Top Story

The return of emerging market political risk

Posted on February 02, 2011

LONDON -- Taking the world by surprise, Egypt’s uprising may prompt renewed focus on political risk in emerging economies at a time of rising food and fuel prices, raising investor fears of unorthodox or repressive policy moves.

That could see investors demand a higher risk premium on investments particularly in authoritarian emerging economies, refocusing attention on potential political and succession risks in countries previously seen to be stable.

Demonstrators thronging the streets in Cairo and other cities continued to call for President Hosni Mubarak’s resignation on Monday in unprecedented protests that come hot on the heels of the ousting of Tunisia’s President Zine-al Abidine Ben Ali.

"The Egypt developments are ... unravelling assumptions about political stability in emerging market countries into question almost overnight," said Tina Fordham, political analyst at Citi.

That could have an impact across commodity, energy, government debt, currency and stock markets as well as on the cost of insuring foreign direct investment.

Recent events may make other leaders more worried about being swept from power -- making them perhaps turn to food subsidies, capital controls and other measures possibly including censorship and crackdowns to try to stave off unrest.

At the very least, governments may hike spending to placate the masses and hope to avoid them taking to the streets.

That would make government bond investors unhappy, while stock and currency traders are more worried about anything that would make it harder to get money in and out. Egypt’s stock exchange has been closed since Thursday, trapping investors.

"Emerging market investors should know these things happen-but what happened was people forgot," said Michael Ganske. "They looked at countries like Egypt and just looked at the numbers -- which were good -- and assumed the regime would be there forever."

As another reminder of the potential dangers of emerging economies, Ivory Coast looked headed for a default on a sovereign debt interest payment on Monday as rival presidential candidates faced off after last year’s disputed election.

That would be the first full sovereign default since 2008.

Global shares slid on Monday on events in Egypt, while oil prices rose towards $100 a barrel on fears unrest might spread to neighboring countries and could affect energy exports.

A more restive Middle East would produce higher commodity prices fuelling inflation particularly in developing economies, increasingly seen as the essential engine of world growth.

Concerns over political fallout from rising food costs is already seen prompting Algeria to boost food purchases, driving up global prices still further and draining state coffers.

Investors had already been worrying over unorthodox policy responses in the face of inflation, with both Turkey and Kenya cutting interest rates just as conventional economic textbooks say they should rise in part for domestic political reasons.

Global investors have increasingly shrugged off political dangers in developing economies in recent years, focusing more on policy risks in the developed world -- particularly around the eurozone’s troubled fringe.

Certainly, emerging European economies in particular have slashed spending much more easily than their Western counterparts -- but Egypt has acted as a stark reminder of the perhaps potentially greater strains within authoritarian states.

After Tunisia and Egypt, analysts say nearby countries probably have the greatest risks of copycat unrest -- but the implications spread much further across Southeast Asian states like Thailand and authoritarian Central Asian countries.

"In terms of contagion risk, Yemen, Sudan, Jordan and Syria all look vulnerable," said Zaineb Al-Assam, head of Middle East and North Africa Forecasting for London-based consultancy Exclusive Analysis. "However, the greatest risk in terms of both probability and severity is in Saudi Arabia."

While few see the ousting of the Saudi government as their base case scenario even a modestly increased perceived risk could push oil higher still.

Analysts disagree over what an environment of greater concern over social unrest and rising commodity prices means for already growing "currency war" tensions. Governments around the world are seen to have been keen to weaken their currencies to promote exports and jobs, sparking fears of wider trade wars.

"In the face of rising inflationary pressures, central banks and finance ministries within this sphere (emerging markets) may well start to see the advantages after all of a strengthening currency," said Bank of New York Mellon in a note.

But unemployment looks to have been at least as big a factor in fuelling discontent in both Egypt and Tunisia, and some argue that could harden attitudes amongst emerging policymakers.

Commerzbank’s Mr. Ganske said that if anything events in Egypt make Beijing more reluctant to allow currency appreciation that could undermine export industries and potentially throw factory workers out of work.

Beijing’s rulers appear to noted events in North Africa with at least some concern, blocking the word "Egypt" from searches on Chinese Twitter-style micro blog social networking sites over the weekend. -- Reuters