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
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.
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 its also a result of the work of three leaders who enter 2013 with significant political capital: post-Lula, Brazils Dilma Rousseff; post-Uribe, Colombias Juan Manuel Santos; and, the most exciting story, post-Calderon, Mexicos Enrique Peña Nietoone 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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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 theyre getting closer, and all look set to solidly perform in 2013 and beyond, they said.
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 presidents political capital has been eroding and prospects for credible economic reform have stalled, Eurasia Groups 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 wont benefit from it.
The investment environment will remain opaque and more oriented toward benefiting domestic players, as Chinas relative power balance vis-a-vis international actors becomes more apparent.
Uncertainty over Chinas 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.
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 dont deserve the benefits they draw from being lumped in the emerging market categoryand should be flagged accordingly.
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President Vladimir Putins popularity is starting to wane, but theres 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. Its not just hard to consider Russia a BRIC, its 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.