1212 Top Risks

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EUROZONE

NORTH KOREA

PAKISTAN

VENEZUELA

RED HERRINGS

EGYPT

SOUTH AFRICA

THE END OF THE 9/11 ERA

G-ZERO AND

THE MIDDLE EAST

US

CHINA

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TOP RISKS OF 2012

As we begin 2012, political risksdominate global headlines in a way

we’ve not experienced in decades.Everywhere you look in today’s globaleconomy, concerns over insular,gridlocked, or fractured politics affectingmarkets stare back at you. Continuationof the politically driven crisis in theeurozone appears virtually guaranteed.There is profound instability across theMiddle East. Grassroots opposition toentrenched governments is spreadingto countries such as Russia andKazakhstan that were thought moreinsulated. Nuclear powers North Koreaand Pakistan (and soon Iran?) faceunprecedented internal political pressure.

Paradoxically, political risk has become so fashionable that its effects are now frequently

overstated. Those 2012 political handovers in countries totaling some 50% of the world’s

GDP? They’re not such a big deal this year, whether the democratic elections in the United

States and France or managed authoritarian transitions in China and Russia. Moreover, seri-

ous challenges to national decision-makers doesn’t mean that governments are all poised

to buckle under pressure. The eurozone isn’t heading toward fragmentation (one of the most

consistently over-exaggerated risks out there). The American economy is more resilient than

many believe. And a Chinese hard landing? Not if Beijing can help it—and it can—in 2012.

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

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

(much of it noise). Our top risks of 2012 are meant to provide you with tools, signposts, and

our best judgments on where all these stories are heading—and on how some stories that

you’re not reading about elsewhere might prove more important than people think.

The most important macro theme for 2012: The world’s key political decision-makers will

be focused heavily on questions of domestic economic stability at the expense of international

security concerns at a moment when politics is having unprecedented impact on the global

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

a moment when decision-makers sought to isolate globalization from international security

concerns. The end of the 9/11 era is our top risk for 2012.

1 The End of the 9/11 Era

2 G-Zero and theMiddle East

3 Eurozone

4 US

5 North Korea

6 Pakistan

7 China

8 Egypt

9 South Africa

10 Venezuela

* Red Herrings

THE BIGCHALLENGE

IS CAREFULLY

WEIGHING

THE RISKS

IN A WORLD

OF EVER-

INCREASING

INFORMATION,

DATA, ANDCOMMENTARY

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THE NEW

NIGHTMARES ARE

OF SPIRALING

DEFICITS, THE

EUROZONE CRISIS,

AND ECONOMIC

RELATIONS WITH

CHINA

strategies have created the Hillary Clinton moment in US foreign

policy. Secretary of State Clinton has developed a doctrine

founded on economic statecraft and a shift in US foreign policy

priority toward Asia, despite continuing instability in the Middle

East. Asia is the engine of global economic growth; it is alsowhere the long-term credibility of US commitments faces the big-

gest potential challenge from a competitor (China). It is therefore

of the highest geopolitical importance. That (accurately) reects

an environment of both risk and opportunity in Asia.

Just as economics is driving geopolitics, politics is now mov-

ing markets as never before. The role of politics in global markets

is hardly new, but before 2008 the overlap was dened and lim-

ited. Only in emerging markets was politics the primary economic

driver. Only in these countries were natural resources especially

susceptible to resource nationalism and interstate conict.

Elsewhere, markets were driven mainly by economic fundamen-

tals. Geopolitics was primarily a matter for those concerned with

national security, not with the Nasdaq.

That’s no longer true, for three reasons: 1) Emerging markets are

now the primary drivers of global economic growth; 2) Developed

states are in structural crisis, and political decisions are an increas-

ingly important determinant of their economic trajectories for the

rst time since the end of World War II; and 3) An overarching rebal-

ancing is needed between developed and developing states. How

quickly and how successfully that rebalancing occurs is primarily a

question of political will and political capacity.

