Global Investing

Measuring political risk in emerging markets

(Corrects to say EI Sturdza is UK investment firm, not Swiss)

Commerzbank analyst Simon Quijano-Evans recently analysed credit ratings for emerging market countries and concluded that there is a strong tendency to “under-rate” emerging economies – that is they are generally rated lower than developed market “equals” that have similar profiles of debt, investment or reform. The reason, according to Quijano-Evans, is that ratings assessments tend to be “blurred by political risk which is difficult to quantify and is usually higher in the developing world compared with richer peers.

However there are some efforts to measure political risks, and unfortunately for emerging economies, some of those metrics seem to indicate that such risk is on the rise. Risk consultancy Maplecroft which compiles a civil unrest index (CUI), says street protests, ethnic violence and labour unrest are factors that have increased chances of business disruption in emerging markets by 20 percent over the past three months. Such unrest as in Hong Kong recently, can be sudden, causing headaches for business and denting economic growth, Maplecroft says. Hong Kong where mass pro-democracy protests in the city-state’s central business district which shuttered big banks and triggered a 7 percent stock market plunge last month.

As a result, Hong Kong jumped to 70th place in the index from a relatively safe 132nd place in the CUI which analyses governance, political and civil rights and the frequency and severity of incidents to assess the current and future civil unrest picture.

Hong Kong performs comparatively well in the economic, social and rights factors in the CUI, but performs poorly for democratic governance, Maplecroft says:

The scale of the protests, which has cost retailers upwards of $283 million, has seen Hong Kong move from the ‘medium risk’ category to ‘high risk’. Beijing’s response will be key to determining whether the situation deteriorates further.”

Bond market liberalisation — good or bad for India?

Many investors have greeted with enthusiasm India’s plans to get its debt included in international indices such as those run by JPMorgan and Barclays. JPM’s local debt indices, known as the GBI-EM,  were tracked by almost $200 billion at the end of 2012.  So even very small weightings in such indices will give India a welcome slice of investment from funds tracking them.

At present India has a $30 billion cap on the volume of rupee bonds that foreign institutional investors can buy, a tiny proportion of the market. Barclays analysts calculate that Indian rupee bonds could comprise up to a tenth of various market capitalisation-based local-currency bond indices. That implies potential flows of $20 billion in the first six months after inclusion, they say — equivalent to India’s latest quarterly current account deficit. After that, a $10 billion annual inflow is realistic, according to Barclays. Another bank, Standard Chartered, estimates $20-$40 billion could flow in as a result of index inclusion.

All that is clearly good news, above all for the country’s chronic balance of payments deficit. The investments could ease the high borrowing costs that have put a brake on growth, and kick-start the local corporate bond market, provided more safeguards are put in. Indian banks that have traditionally held a huge amount of government bonds, would at least in theory be pushed into lending more to the real economy.

China data: Lessons from Yongzheng

 Is China’s data reliable? With official figures showing the Chinese economy grew by 7.7 percent in the first quarter of 2013, a so-called slowdown or ‘soft patch’ in the Chinese economy has concerned some marketeers. Whether gross-domestic-product calculations involve macro data or micro data, the overall picture is not so clear, though some say a focus on regional numbers, cement, oil and gas usage would help complement official statistics. Kang Qu, assistant vice president of research at the Bank of China, said at a panel discussion earlier this week organised by the centre for the study of financial innovation, and supported by NowCasting, on calculating official Chinese data there is not so much government focus as in other countries on business confidence indicators but more on GDP prints, which are still under some doubt:
This is a reference when the People’s Bank of China makes big decisions.
Difficulty in collating accurate data is perhaps not so surprising, given the rapid urbanisation of the world’s second largest economy. Off-beat labour statistics (employing dissimilar methodology to the ILO) are partly skewed due to a large number of temporary registrants that slip the official statistics net. The solution? Jinny Lin at Standard Chartered, who thinks China’s real GDP level is more likely around 5.5 percent, suggested this could be taken from the history books. Emperor Yongzheng, China’s ruler in the late Qing dynasty, set up an independent body to look at data at the local level, and successfully stemmed tax evasion.

