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30 Nov 2022

Fuelling the fire: the biggest geopolitical risks to look out for in 2023

Geopolitics looks set to be a big driver for markets and the economic outlook in the year ahead. 

Scott Livingstone

International Advisor to NatWest Group

 

5 minute read

Geopolitics came to the fore in 2022, primarily in the form of the war in Ukraine. The conflict accentuated the supply-side inflationary pressures facing a global economy already struggling to emerge from the pandemic.

Next year too looks like it could be fraught with geopolitical turbulence, and not just in Ukraine. Here is where Scott Livingstone, International Advisor to NatWest Group, sees the likeliest sources of risk in 2023 across the geopolitical landscape.

War in Ukraine: time is on nobody’s side

The balance of power currently resides with the Ukrainian forces, which currently have better morale, momentum, and munitions than the Russian troops. But while Ukraine has the advantage right now, a harsh winter will take its toll. We’re entering the prime weeks and months for Russian pressure to take effect, both through restrictions on energy flowing to Europe and the destruction of civilian infrastructure in Ukraine. 

As we get into the winter, as we see the economic and the energy cost rising in Europe and possibly after the US midterms, we could see an environment more conducive to some kind of off ramp for the crisis. But Putin’s actions recently suggest he is not looking for an off-ramp, and evidence of Russian war crimes and increasingly focused attacks on civilian infrastructure do not lay the political groundwork for a peaceful resolution. 

Even if there’s a peaceful resolution to the war in Ukraine, Russian oil and gas returning to the world market would come with a heavy tax burden. Reparations may also be an issue as the question of who pays to rebuild Ukraine is yet to be answered. There will be conversations in Washington and European capitals about bringing Russian energy back to the market as part of a package that deals with that question. 

In the medium term, we cannot rule out a collapse in Russia’s capability and forces in Ukraine as its forces struggle with logistics and command and control. My view is that there is no doubt whatsoever that whatever happens in Ukraine, Russia will emerge in a weaker position. And into that vacuum other players, notably China, could step up their regional influence, particularly in Central Asia. 

Taiwan: risk of military action?

Tensions are rising between the US and China once again, but don’t expect them to escalate into the military realm in 2023. From the US side, it’s more likely that we’ll see a continuation of the trend of the last six months since Nancy Pelosi visited Taiwan, fuelled partly by anti-China sentiment. And while there’s a view in China that the West’s influence (cultural, geopolitical, and economic) is waning, China has seen what’s happened in Ukraine – that invading a country is very costly and difficult, and that success cannot be guaranteed. 

That said, there’s a real risk that China will take aggressive action in Taiwan sooner than later. If China were to use its military capability in Taiwan, it would probably be in the form of a comprehensive blockade of the island. 

Trade war 2.0 and friend-shoring

UK Prime Minister Rishi Sunak is on record as taking a hard line on China and we think that political stance will continue next year. That will probably manifest itself in anxieties about a broader decoupling between China and the West, which will put large commercial entities under pressure as they relocate from China. 

We may see more factories moving out as the ‘friend-shoring’ trend – that is, relocating supply chains to ally countries – continues. There could also be more stringent restrictions applied to exports as the trend towards separation gathers pace.

The rise of Chinese soft power

China will continue to extend its soft power and its commercial and economic clout over many areas of the world that were previously seen as reliable democratic partners of the West. For instance, we saw tensions earlier in the year in the South Pacific, while Saudi Arabia will continue to play off the West against China. 

We expect such trends to gain traction, and they could be seen as escalatory by the West as its global influence diminishes. We’re already seeing this in some UN votes, such as the one condemning Chinese human rights abuses in Xinjiang. It was defeated because various countries voted with China: a clear indication that its soft power is on the rise. 

Iran and the West: rapprochement unlikely in 2023

Iran and the West have a strained relationship, but is rapprochement likely and could Iran return to the energy markets? Right now, Iran’s elite is very concerned about the protests about the rights of Iranian women. Their response is to claim the protests are some sort of Western plot rather than authentic discontent from the population. This means the Iranian powers have very little political space to make a deal with the West, and that’s not even taking into account that Iran is supplying drones to Russia in its war against Ukraine. 

All this suggests the notion of a near-term deal nuclear deal, and therefore Iranian oil coming back onstream, is firmly on the backburner. We can never say never, because the creep towards nuclear weapon capability in Tehran cannot be ignored. 

Other geopolitical risks to consider next year

Ukraine-Russia, China-Taiwan and the US-Iran are among the major geopolitical issues right now, but other risks will shape the world in 2023 and beyond, and the biggest of all is climate change. COP27 has shown that the world’s leaders have made little progress on cutting carbon emissions since last year’s conference. Climate is a geopolitical issue, and unfortunately, geopolitics gets in the way of climate action

Terrorism, too, remains an important risk, even though it is not now dominating our thinking like it did earlier this century. The idea of transnational terrorism, whether from Afghanistan or from West Africa, is debatable, but we need to remember that global terrorist groups have not gone away.

Pakistan is having a very difficult time, dealing with the combined impacts of flooding, political and economic failure, and an unheard-of challenge between civilian and military leaders that is generating a sense of looming instability. This is not helpful in the context of Pakistan’s ongoing rivalry with India, and we must remember these two countries are nuclear powers. 

Then there is North Korea. We saw provocative missile-firing from the country recently, and most observers are anticipating a first nuclear test in a number of years. The main danger we see here is the unpredictability of the North Korean regime.

After the US midterms, meanwhile, we’re waiting to see the direction of US foreign policy and the state of US governance. In all, 2023 promises to be an eventful year from a geopolitical perspective.

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