In short, for the rst time in the era of globalization, 2012 re-

ects the full global convergence of politics and economics. This

will fundamentally drive investor sentiment

toward risk aversion, as investors focus

on the obvious lack of strong and effective

political leadership in virtually all of the

major players. Intriguingly, it will lead to an

overestimation of political risks in several

important cases, especially the eurozone,

the US, and China. Our red herrings this

year are much more important than usual,

because baseline expectations for those

risks have become exaggerated.

Concern about macro risks will erode

condence in an improving American

economy, exacerbate concerns of eurozone

crisis, and enhance worries that emergingmarket growth might prove wobbly. Cau-

tion will remain an overarching investment

principle—lending continued support for the dollar, a reluctance to

rebalance portfolios dramatically toward the growth economies, and

a greater desire to stay in “safe havens” such as cash and gold.

At the end of the 9/11 era, politics is driving the global economy,

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

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

1–THE END OF THE 9/11 ERA

The end of 2011 marked the formal close of the 9/11 era—thekilling of Osama bin Laden, the withdrawal of US troops from

Iraq, and an end date for the war in Afghanistan. In 2012, we

begin to put the global war on terror behind us. These are positive

developments for the economy. But for most, what’s replacing it

is of greater concern and far more impactful. It was a truism of

globalization—economics drives the markets, and national security

drives geopolitics. Banks hire economists and worry primarily

about the private sector; the government hires political scientists

and concerns itself mainly with the public sector. No longer. The

culmination of a number of discrete events and longer-term trends

turns the page on this formula as we enter a world where politics

and economics overlap almost entirely.

The war on terror is being subsumedby fears for the global economic balance.

This is not a conventional or unconventional

weapons threat. It’s not a balance of terror

or an individual terrorist. The new night-

mares are of spiraling decits, the eurozone

crisis, and economic relations with China.

These have become the primary risks to na-

tional security, though there are clearly other

ongoing security concerns for the US.

That’s clearest for the country that still

matters most, the United States. During his rst

three years in ofce, President Barack Obama

eschewed an overarching foreign policy strat-

egy. In part, that was driven by the country’s

overwhelming focus on domestic economic

headaches. But as long as bin Laden was still at large and the end-

games in Iraq and Afghanistan remained uncertain, these inherited

concerns dominated the administration’s foreign policy agenda.

The death of bin Laden, the withdrawal from Iraq, and ac-

ceptance that Afghanistan is not amenable to counterinsurgency

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IN THE AFTERMATH

OF THE ARABSPRING, THE

UNITED STATES

FINDS ITSELF WITH

DRAMATICALLY

REDUCED REGIONAL

INFLUENCE

appetite for intervention, and there is virtu-

ally no prospect of regional cooperation to

resolve these issues.In Syria, there’s little chance of mean-

ingful negotiations between Assad and

the opposition, never mind active outside

support for removing him from power.

Given this lack of leadership, the Arab

League process will grind on, extending the

regime’s life without producing a credible

resolution to the crisis. Frustration with this

impasse could trigger a regional confron-

tation, with Iran backing Assad and the

Saudis and Turks backing the rebels.

In Iraq, greater sectarian conict is now

lling the vacuum left by the withdrawal of American troops. Earlier trends toward mutual accommodation have

reversed, and Sunni-Shia tensions are again on the rise. Instead of

opposing the Kurds’ bid for autonomy, Iraqi Sunnis are now pushing

for their own autonomous region. Iran, Saudi Arabia, and Turkey

each look for more inuence. Al Qaeda is back in the game. Until

recently the most exciting investment story in the Middle East, Iraq’s

stability itself now hangs in the balance.

