June 2018

Moving on up

  • Starting in 2019, Saudi Arabia and Argentina will be considered part of the emerging markets. Saudi Arabia has taken steps to bring local capital markets more in line with international standards, including lowering restrictions on international investors. This is part of a reform driven by the Saudi government to diversify its economy and create private sector jobs. Argentina was demoted in 2009 to frontier market status after the past government’s imposition of capital controls. A market-friendly president is seeking to improve the country’s international financial standing after years of economic mismanagement by the former populist government.

Country Ranking Trends

  • Magni completed a review of shareholder rights. Investors generally see less risk in exchange-listed equities where the country of the exchange provides strong protections of shareholder property rights. The review confirmed many existing scores, though two countries were upgraded for progress in implementing reforms, and two countries were downgraded for deficiencies in implementation. The two upgrades were based on India’s implementation of strengthened shareholders rights, and Indonesia’s additional progress in implementing prior reforms. Conversely, the two downgrades were based on Ireland and Portugal having demonstrated behavior inconsistent with strong shareholder property rights.

When Does a Trade Dispute Become a War?

  • The United States and China have each recently announced tariffs that are set to go into effect on July 6. President Trump has also threatened additional tariffs on another $200 billion, bringing the total to around $450 billion worth of Chinese goods. In addition, the US has proposed new investment restrictions and import controls on China, though the Trump administration is beginning to back away from those proposals. The US actions are seen by supporters as a reaction to unfair Chinese trade practices such as intellectual property theft. However, there are concerns about starting a deeper trade conflict with no easy exit. The uncertainty and sometimes conflicting signals about the direction of trade policy also hurts business confidence and disrupts complex supply chains. Trade risks are not limited to China. The prospects of a NAFTA deal this year have deteriorated with Trump threatening a new trade spat with Canada. The European Union has said it will retaliate against US steel and aluminum tariffs, and in response the US has threatened to impose tariffs on German cars.
  • Implications: So far, the absolute level of tariffs as a percentage of global trade is still small, but the longer this goes on the greater the chance of lasting damage to the multilateral trading system and to the major economies of the world. Tariffs and related government actions do not directly impact governance and hence Magni Country Scores. Trade disputes tend to be transitory in nature. While not impacting the inherent and long-term investment attractiveness of a country, the disruptions caused by these sorts of trade actions can have short-term effects on equity prices and can increase volatility. Magni will be watching for extralegal actions which indicate poor governance, and, in the meantime, we will watch the trade dispute play out.

The Conundrum of Erdogan and Turkey

  • Turkish President Erdogan won more than half the votes in the just held presidential election meaning he will be able to avoid a second-round runoff. His Justice and Development Party will also control the Parliament in coalition with a smaller nationalist party. With his re-election Turkey moves closer to one-man authoritarian rule, as he returns to power under a new executive presidential system that gives him greatly expanded powers including the abolition of the post of prime minister as well as the ability to issue decrees and appoint judges. He has also vowed to become more involved in monetary policy. The Organization for Security and Cooperation in Europe said the opposition parties were denied equal conditions for campaigning, but they praised the high turnout of around 87 percent.
  • Implications: As Magni has written in prior commentaries, Turkey under Erdogan’s rule improved its governance at a rapid rate. The improvements stopped around the time of the attempted coup. Since then, the quality of governance has stagnated. The expanded powers make Erdogan even more likely to be an autocrat. Autocrats tend to be harmful to governance. Magni will be watching whether Erdogan rises above history or succumbs to the path of so many other authoritarians.

Merkel’s Coalition Government Appears to have Survived

  • A very recent meeting of government officials on asylum policies ended with surprise progress and a compromise decision. This decision was badly needed by German Chancellor Angela Merkel. She has been in a dispute over migration with her interior minister, who is also a member of the Christian Social Union (CSU), the junior partner in her governing coalition. This dispute threatens to topple her three-month old government. The interior minister has said he will defy Merkel and introduce border controls if a migration deal isn’t reached. The minister wants refugees registered in other EU countries to be turned away at the German border. Merkel seems to have resolved the dispute through the compromise. Merkel’s open-door migrant policy, which has resulted in the arrival of more than 1.6 million migrants in Germany since the start of 2015, is widely blamed for the rise of the far-right Alternative for Germany (AfD). The stance of the CSU in this dispute is seen by observers as an attempt to stem an advance by the AfD in October’s Bavarian state assembly election.
  • Implications: There had been a meaningful chance that Merkel’s coalition government would fall and there would have been new elections. Given the continued rise of the far-right parties and the challenges in forming a government following the prior election, a new election would likely have been a complicated and slow process. Germany is a strong country with a strong economy. It can endure a protracted period of uncertainty.
  • The EU is in a much weaker position. Merkel will probably continue to be focused on maintaining her coalition government, and thus not be able to provide leadership to the EU. France’s Macron has so far been unable to fill the leadership vacuum. Without French or German leadership at the EU, the organization will likely stagnate, which increases the likelihood of starting some sort of EU unwinding process. Yet, the catalytic event to start the unwinding does not appear to have occurred. The leadership vacuum will also reduce the probability that the EU could develop and adopt some package of reforms designed to prevent unwinding once the catalytic event occurs, though the surprising nature of the recent compromise is a small sign of progress. Simply put, Europe will continue to face heightened uncertainty.