Political risks now come to the fore in Emerging Markets

The Developing Countries cluster (EM, Markets = GOP), which includes Turkey, is attracting a high level of foreign investment this year with its strong growth performance and the perception that the Fed-ECB will reduce interest rates and attract money to its own directions during the year. According to the Institute of International Finance, direct and financial foreign capital flows to developing countries may reach $1 trillion this year.

In the first five months of the year, GOP funds turned a deaf ear to the thesis that elections will be held in 64 countries this year and that the results could radically change economic policies. However, the unexpected emergence of presidents or coalitions with the potential to pursue unmarket-friendly policies in the South African, Mexican and Indian elections led to very harsh sales, albeit short-lived.

Tom Olson from the Global Echo news site and Mike O’Sullivan from Forbes underlined the danger of the pricing of political risks in the GOP turning into a permanent process in their reviews written during the week.

Tom Olson noted the following in his column titled “Have Markets Begun to Account for Emerging Market Risk”:

The election of a new president in Mexico increased concerns about the country’s democracy and economic policies, which led to market volatility and a decline in the peso. In India, Prime Minister Modi’s failure to win a majority in the last elections weakened the credibility of his economic reform agenda, even though it may have positive results for democracy. The failure of the African National Congress Party (ANC) to gain a majority in South Africa reflects the risk that the country’s calmness of the last decade will continue.

Investors in emerging economies are increasingly focusing on political and corporate risks; Some investors in countries such as Türkiye are giving up on the market altogether due to the gradual deterioration of the institutional structure. This shift in investor sentiment raises questions about how macro risks relevant to developed economies are addressed. While countries such as Poland, the Czech Republic and the Baltic Trio are examples of successful transition from emerging markets to stable economies, countries such as Nigeria and Argentina are resorting to riskier paths. Chances of success cannot be predicted now.

Investors’ contrasting reactions to political dynamics in Mexico and India reflect broader tensions between authoritarian one-man leadership and Western-oriented models of the rule of law. Emerging economic governments face difficult choices, including how to develop their economies around new technologies as well as their connections to global powers such as the United States and China. The ability of emerging markets to cope with these challenges will be determined by political vision and will as much as economic stability.

Mike O’Sullivan in Forbes “Are Markets Finally Starting To Price Emerging Market Risk?” writes:

What is interesting is that emerging markets show that investors are becoming more sensitive to political and corporate risks (institutional investors in Turkey have almost given up). In this respect, an important question is whether some developed economies have started to price their macro risks more harshly.

Older institutional investors are stunned by the exorbitant valuations, low volatility and very low credit risk in GOP financial assets. Young investors may soon begin to believe that developed world economies should be treated with the same brutality that markets have shown to emerging markets this week.

In other words, there is a possibility that politically motivated crises in the GOP will spread to all world markets.

Sunday’s European elections confirmed the rise of the radical camp. The Macron government and Belgium decided to hold early elections. With the first Trump-Biden TV debate in June, political risks will also enter the radar in the USA.

Institutional investors’ 20-year-old belief that political risks are impermanent and that their portfolios are insured against such shocks while the Fed-ECB cuts interest rates may change.

As market trends continue to evolve, investors are becoming increasingly aware of the value of political and institutional factors in assessing risk. The relative stability of advanced economies challenges classical notions of market behavior, leading to low volatility and credit risk. This shift has implications for how investors perceive and value different economies, as well as the potential of emerging markets to shape future economic growth and development.