That’s a growing danger for Israel, as well. The Arab Spring has

generated a surge of populism across the region, roiling Israel’s

relations with Egypt, Jordan, and Turkey. Meanwhile, Israel has less

condence in support from its international allies—even the United

States. Ally fatigue, a growing feeling of isolation, and Iran’s bid to

move its nuclear program into bomb-resistant underground facilities

make an Israeli strike on Iran more thinkable (though still unlikely),

especially in the face of Tehran’s provocations. It also undermines

efforts at further negotiations with the Palestinians, opening up pros-

pects for more violence—both within Israel and with Lebanon.

The Middle East will provide other potential conicts in 2012.

The G-Zero will complicate efforts to bring a new government

together in Libya, save a failing state in Yemen, and limit proxy

2–G-ZERO AND THE

MIDDLE EAST

The G-Zero—the inability/unwillingness of major powers to take

on new risks and burdens—will become more obvious around theworld in 2012. But the Europeans have the means to solve their

own problems, however haphazardly; Asia faces even bigger struc-

tural challenges, but they’re longer term. In other regions—Latin

America, Eurasia, even Africa—the geopolitics aren’t as turbulent.

Thus, once again, the Middle East is a special case: unresolved

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

a viable regional security framework; and in the midst of continuing

protests, old autocracies at risk and enormous challenges facing

newly “democratic” regimes. Nowhere will

the G-Zero have more serious and immedi-

ate impact than in the Middle East.

In the aftermath of the Arab Spring, the

United States nds itself with dramatically

reduced regional inuence. The demise of

Hosni Mubarak, Washington’s main Arab

ally, tensions with Israel, Riyadh’s increasing

skepticism about American intentions, and

a rm desire to avoid reengagement in Iraq

make a big difference. The US is not about

to exit the region, but declining US leverage

creates a gap in external political engage-

ment, economic support, and security pro-

vision at a time of remarkable geopolitical

volatility. No major player from outside the

region will step in to ll this vacuum. NATO’s

intervention in Libya is not a precedent; it’s the end of an era.

This leaves three regional actors—Turkey, Saudi Arabia, and

Iran—as the major remaining players in the new Middle East game.

Newly self-condent and assertive, Turkey presents itself as the new

Islamic model for modernism, democracy, and economic dynamism.

Saudi Arabia, by contrast, wants to expand the inuence of the Gulf

Cooperation Council (GCC) to counter American pressure for rapid

reform, especially within the region’s monarchies. Iran assumes that

Washington’s withdrawal is Tehran’s gain—and believes its own

rhetoric that the Islamic Republic inspired the Arab Spring.

In 2012, the disengagement of outsiders, the aspirations of

regional powers, and the spreading unrest in the broader region

come together in the challenge to Bashar al Assad’s minority- Alawite regime in Syria and the US withdrawal from Iraq. There are

key differences between these two countries, but in both we see

rising Sunni assertiveness, the reemergence of extremist groups,

and sharp tensions among Iran, Turkey, and Saudi Arabia. Iran sup-

ports the existing governments in Damascus and Baghdad; Turkey

and Saudi Arabia, unlikely allies, are cooperating to counter Tehran

and support Sunni aspirations. Actors outside the region have little

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A EUROPEANRECESSION WILL

ONLY MAKE IT

TOUGHER TO GET

THESE PLANS

APPROVED

resolved quickly to avoid the collapse of the European project,

but Europe’s key politicians don’t see it that way. In Germany,

other core states, and Europe’s ever more powerful institutional

apparatus in the European Commission and the ECB, there is

a consensus on the need to do just enough to avoid disaster,while maintaining market pressure to ensure both sustained

commitment to austerity and the political breakthrough required

for scal union. German Chancellor Angela Merkel is articulating

this pathway, and though a source of derision in the English-

language press, her pronouncements have provided the closest

thing to a signal we’ve seen from Europe, however problematic

the strategy might be.

The Merkel formula will ensure that the uncertainty and

volatility that have characterized the investment and broader

economic environment in 2011 will continue well into 2012. As a

result, the gradual move toward a sustainable solution—both for

a nal bailout and scal union—will be more difcult, more costly,

and less optimal when it’s nally reached.

