Viewpoint

Emerging Market Fixed Income

Elections in 2014 opportunities and risks

January 2014
Introduction
Assessing political risk is a key part of investing in emerging markets. Good governance is important. Markets will reward governments that pursue positive reforms, run sound scal and monetary policies, provide societal stability and maintain strong and independent institutions. While political change can happen at any point in time, heightened uncertainty generally coincides with elections. In 2014, we are facing one of the busiest election years in some time, with many key countries in our universe going to the polls. While political events may seem difcult to forecast, often markets are either too complacent or too pessimistic on election outcomes. In either of these extremes, a thorough assessment of all the scenarios can lead to protable trade ideas.
Peter Eerdmans

Portfolio Managers

Werner Gey van Pittius

Key 2014 elections

All ve of the current account decit countries dubbed the fragile ve face elections this year. These are South Africa, Turkey, Brazil, India and Indonesia. Other key markets with elections scheduled for 2014 are Hungary, Colombia, Thailand and Romania. Nine of the 16 countries in the main emerging market local currency debt benchmark will hold elections in 2014. Iraq and possibly Egypt are two additional countries where for geo-political reasons the elections will be monitored closely by investors. While each election will be dominated by different themes, there are common concerns such as corruption and social divisions, which may prove more important than in previous elections. In some countries we have seen weak reform and populist scal measures in the run-up to these elections as governments become stied. In that sense, a strong election mandate may give a new government the condence to embark on positive reforms. Elections in 2012 in Mexico and 2013 in Malaysia resulted in signicant improvements in terms of reforms in the former and scal prudence in the latter. But this is not always the case. Elections can also mean a shift to a more populist government or embolden governments to continue less-market friendly policies. Elections in 2012 in Russia and Venezuela in 2013 are examples where we have not seen structural improvements in the aftermath. Below we attempt to classify the different elections for 2014 into those where we could see positive surprises, those where no change is likely and those where downside risks are probably insufciently priced in and we could witness some adverse market moves.

Potential positive impact

India, the largest democracy in the world, has been stied by the weak position of the Indian National Congress-led coalition government. Collapsing economic growth, high ination, currency depreciation and corruption scandals are the biggest frustrations for the Indian public. Last year several parties withdrew their support meaning the coalition lost its majority. Consequently, while prime minister Manmohan Singh and nance minister Palaniappan Chidambaram were dedicated to some long-needed structural reforms, implementation has been slow. In recent local elections the main

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opposition and nationalist Hindu party, Bharatiya Janata Party (BJP) did well. Its prime ministerial candidate, Narendra Modi, is seen as a controversial gure but few can argue with his impressive economic record as chief minister of the state of Gujarat. Congress is likely to be led by Rahul Gandhi in the upcoming elections, who has so far kept a low prole, but with prime minister Singh publicly endorsing him, we would expect increased scrutiny on his policies going forward. Momentum seems to be with the BJP, although as always in India, it also matters how some of the smaller parties fare and which coalition they support. The best outcome for markets would be that either of the two main parties win big and can build a strong coalition. This would set the scene for positive reforms, which together with the positive changes we have seen at the central bank since Raghuram Rajan became the new governor, will bode well for Indian assets. In Indonesia the House of Representatives is likely to remain fragmented, with the main parties Golkar and PDI-P expected to gain on the current presidents Democrat party. President Susilo Bambang Yudhoyono has generally been seen as indecisive, with a disappointing second term. A new, strong, reform-minded President could quickly turn around investor sentiment to the country. Several of the current issues facing Indonesia are more cyclical than structural, which means some easy gains can be made before tackling the required longer-term structural reforms. Among the current announced nominees for president, there is no market-friendly candidate in our view. But as is often the case in Indonesia candidates are announced late in the process. The current governor of Jakarta, Joko Widodo, is doing well in the polls. We believe it would be a positive outcome for the markets if he is selected as the PDI-P candidate and wins in the elections.

No major impact expected

In South Africa it will be interesting to see if the opposition (strengthened by the new Agang party) can benet from President Jacob Zumas drop in popularity. While we expect a further erosion of the ANCs majority, partly as support from its alliance partners wanes, the ruling party is still very likely to stay in power which will facilitate Zumas second term as president. In our view this will mean government policies remain on a modestly deteriorating path, which is only likely to turn for the better if we get a strong successor to Zuma as ANC president in the second half of his term. Despite Brazils economy disappointing and a more united opposition, president Dilma Rousseff is still the favourite to win in the October elections. Populist measures in recent years have perhaps not been good for the overall economy, but have helped many potential voters out of poverty. That said, the elections are still some time off and things can change, as we saw during the widespread protests over the summer. If either of the main opposition parties (the Acio Neves led PSDB or Eduardo Camposs PSB) win, it is likely we will see a shift to more market-friendly policies. A Dilma victory, which is our base scenario, would mean largely unchanged policies, although we do believe economic reality will mean more prudent policy-making in her second term. In Hungary, prime minister Viktor Orbans Fidesz party is likely to stay in power. The opposition is weak and for many Hungarians does not provide a viable alternative. The key question is whether Fidesz will maintain a two-thirds majority which would allow it to pass constitutional changes. While Fidesz policies have been unorthodox and at times regarded as poor by the markets, more recently they have yielded positive results with Hungarian local currency bonds posting very strong returns of 12.65% in 2013, bucking the negative trend for the universe. We could see some further populist measures in the run-up to the elections, but generally expect no major change in terms of policies as Orban is very likely to remain prime minister. In Colombia, president Juan Manuel Santoss popularity is rising again, albeit from low levels, now that the peace talks with the FARC guerrillas are making progress again. The peace process will be one of the key issues in the elections, with former president Alvaro Uribes party taking a more hawkish line with FARC. We think Santos is most likely to win, but it could be tight. Regardless, in terms of economic policies the two parties differ very little, so with regards to impact on the markets we expect a smooth transition.

