Big risks lurk in emerging markets: consultants

Emerging markets, which have “kept trade moving” and “commodity prices afloat” during the financial crisis are again a source of risk

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Worries about emerging markets, which have offered attractive investment opportunities over the past 4 years, will resurface as these countries will have “much more” volatility and instability than the advanced ones, analysts from Eurasia Group, a political risk research and consulting firm based in New York, said in a recent report.

In their “Top risks 2013” report, the consultants listed emerging markets as the number one risk but added that this year it will be “critical to understand that emerging market downside differs wildly from country to country.”

Investors should stop treating emerging markets “as an asset class for outsized growth” and consider instead which governments have enough political capital to keep reforms going in order to reach a more advanced stage of development, according to Eurasia Group.

The consultants divided emerging markets into 3 categories according to their potential for development.

BECOMING DEVELOPED

The first category, “Becoming developed,” is made up of countries that have governments with the tools to respond to challenges and put policies that make investment more attractive in place; and many Latin American countries are included in it.

This may be because of a structural advantage due to the lack of geopolitical turmoil in the region and the ability of many Latin American governments to deal with a more fragmented globalization environment, according to the consultants.

“But it’s also a result of the work of three leaders who enter 2013 with significant political capital: post-Lula, Brazil’s Dilma Rousseff; post-Uribe, Colombia’s Juan Manuel Santos; and, the most exciting story, post-Calderon, Mexico’s Enrique Peña Nieto—one of the only leaders in the emerging market space willing and able to advance structural economic reforms.”

Turkey also fits this category, the consultants said, partly due to many years of structural reforms as part of its bid to join the European Union.


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In the Middle East, Oman and the United Arab Emirates belong to this group while in Asia, South Korea, Malaysia and the Philippines also qualify, according to the consultants.

“Given a sudden economic shock, none of these markets has the stability or resilience of the United States, Japan, or even the European economies. But they’re getting closer, and all look set to solidly perform in 2013 and beyond,” they said.

PROBLEMATICALLY EMERGING

The second category is that of the “Still emerging – and problematically so” countries, with upside potential but “dramatically greater” volatility as a result of lower levels of political stability combined with stronger economic headwinds.

India, with “significant long-term structural advantages” but “an extremely troubled political reform environment” belongs to this group of countries and so does Indonesia, whose president’s political capital has been eroding and “prospects for credible economic reform have stalled,” Eurasia Group’s report showed.

Staying in Asia, Thailand is also part of this category “thanks to poor existing governance against the backdrop of troubled and uncertain succession.”

But perhaps the most surprising Asian member of this category is China. The consultants say they are “more confident” on domestic economic growth, but “far more worried that foreign companies and investors won’t benefit from it.”

“The investment environment will remain opaque and more oriented toward benefiting domestic players, as China’s relative power balance vis-a-vis international actors becomes more apparent.”

“Uncertainty over China’s short- to medium-term trajectory is an order of magnitude greater than that of any other major global economy,” the report said.

In the Middle East, many of the larger economies, such as Egypt and Iraq fit in this category and, longer term, even much more stable countries like Saudi Arabia, according to Eurasia Group.

In Latin America, Peru is part of this category and in Africa, South Africa.

‘SUBMERGING MARKETS’

The third and last category is that of “Backsliding” countries, which the consultancy firm calls “submerging markets” – economies that are underperforming and generating “unacceptable levels” of political risks.

“Absent effective governance and facing significant economic challenges, these markets don’t deserve the benefits they draw from being lumped in the emerging market category—and should be flagged accordingly.”

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Russia is the most notable of countries in this category, the Eurasia Group analysts said.

“President Vladimir Putin’s popularity is starting to wane, but there’s no change in his hold on power nor any willingness to reconsider his statist, highly centralized, and staggeringly corrupt approach to economic development,” the report said.

“External relations are becoming more challenging with both Europe and the United States, and capital flight continues apace. It’s not just hard to consider Russia a ‘BRIC’, it’s hard to justifiably categorize it as a truly emerging market,” it added.

In the same category are included many so-called “frontier” markets where political risk “has destroyed” governments’ credibility, such as Ukraine, Pakistan, Algeria, Libya and “the increasingly marginal players” in Latin America like Venezuela and Argentina, the report said.