It will be more difcult because the likelihood of a European

recession will only make it tougher to get these plans approved

by parliaments—or by voters as various referenda are held. It will

be more expensive, because the next round of reform will extend

well beyond the sums needed to bail out Greece, Portugal, and

Ireland. It will be less optimal because the current approach, priv-

ileging scal austerity above all else and turning scal demands

into tests of moral rectitude, will ensure on-

going political turmoil, distrust between the

core and periphery, a contraction in growth,

and further serious damage to market and

corporate condence.

Over the course of 2012, the euro-

zone will continue to struggle to achieve

its self-prescribed solution and will most

likely avoid a systemic market event. But

the long-term risks will not go away. Even

if Europe can get there, the underlying

economic problems will not have been ad-

dressed. And all this uncertainty raises the

near-term risk of recession, which can only

make matters worse.

4–UNITED STATES:RIGHT AFTER ELECTIONS

Like Europe and the Middle East, the G-Zero hits the United

States, but in a way that highlights continuing US advantages. As

Europe’s troubles continue to roil markets, America’s safe-haven

status trumps concerns with decits, keeping interest rates

down and easing pressure on Washington to deal with long-term

scal challenges. With economic indicators improving, there’s

conict in Bahrain. Egypt merits its own risk (listed below). The

only recent case in which outside actors have accepted serious

risks and burdens to settle a conict in this region came with

the NATO assault on the Qadda regime in Libya. That was only

possible because Qadda had alienated just about everyone elsein the region. In 2012, there are no more Qaddas in the Middle

East. Paradoxically, that’s part of the problem.

3–EUROZONE:

THE MUDDLE IS THE RISK

The major nancial upheavals of recent

decades—Mexico’s peso crisis, the East

Asian nancial crisis, Russia’s ruble crisis—had one fundamental thing in common: the

US Treasury Department played a big role

along the road to recovery. That won’t hap-

pen in today’s eurozone. Washington will

speak loudly but let markets carry the stick,

and French President Nikolas Sarkozy

learned the hard way that China won’t pitch

in either. Nor is there a solution involving

some combination of emerging and devel-

oped markets.

But Europe is the most advanced and

institutionalized region in the world, and the political and economic

will to sustain the eurozone, messy as it is, will provide the space

for enough European Central Bank (ECB) intervention to get the

eurozone through the worst of this, at least in 2012. Alas, there’s

still plenty of downside this year.

The biggest risk for Europe in 2012 is not eurozone fragmen-

tation (a Greece-plus exit of peripherals) or disintegration (Italian

and Spanish exit). The real problem is continued incremental-

ism. There’s a market view that the eurozone crisis must be

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KIM JONG-UN MAY

REMAIN IN PLACE,

BUT HE IS VERY

UNLIKELY TO

ACTUALLY RUN

THE COUNTRY

be made during the eight weeks between the elections in early

November and the end of 2012.

Firms and investors will face uncertainty about their taxes, gov-

ernment contracts, and the impact of these policies on economic

growth through the course of the year. With an election that’s likelyto be tight until the very end, there will be few signals along the

way about how these questions will be resolved—though we can

expect plenty of noise. Businesses and investors will be forced

to wait on the sidelines for resolution or expose themselves to

signicantly disparate outcomes. That’s problematic for investor

condence and a damper on economic growth.

5–NORTH KOREA:

IMPLOSION OR EXPLOSION

Don’t be fooled by stories of how smoothly the transition is pro-

ceeding in Pyongyang. The rst rule of analyzing North Korea—

it’s the world’s most opaque regime and no one really knows

what’s going on inside—has not changed. Maybe things really are

going smoothly. Maybe they’re already off the rails. We do know

that North Korea is a nuclear power, that

provocation is its traditional foreign policy

tool of choice, and that North Korean col-

lapse is the likeliest way to bring American

and Chinese soldiers face to face in an

unpredictable and dangerous securityenvironment. That’s why it is precisely the

inability of outsiders to evaluate what’s re-

ally happening in North Korea that creates

so much risk there.

