By Maarten-Jan Bakkum, senior emerging markets strategist, Multi Asset at NN Investment Partners
A deteriorating economy, with an increasing amount of corporate defaults, rapidly increasing unemployment, higher interest rates, less lending and a weakening currency, inevitably increases the pressure on the political system.
The severity of the economic problems and the strength of the political institutions will determine whether a political crisis can be avoided or whether it will ultimately be inevitable.
After roughly five years of declining economic growth and exchange rate corrections, tensions are clearly building in the emerging world. This is reflected in the financial system, where defaults are common and banks’ profits are sinking fast.
It is also visible in society, where rising unemployment and interest rates are leading to a sharp drop in purchasing power, and in politics, where the government has to deal with growing deficits and dwindling support.
Reforms are needed to give the economy a bit of time to breathe, but the fear of taking unpopular actions is now paralysing the system.
The economic crisis is redefining relations inside and outside the government, leading to accusations and disclosure of improper government activities. Corruption scandals often emerge in difficult economic times.
Each country responds differently to increasing economic difficulties. In countries with a clear autocratic tradition, the government toughens state control, the media is controlled more strictly and personal freedom is scaled-down.
In recent years, we have clearly seen this happening in Russia, Thailand, China and Turkey. An official anti-corruption campaign and conflicts with foreign countries in order to divert attention from the real problems fit perfectly into this picture.
In other countries, where democracy is more well-established or where the government has less control over institutions and society, conflicts escalate within the political system. Corruption scandals come to light and will be used to settle the political score.
South Africa, but especially Brazil and Malaysia are the best examples in this category. The Petrobras corruption scandal and the imminent deposition of President Dilma Rousseff in Brazil cause major turmoil and uncertainty.
The scandal surrounding Prime Minister Najib, who allegedly stole 600 million euros from public funds, threatens to plunge the already fragile Malaysia – with its subcutaneous ethnic tensions – into a much larger crisis.
The political risk is rapidly increasing in the emerging world, whether we are talking about the first or second category.
This partly explains why equity, bond and currency markets continue to fall. Corruption scandals, government crises and increasing repression are a huge distraction from the reforms that are so urgently needed to reduce imbalances in the economy, to improve the investment climate and to create an opportunity for growth recovery.