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Emerging market reformers: hope or hype?

Emerging market investors welcome leaders who promise reform – but those promises are not always kept, writes Ed Wiltshire.

7 minute read

picture - Hope written in the sand on a beach

A cynic might suggest politicians are snake-oil salesmen with a limited product range. They really have only two cure-alls: one a bottle labelled Hope, the other Fear. Their offering to the electorate is either the comforting certainty of continuity or the heady optimism of radical reform.

In the emerging markets, where by definition there is always room for improvement, those politicians promising change are more likely to excite the interest of equity investors. Several such reformers have been elected over the past five years; from Enrique Peña Nieto in Mexico to India’s Narendra Modi and Indonesia’s Joko Widodo. In Brazil and South Korea, reformist leaders have emerged in the wake of impeachment scandals.

So what does the performance of the equity market in each of these economies tell us about how investors respond to reformist administrations? Is the mere prospect of change enough – or do politicians need to deliver on their promises to drive stocks to outperform over the medium term?

Slow growth in Mexico

Peña Nieto’s election victory in July 2012 returned his centrist Institutional Revolutionary Party (PRI) to power in Mexico after a gap of 12 years. He promised a number of structural reforms to address the economy’s stubbornly-low growth rate; he argued rising prosperity would also help make the country safer and reduce the appalling impact of organised crime.

During his first two years in office, Peña Nieto introduced reforms in education, the financial sector, energy and telecoms, but the economic effects were negligible. GDP growth has struggled to reach 2.75 per cent during his presidency. Rising violence – driven mainly by drug-cartel turf wars – and ubiquitous corruption scandals have seen his popularity wane.

With the next presidential election due in 2018, the political window for further bold reforms may already be closed. It is unclear whether the PRI can see off the growing challenge of the left-wing opposition; in any case, the constitution requires Peña Nieto to stand down. Recent elections in the State of Mexico, a PRI stronghold since 1929, saw Peña Nieto’s party returned with a much-reduced majority. If the left wins power, it is likely to focus on corruption and crime rather than reforms that would help the market.

Although there is a danger of reading too much into the tea leaves of price-movement charts, it is possible to see this political story writ large in the performance of the MSCI Mexico Index when compared to its peers in the MSCI Emerging Markets Index. Peña Nieto’s election victory in mid-2012 triggered a euphorically-optimistic phase; the Mexican index rose 19.6 per cent between July 2, 2012 and March 31 the following year, strongly outperforming the wider emerging-market index (see figure 1).

Interestingly, the chart shows investors kept faith in Peña Nieto long after his reform agenda began to founder. The euphoria only really started to dissipate in 2016, when it became clear Peña Nieto’s structural reforms had not generated the hoped-for GDP growth.

Figure 1. MSCI Mexico Index versus MSCI Emerging Market Index (indices rebased)1
Figure 1 - MSCI Mexico Index versus MSCI Emerging Market Index (indices rebased)

India: full speed ahead

Narendra Modi’s landslide victory in May 2014 saw his Bharatiya Janata Party become the first in 30 years to hold a clear majority in the Lower House of the Indian Parliament – and gave him a clear mandate to carry out a radical neoliberal reform agenda.

Prime Minister Modi outlined an ambitious programme to privatise and liberalise the economy, opening it up to more foreign direct investment. He favours the interests of employers over the rights of workers and unions. Some of his measures have met resistance in the Upper House of Parliament, which is not controlled by Modi’s party, but for the most part he has made considerable progress with his promised reforms.

Modi’s most daring move came in November 2016, when his government announced the withdrawal of all 500 and 1000 rupee notes in an effort to curb corruption and ‘black money’. This was a brave move given that India remained a cash-driven society; the policy was as likely to hurt Modi’s largely poor voter base as the corrupt elites that he was ostensibly targeting. But despite dire warnings to the contrary, it seems the policy has done little to dent Modi’s popularity.

Modi’s most lasting contribution may yet prove to be the introduction of a nationwide Goods and Services Tax (GST), the biggest reform in this area since independence 70 years ago. Effective from the start of July, the GST has removed separate taxes, tariffs and barriers imposed by different states and effectively turned India into a single economic market for the first time. To provide some perspective, a pre-Brexit European Union, with a population of 510 million, is dwarfed by this single Indian market of 1.3 billion.

Modi’s continuing popularity, as evidenced by his party’s success in recent state elections, suggests that he will be well-placed come the next national parliamentary elections in 2019. Unlike Peña Nieto in Mexico, there is as yet no sign of Modi’s reform programme running out of steam. This is no doubt due to the fact that the Indian economy continues to grow at a rate that outstrips most others in the region.

The Indian equity market’s sustained relative outperformance also reflects the optimism surrounding Modi’s ongoing reforms – and a belief in his continuing ability to deliver them. As of July 13, the MSCI India Index was up 24.6 per cent since Modi’s election victory in May 2014; by contrast, the MSCI Emerging Markets Index has risen 9.2 per cent over the same period (see figure 2).

Figure 2. MSCI India Index versus MSCI Emerging Markets Index (indices rebased)
Figure 2 - MSCI Mexico Index versus MSCI Emerging Market Index (indices rebased)

Widodo’s bumpy ride

Joko Widodo has had a more difficult time of it than Modi since being elected president of Indonesia in October 2014. His first year in office found him struggling with the economic fallout from weak commodity prices, which hurt export revenues. And he was seemingly unable to follow through on promised economic reforms. Ironically, the passage of his most successful reform – the abolition of energy subsidies – was eased by the falling oil prices that impeded the country’s GDP growth.