Will North Korea become history’s rst

leaderless nuclear power? Kim Jong-il’s

28-year-old third son Kim Jong-un has

been named successor, but only after a

not as much urgency on this issue as media hype would have

you believe, and it’s not surprising that a politically deadlocked

Washington continues to push off tough decisions until after the2012 elections. The rubber will hit the road very quickly after the

ballots are counted—but on two much narrower issues.

There’s little doubt that this will be one of the ugliest presi-

dential campaigns in modern US history. Intense partisanship will

reinforce the already sour political mood of the country. Con-

tinued weak economic performance and Washington’s all-too-

obvious political dysfunction will make matters worse. But the

election is not the risk in 2012. Despite the loud noise from both

ends of the spectrum, we expect an election that is fought over

moderates and the center—especially given that the Sturm und

Drang of Republican primaries will likely leave Mitt Romney as his

party’s presidential nominee.

As a result, sharp policy turns after the election are unlikely–over China or long-term decit strategies—despite the dramatic

campaign rhetoric. The United States is structurally bound to

seek improved relations with Beijing even as tensions between

the two countries increase. And the contours of a long-term

decit deal will have to balance entitlement restructuring with

defense spending consolidation and some form of revenue

enhancement, though the balance among

these elements will depend on the post-

election political conguration. So a year

in which the United States does little of

consequence and looks much better than its

developed country peers is a year of low US

political risk, right?

Right. Until November. Then things get

dicey. The contours of long-term decit

reduction are pretty clear, but there are enor-

mous uncertainties in the short term. About

$5 trillion worth of tax and savings deci-

sions ($3.8 trillion of Bush tax cut expiration,

$1.2 trillion of automatic sequesters) must

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given the absence of any joint US-China contingency planning. After

all, the United States and China remain on opposite sides of the

security divide in Asia, a problem that will only get bigger in 2012

(see risk #7).

6–PAKISTAN:

TURMOIL SPILLOVER

In 2012, Pakistan will face its most severe challenges since the

Bangladesh succession crisis more than 40 years ago. Domestic

instability is growing as tensions between civilian and military

leaders simmer, extremists continue to expand their presence

in core regions of the country, and a severe economic crisis

leaves government unable to provide essential public services.The unraveling of ties with the United States adds to the anxiety.

Pakistan is not headed for state failure,

but the risk of severe political instability

and even more direct military interference

in government is on the rise.

Pakistan also faces mounting threats

from across its borders. American soldiers

will begin the handover of Afghanistan’s

security to local troops this year. By Novem-

ber, about 33,000 US personnel will have left

the country. The security vacuum left behind

will become the Pakistani military’s primary

immediate concern as Afghan refugees ow

into Taliban-occupied areas of the country.

Should the Taliban further consolidate ter-

ritory in southern Afghanistan, those areas

could become safe havens for Pakistani Taliban who are challenging

Islamabad’s authority in the tribal areas.

The American withdrawal will also fuel fears inside Pakistan

that Washington is effectively “handing off” informal leadership in

hastily arranged transition and with no meaningful experience in

government. Kim Il-sung took more than two decades to prepare

the ground for Kim Jong-il to succeed him, and it still took years

for the “Dear Leader” to consolidate power. Kim Jong-un will

have to do more with much less.To be sure, there is no North Korean political spring waiting to

bloom. There will be no demonstrations, no opposition. It’s a totali-

tarian state. There’s no reform, no apparent demand for change,

and a massive (when they fall, they fall hard) outpouring of emotion

ongoing. Just as with the death of Mao and Stalin, those bases are

covered. But Kim Jong-un is no Deng Xiaoping or Nikita Khrush-

chev, and security from within the circle around him is an entirely

different matter.

