citigroup study on global protests

Citiisoneoftheworldslargestfinancialinstitutions,operatinginallmajorestablishedandemergingmarkets. Across these world markets, our employees conduct an ongoing multi-disciplinary global conversation accessing information, analyzing data, developing insights, and formulating advice for our clients. As our premier thought-leadership product, Citi GPS isdesignedtohelpourclientsnavigatetheglobaleconomysmostdemandingchallenges,identifyfuturethemes and trends, and help our clients profit in a fast-changing and interconnected world. Citi GPS accesses the best elements of our global conversation and harvests the thought leadership of a wide range of senior professionals across our firm. This is not a research report and does not constitute advice on investments or a solicitation to buy or sell any financial instrument. For more information on Citi GPS, please visit www.citi.com/citigps.

CitiGPS:GlobalPerspectives&Solutions

May2014

TAKING IT TO THE STREETS What the New Vox Populi Risk Means for Politics, the Economy and Markets

TinaMFordham MatthewPDabrowski WillemBuiter RobertBuckland EdwardLMorse

CitiGPS:GlobalPerspectives&Solutions May2014

2014Citigroup

TinaMFordham,Managing Director, is the first and only Chief Global Political Analyst on Wall Street. She has been named in the Top 100 Most Influential Women in Finance and the Top19EconomistsonWallStreet.With Citi since 2003, she has pioneered a political science-based approach to investment research, specializing in geopolitics and socio-economic risks as well as focusing on more traditional elections and policy analysis. Ms. Fordham is a memberoftheWorldEconomicForumsGeopolitical Risk Committee, Associate Fellow at King's College Graduate Centre Risk Management, and a member of Chatham House andLondonsKitCatClub. Previously she served as Senior Adviser in the UK Prime Minister's Strategy Unit and Director of Global Political Risk at Eurasia Group. Ms. Fordham earned her Master's in International Affairs from Columbia University's School of International and Public Affairs.

+44-20-7986-9860 | [email protected] MatthewPDabrowskiis a Political Analyst at Citi. A pollster by training, Matt specializes in public opinion research, global political analysis and electoral politics. Matt has managed political campaigns on both the statewide and federal levels and his experience includes research 'in country' in Afghanistan, on behalf of Members of Congress, and with a former U.S. presidential candidate. Matt holds a B.A. degree in political science from St. Bonaventure University and an M.A. in survey research from the University of Connecticut. He is a member of the American Association of Public Opinion Research and the American Political Science Association. Matt has been with Citi since 2012.

+1-212-816-9891 | [email protected] Willem Buiter joined Citi in January 2010 as Chief Economist. One of the worlds most distinguishedmacroeconomists, Willem previously was Professor of Political Economy at the London School of Economics and is a widely published author on economic affairs in books, professional journals and the press. Between 2005 and 2010, he was an advisor to Goldman Sachs advising clients on a global basis. Prior to this, Willem was Chief Economist for the European Bank for Reconstruction & Development between 2000 and 2005, and from 1997 and 2000 a founder external member of the Monetary Policy Committee of the Bank of England. He has been a consultant to the IMF, the World Bank, the Inter-American Development Bank and the Asian Development Bank, the European Commission and an advisor to many central banks and finance ministries. Willem has held a number of other leading academic positions, including Cassel Professor of Money & Banking at the LSE between 1982 and 1984, Professorships in Economics at Yale University in the US between 1985 and 1994, and Professor of International Macroeconomics at Cambridge University in the UK between 1994 and 2000. Willem has a BA degree in Economics from Cambridge University and a PhD degree in Economics from Yale University. He has been a member of the British Academy since 1998 and was awarded the CBE in 2000 for services to economics.

+1-212-816-2363 | [email protected] RobertBucklandis a Managing Director and Head of Global Equity Strategy at Citi Research. Prior to that he was a European Equity Strategist at Citi when the team was ranked first in all the major investor polls. Before joining the firm in 1998, he was an equity strategist at HSBC for four years. Prior to that, Robert was a sector analyst, economist and strategist at NatWest Securities, starting in 1989.

+44-20-7986-3947 | [email protected]

EdwardLMorseis Managing Director and Global Head-Commodities, Citi Research in New York. He previously held similar positions at Lehman Brothers, Louis Capital Markets and Credit Suisse. Widely cited in the media, he is a contributor to journals such as Foreign Affairs, the Financial Times, the New York Times, The Wall Street Journal and the Washington Post. He was most recently ranked oneofThe36BestAnalystsOnWallStreetbyBusinessInsider)and#23amongtheTop100GlobalThinkersof2012byForeignPolicy.HeworkedintheUSgovernmentattheState Department, and later was an advisor to the United Nations Compensation Commission on Iraq as well as to the US Departments of State, Energy and Defense and to the IEA on issues related to oil, natural gas and the impact of financial flows on energy prices. A former Princeton professor Ed was the publisher of Petroleum Intelligence Weekly and other trade periodicals and also worked at Hess Energy Trading Co. (HETCO).

+1-212-723-3871 | [email protected]

Contributors EricGLee XingXing

May2014 CitiGPS:GlobalPerspectives&Solutions

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TAKINGITTOTHESTREETS WhattheNewVoxPopuliRiskMeansforPolitics,theEconomyandMarkets AndthosepeopleshouldnotbelistenedtowhokeepsayingthevoiceofthepeopleisthevoiceofGod,sincetheriotousnessofthecrowdisveryclosetomadness.AlcuintoCharlemagne,798A.D.

Itseemslikepoliticalriskisonthefrontpageeveryday:crowdsofprotestorsgathering,arallycallingforindependence,amilitarycoup,orscenesofcivilconflict.Istheremoreunrestglobally,oris24/7mediacoveragecreatingthisperception?Issocialmediatoblame?WethinktheanswertothisquestionliesinbetterunderstandingwhatwecallVoxPopulirisk,anewvariationofpoliticalriskwhichwehavebeentrackingforthepasttwoyears.WedefineVoxPopuliriskasshiftingandmorevolatilepublicopinionthatposesongoing,fast-movingriskstothebusinessandinvestmentenvironment.Inthisreport,CitisPoliticalAnalysisteamdocumentsadramaticandmeasurableincreaseinthenumberofelections,massprotestsandgovernmentcollapsesoverthepastthreeyearsa54%increaseversusthepreviousdecadeaswellasaproliferationofnewandfringepoliticalparties,manyofwhichareanti-establishment.

AlthoughtherehavebeenperiodsofVoxPopuliriskthroughouthistory,thedifferencetodayisthattheseeventsarehappeninginhighincomedevelopedmarketsandmiddleincomeemergingmarkets,manyofwhichhaveenjoyedasustainedperiodofgrowthandimprovementsinlivingstandardsandareintegratedintotheglobaleconomyandfinancialsystem.TheauthorsofthereportthatfollowsbelievethatVoxPopuliriskisastructuralchangeandthatitwillbeariskfactoraffectingboththeinvestmentandbusinessenvironmentfortheforeseeablefuture.

Whatiscausingthischange?TheauthorsbelievethenewVoxPopuliisbeingfueledbygrowingperceptionsofincominginequalityandanxietyaboutglobalization,particularlyamongstmiddleclasses.Indevelopedmarkets,thishasresultedinnewandalternativepoliticalpartieswhicharehavinganimpactonpolicydebateandincreasingtheformationoffragilecoalitionsandreferendumrisk.Inemergingmarkets,thereisagreaterchanceofstreetdemonstrations,rebellionsandsustainedtensionsthatelectionsmayfailtoresolve.Insomecases,localprotestscanbecomeageopoliticalriskalmostovernight.Forpetrostates,afallinpetroleumpricesisleadingtoanoutcryforimprovedgovernanceandamoreequitabledistributionofincome.

Thusfar,companiesandmarketshavebeenabletolocalizepoliticalrisksthankstocontinuedlowinterestrates.Onceratesrise,theimpactofsystemicpoliticalriskscouldgrow.Greaterfragmentation,disruption,andthegeopoliticalimplicationsofmorevocal,morequicklymobilizedpublicopinioncouldstarttoweighmoreheavily.

ApplyingtheassumptionthatVoxPopuliriskisunlikelytorecedeintheimmediatefuture,thisreportexploresitsimpactontheglobalpoliticalenvironment,includingahostofupcomingelectionsin2014and2015,theglobalrecoveryandeconomicoutlook,financialmarketsandkeysectorssuchascommodities.

Giving the People What They WantA Risky Business

Shifting and more volatile public opinion Vox Populi is a new structural risk that will generate uncertainty in the business and investment environment.

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Mass Protests (2011 - 2013)

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Countries in orange are included in the Mass Protests maps.

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Contents VoxPopuliRisk:TheNewPoliticsoftheStreetandtheBallotBox 7WhatIsVoxPopuliRisk?IsitReallyNew?HowdoesitWork? 11TheEmpiricalBasisforVoxPopuliRisk 14SocialMediaFuelsFlashMobDemocracy,butDoesntGuaranteePoliticalTransformation 16VoxPopuliandMacroeconomics:UncertaintyCurbsGrowth 18

VoxPopuliandMacroeconomics:IncomeInequalityFuelsPoliticalEconomyofDiscontent 19

VoxPopuliRiskinDevelopedMarkets:DiscontentisAnti-Reform,andMindtheGenerationGap 22

RiseoftheNEAPs 23ReferendumRisk:HowEuropeanVotesMaySurpriseMarketsandLeadtoPolicyUncertainty 25

VoxPopuliRiskinEmergingMarkets:MassProtestCanBePro-ReformYetMayNotLeadtoChangeinGovernment 28VoxPopuliRiskandMarkets 31VoxPopuliRiskinResourceEconomies:ChallengestotheRentierStates 34VoxPopuliRiskandtheInternationalSystem:ABoostforDiplomacyasaSilverLining? 40TheOutlookfortheFuture 41Appendix:VoxPopuliEventsinDMandEMSince2001 43


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VoxPopuliRisk:TheNewPoliticsoftheStreetandtheBallotBox Judgingbythemoodinglobalmarkets,thefinancialcrisisisover.Allhailtherecovery.Yetitseemslikepoliticalriskfeaturesinthenewseveryday:anotherstreetprotestanewgovernmentcollapsearallycallingforindependencetheoutbreakofcivilconflict.Thepast6monthshavewitnessedthefirstUSfederalgovernmentshutdownin17years,amilitarytakeoverinEgypt,Ukrainessecondrevolutioninadecadeandtheannexationofpartofitsterritory,arecurringcycleofprotestsandelectionsinThailandandTurkey,thecontinuationofSyriascivilconflictandtheperiodiceruptionoftensionsintheSouthChinaSea.Meanwhile,globalmarketshavebarelybattedaneyelashandappeartobepricingthemostlikelyoutcome:riskiseithernotperceived,orignored.

Areinvestorsjustifiedinassumingthateconomicrecoverywilltemperanotherwiserestivepublicmoodandthatsuper-empoweredcentralbankswilltakecareoftherest,includingmoreconventionaleconomicrisks,suchassovereigndebtsustainabilityintheeuroareaperiphery,bankingsectorriskintheeuroareafollowingtheAssetQualityReviewandtheStressTestthatwillreportlaterin2014?Ouranalysissuggeststhattheunconciousuncouplingbetweengeopoliticalriskandfinancialmarketscouldbemisplaced,aswhatwecallVoxPopuliriskanewvariationofpoliticalriskdrivenbyshiftingandmorevolatilepublicopinionhasincreasedmarkedlyoverthepast4years,andislikelytocontinuetogenerateuncertaintyinthebusinessandinvestmentenvironment.VoxPopuliriskisalsolikelytointeractwithconventionaleconomicandfinancialrisktocreateapotentandpotentiallypoisonousbrew.

