February 2021

Country Ranking Trends

  • Magni recently completed assessments involving corporate insolvency structure in investible countries. Each country has laws and regulations regarding corporate governance in the processes for handling troubled companies; handling of such companies is important to investors. If a country has weaknesses in protecting the rights of shareholders when a company has financial trouble, the risks from investing in any company in that country are higher than in countries with better processes, especially safeguards for shareholders. Investors will expect a higher return to compensate for the higher risks, thus creating downward pressure — both on the level of investment and on share prices.
  • Both Turkey and Qatar received modest upgrades, because of partial progress in implementing intentions to strengthen corporate insolvency processes. The remaining countries received small downgrades, reflecting various deficiencies in these processes.

Can Super Mario Handle the Immediate Challenge and Set Italy on a Better Path?

  • Former European Central Bank chief Mario Draghi has been sworn in as Italian prime minister following the collapse of the previous coalition. This most recent collapse was precipitated by disagreements over the priorities for distributing funds from the EU’s coronavirus recovery program. Italy’s President Sergio Mattarella asked Draghi to form a new government for reasons beyond the current disagreement. Mattarella hopes that the well-respected leader has the stature to tackle the long-standing problems besetting Europe’s third largest economy. Italy’s sovereign debt load is almost 160% of output and the economy is mired in a deep recession after almost two decades of stagnation. Both chambers of parliament supported Draghi’s government with large majorities, thus ending weeks of political gridlock and avoiding a snap election.
  • In his acceptance speech, Draghi stressed the need for unity, comparing the task ahead to the post-war reconstruction. He outlined an ambitious agenda of structural reforms and called for an ever-more integrated EU with a common budget capable of supporting countries in recession. The government’s immediate task will be to develop a plan on how to use a sum close to €200bn in conditional grants and loans from the EU’s recovery fund available to Italy over the next six years. Final plans must be submitted to the European Commission by the end of April.
  • Implications: Since the end of World War II, Italy has installed a new government almost every year. Draghi faces significant issues both in the complex politics surrounding the recovery fund and in addressing the structural issues in the country. If Draghi’s coalition survives longer than average, his experience as a banker can be applied to reform Italy’s financial services regulations. Such reforms could move Italy’s governance from below average among the countries of the developed markets to ahead of France and Switzerland. While it is a tough challenge, the rewards could be significant.

Mountain Skirmishes Are Symbolic of Growing Rivalry Between China and India

  • China and India have agreed to a phased troop withdraw along their long disputed border in the Himalayas. The undefined border, known as the Line of Actual Control or LAC, was established following a brief war fought between the two countries in 1962. The LAC is characterized by numerous overlapping claims particularly around Pangong Lake where the two side have been engaged in a nine-month-long standoff following a melee in June which left twenty Indian soldiers dead and at least four dead on the Chinese side. Each nation accuses the other of instigating the confrontation. In the subsequent months, both countries have deployed soldiers, fighter aircraft and heavy artillery to the high-altitude border area. The disengagement plan calls for both sides to remove temporary structures and infrastructure built since April and to suspend patrols in the disputed territories, while returning to pre-April 2020 positions. As a confidence building measure, India also has said it would soon begin approving some commercial investments from China, which had been blocked following the increase in tensions.
  • Implications: Chinese foreign policy has grown more aggressive under President Xi. More recently, India under Prime Minister Modi has also become more aggressive. The competition will grow more intense. There likely will be more conflict, though the remote Himalayan locations limit conflicts to small skirmishes. The two countries have comparable overall governance scores with both ranking close to Brazil, in the middle of the countries of the emerging markets. China has improved, intermittently; India had stagnated until Modi was elected with modest improvements after Modi’s initial turbulent year. While China has demonstrated stronger economic improvement and has captured more media attention, India has more upside potential.

Current Brazilian Improvement Does Not Address Biggest Challenges

  • Brazil’s lower house of Congress passed a bill giving the central bank greater autonomy. The legislation was approved by the Senate last year, and it now goes to President Jair Bolsonaro for his signature. The reforms strengthen the bank’s independence by giving the central bank president and directors four-year terms. It sets a two-term maximum for the central bank chief, who, like the directors, will be nominated by the president and confirmed by the Senate. To prevent political interference, the new law restricts the ability to remove directors before their terms expires. Currently, there is no fixed tenure, and they can be replaced at any time. The bill also expands the central bank’s mandate from solely keeping prices stable to include broader concerns such as promoting full employment.
  • The central bank has kept its benchmark interest rate at a record low of 2% to help counteract the pandemic induced economic downturn. However, inflation numbers have risen to near the top of the central bank’s target range, thus creating pressure on the central bank. Greater central bank independence should give investors confidence that policy makers will take the steps necessary to keep inflation under control.
  • Implications: Successful implementation of these changes positions Brazil for an upgrade to its score in monetary policy. That said, Brazil retains an overall country governance rank around the middle of the emerging markets. Improving its position requires implementation of the structural reforms required to reduce corruption. From weaknesses in market integrity to incomplete regulatory frameworks for financial services, Brazil has too many opaque areas which create cover for corruption.

“Groundhog Day” Returns to Argentina

  • Negotiations are continuing between the IMF and Argentina regarding a new IMF program to replace the 2018 loan facility. Argentina is in its third year of recession. So far, more than $44 billion has been distributed through the loan facility, while Argentina remains unable to repay these amounts. Around $5 billion (USD) is coming due this year with most repayments due in the subsequent two years. Argentina is seeking to extend its debt payments for as much as a decade.
  • The government has said that it would like a deal by May: a target that the IMF says is ambitious though feasible. However, negotiations have stalled over how fast Argentina will cut unsustainable government spending. No substantial progress has been made in the six months since Argentina successfully restructured $65bn of bonds owned by private creditors. Vice-president Cristina Fernández de Kirchner, an influential voice with a long history of antagonism toward the IMF, has suggested postponing any deal until after midterm elections in October. Prices for soybeans, Argentina’s major export, recently have hit their highest levels since 2014, thus providing some optimism. Some are advocating a strategy of muddling through to avoid any politically difficult decisions before the election, though delay likely will make the inevitable terms more difficult and painful.
  • Implications: Magni was confused when MSCI chose, in May of 2019, to return Argentina to the countries of the emerging markets. The repeated cycles of financial crisis keep the country unstable. The near-term pressures prevent consideration of the structural reforms required to end the cycle and place the country on a path for success. Argentina retains a governance score just ahead of Pakistan. Resolution of the financial issues, combined with reforms to stop the cycle of frequent crises, would move the score ahead of Russia. For now, it will remain Groundhog Day.