It’s like what they say about family rms: The rst generation

builds it, the second hangs on to it, the third destroys it. And

there are already warning signs in North Korea that the third time

will not be the charm—the quick announcement of events to roll

out the new leader revealed that they weren’t adequately pre-

pared, and a number of high-ranking political gures have died

lately in car accidents in a country notably short on cars. In short,

the preparations for transition were hurried and violent—and the

transition is now in motion.

Kim Jong-un may remain in place, but he is very unlikely to

actually run the country. Those around him and other stakehold-

ers—almost certainly encouraged by China—will have decided

that this is the best outcome for the moment. In coming months,

we should not be at all surprised to see provocative external acts

meant to prove that the government is rmly in place and not to

be tried with.

Alternatively, we could pick up signals of inghting at the

highest levels of government. Those within the leadership who

fear a fall from favor have clear incentives to

derail the process of consolidation of power.

That won’t happen openly or immediately.

(As they used to say in the British special

forces, in a hostile environment you shoot

the rst person who moves. There’s a seri-

ous rst mover disadvantage in a totalitarian

transition). But the initial calm may not last

long, and it’s almost impossible to predict

exactly what sort of political risk the elite

might produce. As we’ve seen in recent

months, another belligerent international actcould be just the thing to provoke a state of

crisis and rally North Korea’s powerbrokers

to the regime.

In the worst-case scenario of rapid govern-

ment collapse, US and South Korean forces would move north to

secure North Korea’s nuclear sites, while China would likely send

forces across the Yalu River to block any ood of refugees and

restore basic security, creating the potential for unintended conict

PAKISTAN IS

NOT HEADED FOR

STATE FAILURE,

BUT THE RISK OF

SEVERE POLITICAL

INSTABILITY IS

GROWING

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today: For many countries in the region,

China’s economic development is a source

of lucrative new business opportunities, but

they want to avoid becoming too economi-

cally or politically dependent on Beijing. In2012, we’ll begin to nd out if this delicate

balance can be maintained.

US-Chinese relations already have their

share of tensions, especially over cyber-

security issues and indigenous innovation/

state capitalism. These problems will make

regional tensions more difcult to manage.

No one wants a security confrontation that

would undermine economic growth, but

the enhanced US security presence in Asia emboldens China’s

neighbors to take on more assertive policy positions with China,

especially on strategic issues. Countries such as Vietnam or the

Philippines—both entangled in boundary disputes with Beijing

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

with Washington provide the cover needed to push back against

perceived Chinese advances. Either government could create a

maritime confrontation that (they hope) might draw in the United

States, tilting the balance of force in territorial disputes to their

advantage. This (mis)calculation would raise a host of risks for the

Asian security environment and for global markets in 2012.

There is already high risk that Beijing will produce unpleasant

foreign policy surprises this year, given rising nationalism in the

country, its ongoing political transition, and the leadership’s unwill-

ingness, and perhaps inability, to resolve internal debates about

China’s role in the world. Beijing will therefore be more apt to meet

provocation with provocation in months to come, using both its

naval and its economic power. A harsh Chinese response to an in-

cident at sea involving an American ally would provide a signicant

test for the Obama administration, which would then face election-

year pressures to project toughness, adding to already signicant

tensions on other issues.

8–EGYPT:

A TRANSITION IN TROUBLE

For most of 2011, it looked like Egypt was on track for a messy but

managed political transition, one that would meet at least some ofthe expectations of both the Islamist and secular political forces

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

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

managed transition is at risk. The ruling supreme military council

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

activists as a threat and seeks to ignore their demands in order to

limit change. But despite its informal partnership with the powerful

Muslim Brotherhood, the military appears incapable of marginalizing

Afghanistan to India, allowing Pakistan’s long-

time rival to encircle the country. Pakistan’s

perceptions are reinforced by India’s large

development and diplomatic presence in Af-

ghanistan, which will continue (and potentiallyincrease) after the US withdrawal. Pakistan is

hedging its bets on Pashtun groups in Afghani-

stan that have a higher likelihood of control-

ling any future government in Kabul. India is

focused on strengthening its historical ties to

northern alliance groups.

