Risk #1: Emerging markets

Note: Today is the first in a series of posts that detail Eurasia Group’s Top Risks for 2013.

Since the onset of the financial crisis in 2008, investors and companies have focused mainly on risks in developed world markets. But as conditions in the U.S. and Europe continue to improve in 2013, the most worrisome risks will again come from emerging market countries. These countries are fundamentally less stable than their developed world counterparts, and some of their governments used a period of favorable commodities prices and the benefits from earlier reform to avoid the tough choices needed to reach the next stage of their political and economic development.

Some of these emerging market nations face more difficult challenges than others, and much depends on the degree of political capital each leader will have in order to make unpopular but necessary changes. These countries can be divided into three broad categories according to the complexity and immediacy of the risks they face and the longer-term upside they offer.

The first category includes the best bets:

• Mexico: Newly elected President Enrique Peña Nieto is one of the few leaders of an emerging market country both willing and able to advance structural economic reforms.

• Turkey: Despite unrest near its borders and elite infighting over constitutional change, Turkey’s institutions and balance of power support a stable and dynamic economy.

• South Korea: Seoul has demonstrated an ability to diversify its trade partnerships, has concluded free trade agreements with the U.S., the EU, and ASEAN, and is negotiating similar deals with Canada, Indonesia, and Vietnam.

The second category of emerging market economies are at risk of considerable volatility.

• India: Regardless of significant long-term structural and demographic advantages, dysfunctional politics and upcoming elections will probably paralyze reform efforts.

• Indonesia: President Susilo Bambang Yudhoyono is a lame duck, and the economic reform process is stalling.

• Thailand: Elites in Bangkok continue to fight over unresolved issues, generating unrest.

• South Africa: Political leadership has deteriorated steadily since Nelson Mandela’s 1999 retirement, and populist pressures are increasing.

• China: The government’s continued focus on social welfare, infrastructure, and industrial policy spending in 2013 will help bolster near-term growth. But geopolitical tensions and more competitive Chinese firms will make it more difficult for foreign companies and investors to secure profits.

Lastly, there are the underperformers, those countries where risks will overshadow returns.

• Russia: President Vladimir Putin retains a strong hold on power, but he has lost significant support from upper- and middle-class Russians, particularly in major urban areas. As a result, reliance on support from conservative Russians and economic elites will likely reduce his willingness to undertake needed reforms. Relations with both Europe and the U.S. are increasingly troubled.

• Pakistan: Political risk could reach critical levels due to a volatile election season.

• Venezuela: Challenges to restore economic health will probably suffer without the dynamic presence of the recently re-elected, but seriously ill, President Hugo Chavez.

• Argentina: Policymaking challenges are widespread due to populist pressure.

On Friday, we’ll profile Risk #2: China vs Information.