Emerging Markets: Ballots ahead
Elections in key countries could put investor confidence to the test
- Several emerging countries will hold elections this year and next
- This raises the prospect of change in certain markets
- Mexico could take a hit if the current left-wing frontrunner does well
- India’s reforms likely to continue, despite elections
Key emerging market countries will hold elections during 2018 and 2019, raising the prospect of political risk.
This year, Russia, Mexico, Brazil, Colombia, Hungary and possibly Turkey will go to the polls to choose new governments or to grant new mandates to current ones. In 2019, it is the time of India and South Africa, among other countries.
Elections will also take place in the next two years in frontier – or recently upgraded – countries such as Argentina, Pakistan, Iraq, Egypt and Venezuela.
The proliferation of elections itself constitutes positive news in countries where democracy has struggled to impose itself, even though doubts have been cast on the legitimacy of the process in Russia, which kicks the electoral season off this March.
But the elections also propose challenges for investors, who worry whether incoming leaders will show the commitment to policies and institutions considered essential for the development of functioning market economies and to guarantee the long run performance of securities markets.
On the other hand, the risk of policy changes creates volatility and swings in asset prices, which means short-term opportunities for the bravest. As emerging markets have become less cheap in the past two years, electoral uncertainty can also provide an entry point for those who are not yet invested.
In that sense, investors are keeping a close eye on Mexico, which has presidential elections in July, and where Andrés Manuel López Obrador, a left-wing politician, known as AMLO, is the favourite. He could succeed Enrique Peña Nieto, a reformist loved by markets, but unpopular among Mexicans.
“Elections polarise the market and create serious mispricing of assets,” says Jan Dehn, the head of research at Ashmore Investment Management. “The market has already begun to characterise AMLO as the devil, and, as the election looms, it tends to massively overprice the risks.”
Dehn expects Mexican assets, and especially the peso, to fall and become attractive in the wake of the vote, if AMLO continues to top the polls. He does not foresee any major macroeconomic imbalances in the economy that could derail the country, however. It also looks unlikely that AMLO will have enough political power to revert reforms to the energy sector and other market-friendly measures implement by the current administration. “If he wins, I do not think he will have a majority in Congress to change the constitution,” Dehn adds.
Risk to structural reforms
There is always a risk that new leaders could derail reforms that investors support. “In the past three or four years, there has been a window of opportunity for major emerging market economies to reform,” said Liam Spillane, the head of emerging markets debt at Aviva Investors.
In addition to Mexico, Spillane highlights Brazil and India. Brazil’s government has taken advantage of a long recession to push through dramatic measures such as a limit to public spending and the flexibilisation of the labour market. But a completely open scenario for the presidential election in October has fed doubts as to whether other much needed policies, such as pension reform, can also be implemented in the short run (see Brazil and politics, in this section).
In India, which has regional elections this year and a general election in May 2019, the government of prime minister Narendra Modi has pursued a reformist agenda, improving sectors such as energy, tax and the financial system, while remaining popular.
This February, Modi announced a budget that puts emphasis on rural infrastructure and healthcare for the poor, which is unlikely to hurt his re-election chances. It could also create opportunities for equity investors. “Fiscal policy is likely to become more expansionary in the run-off to the election, so we can see benefits for consumer companies, for example,” says Sophia Whitbread, the alternate manager of the Newton Global Emerging Markets fund.
Investors are also looking at the extent to which new mandataries can influence the development of institutions, like the judicial and the central bank, that help to give a sense of security when investing in a developing country. “In large parts of the emerging market universe, there are few evidences that institutions are robust enough to withstand the challenge from a government with the wrong priorities,” says Christopher Watson, the manager of the Finisterre Unconstrained Emerging Markets Fixed Income fund. “We have seen in South Africa that even the best institutions can be eroded if a president takes the wrong direction.”
Managers fear this in Turkey, where President Recep Tayyip Erdogan appears to be surfing a nationalistic wave in anticipation of elections. Yet the country looks less inviting to investors. “Turkey is a gradually declining story of institutions that no longer are what they used to be,” says Wim Vandenhoeck, a portfolio manager at OppenheimerFunds.
Confidence in the democratic institutions is ebbing in Russia, where it is hard to envision any outcome for the March election other than a victory for Vladimir Putin. While his victory will doubtless be seen as bad news by human rights and democracy activists, investors have lauded efforts by the Russian government to diversify the economy and stabilise the fiscal situation. “Russia basically engineered a recession to reduce its reliance on imports,” says Salman Ahmed, chief investment strategist at Lombard Odier. “Now, it is the time to reap the benefits of the tough policies that have been taken.”
Tim Stanley, senior managing director for Russia at Control Risks, says the stabilisation of oil prices has helped, and Russia has made an effort to diversify the economy. Yet much still needs to be done, he says.
“In large parts of the emerging market universe, there are few evidences that institutions are robust enough to withstand the challenge from a government with the wrong priorities”
In Hungary, the right-wing prime minister Viktor Orbán is the favourite to regain a majority in the April legislative elections. If he takes the government’s policies too far right, however, the country could be at loggerheads with the European Union, risking turbulence in an economy that is currently doing well, as Dehn points out.
In South Africa, the perspective of continuity for the ruling African National Congress party under a new leader has boosted hopes that the country’s institutions will regain the confidence of investors. Cyril Ramaphosa, a respected businessman, became president in February, after Jacob Zuma was skilfully ousted.
Other countries face complex political situations that do not concern investors. An example is Colombia, where several candidates from the centre-right and centre-left are competing to succeed Juan Manuel Santos in May’s presidential vote. The issue dominating the campaign is the peace process between the government and the left-wing FARC, with little disagreement on the economic policies that have been appreciated by markets in recent years. “All candidates in Colombia support, for example, tax reform, which is needed for the government to stabilise its fiscal position,” says Viktor Szabó, a portfolio manager at Aberdeen Standard Investments.