Focus Switches to Other Emerging Markets as Famous Five Ride Out Election Risks

Elections from Jakarta to Johannesburg have calmed investors' worst fears about political risk in emerging markets this year, but voting in Cairo and Kiev and instability in Thailand and elsewhere are creating new concerns.

Polls in the so-called Fragile Five economies - Brazil, India, Indonesia, Turkey and South Africa - topped investors' list of political worries for 2014.

As these countries were dubbed 'fragile' because of their reliance on foreign investor flows to shore up government balance sheets, elections were seen likely to lead to more spending and more instability.

Presidential polls in Brazil and Turkey are still to come, but parliamentary elections in India and South Africa and local elections in Turkey have been greeted with enthusiasm by investors.

In India, the result was a resounding victory for the business-friendly opposition and in South Africa and Turkey there were strong performances by the ruling parties, who have already shown some willingness to tackle problems.

Uncertainty remains ahead of a presidential poll in Indonesia, following parliamentary elections last month, but markets there are also relatively unscathed.

"So far, elections have not delivered what was feared - political uncertainty," said Jorge Mariscal, chief investment officer for emerging markets at UBS Wealth Management.

"So far, elections have resulted in better outcomes for (financial) markets."

The outcome for October elections in Brazil may be less comfortable for investors as incumbent leftist President Dilma Rousseff has been gaining in the polls.

However, in all of these markets, credit default swaps, often used as a proxy for measuring political risk, have fallen sharply. This also reflects a more positive view than six months ago on the extent of monetary stimulus in developed markets, which has kept US yields relatively subdued and supported high-yielding assets.

Emerging market equities have risen 4 percent this year, outperforming developed market peers, after falling 5 per cent last year.

Brazil's five-year credit default swaps (CDS), used to protect against default or restructuring of debt, have dropped nearly 50 basis points this year, to 155 bps, according to data provider Markit.

That means it costs $155,000 a year for five years to insure $10 million of Brazilian debt against default.

South Africa's CDS have fallen 30 bps this year to one-year lows of 170 bps, while Turkish CDS have dropped by 50 bps, also to 170 bps.

Ukraine, Egypt

Instead, worries have switched to the outcome of elections this weekend in Ukraine and Egypt, the security situation in Nigeria and this week's coup in Thailand.

The flare-up between Ukraine and Russia, which led to the annexation by Russia of Crimea following the ousting of Ukraine's pro-Russian president Viktor Yanukovich, has made investors wary about trading these countries' assets.

Ukrainian presidential elections are expected to result in victory - possibly in Sunday's first round - for confectionery magnate Petro Poroshenko, a former Yanukovich ally who later joined the protests against him and supports Ukraine's tilt towards the West.

But Ukrainian politicians are seen needing to tread a fine line between friendship with Europe and with Russia, and that makes investors nervous.

"It's not just about Ukraine per se, it's what the outcome of the Ukraine elections implies for relations between G7 and Russia," said Jonathan Wood, associate director at political risk consultancy Control Risks.

Ukraine's CDS have fallen from their highs but still trade not far below 1,000 bps, a level representing distressed debt.

In Egypt, former army chief Abdel Fattah al-Sisi looks set to win the presidency in a May 26-27 vote.

But investors are doubtful he is willing to tackle thorny problems such as reform of popular energy and other subsidies, and say plans for increased taxation will hit consumption and dent stock market performance.

Those risks are not priced into Egyptian assets, they add.

Aaron Grehan, emerging debt fund manager at Aviva Investors, does not hold Egyptian debt.

"It's very hard to be positive on Egypt given current (debt) spread levels and a lack of reward for the risks," he said.

Likewise in Thailand, the stock market has risen 7.5 per cent this year as optimism returned to emerging markets after a huge sell-off last year.

But the outlook looks very uncertain after the army seized control of the government in a bloodless coup this week.

"I am worried about Thailand," said Marshall Stocker, global equity fund manager at Eaton Vance.

"I do not see the Thai market as currently reflecting fundamentals, foreigners are not buyers."

Nigeria, which faces presidential elections early next year, has made headlines across the globe with the abduction of more than 200 schoolgirls by Islamist group Boko Haram.

Investors have generally shrugged off attacks by Boko Haram as they have taken place in the north of the country, while foreign investment is focused on the oil-producing Niger Delta in the south. But that could start to change.

"There is a latent concern that what we are seeing in the north could reach further south, that is being expressed by many of our clients," said Wood at Control Risks.

The high-yielding Nigerian naira currency, however, is continuing to attract foreign investors so far.

In Nigeria and across emerging markets, the challenge for post-election governments will be to carry out the reforms that markets expect, while keeping often restless populations satisfied.

"They have managed to win elections," said Wood. "But it gets more and more difficult to fulfill promises and to tame the social pressures that have bubbled up."

Copyright: Thomson Reuters 2014