Financial publications have often highlighted the negative aspects of investing in emerging markets, which plays on the fears of risk adverse investors.
Whether it's end of democracy in Turkey, another political scandal in Brazil, or the risk of further economic sanctions on Russia, the reality is that these are the type of headlines that the media love to embrace. After all, they want to grab the attention of the audience, and what better way to do that than to claim there's another crisis brewing. Quite often, investors are not buying their 'doom and gloom' message. There's a simple reason for that: investors have become much more seasoned to political risk, which can often present an attractive buying opportunity.
The reality is that emerging markets is one of the few areas where investors can find yield with low default risk.
Sure, there will be increased volatility at times, but that comes with every asset class. Political risk is part and parcel when it comes to investing in emerging markets, but what really matters is debt sustainability.
So next time you come across a story about another emerging market crisis, remember this: Fake News.
A closer look at Turkey
The downgrading of Turkey from investment grade to speculative grade (or ‘junk’ status) at the beginning of 2016 saw many investors head for the exit. While headline risk has been elevated over the last year, this has only improved valuations. South Africa’s 10-year Eurobond is a good illustration: despite being rated as investment grade, the bond has worse credit metrics than Turkey’s 10-year Eurobond. Markets are rarely efficient, especially in areas such as emerging market debt, and there are often opportunities to gain exposure via some very attractive entry levels.
Turkey is not without its risks, something we readily acknowledge. However, when faced with collapsing growth and a rapidly depreciating currency, as well as rising inflation following the failed coup attempt, it was encouraging to see the country respond well. The combination of fiscal loosening and monetary tightening was straight out of the economic textbook. This policy mix and the supportive global environment put the country in a sweet spot, allowing time to implement much needed structural reforms to improve its potential growth rate and ensure sufficient job creation to accommodate its growing work age population.
Data doesn’t often lie and the latest set reveals the economy continues to move in the right direction. Strong export performance, robust public spending and the government’s loan guarantee fund deserve a mention, while the tourism sector is also rebounding.
However, the constitutional referendum failed to remove political uncertainty, and hence private investments has so far failed to rebound. A key risk is that the government under-delivers on reforms, meaning they would continue to rely on large-scale infrastructure projects to support growth after the impact of the fiscal stimulus rolls off late in the year. Given the limited fiscal and monetary space, the administration might be forced to revert to more unorthodox measures. This might include leveraging up the Turkish economy and undermining sustainability.
Against these longer term concerns, markets seem to have overpriced political risk in the shorter run. While the state of emergency will remain in place, early elections will not be called this year, while a much anticipated government reshuffle might open the way for economic reforms.
The economy is still grappling with uncertainty, but it’s not in bad shape and Turkish debt is not to be snuffed at.
The value of investments and the income from them can go down as well as up and investors may get back less than the amount invested.
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