and the government will embark on a massive spending spree to stoke economic growth in the run-up to the vote. Venezuela will continue to issue large amounts of debt to finance spending and provide dollar-denominated assets to local agents in order to sustain this growth and ensure Chavez’s reelection. This profli-

gacy will aggravate current financial distor- tions and lead to a further deterioration of fundamentals after the election. Economic policy remains unchanged with a Chavez victory, with a bit more room for adjustments such as a currency devaluation. As a result, economic condi- tions will steadily worsen. Chavez would also try to further tighten his grip on power, something that could threaten stabil- ity and undermine any chance for a rebound in the investment climate. Sadly, that’s the good outcome. What’s the alternative? The opposition has gotten its act together, at least compared to the past. It will have a primary in March to select a “unity” candidate,



TOP RISKS 2012 making process. It’s rule by consensus. We’re long past the days of


TOP RISKS 2012 making process. It’s rule by consensus. We’re long past the days of Deng
TOP RISKS 2012 making process. It’s rule by consensus. We’re long past the days of Deng

making process. It’s rule by consensus. We’re long past the days of Deng Xiaoping or Zhu Rongji, and it will take a year minimum for that new group to come together and start implementing a new strategic plan, which itself will represent only an incremen- tal change from what we’ve seen for the past five years. It’s big headlines, not much impact. In Russia, despite unprecedented popular protests in recent months, there’s not going to be a lot of suspense on election

night as Vladimir Putin retakes the presidential reins. Despite the impressive crowds of recent days, there is no Arab Spring on the horizon in Moscow. Kremlin-sponsored opposition parties will take considerable wind from the sails of Russia’s demonstrators. President Dmitry Medvedev may well be left by the wayside, but that’s not going to affect Russian governance. For 2012, Putin will spend money and co-opt elites to ensure that everything goes as close to Kremlin plan as possible. There’s room for

a little embarrassment, a rogue uncle turning

up at the party, getting drunk, and embarrass- ing his family. But the holidays go on, and so does Russia. Not much to see here. In France, Sarkozy looks weak, no ques- tion. At this point, it’s tempting to call the election for François Hollande. That could very well change, but the candidates’ positions on the issue that matters most for markets—the fate of the eurozone—are quite similar.

Further, there is no effective political mechanism for a eurozone breakup. It’s conceivable that an individual country might volun- tarily leave the eurozone without such a mechanism, but for a real dissolution scenario to have any plausibility, a formal process would have to be created. If you think expanding funding for the European financial stability fund is hard, try organizing a breakup mechanism.

China’s hard landing

A substantial number of market observers and some China analysts believe that some combination of overheated growth and the prolifer-

ation of bad loans in the Chinese banking system will lead to a major financial blow-up or a sharp contraction in 2012 that takes Chinese economic growth down to 5% or even lower for the year. Don’t believe them. There are signs of overheated growth in China—in urban real estate in Beijing

and along the coast, especially. And infrastructure has been overbuilt compared to growth in consumption. But there’s no chance that the government will fail to pull out every stop to prevent a meltdown—or

even a serious bump—especially in the middle of a major political transition. The Chinese banking and financial system is a mess, but it’s also a fundamentally closed system. In a closed system, preventing such a crisis becomes a matter of fiscal capacity and political will. There will be no shortage of either in 2012. In short, China has more of what it needs to kick the can down the road than any other country out there, and in a challenging 2012 environment, look for Beijing to use it.


Eurozone breakup

This is probably the single most overrated risk of 2012. It’s driven in large part by European observers (especially in Britain) who don’t much like the eurozone. The political will to maintain the eurozone remains strong among all the major political parties in the core eurozone states, almost across the board in the European periphery and, just as importantly, among eurocrats in the ever-growing European bureaucracy. To be sure, this could change over time. We’ll see what happens if

Europe’s leaders totally fail to restructure the institutional machinery

of the eurozone. But that’s not a story for this year.

Mayan apocalypse

Just isn’t happening. And if it does, well, sorry.

Just isn’t happening. And if it does, well, sorry. Executive office 475 Fifth Avenue 14th
Just isn’t happening. And if it does, well, sorry. Executive office 475 Fifth Avenue 14th
Just isn’t happening. And if it does, well, sorry. Executive office 475 Fifth Avenue 14th
Just isn’t happening. And if it does, well, sorry. Executive office 475 Fifth Avenue 14th

Executive office 475 Fifth Avenue 14th Floor New York,NY 10017 +1 212.213.3112

Washington office 1818 N Street NW 7th floor Washington, DC 20036 +1 202.298.6300

London office 30–31 Great Sutton Street 1st floor London EC1V 0NA United Kingdom



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