Much Ado About Everything No 3: Emerging Markets — BRICS without straw?

Investors stand to get a negative surprise from two big Emerging Markets, Brazil and India

Straws in the wind

Since I wrote about the upcoming elections in Brazil and Indonesia a month ago, a certain degree of calm has returned to emerging markets (EMs). This is probably mainly thanks to:

  • Recent signs of some progress in Argentina; and
  • An unexpectedly sharp hike in interest rates in Turkey.

However, I still find myself in agreement with veteran investment expert Mohamed El-Ehrian writing for Bloomberg on 10 September as follows:

“Headline-country cases aren't resolved: neither Argentina nor Turkey, the two big headline cases, have produced a combination of policy adjustments and new financing that would place their economies on a secure path to stability. Accordingly, the market relief they experienced at the end of last week is more likely to have been the result of periodic portfolio position realignments than of a fundamental change in the underlying market dynamics.”

And there are in my view plenty of other warning straws in the wind, some of which may be below investors' radar at present.

Thus, despite clear signs of investor-differentiation among EMs, I remain firmly of the view that the question I posed in my 29 May article should be kept firmly in mind, as follows:

“So, the question I have been posing is whether — at a time of not only rising US interest rates but also rising oil prices — we may see turmoil in sufficient individual EM economies to trigger a more general rout?”

As things stand — and without wishing to dismiss China, Russia or South Africa (let alone Argentina, Indonesia or Turkey) — two of the so-called BRICS seem to me to be particularly worthy of more attention in the coming weeks.

Brazil: No good outcome?

The most obvious immediate potential spark is Brazil. As expected, jailed former President Luiz Ignácio Lula da Silva (aka Lula) has withdrawn from the presidential election and endorsed as the candidate for his Partido dos Trabalhadores (PT) Fernando Haddad. The most recent polls I have seen put Mr Haddad in the 16-19% range for the 7 October first round, up significantly relative to when Lula was still (nominally) standing and, with the centre seemingly in melt-down, looking increasingly likely to win through to a second round run-off on 28 October.

Whether it is Mr Haddad or another candidate who makes the run-off in his place, s/he seems all but certain to be up against the right-wing populist, Jair Messias Bolsonaro of the Partido Social Liberal (PSL), who is leading the pack on 28%, up eight percentage points or so over since late August.

Opinion polling on a Bolsonaro vs Haddad second round (my base case) currently has the two statistically tied. But, as at least some sort of guide, it may be relevant to note that Mr Bolsonaro suffers from a significantly higher ‘rejection rate’ among voters of 42%, compared to Mr Haddad’s (still non-negligible) 29%. For now at least, therefore, my personal view is that Mr Haddad is — albeit marginally — the favourite.

As I argued in the aforementioned 20 August article, I don’t think a win for either candidate is good news for investors. But the investor community currently seems to see Mr Bolsonaro as the lesser ‘evil’ and, given how tight the race looks, not be pricing in a Haddad victory.

India: BJP at risk?

Then there is India, a slower-burning fuse of which the 14 September edition of the Economist Espresso nevertheless wrote as follows:

“The rout began on Monday [the 10th]. By Tuesday the ‘Sensex’ stockmarket index had shed nearly 1,000 points and foreign investors had withdrawn 14.5bn rupees ($205m), the highest single-day outflow in over three months. On Wednesday the rupee tumbled to an all-time low against the dollar. Officials will join Prime Minister Narendra Modi this weekend to review the situation. Investors seem spooked, in part by the high price of oil, four-fifths of which is imported. The current-account deficit has ballooned to 2.4% of GDP, the highest in five years. The government says it will prevent the currency from sliding to “unreasonable levels”. Talk of an unscheduled interest-rate rise is rife. With general elections due next year, Mr Modi is trying to accentuate the positive: the economy grew by 8.2% year-on-year in the last quarter, the highest in over two years. He needs more good news.”

It is not clear, as yet, that measures outlined by the Indian government on the 14th are sufficient to stabilise the currency. Even if, that is, the oil price — which the Economist Espresso is right to identify as a significant contributory factor — doesn’t go higher still from where it is as I write, ie Brent crude a smidgen under USD80pb.

Oil per se is a topic for a future article in this series. But it is important to note here that India is in a particular bind over Iran and new US sanctions which are due to come into force on 4 November and are explicitly aimed at wiping out the market for Iranian oil. India currently imports around 0.6mbpd from Iran (at least some of which is almost certainly at a discount). Historic and growing wider ties make the Indian government reluctant to go to zero. But it is not at all clear that the Trump Administration, which has shown itself more than willing to hit US allies with trade tariffs, would grant a waiver even if the inflow from Iran were to be trimmed significantly. Investors should therefore keep firmly in mind the possibility of Washington sanctioning India in some way if, as seems likely, New Delhi fails to toe the line.

Investors are, of course, well aware that there is a general election due in India by April or May 2019. I would not personally put much trust in opinion polls at this time; but I would go along with the general consensus that the Prime Minister Narendra Modi’s ruling Bharatiya Janata Party (BJP) looks to have a tougher battle on its hands than was the case even six months ago and even if the economy does not take a significant ‘hit’ of some sort between now and then.

This being said, where investors may not be sufficiently aware is of the upcoming election in the important state of Rajasthan, due in December or January. Such polls as there are point to a heavy defeat for the incumbent BJP there, which would be bound to set nerves jangling over the general election.

Alastair Newton