Politics: the unquantifiable risk that is rising in emerging markets
Political risks appear to be rising in emerging markets, but how do you measure them?
Protests in Egypt – leading to the ousting of a second president in as many years– Turkey and Brazil have caught investors on the hop this year, causing the kind of market volatility that emerging market bulls had been saying were a thing of the past.
Political risk didn’t go away, so it turned out, it just took a breather, while at the same time spreading to countries like Portugal and Greece.
Market players often use credit default swaps as a proxy for political risk, as they measure a country’s likelihood of defaulting on its debt. Egypt’s five-year CDS hit record highs earlier this week following mass demonstrations, but they fell on Thursday after the army removed Islamist President Mohamed Mursi, as investors hoped for a more business-friendly environment.
But investors find CDS a clumsy and risky tool, that can be easily influenced by other factors, like liquidity or the credit quality of your counterparty. Renaissance Capital measures per capita GDP against government type since 1950 to show the similarities between Egypt in 2013 and Turkey in the 1970s, before Turkey’s 1980 military coup, which was followed by democratic elections only three years later:
A middle class with improving incomes is more likely to demand and get democracy. For a country with Egypt’s per capita GDP, it is more likely that a country moves from autocracy to democracy, than from democracy to autocracy.
That move to democracy is likely to keep investors on the sidelines, however, as long as the situation remains uncertain. Renaissance says Africa funds are likely to stick with sub-Saharan Africa and Morocco, and keep clear of Egypt.
That’s the case for Africa fund manager Alexander Trotter of Fulcrum, who is underweight Egypt because of the political turmoil, despite the country’s attractions as an industrial centre, a so-called “Manchester of the Middle East”:
We are very bottom up, finding stocks where we think there is value. But at times, politics can dwarf all that.