AccordingtoempricalresearchproducedbyCitisPoliticalAnalysisteam,(whichwebelievetobethefirstofitskind)theyearlyaveragenumberofelections,governmentcollapsesandmassprotests(VoxPopuliriskeventsforthepurposesofthisstudy)haveincreasedaremarkable54%since2011comparedtothepreviousdecade.WeclassifyVoxPopuliriskeventsintofourmaincategories:1)electionrisk2)flashmobdemocracymassprotestrisk3)referendumriskand4)geopoliticalrisk.Incontrasttopreviouswavesofpoliticalrisk,whichwereoftenconcentratedinless-developed,lower-incomecountries,VoxPopuliriskismanifestingitselfinmiddle-incomeemergingmarketandindustrializedcountriesasystemicallysignificantsubsetofsovereignsmorelikelytogeneratewidermarketimpact.

During2011-2014,non-mainstreampoliticalpartieshaveseenanunprecedentedspikeinsupport,sappingpoliticalcapitalfromgovernments,promptingfragilemulti-partygoverningcoalitionsandoftensurprisingmarketsbyproducingunexpectedelectionoutcomes.Atthesametime,massprotestshavesweptaswatheofmiddle-incomeEMdemocraciesdespitetheirgovernmentshavingdeliveredasustainedperiodofgrowthandimprovedlivingstandards.Aroundtheworld,grass-rootspressuresareincreasingtheriskoffragmentationsocial,politicalandevengeographical,asanti-government,anti-establishmentsentimentreachesall-timehighsandtrustininstitutionsplummets.

Vox Populi risk events are on the rise and manifest themselves as: 1) election risk; 2) flashmobdemocracy mass protest risk; 3) referendum risk; and 4) geopolitical risk

An increase in non-mainstream politicalparties.


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Figure 1. The Yearly Average of Elections and Mass Protests in Major Markets Has Jumped 54% in the PostCrisis Environment

Source:CitiResearch

AlthoughwedocumentamarkedincreaseinthenumberofpoliticallygeneratedeventsacrossEMandDMcountriesobservingthatthenatureoftheriskvariesslightlymorevocalmiddleclassesareacommonfeature.Fordevelopedmarkets,VoxPopuliriskisbeingfueledbyperceptionsofgrowingincomeandwealthinequalityanddemandsforchangethatoftenmaskadesiretokeepthestatusquoinpublicresourceallocation,favoringtheagingandthemiddleclass.Inemergingmarkets,streetdemonstrationsaregivingpoliticalexpressiontonewmiddleclassesandplacingincreaseddemandsonpoliticalsystemsandonthecapacityofstateinstitutionstodeliverkeypublicgoodsandservices,includinghealth,transportationandeducation,aswitnessedin2012and2013insomeofthelargesteverprotestsinRussia,Brazil,TurkeySouthAfricaandIndia.Forpetro-states,fallingpetroleumprices(theyhaventreallyfallensignficantly)areleadingtoanoutcryforimprovedtransparencyandgovernanceandaquestinmanycountriesforrevenuestobemoreequitablydistributed.

WhattriggersVoxPopulirisk?Afrequentcatalystistheperceptionofelitecorruption.Timeandagain,evidenceofelitemisbehaviorhasrapidlygalvanizedpublicdissatisfactionacrossincomegroupsandregions,acceleratedbysocialmedia.Yetonesomewhatcounter-intuitivefindinginourresearchisthatcountriesthatexperienceVoxPopuliriskevents,suchaslargestreetprotests,donotnecessarilygoontohavechangesingovernmentattheballotbox.Instead,internaltensionsmayremainhighwithoutachangeinleadership,butelectionsmaybringaweakerleaderwithlesspoliticalcapital.

.drivenbymorevocalmiddleclasses

andperceptionofelitecorruption


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Anotherdogthatdidntbark,istheabsenceoflarge-scalesocialunrestduringthedarkestdaysoftheeurozonecrisis.Althougharapidreversaloflivingstandardsishistoricallyassociatedwithprotestsandrevolutions,ouranalysisunderscoredthefactthatausterity-relatedprotestswerelimited,generallyfailingtomeetCitisdefinitionofamassprotest.Eventheeurozoneperipherycountrieshardest-hitbythecrisishaveseenlimitedsocialunrest.Thisfindingisconsistentwithourlong-standingviewthatpoliticalriskwouldbeexpressedthroughtheballotboxinadvancedeconomies,ratherthanonthestreets.Inthecaseoftheeurozone,thepoliticalcalendarhelpedminimizetheimpactofVoxPopuliriskatthemostfragiletimeformarkets.ThisyearsEuropeanParliamentelectionswillbethefirstmajorpoliticaltest,andareexpectedtoreturnthelargest-everresultsfornon-mainstreamparties,andoftenanti-euroandanti-EUparties.Consistentwiththislogic,countrieswheretrustininstitutionsandthepoliticalprocessislowestaremostatriskofassymetricoutcomes,likerevolutionsandcivilconflict.

Couldareturntogrowthreversethetrend?OurfindingssuggestthattheriseofVoxPopuliriskislinkedtoaconvergenceoffactors,particularlymiddleclassanxietyandconcernsaboutglobalization.Indeed,improvedgrowthprospectsdonotappeartobediminishingthesupportforanti-establishmentparties,suchastheUKIndependenceParty(UKIP)inaneconomicallybouyantUK,whiletheinfluenceoftheTeaPartymovementintheUScontinues,despiteperiodicmediaattemptstowriteitspoliticalobituary.Ifanything,amorepositivegrowthoutlookcould,byreducingtheriskofprotestvotesbringinginagovernmentthatcoulddamageanalreadyweakeconomy,emboldenvoterstemptedtosupportnon-mainstreamalternatives.Whenconsideredalongsidethecontinuationofstubbornlyhighunemployment,webelievetheVoxPopuliphenemenonisastructuralchangethatcouldcontinuetogeneratepoliticaluncertaintyintothenextelectioncycle,with2015seeingaresumptionoftheEuropeannationalelectioncycle.

SohowdomarketsrespondtoVoxPopulirisk?Theanswerappearstobe,withremarkablecalm,indeedhardlyatallfornow.TherehavebeenburstsofmarketvolatilityinresponsetosurprisesbroughtonbyincreasedpoliticalriskbutinvestorsaretreatingVoxPopuliasalocalizedratherthanagloballysystemicissue.Forinstance,theUkraine-Russiatensions,consistentwithourviewthatthemarketscurrentlyonlypricethemostlikelyoutcomebutnottherisks,haveresultedinasharpmark-downofUkrainianassets(currency,stockmarket,sovereignandcorporatedebt)andasignificantmark-downofRussianassets.Thematerialriskthattheconflictcouldspreadanddeepen,resultinginsectoral-leveleconomicsanctionsagainstRussiaandeventhecut-offofgasandoilshipmentsfromRussiatoEuropecannotbeobservedinanyEuropeanassetpricestheeuro,Europeanstockindicesordebtmarkets.Thismightreflectthepalliativeeffectofcheapmoneyascentralbankshavecometotherescueandboostedassetpricesthatwouldnormallybehurtbyhigherpoliticalriskpremiums.Theextraordinarilylowsafeyieldsresultingfromthesesamepolicieshavecreatedahungerforyieldamongprivateinvestorsthatmayhaverenderedthemblindeventosignificantrisks.

Thewithdrawalofcheapmoneycouldmarkareturntopoliticalrisk,butfornowmarketsareseeminglyoverlookingaconfluenceofdevelopmentsthatwould,inaworldwithlessliquidity,havelikelypromptedgreaterconcern.Forcorporations,wethinktheimpactfromoperatinginavolatilepoliticalenvironmentwillbemoretangible,whethermanifestedthroughmorefrequentchangesofgovernment,amorechallenginglegalandregulatoryenvironment,orrecurringmassprotests.

Market reaction to Vox Populi risk has been remarkably calm


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Intermsofitseconomicimpact,VoxPopuliriskfuelsuncertainty,leadinghouseholdstoincreaseprecautionarysavingsandbusinessestolowercapitalformationreducingtwomajorcomponentsofdomesticaggreatedemand.Reducedpoliticalcapitalforleaderscanmeanshort-term,populistpolicymaking,reducedwillingnesstounderakereforms,highertaxesandmoreregulation,sometimesforpunitiveratherthanforsoundeconomicreasons,allofwhichcanresultinnegativeincentivestowork,saveandinvest:ultimatelysuppressingfuturegrowth.

VoxPopuliriskisalsoinfluencinggeopolitics.OnepositivebyproductisaboostfordiplomacyinthecaseoftheSyrianchemicalweaponsdisposalagreementandthehistoricfirststeptowardsadiplomaticbreakthroughonIransnuclearprogramaspublicopiniontiesleadershands,effectivelyprohibitingtheuseofmilitaryforce.Yetamoremuscularisolationismwouldbearwiderimplicationsforglobalalliancesandconflictresolution,likelyaffectingenergysecurityandthenuclearnon-proliferationagenda,amongotherthings.Marketshavegrownaccustomedtothepost-ColdWarpeacedividend,andhistorysuggestsmarketshavetroublepricinginparadigmshifts.

SincethefalloftheBerlinWall25yearsago,companiesandinvestorshaveoperatedinanenvironmentcharacterizedbyrelativestability,theerosionofideologyasadrivingforce,risingintegrationintheglobalfinancialsystemandunprecedentedeconomicexpansion.Inthefirstpost-ColdWarera,politicsandsecurityplayedarelativelyminorroleindisruptingmarketsandtheglobaleconomy.IfVoxPopuliriskcontinuesorworsens,itcouldfuelachangeinthistrendpromptingmorefrequentdisruptionstotradeandcommercialrelationsandchallengestotheglobalsystemaNewNewWorldOrder,wheretherulesofthegameareundernewmanagement.Butwhose?

whiletheeconomicimpacthasshort- and long-term components

On the positive side, Vox Populi risk is boosting diplomacy


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WhatIsVoxPopuliRisk?IsitReallyNew?HowdoesitWork? ThepowerandinfluenceofpublicopinionhasgainedinimportanceandinfluenceintheaftermathoftheglobalfinancialcrisisandadventoftheArabSpring.WedefineVoxPopuliriskasthepresenceofshiftingandmorevolatilepublicopinion,thepressureitplacesonpolicymakersand,throughthat,itsrelationshiptomarkets.CitiResearch1firstcoinedthisconceptin2012toidentifywhatweobservedastheemergenceofanewtypeofrisktotheinvestmentenvironmentandthepolicy-makingsphere.Examplesabound,fromnewtrendsliketheideaofcrowd-sourcing,tosomeofthelargest-evermassprotestsandpopulardemandsforrepresentativegovernmentmanifestingthemselvesinnewregionsoftheworld.Farfrombeinginretreat,democracyappearstobeonthemarchandpeoplepowerontherise.Forbetterorforworse,theconsequencesaregeneratingchangesinnationalpoliticaloutcomes,aswellasintheinternationalsystem,withwidespreadimplications.SociologistCharlesTillyhasnotedthat,ratherthanbeingentirelyseparatephenomena,theseeventsfallalongacontinuumreferredtoascontentiouspolitics.2

Moreglobalizedpublicexpectationsandthedeclineofthepost-WorldWarIIsocialcontractmeansthatconstituentsdemandmorefrompoliticalleadersthaneverbeforeyetthecapacityfortheseleaderstodeliverislimitedinaslower-growthworld.Trustineliteswhetherbusiness,politicalormediaandininstitutionshasdeclined,asnotedbyEdelmanPublicAffairsinitsannualTrustBarometer.Thisdisconnectfuelspopulardiscontent,especiallywhencoupledwithstagnantordeclininglivingstandards.

Inthemeantime,globalequityindicestradeatall-timehighs.Politicalflare-upscaninduceshort-termburstsofglobalmarketvolatility,asweareseeingwiththeUkrainecrisisnow,butthelonger-termimpacthasbeenremarkablysmall.Thismayreflectthegreaterweightingofstockmarketsinmorepoliticallystablecountries.Itmayalsoreflectthesoothinginfluenceoftheultra-lowinterestratesandopen-endedliquiditybeingprovidedbyleadingDMcentralbanks,oritmaysimplyreflectinvestorcomplacency.Theycanseethelocalrisksfromincreasedpoliticaltensions,buttheydonotyetappeartoseethisaspartofabroaderglobalthemethatshoulddemandhigherriskpremiumsacrossallmarkets.

