December 2018

Country Ranking Trends

Governance in the investible countries continued to improve during 2018, though at the very slow rate of 0.25% (about a quarter of historical rates). Six countries improved, while eleven countries deteriorated. The biggest improvements were in India and Indonesia, and those more than offset the mostly small deteriorations.

Yellow Vests are Distracting More Than France

Protesters, dubbed the ‘yellow vests’, protested throughout France. Unlike earlier protest movements, these have been planned largely through social media without union or political party organization. The immediate spark was the almost 20 percent increase in the price of diesel fuel since the start of the year, as well as the recently announced hike in fuel taxes. However, the protesters are also expressing frustration with President Macron and the political establishment that they accuse of being out of touch. The protesters are primarily from rural towns and suburbs where fuel price increases and concerns about living costs are felt most acutely. In response to the protests, Macron has promised to get more money into the hands of working people. In addition to scrapping the new gas tax, he has proposed raising the minimum wage and removing the tax on overtime. He also encouraged employers to give workers a tax-free bonus. The first weekend following Macron’s concession speech saw a reduction in protester turnout, but the issues raised by the protestors will continue to be a challenge for Macron’s reform agenda.
Implications: As with other major European countries, these events need to be viewed as more than country issues; there are EU implications. The protests and related activities both consume time that could have been used to reform France and, at the same time, weaken Macron. In addition to impeding much-needed French reforms, Macron has less ability to help the EU navigate complex issues. These uncertainties create risk, and that risk will likely sustain a headwind on European equity valuations.

In Britain “Compromise” Appears to be an Endangered Species

There has been a lot of news about Brexit. It can be easily summarized. The default position is a “hard exit” where there is no agreement. Prime Minister May will attempt a “Hail Mary” pass to get some variation on the recently negotiated agreement with the EU through Parliament. Other forces are attempting a different “Hail Mary” pass by seeking a new Brexit referendum. A new referendum appears to have somewhat better odds, though neither appears likely. A new referendum carries risks as well given that there is little data on the probability of a different result. Britain and the EU are now beginning to accept the reality of a hard exit.
Implications: The level of disruption from a hard exit will be higher than it would have been had preparations been started earlier. As we said last month, Britain is fairly strong and likely to be fine over the long term regardless of events. The implications for the EU are more complicated. Various uncertainties are likely to remain over the continent, thus preventing equities from achieving valuations consistent with traditional earnings multiples. Whenever these clouds disappear, there could be a nice rebound in valuations.

Can India Sustain the Progress?

The Reserve Bank of India (RBI) governor Urjit Patel has resigned citing personal reasons, though government efforts to undermine the independence of the central bank were likely a factor. The central bank and the government have clashed over easing lending curbs and using RBI reserves to help fund India’s fiscal deficit. The government has named Shaktikanta Das, a retired bureaucrat, as the new RBI governor. He is seen as having the experience necessary to reassure investors, but his close ties to the administration won’t lessen concerns over the independence of the RBI. In his early comments following his appointment he pledged to uphold the central banks’ independence. However, he also said he would consult more closely with the government on policy issues and meet heads of state-run lenders to address problems facing the banking sector. He also struck a more dovish tone on prospects for inflation.
Implications: A key question will be if Das continues the clean-up of India’s banking system that began under his predecessors. Overall, a series of improvements in Indian governance have moved the country toward the top of the emerging markets. Continued reforms could move India ahead of troubled countries such as Poland and Hungary. Conversely, a loss of central bank independence could signal a retrenchment and become a leading indicator of future problems.

How Far Will Poland Fall?

Poland’s president has signed legislation that allows supreme court judges to return to work after they had been forced into early retirement. The legislation answers the European Union’s Court of Justice interim verdict ordering Poland to freeze its judiciary overhaul. The new legislation is a retreat for the ruling Law and Justice Party (Pis). The fact that Poland has complied is at least a partial victory for the EU, however other disputed PiS reforms remain in place. Polish authorities have adopted over a dozen laws allowing the government and parliament to assert control over the judiciary. While signing the recent legislation into law, the president also indicated he was doing so only to relieve the current pressure on the government. Poland’s reversal is unlikely to be the last word in its dispute with the EU.
Implications: Poland’s compliance with the EU somewhat diffuses the most acute issue; however, it doesn’t change the risks posed by the populist government. Over the last year Poland was downgraded for opaqueness in its Fiscal Transparency, and as a result the country dropped three places in the Magni Rankings. After the collapse of the USSR, Poland was the shining success of countries in eastern Europe, but it is now at risk of falling below Asian countries.

Are They “Hungary” Enough to Change?

Hungarian lawmakers approved a law that will further tighten the government’s hold over the court system. The new law creates a parallel court system to handle all cases relating to the state, and as a result gives the executive (Prime Minister Victor Orban) greater control over the judiciary. Legislators also approved a law raising the amount of overtime that employers can demand of workers: from 60 percent, to 400 hours annually. Critics dubbed it the “slave law”. Daily protests against the government have begun and reflect broader discontent with the government. The disparate opposition groups have formed an uncharacteristic, and perhaps temporary, alliance.
Implications: So far, the protests do not pose a serious challenge to Mr. Orban’s government, but they may mark the start of a new phase in Hungary’s politics. Like most populist governments, actions by the leaders erode the quality of governance. Magni will be watching events as they unfold. Perhaps the protests will evolve into a positive force to minimize damage, however the history of popular rebellion against populists is not good. Hungary’s relatively high ranking among the countries in the emerging markets remains at risk.