How Risk Indices Help Navigate More Turbulent Times

The years 2018 and 2019 have seen renewed turbulence in financial markets, growing trade tensions between China and the US and ongoing risks of a disorderly no-deal Brexit in the EU. These events are happening against a background of rising global populism, the threat of deglobalisation and the revival of geopolitical tensions around the world.

The uncertain global economic environment emphasises the need to look beyond a single baseline forecast and examine potential downside risks in order to perform business planning.

Risk indices provide simple-to-interpret and transparent measures of macroeconomic risks for incorporation into financial and business planning. In this post, we will look at how a Global Risks Index and a Country Risks Index can help navigate these more turbulent times.

Global Risks Index

The Global Risk Index (GRI) quantifies global macroeconomic risks and ranks them by their expected global GDP impact if the global economy enters a negative state/slowdown. It provides a summary of the impact and likelihood of different negative global scenarios.

This allows businesses to rank major global risks and prioritise those that are more significant for business and financial stress-testing. In the image below taken from Euromonitor International´s Global Risk Index, there are three key adverse scenarios for 2019-2020: A Global Downturn, an Emerging Markets Slowdown and a Global Crisis.

Global Risks Index August 2019

Source: Euromonitor International Macro Model

In the Global Downturn scenario, fears of escalating protectionist and populist policies in advanced economies, growing geopolitical tensions and heightened investor risk aversion raise uncertainty levels and worsen global financial markets’ sentiment.

Declining private sector confidence and future income prospects, lower employment and rising borrowing costs all reduce consumption and investment and cause the global output to decline by more than 5% over a 3-year horizon relative to the baseline forecast. A robust business strategy could allow a company to remain profitable even in a global downturn scenario.

In an Emerging Markets Slowdown scenario, rising global financial markets risk aversion and greater pessimism about long-term emerging and developing economies’ growth prospects raise borrowing costs and reduce private-sector spending in these economies.

Over a 3-year horizon global output declines by almost 3% relative to the baseline forecast. However, the impact of this scenario is significantly stronger for developing and emerging economies, with output losses ranging from 3% to 10%.

The Global Crisis scenario combines a severe global downturn with a Chinese hard landing and a Eurozone recession. While the probability of this scenario over the next 12 months is low, its high impact makes it a potentially important “black swan” extreme stress-test for business strategy. The goal of a more extreme stress-test would be to ensure that a company can survive and return to profitability even after a global crisis.

The Country Risks Index

The Country Risk (CRI) Index compares macroeconomic risks across more than 50 countries. The CRI provides an estimate of the expected decline in income levels or market sizes under adverse macroeconomic conditions, combining both global and country-specific scenarios.

The country-specific adverse scenarios incorporated in the index below are especially important in developing and emerging markets that are more dependent on commodity exports, foreign capital inflows or volatile agricultural production sectors.

CRI 2019 Lowest and Highest Risk Countries

Source: Euromonitor International Macro Model

Companies can use the CRI to rank countries by their macroeconomic riskiness and to incorporate a typical pessimistic scenario into financial analysis and business decisions. For example, a ranking of 10.4 for Turkey can be interpreted as a representative adverse country scenario in which real GDP and income levels decline by 10.4% over a 3-year horizon. This can be combined with information on spending elasticities in micro industry level forecast models to estimate representative adverse scenarios for more specific consumer spending categories.

Based on this information, a company can evaluate the riskiness of market entry or market expansion projects across countries, potentially identifying new expansion opportunities while scaling down activities in other markets.

For further information and detailed methodology for these new risk indices, see the Global Risk Report 2019 and the Country Risk Index 2019.