Indeed,capitalmarketsmayinadvertentlybecontributingtosocialandpoliticaltensionsbyvirtueoftheirunconsciousuncoupling.Cheapmoneyhasboostedassetprices.Thiswillhavehelpedtostabilizefragileeconomies.However,italsowidenswealthgapstheasset-richhavegotricher.Buthighlevelsofunemploymentsuggestthatthetrickle-downtoabroaderconstituencyhasbeenslow.

HownewisVoxPopulirisk?Tobesure,protestmovementshavehadasignificantimpactonthegloballandscapeinthepast.Thecivilrightsandanti-VietnamWarmovementsintheUSinthe1960s,thelaborandstudentmovementsinEuropeduring1968,andthe1989WindsofChangethatultimatelybroughtanendtotheIronCurtainandSovietUnionareprominentexamples.Butinalessglobalizedenvironmenttheirinfluencewasmainlydomestic,intheUSandEuropeancontext,andregionalinCentralandEasternEurope.

1 TinaFordhamGlobalPoliticalInsights:TheYearofLivingDangerouslyComestoaClose,CitiResearch,October24,2011 2 Doug McAdam, Sidney Tarrow and Charles Tilly. Dynamics of Contention. Cambridge University Press, 2001.

Vox Populi risk is the presence of shifting and more volatile public opinion, the pressure it places on policymakers and its relationship to markets

Trustinpublicinstitutionshasdeclined

But global equity indices are trading at all-time highs

Protest movements in the past had greater influence in a domestic environment


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Contrasttheseprotestsofthe1960sandlate1980swiththeArabSpring,wheretheexampleoftheself-immolationofaTunisianfruit-sellersparkedawaveofprotestsacrossaregionthathadlittlerecentexperiencewithit.TheUSsOccupyWallStreetmovementcrystallizedthesentimentofWearethe99%,pittingelitesagainsttheoverwhelmingmajority.Twoyearslater,acrosstheworldinNigeria,aplanfortheremovaloffuelsubsidiesquicklyturnedintoamassprotestunderthebannerofOccupyNigeria.TheAmericanOccupymovementitselfclaimedtodrawinspirationfromtheArabSpringandtheSpanishIndignadosmovement.AlthoughOccupyWallStreetfailedtoaccomplishanyconcretepoliticaloutcomesintheUSwhereitoriginated,itsanti-establishment,anti-elitecatchphraseencapsulatesaconceptthathasresonatedwithmiddleclassesacrossbothdevelopedandemergingmarkets.

Figure 2. The Continuum of VoxPopuliRisk and Some of Its Effects

Source:CitiResearch

Evenleaderssweptintoofficeonthebackofapopularmandatemayfindthemselvesonthewrongsideofpublicopinionveryquickly,aspost-revolutionaryEgyptianPresidentMohammedMorsilearned.Oneconsequencehasbeentheemergenceofshorter-tenuredgovernmentswithreducedroomforpolicymaneuver,andeventhehandoverofpowertonon-electedtechnocrats.OnesuchexamplewasEuropeanCommissionerMarioMontisbrieftenureasItalianprimeministerhehasbeenfollowedbytwomoreunelectedpremiers,EnricoLettaandMatteoRenzi.Acrossthedevelopedworld,electedleadersarehamstrungbyever-shorterhoneymoonperiods,roller-coasterpublicapprovalratings,legislativegridlock,fractiouspoliticalpartysystems,andausteritybudgets.

Todaysprotestsarefeedinguponeachother in a more global way

Figure 3. Fractious Politics: A Few Effects of VoxPopulirisk Over the Past Two Years

Bulgaria: Hung parliament Finland: Anti-bailout MP's push

government's hard stand France: Resurgent far-right Front

National Greece: Rise of hard-left and neo-Fascist

parties Italy: Hung parliament Spain: Catalan secessionist movements UK: Push for Scottish independence and

in-out EU referendum US: First government shutdown in 17

years, aborted Syria intervention

Source:CitiResearch


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Figure 4. The Mechanism of VoxPopuli Risk

Source:CitiResearch

Thesedevelopmentsarealsotakingplacebetweenelectioncycles,underscoringhowinanenvironmentofpopulardiscontent,disgruntledpublicsmaynotbewillingtowaityearsfornewelectionsbeforetheydemandtheopportunitytomaketheirviewsknown.Whereelectionsoccur,theymorefrequentlyresultinfragmentedoutcomes,suchasmulti-partycoalitions,asintheUKin2011(thefirstcoalitiongovernmentinBritainsince1974)andhungparliaments,asinItalyandBulgariain2013.

Figure 5. After Decades of International Convergence, Fragmentation?

Source:CitiResearch


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TheEmpiricalBasisforVoxPopuliRisk ToquantifytheeffectofVoxPopulirisk,weexaminedtheelections,massdemonstrationsandotherpoliticaleventsinthecountriesthatmakeuptheMSCIDevelopedMarketsandEmergingMarketsuniverses.WeclassifiedtheseasVoxPopulirisk(VPR)events.

VPReventsinouranalysishadmoreorlesspoliticalimpactdependingonthepresenceofkeycharacteristicsthatmaycombinetoproduceamarket-movingsurprise.Theseincludemassprotestsinmultiplecities,thepresenceofviolence,afailedelectionorhungparliament,theriseofnewpoliticalactorsorNEAPs,andsecessionistorterritorialclaims.Thepresenceoftwoormoreofthesefactorscouldbeconsideredahigh-VPRevent,thepresenceofoneamid-rangeVPRevent,andthelackofanyalow-VPRevent.

Wenoted69sucheventsbetween2011andApril2014,thoughmost(43of69,or62%)hadlimitedpoliticalimpact.Ingeneral,thesewereregularlyscheduledelectionswhereincumbentsweresuccessfulorwheretheelection'soutcomewaslargelyexpected.TypicalinthisgroupistheSingaporeelectionin2011.Nineeventshadaparticularlydestabilizingimpactonpoliticaltrends.Ingeneral,theselarge-scaleeventsinvolvecoupdtats,massiveprotests,snapelectionsresultinginhungparliaments,orconflictswhereopposingpartiesdisputedthebasicnatureofthestate(i.e.,pro-/anti-democracyorsecessionistmovements).WithinthisgrouparetheGreekelectionofMay2012,TurkeysGeziParkprotests,andtheEgyptianmilitaryinterventionthatremovedMohammedMorsi.Thefinal17hadanintermediatepoliticalimpact,liketheSouthAfricanlaborprotestsandtheriseofNEAPsinFinnishandAustrianelections.Thesetendedtobemassproteststhatdidn'thaveasignificantpolicyimpactorelectionswherepopulistpartiesmadenotablegains.

WhatcharacterizedtheVoxPopuliriskeventsthatmostaffectedglobalpolitics?First,thesepoliticaleventscameasasurprisetomarketsonaccountofasuddenelection,ahungparliament,orarapiddescentintoprotest.Evenwhereourpoliticalanalysisanticipatedrisksorpollingdatamayhavebeenpredictive,marketswereoftencaughtunaware.Second,manyofthemostseriouseventsinvolvedirreconcilabledisputesbetweenelitegroupsoverthebasicnatureofthestate:whetherbetweendemocracyandauthoritarianism,betweenopposingsocialbases,oraspartofcenter-regionaltensions.

Theelementofsurprise.Consistentwithabroadacademicliteratureonmarketpriceaction,thehighest-impactVoxPopuliriskeventscomeassurprises.Ingeneral,thismeansanunscheduledelectionorgovernmentcollapse,aspontaneous/unexpectedmassdemonstration,oranelectionthatendedinasurpriseresultorhungparliament.Snapelectionsareanoutcomelimitedtoparliamentarydemocracies,meaningthesesystemsmayrepresentdisproportionatepoliticalriskintimesofeconomicstress.Allofourhigh-VPReventswereunscheduled,aswere14ofthe17mid-impactVPRevents.Low-VPReventswerescheduledandpredictable29of43times.

Irreconcilableelites.ThirteenVPReventscouldbesaidtorevolvearoundthebasicnatureofthestate,meaningtheywerepro-representativegovernmentinthecaseofanauthoritarianregime,oracoupdtatorsecessionmovement.Thisincludedfiveoftheninehigh-VPRevents,includingarevolutioninEgypt,theRussianinterventioninCrimea,andmassprotestinThailand.Thefivemid-or-lowVPReventsincludepro-democracyprotestsinChina,andstudentandfarmerprotestsseentoberelatedtotheFARCinsurgencyinColombia.

Of the 69 Vox Populi risk events that we identified, 43 had limited political impact as most were regularly scheduled elections with expected outcomes

Events that impacted global politics the most were ones that were a surprise to the markets or involved irreconcilable fights between elite groups


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Whatdidntaffectglobalpolitics?Contrarytothepopularnarrativesofwhatmaybedrivingcontemporarysocialunrest,wefoundlimitedevidenceoftheeffectsofGDPgrowthorausteritypoliciesorviolence.Whileallofthesevariablesarerepresentedatleastinsomerespect,nostrongpatternsorrelationshipsareapparentinDMorEMmarkets.

GDPpercapita.GDPpercapitawaslowerinhigh-VPRcountries(mean$14,100,median$11,600)andhigherinlow-VPRcountries(mean$25,700,median$12,700).Allthreegroupshadabroaddistributionofincomes,however.Inthehigh-VPRgroup,wefoundcountriessuchasEgyptandBrazilbutalsoItalyandGreece.Thelow-VPRgroupincludedNorway,theUSandTaiwan,butalsoColombia,ChinaandMexico.

Austerityasariskfactor.Fifteenofthe69eventsrevolvedaroundausterityasakeyfactor.MostofthesewereinEurope,whereausterityhasdominatedthepublicdebate.Thisincludesfouroftheninehigh-VPRevents,butitalsoincludeslow-riskEuropeanelectionsandmid-riskEuropeanprotests.

Corruptionasacatalyst.Eleveneventsexplicitlyinvolvedstatecorruptionasamotivationfordiscontent.Onlytwowerehigh-VPR(BrazilandItaly).Therestwereamixofmassprotests(inBrazilorChina)orelectionscalledinthemidstofcorruptionscandals(inFinland,AustriaandtheCzechRepublic).

Violence.Comparativelyfeweventsinthedatasetcouldbecharacterizedasviolent:eightof69.ThisgroupincludedEgypt,Brazil,Turkey,GreeceandSouthAfrica,aswellasRussiasinvolvementintheCrimea.Theseweretheonlyeventsthathadanyreporteddeaths.MostdeathswereinEgypt(over2,200inbothevents)onlySouthAfricaandRussiahadmorethan10reporteddeaths(40inMarikana,80inUkraine).Nevertheless,politicalscienceliteraturesuggeststhatwhenthemajorityofthepublicregardsdemonstratorsashavingalegitimategrievance,thedeathsofprotestorscanoftengalvanizepublicsupportintheirfavoroftentothedetrimentofincumbentgovernments.

Relatedtotheelementofsurprise,VoxPopuliriskhasbeenakeydriverofshort-termvolatility.Lookingatthelargestsingle-daymovesintheVIXoverthepastfiveyears,halfwereduetopolitical-orpolicy-drivenevents.Notablepoliticaleventrisksover2013thathavemovedmarketsincludetheconsequencesofelectionsandriotsofthetypeinourVoxPopuliriskeventdataset.Alsoincludedweremarket-relatedpublicstatementsbyUSPresidentBarackObama(Figure6).

Little impact from the effects of GDP growth, austerity policies, government corruption or violence

Surprise and Vox Populi has been a driver of short-term volatility


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Figure 6. Liquidity Aside, Politics Still Matters. Many Of The Top OneDay VIX Moves Since QE Began Correspond to Political Events.

