Should Crumbling Regimes Worry Investors?

Some had already considered democracies a safer bet than autocracies, and the recent events may drive others to assume the same.

590 yemen protest AP Muhammed Muheisen.jpg

The unrest in the Middle East obviously will have a big impact on global politics, but could it also have ramifications on how investors view autocracies going forward? The market now understands that when oppressive regimes rule, instability is sometimes just a political movement away -- and the changes that result can affect the economies of these nations significantly. As a result, recent events have made assessing the certainty of some global investments even more difficult for fund managers: investments linked to authoritarian regimes might contain more risk than previously thought.

This assertion was made last week in one of the newsletters I receive from investment management firms. It said that, in the past, many investors did not discriminate between democracies and autocracies. In fact, some believed authoritarian regimes to be even more stable than democracies, which are more reliant on the whims of the people. But the unrest in the Middle East has begun to change that view. Suddenly, it has become clear that if the people demand democracy, then political instability can very quickly follow.

The consequence is that investors may begin to associate a higher risk premium with investments tied to autocracies in comparison to democracies. While election cycles can introduce changes to the economic path a nation is on, giant swings in a government's structure through revolution that leads to unanticipated changes in leadership can more significantly alter a country's direction.

Of course, some in the financial world should already have their eye on the more severe political risk that be associated with autocracies. One major job for the credit rating agencies is to evaluate sovereign debt, and a government's stability is essential to their calculations. Have the events in the Middle East changed the way they view authoritarian regimes?

If you look merely to downgrades, then it's clear that the unrest in the Middle East has had some effect. On January 31st, Moody's downgraded Egypt's government bond rating to Ba2 from Ba1. Its note read:

Today's rating action was prompted by the recent significant rise in political event risk and concern that the policy response could undermine Egypt's already weak public finances. We had previously signaled that such developments may result in a ratings downgrade (see Moody's latest Credit Opinion on Egypt published 24th November 2010).

S&P took similar action.

But is there some broader change in philosophy? Are authoritarian nations in general -- beyond just those in the Middle East with citizens demanding democracy -- now viewed as more susceptible to political risk than they previously believed?

"Succession risks or high concentration of power are factors that can pose risk to institutional stability."

The rating agencies have complex models for evaluating nations' stability. For example, among other factors, Moody's criteria consider a country's institutional strength and susceptibility to event risk. Both of these risk factors would potentially be more significant in an autocracy than in a democracy. Similarly, S&P incorporates a "Political Score" as one of the five components in its newly proposed sovereign debt rating criteria. Although the firm does not explicitly name autocratic rule as a negative factor, it does say that "succession risks or high concentration of power are factors that can pose risk to institutional stability." Both of those may be bigger problems in an autocratic regime than in a democracy.

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Daniel Indiviglio was an associate editor at The Atlantic from 2009 through 2011. He is now the Washington, D.C.-based columnist for Reuters Breakingviews. He is also a 2011 Robert Novak Journalism Fellow through the Phillips Foundation. More

Indiviglio has also written for Forbes. Prior to becoming a journalist, he spent several years working as an investment banker and a consultant.

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