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Arab shocks demand risk rating rethink

A complete failure to predict 2011's Arab revolutions suggests investors need to think more imaginatively and ask 'what if' questions, say analysts

Reuters, Tuesday 26 Apr 2011
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Investors should be taking greater gambles in their predictions (Photo: Reuters)
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Attempting to predict the future, rather than imagining possible versions of it, may have blinded risk analysts to the likelihood of this year's uprisings across the Middle East and North Africa.

Concentrating on what precedent taught was probable, and trying to pick the likeliest of those eventualities, left only a narrow range of events considered -- like a sports bookmaker not even offering odds on an outsider winning a competition.

Some inside the industry, and some investors who use that research, think the fact that among traditional analysts, the 'Arab Spring' wasn't even on the cards should be the cue for changes in how political risk analysts do their work.

"Most if not all risk rating agencies ... were comfortable with the future outlook despite highlighting the fact that 2011 (was) the year for political succession (in Egypt)," said Ahmed Ali Abdel Rahman, chief executive for Egypt at Kuwaiti asset management firm Global Investment House.

The most radical scenario postulated, he said, was opposition party the Muslim Brotherhood winning the election scheduled for later in the year.

"Other than the election outcome there was no concern whatsoever over the political situation."

Though on the face of it the preservation of the status quo may have been the likeliest outcome, investors would be better served by a more imaginative approach that considers the possible events that would mark a departure from the established narrative, rather than analysis that aims to forecast the future.

"The key lesson for political risk consultancies is not about how better to predict the kind of events we have been witnessing: that is simply not possible," said Nigel Inkster, director for transnational threats and political risk at the International Institute for Strategic Studies.

"Rather they should look at regimes like Egypt's and ask more 'what if' questions which don't just assume the status quo will continue."

Investors and others interested in the country in question would then be able to examine a range of possible futures, and consider how they might respond to each.

By doing this, they would be better prepared to cope with an actual future which is unlikely to be identical to any they have imagined, but would at least have elements of some of them, he said. Scenario planning would be more constructive than trying to rank potential outcomes by likelihood.

"Many investors and some analysts use the recent past as a guide to the future which is often misleading at best," said Elizabeth Stephens, head of credit and political risk analysis at insurance broker Jardine Lloyd Thompson Group.

At the core of popular revolutions in Egypt, Tunisia and Libya was deep, widespread unhappiness about being poor, repressed and denied opportunity by regimes run by coteries of corrupt, lavish-spending officials and their families.

But for years, unequal societies and unbending governments had been seen as the price of stability, and as a result there was little expectation among observers that street-level misery would blow up into revolt.

"It is difficult to calculate the impact of discontent as local grievances don't often flare into regime change," said JLT's Stephens.

One of the key lessons for risk analysts is that big-picture economics and politics should not overshadow events and sentiment on the ground.

"While the basic risk metrics for analysing regime stability may not necessary have changed, they are more nuanced now," said Christopher McKee, chairman of U.S.-based political risk analysis firm The PRS Group. "Analysts must look deeper into the various sources of discontent and the resources the disaffected have at their disposal to effect change."

Among the most powerful of those resources are new social networking websites and mobile communications, which activists in the Middle East and North Africa used to organise and mobilise anti-regime protests.

"(Analysts) have to realise that, given the widespread use of public networking sites, as an example, the material conditions of life are an incredibly important factor shaping public action now," McKee said.

Others believe that, when trying to imagine possible scenarios, analysts and investors should try to discern and take account of larger global, historical trends, and whether a possible event may fit into that trend.

David Murrin, chief investment officer at Emergent Asset Management and author of 'Breaking the Code of History' argues that the great "empire" of the West, the United States, is in decline.

He believes the inability of the West to foresee events in the Middle East and North Africa was due to its failure to adjust to its lesser military, diplomatic and economic status.

That blindness left it unable to perceive the level of hostility and capability of regimes aligned against it, and the disaffection of those traditionally aligned with the U.S.

"Failures to predict unrest in the Middle East and North Africa by the West are symptoms of a system in decline. When you're old, you're in denial. Old systems are in denial," Murrin said.

"The general decline of America means those countries that were affiliated with it don't want to be any more. They have rejected American power and there's no going back to that."

On a practical level, the geopolitical theory that informs Murrin's writing and Emergent's investment strategy holds that the rise and fall of nation states is repetitive and can be predicted. Those rises and falls create volatility in financial markets, which are trading opportunities.

That the Arab revolts came as such a shock was not a methodological failure of analysis, but a result of an inability to see the new evolving world as it is, Murrin said.

"Detailed analysis doesn't work. You need to look at the whole process and see what are the large forces at work. When you're growing, you see the bigger the picture, you get stronger. When you're contracting, you're so busy fighting fires you think the big picture is the same, but it isn't."

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