Date %Change

in VIX %Change

in S&P Political Events Financial/Macro Events 2/25/2013 38.7% 1.83% Italianelection 8/8/2011 30.1% 6.59% USdowngrade 8/4/2011 28.9% 4.77% ECB,BoJactions,

slowdownfears5/6/2010 26.7% 3.11% Flashcrash4/27/2010 25.8% 2.17% Greecedowngrade1/28/2011 25.7% 1.79% TahrirSquare Japandowngrade5/7/2010 25.0% 1.43% UKelection,Greeceriots 10/30/2009 23.9% 2.74% Endofmonth1/22/2010 22.6% 2.13% USpolicyuncertainty,Fed 1/24/2014 21.3% 2.01% Chinafears,USearningsmiss1/21/2010 19.8% 1.95% Obamacallsforbankregulations 3/16/2011 19.3% 1.76% UShousingdata,

Fukushimadisastercontinues3/1/2011 19.2% 1.68% Libyancivilwar 2/20/2013 19.2% 1.24% Fedcommunication

Source:ChicagoBoardofExchange,Bloomberg,AssociatedPress,CNNMoney.com.CitiResearch

SocialMediaFuelsFlashMobDemocracy,butDoesntGuaranteePoliticalTransformation Whyispublicopinionmoreglobalizedandfastermovingthaninthepast?Althoughtechnologyenablesprotests,ratherthanbeingacasualfactor,advancesinsocialmediaandcommunicationstechnologyhavedriventheseeminglyinstantaneousnatureofcontemporarymassprotest.ProtestsinEgypt,BrazilandTurkeywereorganizedonline,aswastheOccupyWallStreetmovement.Thesetacticshavebeencopiedandre-interpretedaroundtheworld.Episodesofwhatwecallflashmobdemocracycanappearovernightandrapidlymultiplyacrosscities,townsandregions,placingsignificantpressureongovernmentelites.SkyrocketingInternetpenetrationinthepastfiveyearssuggeststhetrendislikelytointensify.Thisallowswould-berevolutionariestoorganizeinmultiplecitiesaroundawholecountryindaysorevenhours.

Indiahasseenover100millionmoreInternetusersgainaccesstotheInternet,apossiblefactorinitselectionthisyear.Eveninsmallercountries,theimpactcanbesignificant.UkrainesInternetpenetrationincreasedfromroughly3millionupto9millionpeople,representinga515%jumpfrom2007to2012.China,inthesamefive-yearperiod,gainedanamazing360millionmoreInternetusers.Thisrapidincreaseleadstoanobviousquestion:asChinaseconomybecomesmoreglobalizedanditspopulationmoreconnected,couldit,too,seeariseinprotestactivitysimilartootherEMcountrieswithlarge,emergingmiddleclasspopulations?

Advances in social media and the Internet have driven the speed of contemporary mass protest and ease of organizing large crowds

The rise of the internet has been rapid in emerging markets


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Figure 7. Internet Penetration Skyrocketed Between 2007 and 2012, With the Addition of 360 Million New Users in China Alone.

Source:WorldBank,CitiResearch

Thoughthepotentialforonlineproteststogenerateshort-terminstabilityishigh,therecentrashoflarge-scaleEMprotestshasgenerallyfailedtotranslateintochangesofgovernmentorevenpolicy.Whataccountsforthis?PartoftheexplanationliesinthefactthatInternet-ledprotests,althoughtheycanbeorganizedquicklyandbenefitfromtheirabilitytoproduceasenseofsafetyinnumbers,usuallylackthesocietalnetworksandleadershipnecessarytofocussuchpopulardiscontentandconvertitintoconcretepoliticaloutcomes.TheabsenceofasignificantbenefittoTurkeysoppositionpartiesasaresultoftheGeziParkprotestshighlightstheincreasinglydecentralizednatureofprotestactivity.Traditionally,successfulpoliticalmovementsdrewtheirorganizationalsupportfromcivilsociety,vanguardpoliticalparties,universitiesorareligiousinstitution.Withouttheestablishmentofsuchnetworks,theseoutburstsofpopulardiscontentmayfizzlewithlittleconcretepoliticalimpact,withthemostsignificantcollateraldamagecomingintheformofdentedapprovalratingsandreducedpoliticalcapitalforincumbents,ratherthanregimechange.

VoxPopuli,withthehelpofsocialmedia,createmanymorevetogroupsthatcaneliminateindividualcomponentsofaprogram,oftenmakingwhatisleftincoherentandunworkable.Atthesametime,itcanalsosignificantlylowerthecostoflobbyingtoremoveanunpopularpolicy.Thatisparticularlytrueforfiscalausterityandstructuralreformwherethereareoftenasignificantnumberoflosers.Isitemasculatingrepresentativedemocracywithitscapacitytoreachcompromisesacrossissuesandtime?Thereisnoinvisiblehandoftheflashmobthatensuresthattheuncoordinatedactionsofsingle-issuemovementsproduceasetofpoliciesandadministrativeactionsthatmakesense.Ifanything,theoverarchingtrendisoneoffragmentationratherthanagroundswellofsupportinfavorofaparticularpoliticalagenda.Onepossible,andnotableexception,isregulationandtaxation,particularlyofunpopularindustries.

116

189

248

100

150

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250

300

350

400

450

500

550

2007 2008 2009 2010 2011 2012

Index Increase in Internet Penetration

DevelopedMarkets

(Inde

x200

7=10

0)

264

318

275

100

161

515

100

150

200

250

300

350

400

450

500

550

2007 2008 2009 2010 2011 2012

Index Increase in Internet Penetration

(Inde

x200

7=10

0)

India

Egypt

China

Brazil

Ukraine

211

46 5912 20 3

571

156

99

36 33 150

100

200

300

400

500

600

China India Brazil Egypt Turkey Ukraine

Nominal Internet Penetration (Millions of Persons)

2007 2012

Interne

tPen

etration

(Nom

inal,M

illion

s)

Although quicker to organize, Internet-inspiredprotestsdontalwaysconvertintoconcrete political outcomes


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VoxPopuliandMacroeconomics:UncertaintyCurbsGrowth JayUlfelder,scholarofdemocratictransitionsandprediction,foundthatcoupsdtattypicallyresultina2%economicdragontheaffectedcountriesduringtheyearoftheintervention,andthenanother1-2%thefollowingyearbeforereturningtotrend.Thiscouldbecalledthecoupoutputgap?3Byextension,couldmassprotestsandprolongedperiodsofheightenedpoliticaluncertaintyproduceasimilardeclineinGDPfigures?Withthisinmind,weexpectnotjusttheshort-termnegativeeffectsonGDPforecaststhatUlfelderdiscusses,mainlydrivenbydomesticaggregatedemandbutweshouldalsoexpectlowerlong-rungrowthbecauseofbadpolicies,clientelismandaneglectofincentivestowork,saveandinvest.

Oneoftheoldestobservationsabouthouseholdandfirmdecision-makingundertimesofuncertaintyisthatgreateruncertaintyincreasesprecautionarysavings(thusreducingconsumptiondemand)and,byraisingtheoptionvalueofwaitingtofindouthowtheuncertaintywillberesolved,lowerscapitalformation.Thismeansthetwomaincomponentsofdomesticdemand(accountingoftenfor80%ofdomesticdemandormore)areadverselyaffectedbythegreateruncertaintycreatedbyVoxPopulirisk.4

Moregenerally,thereisawidereconomicimpactfromVoxPopuliriskbeyondassetprices.Therearemanyimportantbusinessdecisionsandeconomicpolicydecisionsthatarenotdirectlyorvisiblydrivenbyliquidfinancialmarkets.Forexample,theimpactofUkrainianVPRandthesubsequentRussianinvolvementinCrimeawillhaveimportantconsequencesforEuropeaninvestmentintheinfrastructureofreducedenergyimportdependencefromRussia.Thismeansmoreinvestmentintransportation,shipmentandstoragefacilitiesforgas(includingLNG),coal,oilanduranium.Itmeansgreaterinvestmentintheelectricpowertransmissiongrid,integratingtheBalticsintothewiderEUhigh-tensionelectricpowertransmissiongrid.

Greaterpoliticalrisk,includingVPR,isadeterrenttocapitalexpenditureinthecountrieswhereitoccurs,evenifthesecountriesdonthavewell-developedliquidanddeepfinancialassetmarkets.InwardforeigndirectinvestmentinVPR-afflictedcountrieslikeThailandandUkraineisboundtosuffer.Anyeconomicactionthatiscostlyorevenimpossibletoreverse,likeengagingingreenfieldinvestmentinafactoryorstoragefacility,islikelytobediscouragedbyVPR.Businessdecisionswitha30-yearhorizon,likeexplorationfornaturalresourcesorcapitalexpenditureonextraction,transportationandstoragefacilities,arelikelytobeputonholduntilVPRisresolved.

Althoughmostoftheoutstandingstockofequityistradedinthemarketsofalimitednumberofadvancedeconomies,mostphysicalcapitalexpenditurenowoccursinemergingmarkets.Inaddition,althoughtheUSnowaccountsfor49%ofstockmarketvaluationsandEuropeforanother25%,asignificantpartofthefuturestreamofprofitsandearningspricedinthesemarketsaregeneratedbyrealeconomicactivityinemergingmarketswhoselocalstockmarketsareoftensmall,illiquidandnotsystemicallyimportant.

3 Jay Ulfelder.CoupsSlowEconomicGrowth.JayUlfelderblog.July11,2013. 4 WilliamLee.Policy Uncertainty and Investment - How Much Lower Must Real Interest Rates Go? Citi Research. February 3, 2014

Economic drag is seen with coups dtat but also in the short-term with Vox Populi events and longer long-run growth is also expected to suffer

Greater uncertainty leads to household savingsandadomesticdemand

.andisalsoadeterrenttocapitalexpenditure


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Inouranalysis,wenotedimmediatedropsintheGDPforecastforcountrieswhichexperiencehighVoxPopuliriskevents.FollowingtheDecember2013unrestinThailand,CitisGDPforecastdroppedmateriallythenextmonthandcontinuedtodrop.ThesamehappenedinEgyptaftertheJuly2013militaryintervention,thoughtheGulfStatesattemptstoshoreEgyptscurrentreserveshelpedstemthefall.

Figure 8. Major VoxPopuli Events Caused Citi GDP Forecasts To Drop Materially

Source:CitiResearch.Datareflects2014GDPforecastbeforeandaftertheThailandunrestofDecember2013andtheEgyptianmilitaryinterventionofJuly2013.

VoxPopuliandMacroeconomics:IncomeInequalityFuelsPoliticalEconomyofDiscontent Perceptionsofgrowingincomeandwealthinequalityareincreasinglyregardedasbeingattheheartofmiddleclassdiscontent.Thisdiscontenthasbeenexacerbatedbythefinancialcrisisandthesubsequentrollbackinmiddleclasslivingstandards,thefirstindecadesinsomecountries.IntheUS,realwageshavebeenstagnantforoveradecade.PollingdatahasshownthatpopulationsacrossDMandEMcountriesareexperiencingsignificantmiddleclassanxiety.In2013,forexample,Pewreportedamajoritybelievingtheirchildrenwillbeworseofffinanciallythantheyarethemselves.Inmanyinstances,suchastheUS,thisrepresentedahistoricalchangeintrend.InFrance,thismajoritywas90%,andinJapan,78%.

1.0%

2.0%

3.0%

4.0%

5.0%

4 3 2 1 MonthOf +1 +2

Citi GDP Forecasts After VoxPopuliEvent

Thailand, Dec. 2013

Egypt , July 2013

Both Thailand and Egypt saw immediate drops in economic forecasts following VPR events

Middle class anxiety from growing income and wealth inequality is a driver of Vox Populi


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Figure 9. Middle Class Anxiety: Large Numbers Across Major Markets Believe Their Children Will Fare Worse Than Themselves

Whenchildrentodayin(country)growup,doyouthinktheywillbebetterofforworseofffinanciallythantheirparents?Worseoff

Source:PewResearchGlobalAttitudesProject,CitiResearch.SurveysconductedMarchApril2013,marginsoferrorranging+/3.37.7%.