If local data is reliable enough, we should use local data.

photo

Source: Flikr creative commons

Problems are found at a local level too, however. While the current system sets local government officials’ bonuses for better GDP growth, there is no penalty for supplying incorrect data, neither are local government officials assessed on the jobs they create but via a points system. Instead local governments have ‘soft’ and ‘hard’ targets to attain, according to the panellists, some of which include environmental targets.

Then there is the issue of language. Some say data is more detailed in the Chinese language than in English, though official translations help bridge this gap. Quandaries remain, the resolution is still far from clear.

Indian markets and the promise of reform

What a difference a few months have made for Indian markets.

The rupee is 8 percent up from last summer’s record lows. Foreigners have ploughed $17 billion into Indian stocks and bonds since Sept 2012 and foreign ownership of Indian shares is at a record high 22.7 percent, Morgan Stanley reckons.  And all it has taken to change the mood has been the announcement of a few reforms (allowing foreign direct investment into retail, some fuel and rail price hikes and raising FDI limits in some sectors). A controversial double taxation law has been pushed back.  The government has sold some stakes in state-run companies (it offloaded 10 percent of Oil India last week, netting $585 million).  If the measures continue, the central bank may cut interest rates further.

Above all, there have been promises-a-plenty on fiscal consolidation.

The promises are not new. Only this time, investors appear to believe Finance Minister P. Chidambaram.

Chidambaram who was on a four-city roadshow to promote India to investors, pledged in a Reuters interview last week not to cross the “red line” of a 5.3 percent deficit for this year in the Feb 28 budget. Standard Chartered, one of the banks that organised Chidambaram’s roadshow, sent out a note entitled: “The finance minister means business”.

India, a hawk among central bank doves

So India has not joined emerging central banks’ rate-cutting spree .  After recent rate cuts in Brazil, South Korea, South Africa, Philippines and Colombia, and others signalling their worries over the state of economic growth,  hawks are in short supply among the world’s increasingly dovish central banks. But the Reserve Bank of India is one.

With GDP growth slowing to  10-year lows, the RBI would dearly love to follow other central banks in cutting rates.  But its pointed warning on inflation on the eve of today’s policy meeting practically sealed the meeting’s outcome. Interest rates have duly been kept on hold, though in a nod to the tough conditions, the RBI did ease banks’ statutory liquidity ratio. The move will free up some more cash for lending.

What is more significant is that the RBI has revised up its inflation forecast for the coming year by half a  percentage point, and in a post-meeting statement said rate cuts at this stage would do little to boost flagging growth. That, to many analysts, is a signal the bank will provide little monetary accommodation in coming months. and may force  markets to pedal back on their expectation of 100 basis points of rate cuts in the next 12 months.  Anubhuti Sahay at Standard Chartered in Mumbai says:

Emerging bonds say thank you, Ben

Last week the U.S. Federal Reserve may have lit a small fire under the emerging bonds market. Already boasting double-digit returns this year, bonds from the developing world are the hot ticket this year, contrasting with the lacklustre performance on stocks or commodities.

The Fed’s move is likely to increase this divergence in returns.

Essentially the Fed has decided it will reinvest proceeds from its maturing mortgage investments back into Treasury bonds, thus keeping market liquidity levels high and signalling to the world its belief that the U.S. economy is still weak enough to need financial stimulus.  Its action also leaves  investors staring at the prospect of near-zero interest rates in the United States and the industrialised world for another year or so.

Such monetary stimulus is usually a godsend for stocks — something investors such as Phil Poole of HSBC Asset Management liken to a “comfort blanket” for investors. In 2009 for instance emerging stocks  jumped 80 percent as global central banks unleashed torrents of liquidity onto world markets.  But Chart1this year investors have been wary of boosting allocations to stocks — fearing that robust growth in emerging markets will not shield their export-oriented companies from the impact of a U.S. slowdown.