Political and economic volatility in important markets


Amid turmoil in international markets, there are a host of countries whose economic circumstances will be shaped ultimately by their geopolitical circumstances. A rush of repositioning in global capital markets has exposed very clear financial vulnerabilities in several countries. Though few countries are completely safe from the current economic turmoil, those caught in moments of political transition are particularly vulnerable. Indonesia, Ukraine, Thailand, India and Turkey are all countries where geopolitical shifts are intersecting with international economic volatility in a potent mix of potential instability.

Ukraine’s geopolitical plight provides significant opportunities but includes extreme risks. Ukraine suffered a 14 percent contraction of its gross domestic product in 2009 and has recovered poorly, despite portfolio and direct investment inflows. Growth in 2012 and 2013 were effectively zero, and the country’s chronically negative current account is expected to have been negative $13 billion in 2013. The country’s foreign currency reserves are falling quickly, reaching a mere $20 billion at the end of 2013, down from more than $30 billion in the middle of 2012. That amount is enough to finance only about two months’ worth of imports, and to make things worse, within the next year Ukraine is committed to $7 billion in short-term liability payments.
Meanwhile, the country’s elected government is under siege in Kiev by anti-government protesters. Ukraine faces a strategic choice between alignment with Europe or Russia, and Ukraine’s pressing financial realities at home will play a key role in this drama. Russia has already delivered $3 billion of a promised $15 billion emergency loan to Kiev— a sum of money that would substantially ease Ukraine’s burden—but announced Jan. 29 that the remainder of the loan could be put on hold if a new government is formed.

The fate of Ukraine will likely be hashed out in the negotiations between the Ukrainian government and the protesters, backed by Russia and Germany, respectively. But unless the European Union is willing to assist Ukraine in stabilizing its financial situation —an unlikely outcome—Russia still seems to have the upper hand in determining Ukraine’s ultimate geopolitical orientation.

Turkey’s ruling Justice and Development Party (abbreviated in Turkish as AKP) came into power on the heels of a major banking crisis in 2001, ushering in more than a decade of relatively stable economic growth. With the AKP’s rise also came the sidelining of the republic’s wealthy secular elite, as Turkish Prime Minister Recep Tayyip Erdogan seized the opportunity to raise a new crop of corporate loyalists. But Turkey was also benefiting from cheap but mobile portfolio capital inflows during this period. With a population of more than 70 million and a steadily growing economy, Turkey became heavily reliant on outside investment to finance a hefty energy import bill, leading to chronic current account deficits.

Turkey’s key vulnerability is that most of the foreign investment it attracted was made into debt, and to a lesser extent equities, instead of foreign direct investment into companies that both provide jobs and are more difficult to liquidate in times of crisis.

Total portfolio investment into Turkey in the year ending in November 2013 equaled $26 billion, while foreign direct investment was only $11 billion. Therefore, market skittishness has a much higher potential to severely undermine Turkey’s finances than in other countries where foreign direct investment is the primary type of financial inflows.

With Turkey’s economic record tightly linked to the AKP’s political track record, it is little wonder that deeper political forces are now realigning to challenge the AKP’s clout and fracture Erdogan’s patronage network in this highly volatile election season.

Turkey’s venomous political struggle will intensify in the coming months, blunting efforts by the Turkish central bank to assuage investor fears.

Indonesia’s economic situation has changed rapidly in recent years. Cheap capital inflows primarily into public sector debt facilitated a significant boost in Indonesia’s imports. Rising demand for foreign goods coupled with a fall in prices in commodity markets pushed Indonesia’s current account balance into negative territory for the first time in 2012, and it has worsened since then. (A recent decision to ban exports of some unprocessed minerals will not help.) The currency fell by 20 percent in relation to the dollar since the United States first began discussing withdrawing monetary stimulus in mid-2013. The Indonesian central bank has responded by gradually raising interest rates, but rates remain below inflation, which is at the highest since the credit bubble in 2008, creating a situation of real negative interest rates.

The government’s response is complicated by upcoming legislative elections in April and presidential elections in July that will likely give Indonesia a new ruling party for the first time in a decade. Indonesian voters have already had to endure a fuel price hike in 2013 as the government sought to trim its subsidy bill. A rapid increase in interest rates would have the effect of slowing spending domestically and could hurt the country’s growth prospects. With the prospects of a meaningful shift in the leadership ahead for Indonesia, there is persistent concern over whether the country will be able to convert economic uncertainty and a slowdown in growth into an opportunity for reform.

Much like Ukraine, Thailand’s instability is apparent in the streets of the capital. Unlike many of the countries seeing economic turmoil, Thailand’s financial status is not at critical levels, but the threat of worsening political polarity raises the risk of a misstep in the Southeast Asian country. Though its current account has declined significantly, Thailand still managed to maintain a small surplus in 2013. Portfolio flows shrank rapidly in the second half of 2013 as emerging markets began to be affected in anticipation of the US Federal Reserve drawing down stimulus, triggering a 10 percent decline in the value of the baht. Nevertheless, Thailand has around $134 billion in foreign currency reserves, enough to stabilize the currency if it experiences a shock.

However, Thailand’s real challenge is in the political sphere. A conflict that has its roots in geopolitical divides between the two main population centers in the country has once again left Bangkok besieged by protesters. The traditional Bangkok political system is reaching the end of its ability to accommodate the country’s rapidly shifting political landscape as Thailand’s rural population continues to gain political clout, and a return to the status quo is increasingly unlikely without a broad reconciliation between the two factions.

Amid speculation that the military may be seriously considering staging a coup, voters head to the polls Feb. 2 in a vote that may further exacerbate turmoil and weaken investor confidence. Most worrisome for those currently invested in Thailand or considering investing in the country is that the underlying constitutional crisis and impending royal succession suggest a trajectory of continued division, political uncertainty and periodic mass protests even beyond this immediate episode of unrest. Although there are no clear signs that foreign manufacturers are considering pulling out of the country, persistent unrest could severely undermine Thailand’s competitiveness as an investment destination.

India is gearing up for general elections expected in May. Current polling shows the Bharatiya Janata Party, India’s main opposition party, leading ahead of the incumbent Indian National Congress. Domestic and foreign observers expect a Bharatiya Janata-led government to have a more investor-friendly, pro-business policy agenda. However, the challenges facing India’s new government will be extensive, including strong institutional barriers for New Delhi to rapidly assert control over India’s disparate states.

The election comes as India anticipates growth to slip below 5 percent in the coming year. India’s current account is in chronic deficit. Marginal gains were made in 2013, when the current account deficit was estimated to be $78 billion. However, this slight improvement was driven in large part by restrictions on gold imports that merely shifted the gold trade into the black market, meaning that foreign currency continues to drain from the country at an even more rapid rate than official statistics indicate.

India has also seen a downturn in portfolio investment from abroad, and the currency has depreciated 14 percent since the first whispers of a taper began—something that could worsen inflation on imported goods but that has already helped Indian textiles to be more competitive on global markets.

However, India’s real challenges are longer term. The country remains very energy poor and burdened with serving a population of 800 million people living in poverty.

New Delhi is caught between having to develop policies that not only facilitate the growth needs of a vibrant metropolitan marketplace with deep ties to international markets but also address the needs of an enormous, poor rural population requiring consistent subsidization. The indelible contradiction and competition for resources between the two economies of India will only exacerbate divisions between local and national authorities, restricting New D.

Republishing by The Manila Times of this analysis is with the express permission of STRATFOR.


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