A rally in some of the world’s riskiest emerging markets, triggered by a pivot to market-friendly policies, is already showing signs of fatigue.
Markets from Egypt and Turkey to Nigeria and Argentina had soared in recent weeks as the promise of normalizing economic policy — currencies were devalued and financial restrictions lifted — buoyed investor sentiment. That enthusiasm is already dimming, however, as some Wall Street veterans offer a grim reminder: Reform agendas often have a way of stalling in developing nations, punishing bulls who buy into the optimism.
“Investors should be skeptical of the reform pledges because real reform takes time and compromise,” said Adriaan Du Toit, the London-based director of emerging market economic research at AllianceBernstein. “And it’s harder to pull it off in a weak growth environment.”
The quick end to these rallies would underscore a key challenge that developing nations face in 2023: With benchmark interest rates still rising in the US and Western Europe, long gone are the easy-money days when foreign investors were eager to plow cash into more exotic, riskier assets in the hope of eking out strong returns.
Almost nowhere are investment questions looming larger than in Turkey. In the wake of his re-election, President Recep Tayyip Erdogan has handed the reins of the economy to an advocate of conventional policies, likely signaling a shift from unorthodox measures that have been blamed for galloping inflation and an exodus of foreign money.
Treasury and Finance Minister Mehmet Simsek, however, has already indicated he will take a measured approach in steering toward more conventional policies.
“Not only is the shift more gradual than some short-term investors might have hoped for,” said Hasnain Malik, a strategist at Tellimer in Dubai. Longer-term investors “considering a revisit of Turkish assets should have eyes wide open to the risks to the durability of this change in direction.”
Lingering Doubts
Investors are also considering the potential for change in Egypt, which has yet to fully execute the free-floating currency it’s been talking about since 2016.
Even after a few periodic devaluations, the country’s unofficial currency market is still thriving. That’s left the cash-strapped government to race to raise dollars via sales of state assets. Goldman Sachs Group Inc. strategists estimate the nation needs more than $5 billion for an “orderly transition to a unified, market-clearing exchange rate.”
Initial euphoria about Nigeria’s incoming President Bola Tinubu, who unleashed a wave of policy changes as soon as he took office, is also starting to raise questions.
The new leader surprised money managers by embarking on a series of bold fiscal moves, unshackling the country’s currency and dismantling a costly decades-old system of fuel subsidies.
But transport costs have doubled in the nation after the subsidies were vanished, spurring signs of simmering social tension. The naira has swung wildly since controls were lifted.
Argentina’s upcoming presidential election has also triggered a bout of investor optimism, helping the nation’s dollar debt due in 2030 to last week touch its highest since March. The theory is that voters, faced with triple-digit inflation, will ultimately spurn a left-leaning government in October’s elections and welcome a more market-friendly leader.
Across these markets, it’s a question of “policy objectives meet political realities,” said Todd Schubert, the Dubai-based head of fixed-income research at Bank of Singapore. The ability of leaders to strike a delicate balance between the need to bring order to fiscal chaos and the imperative to protect the vulnerable will determine the continuity of reforms.
“I have not turned more constructive on any of these countries yet,” Schubert said. “From a risk-reward objective, I am willing to miss some of the initial upside and wait until the hopes become reality.”
What to Watch
- China’s PMIs will likely show the recovery lost more momentum in June and declines in industrial profits will probably deepen, according to economists surveyed by Bloomberg.
- Sri Lanka will report inflation, which Bloomberg Economics expects to have fallen in June price gains in food and fuel slowed and a stronger currency helped lower the cost of imports.
- Poland is also set to release inflation data, which will likely confirm that the year-on-year rate is on track to reach single digits by September, according to Bloomberg Economics.
- Brazil’s National Monetary Council is expected to review inflation targets for 2024 and 2025 and set a target for 2026. The meeting could influence the rate outlook.
- Colombia’s central bank is expected to hold its benchmark rate at 13.25% at its June 30 meeting.
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