ThankstorapidEMgrowth,globalincomeinequalityacrosscountrieshasdecreasedsignificantlyandindeedtheGinicoefficienthasdeclinedsincethebeginningofthecentury.Yetwithinindividualsocietiesthatis,thenational,regionalorlocalcommunitiesthatdefinepeoplesreferencegroupsandbenchmarksagainstwhichtheymeasuretheirpersonalmaterialwell-beinginequalityhasskyrocketed.Globalizationhasraisedworldwideincomes,removingthefocusfrompovertyreduction.Forthefirsttimeinthestudyseight-yearhistory,the2012WorldEconomicForum(WEF)GlobalRisksreportidentifiedincomeinequalityasthemostlikelyglobalriskforthenext10years.AWEFexpertsurveysuggestedthatinequalitywasconnectedtomorethan40globalchallengesstudied,exceedingstatefailure,corruption,andclimatechangeinperceivedsignificance.

However,parentsfearingtheirchildrenwillbeworseoffthantheyareisnotfearofinequalityperse.Rather,wethinkitshouldbeinterpretedasanxietythatthesystemischanginginawaythatpeoplehavelessfaiththatthepathtoprosperity,andtheopportunitiesitaffords,willbeasopentotheirchildrenasitwastothemselves.Thisdeclineinoptimism,ifsustained,couldstrengthendemandsforsocialsafetynetsandreduceincentivesforadvancededucationandotherchoices.Evenifallchildrenwereexpectedtobeequallypoor,theparentswouldstillcare.Regardless,concernsaboutincomeinequalityhavebeenatthecoreofsomeofthemosthigh-profileexamplesofVoxPopuliriskinDM,includingOccupyWallStreetintheUSandtheIndignadosprotestsinSpain.Bothmovementswereprofoundlymiddleclassprotests,galvanizingprotestorsagainsttherollbackofthesocialsafetynetandrisingyouthunemployment.Sofar,nosignificantpoliticalactorhasbeenabletocapitalizeuponthisanxiety,butitrepresentsfertilegroundforaspiringpoliticalupstarts.

Thepainofthefinancialcrisisanditsaftermathhasbeenborneoverwhelminglybytheyoung.IntheUS,SocialSecurityandMedicarebenefitsaresacredcows.InEurope,wherelong-termcontractswithbenefits,rightsandentitlements,includinglast-infirst-outseverancerulesandotherseniorityfeaturesarehelddisproportionatelybytheolderworkers,withtheyoungmakingdowithso-calledflexiblecontracts,whichareoftennotmateriallydifferentfromthedaylaborerarrangementsofthepast.Butthisinter-generationaldisparityisnotcapturedwellbythesnapshotGinicoefficientsforincomeorwealth.

27%53%

62%64%64%65%

73%74%76%

90%

0% 20% 40% 60% 80% 100%

Israel

Australia

UnitedStates

Canada

Germany

Spain

Italy

UnitedKingdom

Japan

FranceDeveloped Markets

7%12%13%18%24%25%29%

37%39%40%42%43%

58%61%67%

0% 20% 40% 60% 80% 100%

ChinaMalaysia

ChileBrazil

RussiaIndonesiaPhilippines

SouthKoreaMexico

SouthAfricaEgyptTurkey

CzechRepublicPolandGreece

Emerging Markets

Global inequality across countries has decreased, but within individual societies, it has shot up

Generational inequality is also on the rise buthasntbeencapturedwellyet


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Theworseningemploymentsituationhasintensifiedtheriskofsocialunrest. INTERNATIONALLABORORGANIZATION

Theimpactfromincomeinequalitymaynotbelimitedtostreetprotests.AmericanpoliticalscientistshaveobservedthatincomeinequalityishighlycorrelatedwiththeriseofpartisanpolarizationintheUSCongress.Incomeinequalitymaybefuellingapoliticaleconomyofpolicyeliteswhoareoperatingwithinanenvironmentofseeminglyirreconcilabledifferences.

Figure 10. Partisan Polarization in the US Has Risen Along with Income Inequality in a Highly Correlated Way

Source:PooleandRosenthal/PolarizedAmerica,FederalReserveBankofSt.LouisFRED,CitiResearch

0.300

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Partisan Polarization in theUS Congress & Income Inequality

HousePolarization

SenatePolarization

GiniCoefficient

Houser=0.96Senate r=0.84

Income inequality is driving partisan polarization in government


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VoxPopuliRiskinDevelopedMarkets:DiscontentisAnti-Reform,andMindtheGenerationGap Inacycleofdeleveraging,theinterestsofcreditorsanddebtorsinsocietyareopposedinazero-sumgame.Todayspoliticalbattlelinesaredrawnovertheallocationofstateresourcesratherthanideology.Theconflictcanbenegative-sumifthefightoverthedistributionoftherentsdestroyssomeormostoftheserents.Suchdividedinterestsfuelpolarization,gridlockandaversiontostructuralreform.Therearedemandsforchange,buttypicallycitizensseektomaintainthestatusquoforthemselves.

Developedmarket(DM)middleclassesnowoftenconstituteananti-reformbulwark,punishingausterity-budgetincumbentsinthevotingbooth.TheUKthinktankPolicyNetworknotedthefactthatthemiddleclassesarethebeneficiariesofthepriorfiscalorder,whichmakespensionsandwelfarepaymentstooldcohortspracticallyuntouchable.5

IntheUS,budgetcutshavefallenalmostexclusivelyontheyoung,withentitlementssuchasSocialSecurityandMedicarelargelyuntouched.Thefactthatoldervotersnowinmanycountriesoutnumberyoungervoters(witholdervotersgenerallymorelikelytovotethanyoungervoters)reinforcesthebiasinpublicsectorresourceallocationsinfavorofagingpopulations.Withgovernmentsamajoremployerofthemiddleclass,publicsectorreformmayconstituteathird-railofpost-crisispolitics.Astraditionalmainstreampartiesimplicatethemselvesinthereformprocess,theriskincreasesthatmust-winmiddleclassvotersrejectthemandturnincreasinglytounconventionalpoliticalalternatives.Inthisenvironment,jobapprovalformostDMleadershasstoppedorstayedlowoverthepasttwoyearsAngelaMerkelbeingthemostnotableexception.

Figure 11. Public Approval for Major DM Leaders Has Dropped Or At Relatively Low Levels Over the Two Years

Source:Pollster.com/TheHuffingtonPost,Electionista,Sondageenfrance.fr,YouGovUK,CitiResearch

5 Patrick Diamond and Guy Lodge. "European Welfare States After the Crisis: Changing Public Attitudes." Policy Network, January 2013.

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David Cameron

The struggle for limited state resources fuels polarization, gridlock and aversion to structural reform

DM leader approval ratings continue to plummet as middle classes constitute an anti-reform bulwark


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Thisbegsthequestion:forhowlongcantheoldout-votetheyoungbeforethedynamicshifts?Inter-generationaltensionswereamajorfactorinthe2013Italianelectionresultthatproducedahungparliamentwherenopoliticalpartywasabletogainanabsolutemajorityofseats.Whatpreventsthistensionfrombeingamoresignificantfactorislikelytobetheapathyofyoungervoters,whotypicallyscorelowonpoliticalparticipation,forfeitingtheirpowerattheballotboxandmaintainingtheelectoralprimacyofbabyboomervoters.Couldacatalystemergethatgalvanizesyouthvotersandseesthemengageinthepoliticalprocess?Sofar,theissuecapableofinspiringthischangeisnotapparent.

RiseoftheNEAPs Abyproductoftheerosionofthepost-Warpoliticalorderisthatmainstreampoliticalactorshavebeenjoinedonthescenebynewplayers.Ourtermforthesenewpoliticalparties,whichspanthepoliticalspectrum,isNEAPs,ornew,extremeoralternativeparties.Asarule,thesemovementsandpoliticalpartiesareanti-establishment,and,intheEuropeancontext,euroskeptic.Somerepresentsingleissuesorsimplyageneralizedanti-orientation,ratherthanthebroadplatformsthatcoulddrawinawidercoalition.WhenNEAPsattackthemainstreampartiesfromtheirrightandleftflanks,mainstreampartiesarelikelytoadoptsomeNEAPpolicypositionsastheytrytomaintaintheirconstituencies,inasortofpoliticalcross-dressing.Thus,evenifnotelectedtoleadgovernments,NEAPsarehavingasignificantinfluenceonthepolicydebate.UKPrimeMinisterDavidCameronhasplacedanin-outreferendumonBritishmembershipintheEuropeanUnion(slatedfor2017)atthecenterofthenationaldebate,overtheobjectionsoflargesegmentsofhisownpartyandmainstreamBritishbusinessinterests,inanefforttostemtheriseoftheeuroskepticUKIndependenceParty(UKIP).UKIPisdrainingsupportfromConservativesheadingintoMay2014EuropeanParliamentaryelections,andevenhassomeToriesworriedaboutthe2015UKgeneralelections.

Figure 12. Challenges to Mainstream Political Parties and the Rise of Euroskeptic or AntiEstablishment NEAPs

Figure 13. In European National Parliaments, NEAP Parliamentarians Have Tripled Since The Crisis Began

Country Party(ies) Country Party(ies) Austria FreedomParty Japan JapanRestoration

AssociationNEOS Latvia NationalAllianceTeamStronach Lithuania OrderandJustice

Belgium VlaamsBelang WayofCourageAttack Luxembourg ADR

CzechRepublic ANO TheLeftUsvit Netherlands FreedomParty

Denmark People'sParty/DF ReformedPartyRedGreenAlliance SocialistParty

Finland TheFinns Poland SolidarnaPolskaFrance FrontNational YourMovementGermany Afd Portugal LeftBloc

PirateParty Slovakia SlovakNationalPartyGreece ANEL Spain Secessionist&nationalist

partiesGoldenDawn UnitedLeftSyriza Sweden LeftParty

Hungary Jobbik Sweden SwedenDemocratsIndia AadAadmiParty UnitedKingdom RespectIreland SinnFein UKIndependenceParty

UnitedLeftAlliance UnitedStates TeaPartymovementItaly FiveStarMovementSource:CitiResearch Source:CitiResearch

225

703

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2008 2009 2010 2011 2012 2013 2014

EU P

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New, extreme or alternative parties are on the rise and representanantiorientation


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TheNEAPstrendisparticularlypronouncedintheEU,thoughfarfromexclusivetoit.Byourcalculations,thenumberofEuropeanUnionparliamentariansrepresentingeuroskepticpartiesatthenationallevelhastripledsince2011toover700,oraround10%,outof~7,200members.Thesenewmovementshavewonseatsin21ofthe28EUnationalparliaments.ThelargestincludeItalysFiveStarMovement,whichwonasurprising25%ofthevotein2013elections,aswellasGreecesSyriza,PolandsPalikotMovementandHungarysJobbik.WeexpectthatasignificantnumberofNEAPmemberswillenterlocalgovernmentandtheEuropeanParliamentoverthecomingyear.

IntheNetherlandsGeertWildersandhisFreedomPartyhaveannouncedplanstocreateablocthatwouldbringtogethereuroskepticandanti-immigrantpartiesafter2014sEuropeanParliamentelections,potentiallyjoiningwithFrancesNationalFront.AlargeeuroskepticblocintheEuropeanParliamentcouldfurtherinhibitprogresstowardtheintegrationandreformsattheEAandEUlevelsthatarenecessaryforfurtherpoliticalandfiscalintegration.Havingsaidthat,wenotethatanti-partiesmaystruggletoworktogethertowardasharedpoliticalobjective.Indeed,intherunuptotheEuropeanParliamentelections,manyhavebeenatpainstodeclaretheirunwillingnesstocollaboratewithpartiestheyfearwilltarnishtheirbrand,particularlywheretheremaybeperceivedconcernsofxenophobia.EventhenotableperformancebyNEAPsinEuropeanParliamentaryelectionsthisyearmaynotnecessarilytranslateintoaconcretepolicyagendainstead,theymayactasspoilers,slowingthemachineryofpolicymaking.Apossibleexceptionmaybeintheareaoffurtherregulationandoncurbstoimmigrationamongthefewareaswheretheantisfindcommoncause.