As it tries to extend its economic reach into

Asia, India will nd itself drawn more deeply

into the South Asian geopolitical morass, po-

tentially provoking a proxy war that spells trouble for the region.

The looming security failure threatens prospects for South Asian

economic integration—and just at a time when greater col-

laboration is needed to meet growing energy, consumption, and

production demands.

7–CHINA:

REGIONAL TENSION

Despite a laundry list of regional and sub-regional institutions, the

basic contours of economic, political, and security integration in

Asia remain very much in ux. In recent years, China has driven

the economic growth story, raising concerns among others in the

region that greater strategic balance is needed.

It’s no surprise then that 2011 ended with a number of suc-

cessful Asian security initiatives for the United States. An agree-

ment with Australia’s government adds 2,500 US marines in

Darwin. There will be new coastal combat navy ships in Singapore,

and Indonesia purchased 24 new F-16 ghter jets. These moves

are disquieting for Beijing, but they highlight the realities of Asia

US–CHINESE

RELATIONS

ALREADY HAVE

THEIR SHARE OF

TENSIONS

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President Jacob Zuma and the ANC’s top leaders face reelec-

tion at the party leadership conference in December. Zuma has

disappointed many former allies, and while a united anti-Zuma

front has yet to emerge, that’s not positive news for markets and

investors. One of the biggest question marks is the fate of sus-pended rebrand ANC Youth League leader Julius Malema, and a

central part of Zuma’s strategy to sideline Malema will be to co-opt

at least some of his populist message.

Other sources of dispute include the balance between central

and provincial governments; the role of labor unions in the ANC;

control of the intelligence apparatus; and the use of corruption

investigations against Zuma’s suspected rivals. ANC stalwarts such

as Kgalema Motlanthe enjoy broad party support but may fail to

mount an open challenge at the party conference. Zuma will likely

be reelected party president, but this will not be the product of

widespread party support but of intensifying factional, generational,

and even ethnic divisions within the ANC. That’s hardly a recipe for

a strong and stable Zuma administration, undermining South African

governance in 2012 and beyond.

These tensions will be visible in the February budget as the

treasury battles with slower-than-anticipated growth and revenue.

Competing spending priorities (scal stimulus for the economy

that includes a $100 billion infrastructure package, higher public-

sector wages, and social grants for 30% of South Africans) will

prove politically difcult to negotiate and could force slower

scal consolidation. Worse, the mid-year ANC policy conference

will raise populist pressures further—with resolutions seeking to

reafrm a policy shift to the left. These will include at least some

support for the nationalization of mines, which will generate a lot

of headlines even if it is unlikely to be adopted.

It’s not an all-out disaster; there are limits to the populist trend.

But 2012 is likely to inict lasting damage on policymaking and insti-

tutions, and it’s almost certainly a lost year. That’s not the best way

for South Africa to join the BRICS club—not that it really belongs.

the rejuvenated alliance of Islamist and secularist protesters without

resorting to violence. That will undermine the popularity of the

military and harden the resolve of the protest movement—polarizingpolitics at a critical time.

That’s why Egypt faces the possibility of political disintegra-

tion this year, as anger builds between military and civilian politi-

cal forces, both Islamist and secular. The Muslim Brotherhood

and the Salast Nour party are not headed toward any kind of

formal alliance, but Islamist forces will dominate the new legis-

lature to an extent that the military high command may simply

reject, especially if the Islamists use their new clout to dominate

the writing of a new constitution and back a presidential candi-

date that the military dislikes. If so, the generals’ understanding

with the Muslim Brotherhood could come apart with the military

trying to impose a cabinet largely comprised of technocrats and

Mubarak regime insiders.That outcome would be bad for Egypt’s base-line stability,

its economic recovery, and its broader regional role. The fallout

would be especially damaging for Egypt’s all-important tourism

sector and the ow of aid from abroad. It could also spill instabil-

ity into the region, given Egypt’s central importance for the Arab

Spring and its historic role as an Arab bellwether.

