Political risk almost always features prominently on the list of concerns for investors in emerging market debt, as the countries in which they invest are prone to occasional bouts of instability, unrest and even revolution.
Recently, though, upheaval in the politics of a number of key emerging economies has been something to welcome, rather than fret about, as it is the result of voters demanding better economic stewardship.
The trend complements a shift in other factors that were previously bearish for emerging market bonds, and have now become bullish, helping the asset class to generate some of the best returns of 2016. These factors are economic growth, where the prospects have improved in emerging versus developed economies; commodity prices, which have rebounded strongly; China’s economy and financial markets, which have stabilised; and the outlook for US monetary policy, where rates are now expected to remain lower for even longer.
In this note, we discuss four high-profile emerging markets that suffered both from matters beyond their control, before the areas listed above turned from headwinds to tailwinds, and from matters within their control – and which they are now in the process of confronting.
The presidency of Luiz Inácio Lula da Silva, a founding member of the left-wing Workers’ Party, or PT, from 2003 to 2011 coincided with a period of rising commodity prices, stoked in large part by demand from China. Unfortunately for his successor, Dilma Rousseff, this important prop for the economy was gradually removed during her tenure.
Rousseff also took a different approach to economic policy from Lula, who had managed the economy well over his two terms. She adopted a number of misguided policies that weakened the country’s fiscal credibility and undermined the independence of its central bank. Recession struck; investors dumped Brazilian assets; and the country lost its cherished investment-grade credit rating.
Over this period, a corruption scandal known as the ‘Car Wash’ affair erupted, over a kickback scheme at the state oil company, Petrobras. While Rousseff was not directly implicated, many of her party members were – including Lula. Ultimately, the economic crisis and public rage against alleged widespread graft undercut Rousseff’s popularity and derailed her government. She was ousted from office this year and replaced by her former vice president, Michel Temer, who appointed figures regarded highly by investors to lead the finance ministry and central bank.
It is unclear whether Temer will manage to enact all of his plans to steer Brazil out of its current quagmire, but investors are optimistic.
The Kirchners – first husband Néstor, then wife Cristina Fernández – governed Argentina from 2003 to 2015, over which period they pursued largely populist and investor-unfriendly policies, such as giving sizable energy subsidies to consumers and forcing the central bank to fund the government. These policies stoked inflation – which the government tried to hide by manipulating the official data.
The difficult global backdrop only worsened the country’s economic malaise. But in December, Fernández was replaced by Mauricio Macri, the centre-right mayor of Buenos Aires, who beat the government-backed candidate in a general election.
Macri won on a pro-business platform that included pledges to reduce subsidies and export taxes, and normalise economic reporting. He also helped Argentina end a standoff with ‘holdout’ creditors, who had prevented the country from paying other investors to whom it had sold debt. These measures enabled Argentina to return to the bond market earlier this year with a US$16.5bn debt sale, a sign of renewed investor confidence.
Home to the largest proven oil reserves in the world, Venezuela is another South American country that experienced a sudden reversal of fortunes when commodity prices slumped.
During the good years, Hugo Chávez, its socialist president who held office from 1999-2013, borrowed heavily and used profits from oil exports to spend lavishly on his constituents. At the end of his presidency, these policies proved unsustainable: poverty, inflation and crime spiked; investors fled Venezuelan assets.
The social and economic crisis worsened after Chávez’s death in 2013, as his successor, Nicolás Maduro, continued the former president’s policies but without his charisma, while oil prices fell precipitously. This year, large numbers of Venezuelans have pressed the authorities to allow a recall referendum to remove Maduro – a process that has so far been stymied by the government-influenced electoral council.
While the outlook remains highly uncertain, it is clear that the military will be key to how the situation plays out, given its grip on many areas of the economy.
After the end of apartheid, South Africa was well run for many years: its institutions remained strong; its financial markets, first-class. The government was fiscally prudent, keeping the country’s debt-to-GDP ratio low.
But as power passed from Nelson Mandela, to Thabo Mbeki, to Kgalema Motlanthe and most recently to Jacob Zuma, economic policy-making deteriorated, while issues such as high unemployment persisted. This became more problematic following the slowdown in Chinese growth and collapse in commodity prices, especially as the government did little to change course.
Zuma has presided over a host of corruption scandals, and an ill-fated attempt to replace South Africa’s highly respected finance minister, Nhlanhla Nene, with a little-known politician. The latter move sapped investor confidence in the country, triggering a bout of market stress that only dissipated when Pravin Gordhan, a former finance minister, was reappointed to the position.
In South Africa, too, the electorate has recently voiced its displeasure with the government’s economic stewardship: in local elections in August, the ruling African National Congress party in August suffered its worst election result since coming to power in 1994.
Clearly some of these countries are closer than others to achieving the better economic stewardship that their electorates are demanding. There will doubtless be further moments of drama as voters press their case against governments and vested interests. But the important thing is that while the process is noisy and messy, it is democracy at work. And it shows that these countries are moving in the right direction, however fitfully.
Looking ahead, we expect the clamour for reform across emerging markets to support the asset class, alongside the improvement in growth prospects, bounce in commodity prices, stability in China’s outlook and a still-accommodative US Federal Reserve.
In this context, we expect the appeal of emerging market debt to grow as more investors seek out the attractive sources of return offered by the asset class, especially in light of the low-to-negative yields on offer by developed market government bonds.