Stéphane Monier comments on the investment opportunities following the Indonesian, South African and Indian election results. He argues that with strong emerging market fundamentals in place, investors look for higher yields by including emerging market assets in portfolios.
A series of elections in emerging markets have demonstrated some resilience as three incumbents were re-elected in recent weeks. Indonesia, South Africa and India have all democratically returned leaders with majorities large enough to ensure they can continue reforms to their economies.
Each of the three democracies has delivered an opportunity for change. That contrasts with rising tensions in the EU and a lack of coordinated political vision for the bloc, suggesting that once global tensions over trade are resolved, there is plenty of potential for emerging market optimism.
In the current environment, the US dollar should remain resilient against emerging currencies."
17,000 Indonesian islands
Indonesia's President, Joko Widodo secured a second five-year term last month, on a pluralist, secular platform with a 55.5% share of the 154 million votes cast across 17,000 islands. In a repeat of the aftermath of the 2014 election, the opposition leader challenged the victory, and there were riots in Jakarta, the capital. Nevertheless, the country's electoral agency said there is no evidence of fraud in the world's third-largest democracy.
The fiscally conservative Jokowi plans to continue reforms, including a national land register to resolve ownership disputes and redistribute land to indigenous tribes, a source of tension in the world's biggest palm oil producer with the globe's third-largest area of tropical forest. The election delivers a window of economic opportunity for further GDP growth if a young population can be helped by infrastructure spending and improved labour laws.
South Africa's reform window
Cyril Ramaphosa, the incumbent African National Congress President, was re-elected by his party last week following the 8 May general election victory. While the ANC's 57% of the vote fell to its lowest share in the post-apartheid period, it hands Ramaphosa a mandate to change the constitution to allow for land expropriation without compensation and tackle the corruption that forced his predecessor from office.
Struggling with a widening current account deficit, falling productivity and unemployment of 27.1%, South Africa's structural economic weaknesses are in desperate need of reforms. With growth forecast to expand this year at 1.5%, compared with an estimated 0.8% in 2018 and the central bank's interest rates on hold at 6.75% for now, the newly re-elected President now has some time to show he can make progress addressing the country's inequalities and the corruption of the Zuma era. In 2017, corruption was estimated to cost the South African economy at least R27bn ($1.9bn) per year, according to Ebrahim Patel, minister for Economic Development.
The other sector of the South African economy that needs an overhaul is mining, to better regulate the country's mineral resources in the form of gold, platinum and uranium. The highly unionised industry and the question marks over the future of land reform are two factors still deterring investors. With a lack of external investment, the country has been forced to rely on government spending to boost the economy.
Modi's landslide mandate
India's Hindu nationalist Prime Minister Narendra Modi won a second landslide in the world's biggest-ever democratic exercise last week, based on promises to take a harder line on national security and a pro-business agenda.
The Hindu-nationalist Bharatiya Janata Party (BJP), part of a coalition known as the National Democratic Alliance, recorded a resounding success. It is the first time since 1971 that a party has won consecutive single-party majorities and is the largest vote for an incumbent since 1957, together with the highest ever voter turnout, at 67.1%.
Still, unemployment is at a 20-year high and Modi's re-election strategy has been to attack political opponents, highlight religious differences and national security by stoking tensions with Pakistan after a terrorist attack in February. There are also open questions about the continued independence of the national bank. Since a new governor took over in December, the Reserve Bank of India has cut repo rates twice after government criticisms that high lending costs are restraining growth.
Modi's pro-business reforms have overhauled sales taxes, currency circulation and accelerated bankruptcy and business arbitration. India's productivity has improved, and coupled with improved foreign direct investment, it has recorded five consecutive quarters of double-digit growth.
Last week's election result reinforces Modi's mandate to continue reforms to Asia's fastest-growing economy, without fundamentally changing his government's capacity for passing new legislation. Nevertheless, with demographics shifting to the new middle class and younger voters, the country needs to take advantage of the stability from Modi's grip on the leadership to increase incomes in the coming years.
Trade tensions trump the positives
With strong emerging market fundamentals in place including stable currencies, favourable oil prices, combined with the US Federal Reserve's dovish stance, it has made sense for investors to look for higher yields by including emerging market assets (with the notable exceptions of Argentina and Turkey) in a portfolio.
However, the US/China trade dispute escalated further last week as the US government put Chinese telecoms company Huawei on a trade blacklist, banning US businesses from trading with the firm. China, which has denied that Huawei has links to the government, then sent a clear message when President Xi Jinping visited a rare earths producer. Four-fifths of US imports of the costly-to-mine elements, found in everything from iPhones to super conductors and military missiles, come from China.
US President Donald Trump, then said that an agreement on Huawei may be "some form or part of" an eventual trade agreement.
We still expect the trade dispute to be resolved, even though a solution looks inevitably slower than we anticipated. For now, we estimate that the probability of a deal in June is about 40%, with the same odds for a deal being postponed to later in the year or even 2020. Finally, we believe that the chances of a breakdown in negotiations, which would raise the prospect of recessions, to be about 20%.
In the current environment, the US dollar should remain resilient against emerging currencies. Given that the trade risk overrides the recent emerging economies' positives, we have reduced our emerging market equity allocation and are now neutral on emerging currencies.
Once the geopolitics between the US and China are resolved in the near or longer-term, we believe that there will be opportunities for investors to re-build their positions in emerging market assets.
Stéphane Monier is CIO at Lombard Odier
Rising incomes in Asia will probably be the most important investment story of the 2020s. Asia is home to 60% of the world's population, with both China and India each accounting for about 18% of the global total.