By contrast, other stimulus measures were deemed too little, too late. Most damning were criticisms of his failure to fight corruption or limit illegal forest clearing activities, which waste a valuable natural resource and leave much of the country polluted with smoke.

Unlike Modi, Widodo has been constrained by his lack of control over his parliament; indeed, much of the opposition to his proposed reforms has come from within his own party. Measures that have gone through have generally been implemented by presidential decree, a less permanent solution than legislation. The opposition to Widodo has also meant certain areas crying out for reform – such as the need to end restrictions on foreign investment in certain sectors – have not been tackled at all.

One anti-corruption measure that did eventually get through parliament was a tax amnesty; designed not only to boost tax receipts in the near term but also to improve the tax base over the long run. The amnesty, which ran from July 2016 to March 2017, resulted in the declaration of $336 billion of previously hidden assets. Clearly it is too soon to judge the lasting impact of the measure, but it may have given Widodo’s reforming administration a second wind.

For now, equity investors appear to be giving the president the benefit of the doubt. The MSCI Indonesia Index is now outperforming its peers in the MSCI Emerging Markets after a pronounced dip in 2015 that coincided with a further slide in oil prices (see figure 3).

Figure 3. MSCI Indonesia Index versus MSCI Emerging Markets Index (indices rebased)
Figure 3 - MSCI Mexico Index versus MSCI Emerging Market Index (indices rebased)

The strange case of Brazil

What are the lessons to be learned from these examples? Modi’s success demonstrates reformist leaders need to carry their legislatures with them. Investors have rewarded Modi’s success in driving through reforms, and the Indian stock market continues to outperform its peers in the wider emerging-market indices.

Meanwhile, the performance of Mexico’s equity markets in the wake of Peña Nieto’s election victory shows the mere promise of reform can give stocks a significant boost, although investors will eventually lose patience if structural reforms fail to deliver the promised effects on economic growth. The Indonesian market may eventually suffer the same fate if Widodo’s reform agenda continues to falter.

Brazil offers a more recent example of investor excitement at the prospect of reform. In August 2016, President Dilma Rousseff was impeached and her vice president, Michel Temer, took over to serve out her term until the end of 2018. The ousting of Rousseff led to hopes of economic and political reform and the MSCI Brazil Index rose a remarkable 66.2 per cent in 2016, compared with only an 11 per cent rise in the wider MSCI Emerging Markets Index.

In May 2017, Temer himself became embroiled in scandal, when a recording emerged in which he allegedly endorsed bribes.2 The stock market fell sharply on the news, but it soon stabilised. The resilience of the market may partly reflect other factors, such as Brazil’s improved current account balance, but it is clear equity investors have maintained their faith in the country despite the political chaos. A record $1.1 billion flowed into Brazilian equities in the month after the Temer tapes were made public, the highest level in five years, according to data tracker EPFR.3 This suggests investors are confident Brazil will not let its crisis go to waste, and that more fundamental economic and political reforms will now be forthcoming.

A bottle labelled Hope

To lose one emerging-market president to a corruption scandal is unfortunate; to lose two within six months looks like carelessness. But soon after Rousseff’s impeachment, South Korea’s president Park Geun-hye was toppled following cash-for-influence allegations.

The situation in South Korea is different from Brazil. Park’s departure automatically triggered fresh presidential elections in May 2017. New president, Moon Jae-in, is regarded as a ‘clean pair of hands’, untainted by his predecessor. This puts him in a far stronger position than Temer as a reforming candidate. The public’s disquiet over what the Park scandal brought to light – the corrupt relationship between the family-owned conglomerates that dominate the Korean economy and its politicians – has been made demonstrably clear. This should provide a democratic tail-wind for Moon’s plans for reform.

As was the case in Mexico and Brazil, history suggests the promise of reform will give the Korean equity market a relative boost in the near term: indeed, that already appears to be the case (see figure 4). How long this outperformance will last will depend for the most part on two things: Moon’s ability to deliver politically and the economic consequences of what he proposes. Unlike Modi, Moon lacks control over his legislature, but the hope remains that he may be able to draw on the strength of public opinion to confront vested interests and improve corporate governance. That would greatly benefit minority investors, who have not always received full reward for their participation in the South Korean market.

We can draw some tentative conclusions from these examples. There does seem to be an explicit link between investors’ expectation of reform and equity-market performance. The prospect of reform in itself often sends markets higher, as in Mexico and Brazil. In markets where an economic reform programme is successfully implemented, as in India, we see deeper, more sustained outperformance over the medium term.

But even in those countries where reform appears to have stalled, such as Mexico and Indonesia, it can take some time for equity investors to become disillusioned with the direction of travel. Given recent developments in South Korea’s equity market, there is no reason to believe emerging-market investors will stop backing economic reformers any time soon. It seems investors and voters are alike: they never really lose their taste for the bottle labelled Hope, regardless of any previous hangovers. 

Figure 4. MSCI South Korea Index versus MSCI Emerging Markets Index
Figure 4 - MSCI Mexico Index versus MSCI Emerging Market Index (indices rebased)


All MSCI indices are quoted on a net total return basis in US dollars.

‘Report by Brazilian police ties Michel Temer to bribery scheme’, New York Times, June 20, 2017

‘Brazilian markets reflect investor resilience’, Financial Times, June 19, 2017


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