9–SOUTH AFRICA:

POPULISM ASCENDANT

An uneasy political balance between populism and pro-growth

elements has dened South Africa’s policy environment since the

transition to majority rule in 1994. In 2012, a bitter struggle for

leadership of the ruling African National Congress (ANC) will at

least temporarily tip that balance. Growth will be the loser—and

at a time when the eurozone crisis already weighs heavily on

South Africa’s trade and its currency.

8/3/2019 1212 Top Risks


8/3/2019 1212 Top Risks


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Further, there is no effective political mechanism for a eurozone

breakup. It’s conceivable that an individual country might volun-

tarily leave the eurozone without such a mechanism, but for a real

dissolution scenario to have any plausibility, a formal process would

have to be created. If you think expanding funding for the Europeannancial stability fund is hard, try organizing a breakup mechanism.

China’s hard landing

A substantial number of market observers and some China analysts

believe that some combination of overheated growth and the prolifer-

ation of bad loans in the Chinese banking system will lead to a major

nancial blow-up or a sharp contraction in 2012 that takes Chinese

economic growth down to 5% or even lower

for the year. Don’t believe them.

There are signs of overheated growth

in China—in urban real estate in Beijing

and along the coast, especially. And

infrastructure has been overbuilt compared

to growth in consumption. But there’s no

chance that the government will fail to pull

out every stop to prevent a meltdown—or

even a serious bump—especially in the

middle of a major political transition. The

Chinese banking and nancial system is a

mess, but it’s also a fundamentally closed

system. In a closed system, preventing such a crisis becomes a

matter of scal capacity and political will. There will be no shortage

of either in 2012. In short, China has more of what it needs to kick

the can down the road than any other country out there, and in a

challenging 2012 environment, look for Beijing to use it.

Mayan apocalypse

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

making process. It’s rule by consensus. We’re long past the days

of Deng Xiaoping or Zhu Rongji, and it will take a year minimum

for that new group to come together and start implementing a

new strategic plan, which itself will represent only an incremen-

tal change from what we’ve seen for the past ve years. It’s bigheadlines, not much impact.

In Russia, despite unprecedented popular protests in recent

months, there’s not going to be a lot of suspense on election

night as Vladimir Putin retakes the presidential reins. Despite the

impressive crowds of recent days, there is no Arab Spring on the

horizon in Moscow. Kremlin-sponsored opposition parties will

take considerable wind from the sails of Russia’s demonstrators.

President Dmitry Medvedev may well be left by the wayside, but

that’s not going to affect Russian governance.

For 2012, Putin will spend money and co-opt

elites to ensure that everything goes as close

to Kremlin plan as possible. There’s room for

a little embarrassment, a rogue uncle turning

up at the party, getting drunk, and embarrass-

ing his family. But the holidays go on, and so

does Russia. Not much to see here.

In France, Sarkozy looks weak, no ques-

tion. At this point, it’s tempting to call the

election for François Hollande. That could very

well change, but the candidates’ positions on

the issue that matters most for markets—the

fate of the eurozone—are quite similar.

Eurozone breakup

This is probably the single most overrated risk of 2012. It’s driven

in large part by European observers (especially in Britain) who

don’t much like the eurozone.

The political will to maintain the eurozone remains strong among

all the major political parties in the core eurozone states, almost

across the board in the European periphery and, just as importantly,

among eurocrats in the ever-growing European bureaucracy. To

be sure, this could change over time. We’ll see what happens if

Europe’s leaders totally fail to restructure the institutional machinery

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

THE POLITICALWILL TO MAINTAIN

THE EUROZONE

REMAINS STRONG

1212 Top Risks

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