Increased downside risks

In Turkey we will only see municipal and presidential elections, with parliamentary elections not until 2015. Therefore, until recently, we would have put Turkey rmly in the camp of no major impact expected, with the key question if prime minister Recep Tayyip Erdogan and president Abdullah Gul would swap roles. However, politics have certainly heated up in recent months. Erdogans style is judged to be too authoritarian in many quarters. This led to signicant street protests over the summer and more recently internal struggles attributed to opposition from the strong Gulen movement which had been a key supporter of Erdogans AK Party for many years. The Istanbul municipal elections in March will be a key test for the AK Party. A scenario where Erdogan becomes president and Gul leads the AK Party into the 2015 parliamentary elections could ease tensions, but for now we think uncertainty will increase in coming months. Erdogan may become increasingly authoritarian in an effort to maintain his power base. Thailand was not scheduled to hold elections in 2014, but the massive street protests have forced prime minister Yingluck Shinawatra to dissolve parliament and call for elections. But the problem is that the street protestors, now united in the Peoples Democratic Reform Committee do not want elections, as they rightly fear Yinglucks party would easily win yet another election. They want to run the country unelected for some time so that through electoral reform they can purge Thailand from the inuence of Yingluck and importantly her brother Thaksin. The opposition Democrat party has already said they will boycott the elections and at the time of writing it is unclear if the elections will even go ahead or can yield valid results. It is very difcult to see a solution to the current impasse, with the army staging another coup increasingly likely. As uncertainty reigns, risk premia will remain high. There are several elections in the turbulent Middle-East/North Africa region, each with signicant uncertainty in terms of outcome. The key elections will be in Egypt and Iraq. We will also be closely watching Tunisia to see if a peaceful election is possible following the Arab Spring, while elections in Lebanon will also be tense. Violence has ared up in Iraq with 2013 the most violent year since 2008. Prime minister Nouri al-Maliki will stand for a third term and while he faces increased opposition from different sides, he could well win as people vote for what they know rather than the uncertainty of a change in leader. Egypt will likely hold elections before the summer. The key test is if this proves the transition back to democracy following the overthrow of president Muhammad Morsi by the army, but we are sceptical the transition will be smooth. The authorities are clamping down on the Muslim Brotherhood, and it is not clear if their political arm, the Freedom and Justice Party will be able to run in the elections. In any case, the divisions in Egyptian society are stark with supporters of the army and the current caretaker government pitted against supporters of Morsi and more conservative Islamic parties.

Conclusion
While uncertainty is always elevated around elections, for some countries a change towards a more decisive or reform-minded government will be positive. We specically think the situation in India and Indonesia will be better after the elections. For most other countries we see a continuation of the status quo, but we are particularly cautious towards Turkey, Thailand and Egypt as political risks could increase in coming months. As always, politics will be one of the key drivers of our portfolio positioning, alongside macroeconomic fundamentals, valuations and market price behaviour. As we see markets price in an overly optimistic or pessimistic scenario, we will look to take advantage by adjusting our portfolios.

Important information
This document is not for general public distribution. If you are a private investor and receive it as part of a general circulation, please contact us at +44 207 597 1900. The information discusses general market activity or industry trends and should not be construed as investment advice. The economic and market forecasts presented herein reect our judgment as at the date shown and are subject to change without notice. These forecasts will be affected by changes in interest rates, general market conditions and other political, social and economic developments. There can be no assurance that these forecasts will be achieved. Investors are not certain to make prots; losses may be made. Past performance should not be seen as a guide to the future. The information contained in this document is believed to be reliable but may be inaccurate or incomplete. Any opinions stated are honestly held but are not guaranteed and should not be relied upon. This communication is provided for general information only. It is not an invitation to make an investment nor does it constitute an offer for sale and is not a buy, sell or hold recommendation for any particular investment. In the US, this communication should only be read by institutional investors, professional nancial advisors and, at their exclusive discretion, their eligible clients, but must not be distributed to US persons. In Australia, this document is provided for general information only to wholesale clients (as dened in the Corporations Act 2001). All data sourced from Bloomberg and Investec Asset Management. Outside the US, telephone calls may be recorded for training and quality assurance purposes. Issued by Investec Asset Management, January 2014.

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