Anti-establishmentforceshaventarisenmerelyfromcenter-rightoranti-systempositions.ThepopulistLeftmayberesurgentaswell,directlypositioningitselftospeaktotheissueofincomeinequality.NewproposalsforminimumwagehikeshavemadeheadlinesintheUS,andinGermanywasevenakeyplankoftheincominggrandcoalitionsgoverningagreement.In2015,Switzerlandwillholdareferendumonabasicincomeprogramforallcitizens,thoughitsworthnotingthatSwissvotersrejectedaplantocapexecutivepayaslateasMarch2013.ThepotentialpolicyimpactinDMisconsiderableasevidencedbymostlegislatureshavingenactedorareconsideringnewregulationthatfocusonanti-financialserviceslegislation,CEOpay,wealthtaxes,minimumwageincreases,andrestrictionsbothonnewimmigrationandontherightsofoldandnewimmigrants.

Notallofthesenewgroupsarespecificresponsestothepost-crisispoliticsofausterityandbailoutdemands.PolandsYourMovement,forexample,drewtogetherliberal,anti-clerical,andanti-establishmentopinionatamomentwhenthecountryscenter-right-leaningpoliticalpartyspectrumofferednoseriousleftistalternatives.OutsideEuropebutwithinthisanti-establishmentcategorycouldincludetheTeaPartymovementintheUnitedStatesandJapansRestorationParty.Butinourview,allreflectdissatisfactionwiththelongstandingmainstreampartiesthathavedominatedthepost-Warpoliticalsystemindevelopeddemocracies,andademandforpoliticalalternativesthatisnotstrictlyaconsequenceofeconomicfactors.

The NEAPs trend is particularly pronounced in Europe


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Figure 14. Referendum Risk: Centrifugal Forces Increase Uncertainty, But Will They Change the Status Quo?

Source:CitiResearch

ReferendumRisk:HowEuropeanVotesMaySurpriseMarketsandLeadtoPolicyUncertainty Againstthisbackdropofdiscontentandmistrustforinstitutions,severalDMgovernmentsarestrugglingwithregionalism,secessionismandadriveforthereturnofsovereignty.Evenafailedvotemaysetthestageforamarket-movingsurpriseinEurope,inwhatwecallreferendumrisk.BothScotlandandCataloniaplantoholdindependencereferendumsin2014,andin2017theUKisduetoholdanin-outreferendumonEUmembership.Thoughnoneoftheseballotsareexpectedtotranslateintovictories,theyaddtothesenseofpoliticaluncertaintyandfragmentation,weighingonconfidenceandsentiment.

Surpriseoutcomescouldhaveimmediatemarketimpactsorwide-rangingpolicyconsequences.First,theresultofanelectionmightinandofitselfsurpriseinvestors.Second,nationalgovernmentsattemptstooutmaneuverpublicopinionmayleadtonegativepolicyconsequences.Withthisinmind,weviewreferendumriskasanewandpotentiallypotentformofVoxPopulirisk,asaretreattonationalismandlocalismbecomesapowerfulpopularresponsetoglobalization.

Switzerlandimmigrationcontrols(February2014).OnFebruary9,2014Swissvotersnarrowlyapproved(50.3%to49.7%)areferendumtorestrictimmigrationfromtheEU.ThisvotewasseenascontrarytoEU-SwissbilateraltreatiesguaranteeingfreedomofmovementaspartofSwitzerlandsmembershipintheSchengenZone,andtheSwissgovernmentwillnowhavetoenactlegislationimplementingthereferendumsresults.ThoughthevotehadlimitedimpactonSwisscapitalmarkets,manyofEuropeseuroskepticandanti-immigrantpoliticiansareseekingtobuildsupportnowthattheissuehasgainedprominence.6Withthisinmind,nationalleadersmayattempttocounteractorco-optthesepartiespositions,withunforeseenconsequencesformedium-termEuropeanintegration.

Scottishindependence(September2014).TheScottishNationalParty-ledgovernmentinEdinburghhasscheduledareferendumonindependencefromtheUKonSeptember18.Thereferendumisexpectedtofail.BytheendofFebruary,forexample,48opinionpollsheldinScotlandhaveshowntheNosideupbyatleastsevenpointsormore.OnlyonesurveyhasshowntheYessidecloserandthatwascommissionedbytheSNP.Evenso,thepossibilityofaUKbreakuphasgeneratedpoliticaluncertaintywithinthecountryandconfusionabroad.BritishandEuropeanpolicymakershavespokenoutstronglyagainstthelikelihoodthatanindependentScotlandcanstaywithintheEUandthesterlingcurrencyzone.

6GiadaGianietal.Euro Economics Weekly - Could Eurozone Politics Return to the Fore?CitiResearch. February 14, 2014.

A number of governments are struggling with regionalism, secessionism and a drive for the return of sovereignty


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Catalonianindependence(dueinNovember2014).Catalonia,oneofSpainsregionaleconomicpowerhouses,haslonghadanactiveseparatistmovement,anditssupporthasgrownasCatalansassociatethecentralgovernmentinMadridwithausterity,unemploymentandwaste,inadditiontolong-standingcomplaintsaboutnetbudgetarytransfersfromCataloniatotherestofSpain.RegionalelectionsinNovember2012werelargelyfoughtontheindependenceissue,andpro-sovereigntyCatalanPresidentArturMastookhisvictoryasamandatetoproceedwithareferendum.Afavorablevoteforindependence,scheduledforNovember9(butlikelypostponedafterarecentconstitutionalcourtruling)wouldcomeasasurprisetomarketstoday,astheSpanishgovernmenthasvowedtoblockitasunconstitutionalandthereforeillegal,sinceundertheSpanishconstitutiononlythecentralgovernmentcancallareferendum.WhenCitiResearchlastconsideredtheissue,ourEuropeanEconomistsexpectedthelossofCatalan-basedgovernmentrevenuetocauseasignificantnegativefiscalimpactfortheSpanishsovereignintheshortterm.7Atthetime,ourforecastforSpains2012fiscaldeficitwasat7.1%ofGDP.Todayour2015deficitforecastisanimproved4.8%,butthebasicargumentstillapplies.

Brexitin2017.Inperhapsthemostextremecaseofreferendumriskcurrentlyonthepoliticalhorizon,growingeuroskepticismintheUnitedKingdomhasculminatedintheproposalforanin-outreferendumonBritainsEUmembership.PrimeMinisterDavidCameronhassuggestedthat,werethegovernmenttobere-electedin2015,hewouldcallforsuchavotetotakeplacein2017.Brexitwouldhaveasignificantimpactontheeconomicandbusinessenvironmentwhatsmore,pollsareinfavorofsecession,werethevotetotakeplace.InJanuary2013,CitiUnitedKingdomEconomistswrote,EUexitwouldbeamajoreconomicnegativefortheUK,damagingtheUKsabilitytoattractforeigndirectinvestment(FDI)ingloballytradedgoodsandservicesindustries.8

7EbrahimRahbariandAntonioMontilla.ElectionsInCatalonia:DownThePathOfTwo-SpeedSpain.CitiResearch.November23,2012. 8MichaelSaundersandAnnOKelly.UK Economics Weekly - Brexit Could It Happen? Would it Matter?CitiResearch.January18,2013.


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InFocus:ReferendumRisk:SecessionVotesMoreLikelytoFailthanPass,OtherthaninthePost-CommunistCountries In the modern era, referendum votes are more likely to fail than pass, unless the country is postcolonial or postCommunist. Indeed, only three new states have come into existence that werent the result of an explicit European decolonization process or a Communist collapse since 1974, and all these were a product of a United Nations process. Postcolonial and postCommunist.Ofthe29independencevotesconductedbydecolonizedorpostCommunistnations,onlytwofailedtopass:a1967voteinDjibouti,thencalledFrenchSomaliland,anda1992voteinMontenegro.Bothcountrieslaterconductedfavorablesecessionreferenda.Little luck in Europe and North America. FourteenindependencevoteshavebeenheldintheWestsinceWorldWarII,butonlyone(Iceland)resultedinthecreationofanindependentstate.TheFaroeIslands(Denmark)andNewfoundland(UnitedKingdom)alsovotedtosecede,buttheDanishparliamentoverturnedtheFaroesevoteandNewfoundlandlaterdecidedtojoinCanada.Mostsecessionballotshavebeenunsuccessful,mostnotablyinQuebec(Canada)andPuertoRico(UnitedStates). Quebec. TheCanadianprovinceofQuebechasheldtwosovereigntyvotes,onein1980andonein1995.The1980votewasaclearlossforthesovereigntymovement,60%Noto40%Yes.Butthe1995voteshockedCanadiansbyitsmuchcloserresult.Theprosovereigntypositionstartedstronglyandwasexpectedtowin,butavigorouscampaignbytheproCanadasideandthepromiseofconcessionsbyPrimeMinisterJeanChretienclosedthegapandthevotefailed,51%to49%.

Puerto Rico. TheAmericanterritoryofPuertoRicohasheldfourstatusvotessince1967,themostrecentin2012.Islandpoliticsrevolvearoundthestatusissue,andPuertoRicanpoliticiansdividethemselvesintoprostatusquoandprostatehoodpoliticalparties,ratherthanthemainlandRepublicansandDemocrats.Theindependenceoptionhasneverwonmorethan6%ofthevoteoverfourballots. Czechoslovakia.TheothermostnotableWesternsplit,Czechoslovakiain1992,wasconductedbytheCzechoslovakparliamentwithoutreferencetoapopularvote.Atthetime,theSlovakNationalAssemblyinBratislavahadalreadyissuedadeclarationofindependence.Eventhoughopinionpollingsuggestedthattheelectoratewouldopposethemove,thefederationparliamentinPraguebrokeredadealbetweentheCzechandSlovakleadershipandthebreakwaseffectedattheendoftheyear.PostCommunist and postSoviet.Between1990and1992,nineofthefifteenconstituentrepublicsoftheSovietUnionandfiveofthesixdivisionsofYugoslaviaheldindependencevotes.Fifteenofthesixteenvotespassed,withtheaforementionedexceptionofMontenegro.ThebreakawayregionsofNagornoKarabakh(Azerbaijan),SouthOssetia(Georgia)andTransnistria(Moldova)havealsoheldvotes,butnonehavebeeninternationallyrecognized.Three new nations, but birthed under UN supervision.Startingin1993,Eritrea,EastTimorandSouthSudanallconductedsuccessfulindependencevotesfollowingcivilwarsorinvasion.AllofthesevoteswereconductedundertheauspicesorsupervisionoftheUnitedNations.Somalilandalsodeclaredindependencein2001andhasoperatedasanautonomousrepublicintheHornofAfricawithoutinternationalrecognitionsincethattime.

