Emerging market investors face political risks

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As the tidal wave of global central bank liquidity recedes in 2014, emerging market investors are growing more anxious about local political risks and how to spot them early on.

Developing economies have had a rough ride since the Federal Reserve first muted a wind-down of its money printing last year.

The looming withdrawal of easy cash worldwide pushed the dollar and Treasury yields up and drove Western investors home, jarring countries most dependent on foreign capital.
Emerging market bonds posted only their third year in the red since 1998 last year, while emerging equities ended 2013 in the red for the second year in three.
And as the global investment tide sweeps out, it may reveal a beach strewn with political detritus.

As competition for funds hots up while their economies rapidly lose steam, political risks have been amplified in the so-called ‘Fragile Five’ of Turkey, South Africa, India, Indonesia and Brazil, the emerging economies with the biggest overseas financing needs.

All five face elections this year, adding to brewing local concerns over a deepening corruption probe in Turkey or the waning popularity of South Africa’s and Brazil’s leaders.

South Africa and India hold parliamentary elections in 2014, while Brazil and Turkey have presidential elections. Indonesia had both. In fact, 12 of the major emerging markets go to the polls in some format this year.

“2014 will be a year in which the return impact from idiosyncratic political events in emerging markets could increase substantially,” asset manager M&G Investments told clients this week.

“The prospect of these elections could potentially reduce the net capital flows into these economies on a temporary basis,” it added, citing the threat of local capital flight, delayed foreign direct investment or portfolio flows as well as increased demand for currency and bond hedging.

Navigating the scheduled elections may be the easy bit, however. Some of the biggest political disruptions of the past four years were rather more sudden, such as the Arab Spring upheavals across the Middle East and North Africa or the more recent street protests in Ukraine.

For funds seeking to assess political risk well in advance, some form of advance warning system or scorecard is critical.

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