How Deadly Are Political Games to Emerging Economies?Author: Seb Constantine
Why invest in emerging markets?
It’s the age-old question. But what benefits do investors get from taking a chance on emerging markets? For one, they provide new investment opportunities, including elevated economic growth rates, higher expected return rates, and diversification benefits. But, as anyone who has been reading the news recently could tell you, it’s a hazardous business. Take Turkey as an example: often labeled as an economic miracle, booming to epic proportions. But its politics are wayward. There seem to constantly be protests raging against its President, while the suspicion is that he has his eyes on a military move against neighboring Syria. With this in mind, and with national censorship and restriction of social media access on the table too, no wonder investors are hesitant to commit to Turkey’s economy. And if to look at Africa’s number two (after Nigeria) strongest economy, the concerns become quite justified. The situation in South Africa is such that every President’s address to his government or the nation usually results in yet another drop in the local currency’s value. This is getting more and more worrying. At this very moment, President Zuma could be failing to read yet another crafted speech.
Political instability in emerging markets
The term ‘political instability’ tends to refer to uncertainty regarding national and international political decision-making, and its subsequent effects. While developed countries tend to follow a trend of low government intervention and a free market, this is not always the case in developing nations, where businesses are often privatized on and according to demand. Additional factors that contribute to political (and therefore investment) risk include the possibility of war, tax increase, loss of subsidy, a change in market policy, out of control inflation and government control over the extraction of resources. Major political instability can also result in civil war and industry shutdown. The overall effect of political instability in emerging markets can be enormous: emerging economies grind to a halt without output from industry and input from investors, who are driven away by the risk.
Are investors indifferent to noneconomic risks?
But for all this, the question of whether noneconomic factors impact on the decision to invest remains up for debate. In fact, Foreign Direct Investment (FDI) in emerging markets is currently on the rise. In emerging markets, FDI now accounts for one third of total financial flow. A recent survey of cross border investors from four emerging economies – Brazil, India, South Africa and South Korea – New Voices in Investment, found that less than 14% of existing investors identified political risk as a significant factor in decision-making. And yet, this surprisingly low figure raises the suspicion that investors may be considering their investment decisions with the benefit of rosetinted hindsight. Indeed, the story is markedly different for those potential and noninvestors surveyed, as almost half of the latter group suggested political instability was a key factor that would prevent them investing in emerging economies in future. In addition, the findings showed that most exportoriented companies, especially those from India and South Korea, are particularly concerned by political risk – a surely reasonable concern, given that the firms are often part of an international production network, facing greater costs if unexpected changes occur in a particular economic climate.
How diversify risks?
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