Figure 15. In FiftyFour (54) Independence Votes Since WWII, Few Have Passed Outside PostColonial and PostSoviet Spheres

Decolonization & Trusteeship PostCommunist Independence Europe & North America New States Country Year Result Country Year Result Country Year Result Country Year Result Mongolia 1945 Passed Slovenia 1990 Passed Iceland 1944 Passed NewCaledonia 1987 FailedCambodia 1955 Passed Armenia 1991 Passed FaroeIslands 1946 Passed Eritrea 1993 PassedGuinea 1958 Passed Azerbaijan 1991 Passed Newfoundland 1948 Passed EastTimor 1999 PassedAlgeria 1961 Passed Croatia 1991 Passed Saarland 1955 Failed Somaliland 2001 PassedJamaica 1961 Passed Estonia 1991 Passed PuertoRico 1967 Failed SouthSudan 2011 PassedSamoa 1961 Passed Georgia 1991 Passed Aruba 1977 Failed 4 of 5Malta 1964 Passed Kosovo 1991 Passed Nevis 1977 Failed (80%) Rhodesia 1964 Passed Latvia 1991 Passed Quebec 1980 Failed Djibouti 1967 Failed Lithuania 1991 Passed PuertoRico 1993 Failed PostSoviet Breakaways Comoros 1974 Passed Macedonia 1991 Passed Quebec 1995 Failed Country Year Result Micronesia 1975 Passed Turkmenistan 1991 Passed Bermuda 1995 Failed NagornoKarabakh 1991 PassedDjibouti 1977 Passed Ukraine 1991 Passed Nevis 1998 Failed SouthOssetia 1991 PassedPalau 1993 Passed Uzbekistan 1991 Passed PuertoRico 1998 Failed Transnistria 1991 Passed

12 of 13 Bosnia 1992 Passed PuertoRico 2012 Failed SouthOssetia 1992 Passed (92%) Montenegro 1992 Failed 3 of 14 SouthOssetia 2006 Passed Montenegro 2006 Passed (21%) Transnistria 2006 Passed 15 of 16 6 of 6 (94%) (100%)

Source:CitiResearchbasedondatafromtheJournalofPublicMoney&Management,nationalelectionagencies.ThischartdoesnotincludeanyvotesrelatedtothecurrentUkrainecrisis.


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VoxPopuliRiskinEmergingMarkets:MassProtestCanBePro-ReformYetMayNotLeadtoChangeinGovernment Inyoungerdemocraciesorstateswheretheballotboxisnotanoption,socialunrestbecomesthemostvividexampleofVoxPopulirisk.Intermsofunrest,VoxPopuliriskcanbecapturedintheemergenceofnewsocialmovements,streetdemonstrations,rebellionsandinsurgencies,evencoupsdtatandrevolutions.Unelectedleadersinlessdemocraticregimesalsofacethreatstolegitimacy,evenincaseswheretheyhavesuccessfullydeliveredimprovedlivingstandardsinthepre-crisisperiod.In2012and2013,majorpublicprotestsoccurredinBangladesh,Brazil,Bulgaria,Egypt,India,Jordan,Morocco,Pakistan,Romania,Russia,Slovenia,SouthAfricaandTurkey.Evenafterprotestmovementsculminateincrisesorrevolutionarytransformations,historysuggeststhattheyalsore-emergeperiodicallyinthesubsequentmonthsorevenyearslaterapatternsuggestingthatprotestsbegetprotests.

AkeybyproductofthenewEMmiddleclassistheirincreaseddemandsonthepoliticalsystem.Thesecanincludehigherpublicspendingontransport,healthandeducation,greateraccountabilityforpublicofficials,plusgreatercivilandpoliticalrights.Inmanyemergingandfrontiermarkets,thepoorqualityoftheofficialbureaucracyandtheoftenroutinenatureofgraftandcorruptioncanfueldistrustofelites.

Figure 16. Protests and Civil Conflicts, 20112014

Source:CitiResearch

BrazilandTurkey:ProtestsandElectionsinTwooftheFragile5 WhenVoxPopuliriskpresentsitselfonthestreets,akeyvariabledeterminingwhetheritwilltranslateintowiderdisruptionisthenatureofthegovernmentresponse.Agovernmentsconciliatoryposturecanlowertherisksresultingfromsocialunrest,whileadefiantcrackdown,especiallywhenthedeathsofprotestorsisinvolved,willlikelyincreasethem.Toillustratethis,wecomparethepathsofBrazilandTurkey.

Russia

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New middle class in EM are increasing demands on the political system

How a crisis is handled is as important as what the crisis is about


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Figure 17. Protests By The Numbers: Little Similarity in Key Indicators, Except for Long Tenures in Office for Ruling Parties in the Biggest EM Economies with Social Unrest

Brazil Indonesia Russia South Africa Turkey Leader Rousseff Yudhoyono Putin Zuma ErdoganTenure of party in government

10 years 9 years 14 years 19 years 11 years

Partyorientation

Socialdemocratic

Centerright Conservative Socialdemocratic

Conservative

FreedomHouserating Free Partlyfree Notfree Free PartlyfreeNextelections October2014 April2014 2016 Summer2014 Spring2014Catalystforprotests Transitfare

hikesFuelpricehikes Democracy

activismLabordisputes Istanbulpark

redevelopmentGDPgrowth(2013F) 2.3% 5.8% 1.3% 1.9% 4.0%Unemployment(2013F) 5.5% 6.3% 5.5% 24.7% 9.8%Inflation(2013F) 6.2% 6.4% 6.8% 5.8% 7.5%Personalsatisfactionrate 59% 15% 22% 17% 21%Businessclimate(rankof185) 130 128 112 39 71Corruptionindicator 63 28 13 59 61Ruleoflawindicator 52 34 24 58 57

Source:FreedomHouse,WorldBank,GallupWorldPoll,CitiResearch

InBrazil,reactiontotheperceivedharshpoliceresponsetotheSaladRevolutionprotestorsonthestreetsofRiodeJaneiroswungpopularsupportbehindthedemonstratorsandwithitthesympathyofthemediaandgovernmentofficials(indeedmanyfiguresintherulingWorkersParty(PT),includingPresidentDilmaRousseff,areproductsof1980s-eraprotestandrevolutionarymovements).Ultimately,inachangeofstance,theBraziliangovernmentagreedtoreversethetransitfarehikesthatsparkedtheprotests,andtocommittoadialogueonreform.Rousseffsapprovalratingdroppedfromahighof65%inMarch2013to30%followingprotestsinJune2013,accordingtoDatafolha.EvengiventhatRousseffsapprovalratingshaveimprovedslightlyandsheremainsthefavoriteforre-electionin2014,albeitwithherchallengersenjoyingamodestboost,thisnewchallengehashadanimpactonherpoliticalcalculus,thatofherWorkersParty,andoftheopposition.9

TurkishPrimeMinisterRecepTayyipErdogansresponsetotheMay2013GeziParkincidentsoughttolimitprotestswithastrongresponsebythesecurityservices.ThespreadanddurationoftheprotestsincreasedpressureontherulingAKParty(AKP).Erdogansapprovalratingsdroppedfrom62%inDecember2012to53%inJune2013,andnowstandat44%inFebruary2014,accordingtoMetroPoll.10Withfallingapprovalratings,prospectsforconstitutionalreformmaybedelayed,butgiventhepartysperformanceinspringmunicipalelections,planstoholdthefirstdirectelectionsfortheTurkishpresidencyin2014arelikelytogoforward.Thus,despitethescaleoftheprotests,theAKP-ledgovernmentlargelyretainsitscoresupport,whiletheoppositionhasfailedtocapitalizeuponpublicdissent,suggestingdivisionandparalysisratherthanpoliticalchangemaybethekeyoutcome.WithBrazilandTurkeyheadingintoelectionsthisyearand2015,thereissignificantpotentialinbothcasesthatprotestactivitywillreturnyetinbothcases,theincumbentpoliticalpartiesareexpectedtobere-elected,albeitbysmallermargins,accordingtothelatestpolls.

9 Datafolha.ApsCairPelaMetade,AprovaoaGovernoDilmaVoltaaCrescer.August12,2013. Based on a survey of 2,615 adults conducted August 7-9, 2013, margin of error +/- 2%. 10 TomPeter.PollShowsErdogansPopularityHasTakenAHit.CouldHeLoseHisMandate?The Christian Science Monitor, June 18, 2013.

The Brazilian government sought to resolve theconflictquicklythroughnegotiation

whiletheTurkishgovernmenttookahardline response to protestors


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IntheTurkishcase,theprotestshighlightedexistingsocialandpoliticaldivisionsaswellasthecontinuedfragmentedstateoftheopposition.TheincumbentAKPislikelytoseeitscorepoliticalsupport,drawnlargelyfromthecountrysnewmiddleclasses,continue.YetitsapproachtotheGeziParkprotestmaymeanthattheoppositiontoitspoliciesremains,occasionallygeneratingperiodicdisruptions,evenasitlacksthestrengthtodisplacetheincumbentpartyattheballotbox.InBrazil,alongstandingconsensus-basedmodelmayreducetheintensityoffutureprotestsbutpavethewayformorewithin-systempoliticalchallengersovertime.Wesurmisethattheseflashmobprotestmovementsmayserveasmid-cyclereferendaonincumbents,reducingtheirroomformaneuverandwillingnesstoundertakeunpopularpolicymeasures,suchasreforms.

Havingsaidthat,notallEMeconomiesareexperiencingVoxPopuliriskinitsmostdisruptiveform.InChina,localstrikesandprotestscalledmassincidentsbyChineseauthoritieswerereportedtohavedoubledbetween2006and2010to180,000nationwide,accordingtotheWallStreetJournal11.Yet85%ofChinesereportbeingsatisfiedwiththeircountrysdirection,70%ratetheirlivingstandardsashigherthantheywerefiveyearsago,and67%saytheirpersonaleconomicsituationisgoodallatornearthetopofmorethan40countriessurveyedbythePewResearchGlobalAttitudesProject.12Thesesnapshotsofpublicopinionsuggestthat,despiteChinasgrowth,environmentalandgovernmentchallenges,theriskofanyJasmineResolutionmaybelimited.Nevertheless,Chineseauthoritiesappearmindfuloftheriskthatperceptionsoncorruptioncanposetogovernmentlegitimacy,judgingbyBeijingscrackdownonvisibleofficialcorruption.Andaspreviouslymentioned,thestrongcorrelationbetweeninternetpenetrationrates,aglobalizedeconomyandprotestssuggeststhatChinacouldseemoresuchactivityinyearstocome.

11 TomOrlick.UnrestGrowsAsEconomyBooms.TheWallStreet Journal, September 24, 2011 12 PewResearchGlobalAttitudesProject.GlobalIndicatorsDatabase.AccessedSeptember13,2013.

DespiteChinasrisingmiddleclass,ithasnot experienced Vox Populi risk events


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VoxPopuliRiskandMarkets Fornow,globalmarketsseemremarkablyimmunetorisingVPR.Afterall,theMSCIACWorldequitybenchmarkistradingaroundall-timehighs(Figure18).TheUSVIXindex,sometimescalledtheinvestorfearindex,remainsdownaroundmulti-yearlows(Figure19).

Figure 18. Global Equity Prices Figure 19. US VIX Index

Source:CitiResearch,Datastream Source:CitiResearch,Datastream

Thisdoesnotmeanthatburstsofincreasedpoliticalriskcannotinduceburstsofglobalmarketvolatility,asweareseeingwiththeUkrainecrisis.However,thelonger-termmarketimpacthasgenerallybeenmorelocalized.So,globalinvestorsmightseethecurrentcrisisasareasontosellRussianassets.TheymightevenseeitasareasontosellEMassets.ButtheydonotitasareasontoselltheS&P.Ifanything,volatilityinriskierpartsoftheworldseemstobeincreasingthedesirabilityofassetsinthemorestableDMeconomies.RapidlyrisingLondonhousepricesareclearenoughevidenceofthattrend.

WhyaremarketstreatingVPRasalocalizedratherthangloballysystemicissue?Thismightreflectthepalliativeeffectofcheapmoney.Centralbankshave(intentionally)boostedassetpricesthatcouldotherwisehavebeendamagedbyhigherpoliticalriskpremiums.Fornow,globalmarketsseemmoreinterestedinJanetYellensnextmoveonQEthanVladimirPutinsnextmoveinUkraine.Maybethiswillchange,butonlywhenwehaveseentheendofDMnear-zeropolicyratesandopen-endedliquidityatthoseextraordinarilylowrates.

Forthoseperplexedbythisapparentinvestorcomplacency,wewouldhighlightthatmarketscangiveaskewedperceptionofwhatmatters.ThisismadeveryapparentinFigure20.Herewerankcountry/regionalequitymarketweightingsagainsttheireconomicimportance.Wealsoshowtheirpercentageoftheglobalpopulation.TheUSdominatesglobalequitymarkets,accountingfor49%ofmarketcap.Italsoaccountsforameaningful,ifnotdominant,22%ofglobalGDP.However,itonlyaccountsfor6%oftheworldspopulation.

140

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95 97 99 01 03 05 07 09 11 13

MSCI AC World Index

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Markets seem relatively immune to rising Vox Populi risk

Volatility in riskier parts of the world seems to be increasing the desirability of assets in more stable DM economies

Central banks have boosted asset prices that could otherwise have been damaged by high political risk premiums


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Figure 20. % Weighting In Global Equity Market, GDP And Population

Source:CitiResearch

Bycontrast,EMeconomiesaccountforonly10%ofequitymarketcapbut81%oftheglobalpopulation.So,bydefinition,anyanalysisofVoxPopuliriskisgoingtocaremostaboutwhathappensinEM.Afterall,theyaresomuchmoreofthepopuli.However,wethinkinvestorsaregoingtocaremostaboutwhatshappeninginDMeconomiesandtheUSinparticular.ThatswhyitseasiertoseetheimpactoftheLehmancrisisinFigure18thantheArabSpring.Investorsaredoingwhatcomesnaturallyworryingaboutwhatmatterstothem.

Thisdoesntmeanthatmarketscantbemoreseriouslyaffectedbyelevatedpoliticaltensions,especiallyinmoresystemicallyimportantDMeconomies.Forexample,globalequitiesfellby25%in2011onfearsofaEurozonebreak-upandsubsequentsovereignandbankinsolvencies.Risingpoliticaltensionsintheperipheralcountriescontributedtothesell-off.EventhemightyS&PwobbledinresponsetoeventsonthestreetsofAthens.

However,evenherecentralbankactioncametorescue.EversinceECBpresidentMarioDraghisaidthathewoulddowhateverittakestopreservetheeuro,theabilityofEurozonepoliticalchaostodragdownglobalmarketsismuchreduced.GlobalinvestorsnolongeraskusaboutthelatestgovernmentcollapseinItalyorriseofextremisminGreece.Thesearestillveryrealpoliticalthemes,itsjustthemarketsseemtocareaboutthemmuchless.

TheUSfinancialcrisisof2008-09andtheEurozonecrisisof2010-12boththreatenedtheveryintegrityoftheworldsfinancialsystem.Thatiswhatmadeglobalinvestorstakenotice.Thefactthatcurrentheightenedpoliticalriskshaveshownlessabilitytomoveglobalmarketsreflectsthatinvestorsdonot(yet)seethemrepresentingsimilarsystemicfinancialthreats.

Indeed,wesuspectthatrobustglobalmarketsmayactuallybeaddingtoVoxPopulirisks.Risingassetpriceshavemadetherichricher.Thetrickledowntotheother99%isprovingmoreelusive.InDMeconomiesstockmarketshaverisenmorethanunemploymenthasfallen.Wealthgapshavewidened.Thereisabroadperceptionthattheresponsetothefinancialcrisishasbenefitedtheelitesmorethantherest.

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US EURxUK UK JP PACxJ CEEMEA EMASIA LATAM

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Although more of the population is in emerging markets, investors care most aboutDMasitsalarger%ofmarketcap


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Thishasaddedtowell-establishedgrievancesaboutrisingincomeinequality.ManygoodDMbluecollarjobswerelostasglobalizationshiftedlargepartsofthemanufacturingbasetolower-costEMeconomies.Thebargainingpositionoflower-skilledworkersinDMeconomieshasbeenfurtherunderminedbylooseningimmigrationpoliciesandthesubsequentinflowsofcheaperlabor.Ofcourse,manyhavebenefitedfromthepositiveimpactofglobalization.Inparticular,hundredsofmillionshavebeenliftedoutofpovertyasEMworkershavegainedaccesstohigher-paidjobs.DMshareholdershavebenefitedaslowerlaborcostshaveallowedcompaniestokeepprofitmarginshigh.ButthishasputpressureonDMwages.Forexample,theUSmedianhouseholdrealincomeshavegonenowheresincethemid-1990s.Abroadsenseofrisinginequalityhasprovenafertilehuntinggroundforpopulistpoliticians.

Overallitseemsthat,unlesseventsreallyescalate,globalmarketswillbeabletolocalizeperiodicoutburstsofVPR.However,theEurozonecrisisshowedusthatthefocusonpoliticalriskcanrisesharplyifinvestorsseetheprospectofamoresystemicthreattoglobalmarketstability.Inthemeantime,theongoingthemesofhigherassetpricesandglobalizationhavecontributedtoawideningsenseofincomeinequality.SoeventhoughglobalmarketsmayseemremarkablyimmunetoVPRrightnow,webelievetheyareindirectlycontributingtoit.

While,fornow,globalmarketsseemabletowithstandrisingVPRatamacrolevel,wecanseesomemoremicroimpacts.GreaterregulationofthedeeplyunpopularBankingsectorhasaffectedprofitability.Morescrutinyofthesectorsfrequentmisdemeanorshasbeenaccompaniedbyincreasinglypunitivefines.Windfalltaxeshavealsobeenimposed.Overall,however,ananti-capitalistbacklashhasnotreallymaterialized.Postthefinancialcrisis,globalcorporationtaxrateshavefallen,notrisen.Governmentshavebeenmoreinterestedinattractingmultinationaljobsthantaxingtheirprofits.InEMcountries,resentmentofcronycapitalismhasemboldenedgovernmentattemptstobreakembeddeddomesticmonopolies.Inthosecompaniesthatarelisted,shareholderscouldloseoutalongsidetheoligarchs.

Global markets will be able to localize periodic outbursts of Vox Populi risk

Although the effect may not be seen on the macro level, increased regulation on the micro level is having an effect


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VoxPopuliRiskinResourceEconomies:ChallengestotheRentierStates Thecomingyearlookstobeoneofwideranddeeperstrainforpetro-statescountrieswhosegovernmentrevenuesareparticularlydependentonoilandnaturalgasexportsgiventheoutlookformoderatelyifnotsignificantlyloweroilprices.Thefactorsthatgaverisetotheso-calledArabSpringhavebecomeamorepermanentpartofthedomesticlandscapeformanyifnotmostpetro-states,andcontinuingpressuresforgovernmentstospendtheirwaytolegitimacyandauthoritywillgrowiflowerpricescauserevenuegapstowiden.

TheUSEnergyInformationAdministration(EIA)estimatesthatlastyeartotalOPECrevenuesamountedto$940billion,$42billionlessthanin2012,andthatestimatedOPECrevenuescouldfalltoalittlemorethan$900billionthisyear,adropofover$80billion,or8%,injusttwoyears.Onapercapitabasis,thatsadeclineof$351,or11%,overthesameperiod.Thisisaresultofrisingpopulations,fallingpricesandstagnantproduction.

Theunderlyingfactorsgivingrisetothepredicamentthesecountriesarenowinhavetheiroriginsintherelativelydistantpastthe1970s,thedecadeinwhichOPECcameintoitsown.Thesharpriseinoilpricesafterthe1973YomKippurWarwasaccompaniedbyadecadeofnationalizationofoil-producingpropertiesandtightenedgovernmentcontroloverthepetroleumandnaturalgassectors,withtheOPECcartelputtingafloorunderpricesthatboostedtherentsreceivedfromlow-costproduction,creatingtheconditionsforrentierstatestoflourish.BeforetheuprisingsinNorthAfricainthewinterof2010-11,thesecountriessuccessfullysurvivedseveralperiodsofsharplylowerprices:1981-82,1985-86,1989-90,andespecially1998-99.Butthesurgeinpricesoverthelastdecadegaverisetoafalsehopethatthesecountriescouldavoidreformandspendtheirwayoutofdifficulty.Severalnewfactorsmakeitclosetoimpossibleforthistohappenasoilandgaspricesstabilizeandappeartobeweakening.

UnderlyingconditionsinmanyoilproducingcountrieswiththenotableexceptionofNorwayintheOECDandthesmallercountriesintheGulfCooperationCouncil(Kuwait,UAE,Qatar)areskewedtocreateproblems.Theseincluderapidpopulationgrowth,fallingpercapitaincome,starkincomeinequality,highlevelsofunemploymentandanincreasenotjustintheawarenessofopportunitieselsewhereintheworld,butalsoofsocialmediaandanabilitytocommunicateinternallyandinternationally.Tribalandreligiousschismsexacerbatetheseothertrends.

Figure 22. MENA Countries: Young and Unemployed

Source:CIAWorldFactbook,CitiResearch

05

1015202530354045 Median age

05

10152025303540

% unemployment

Lower oil prices are a particular worry in petro-states

Figure 21. Fiscal Oil Breakeven Prices for Selected Countries ($/bbl, 20112014)

2011a 2012a 2013a 2014e Qatar 38 42 46 46Kuwait 44 49 54 58SaudiArabia 77 74 84 88Oman 78 80 94 104UAE 92 79 68 67Libya 183 89 99 100Iraq 93 95 99 93Russia 100 115 118 112Iran 84 130 140 143Bahrain 111 115 119 117Algeria 111 120 113 113Venezuela 140 170 165 156Yemen 195 237 215 201

Source:CitiResearch


2014Citigroup

35

Allofthepetro-states,fromRussiatoVenezuelaandacrosstheMiddleEast,havetriedtodealwiththeseproblemsbyspendingathomeandmostofthemareunderrisingpressurestoboostincomegrowth.Inpetro-statesitismoreeasilyachievedthroughfasterrentconsumptionfromhigherextractionrates,orhigherpricesthanthroughdifficulteconomicreforms,especiallyreformsthatcurbdomesticenergyuse(endingpricesubsidies)orpromoteeconomicgrowthandemploymentoutsidethepetroleumsector.Duetopricesubsidies,fuelpricesinmanyofthesecountriesareverylow,drivingsomeofthemostrapidconsumptiongrowthratesintheworld.Inaddition,slowprogressindevelopingmorenaturalgasresourceshasmeantmorecrudeoilisburntdirectlyforpowergeneration.Curbingdomesticenergyuseintransportationanddevelopingalternativestodirectcrudeburnforpowergenerationcouldfreeupoilformorelucrativeexportrevenues,butthesemeasuresremainpoliticallydifficult,keepingthepressureontogrowincomefromtargetingprices.

Figure 23. Project Breakeven Costs for Planned IOC New Developments to 2020

Source:CitiResearchestimates

OPEChashistoricallysustainedrevenuebyagreeingproductionquotasenablingthegroupasawholetoputafloorunderpriceswellaboveOPECsverylowcostsofproduction.Butrisingsocialwelfarerequirementsarestretchingthebudgetsofalltheproducers.

RumailaGumustKakapSBJ

WestQurna1

JohanSverdrupZubair

CepuExpBauna/Piracaba

WhalesPark FrancoLula

PaodeAcucarLuciusSapinhoa

IaraTempaRossa MarsB

TEN NeneMarineThuderHorsePh2 AppamattoxChinaOffshoreOilBigFoot

PapaTerra ChiragOilLokicharCarioca

MafumeiraSulHalfayaEagleFord

KBB NiobraraTengizExp

Bl.15/06WestClairPh2

Shenandoah Libra BakkenStones MadDog2

CLOV BongaSW/AparoUgandaBl.1,2,3Bosi

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JackStMaloMohoNord Utica HorizonExpansionKaskida YTKaombo

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CarmonCreekKearl AOSPDebottle

MackayRiver2 Rosebank

Goliat FortHills

KashaganPh1

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0 2 4 6 8 10 12 14 16 18 20 22 24 26

Cost

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2020e Net Production, Mboe/d

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US shale oil

Lowcost conventional giants: Brazil, Norway, Iraq

Can. Heavy Oil Kashagan

Producing country crude oil fiscal

breakeven price 2014 ($/bbl)

Qatar

Kuwait

SaudiArabia

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