Chinese real estate: systemic risk or specific opportunities for credit investors?
Alan Siow discusses recent volatility in China’s property sector and its implications for investors in the country’s credit market.
May 24, 2022
Rising populism, which is generally accompanied by more polarised politics, resurfaced in Latin America in 2018/19 and the pandemic accelerated it. The region’s response to the COVID crisis was justifiably strong, but removing this fiscal support – while vital for long-term debt sustainability – has proven to be highly unpopular and politically unpalatable. In reflection of this, some high-quality countries have surprised investors in recent months by moving sharply to the left, rolling out heavy fiscal spending and dipping into domestic pension pots. This has created significant political uncertainty and fuelled concerns over the path towards fiscal consolidation. But the ultimate outcomes of some recent elections were more nuanced and diverse, and less economically damaging than feared. Reflecting on these could provide useful insights for investors assessing forthcoming elections in Colombia and Brazil.
Chileans’ appetite for change – in evidence since the October 2019 protests – shone through as they cast their votes in the first round of the country’s presidential election. As we wrote about last year, a more polarised political picture emerged. The comfortable second-round win by left-wing Boric took the market by surprise, after polls had suggested a very tight race. However, President Boric’s new cabinet has been more market-friendly than expected, especially the highly experienced minister of finance. Furthermore, the right and centre-right’s strong performance in the congressional election has created an important buffer against any future radical policy; this was in evidence in April as the proposal for a large fifth pension fund withdrawal in Chile was rejected by the Chilean Chamber of Deputies. The rejection of this bill is blamed for the fastest drop in presidential popularity on record in Chile, as revealed by several recent polls.
In February, negative headlines and noise emerged around the constitutional convention, particularly involving the process of nationalising some of the country’s largest mines. Following a long process, the proposal did not end up in the final draft, but the issue temporarily impacted asset prices.
In neighbouring Peru, the unexpected congressional impeachment of popular President Vizcarra unleashed violent protests in November 2020 and led to three presidents over a single week, all while the country was enduring one of the highest COVID-19 infection rates globally and one of its worst economic contractions. Against this backdrop, the 2021 presidential election became a race between an anti-establishment populist and a market-friendly establishment candidate, with the former – Free Peru party candidate Pedro Castillo – taking victory. Castillo’s early attempts to undermine the power of the legislative were thwarted by the country’s politically fragmented Congress, which passed a law to limit presidential powers. With Congress also pushing back on some early cabinet appointments, what followed was a bumpy path towards political moderation that ultimately restored confidence, with asset prices recovering as political risk reduced. However, the recent truckers’ strike in Lima, which prompted the government to increase the minimum wage by 10% and reduce tax levels, highlights the challenging near-term backdrop.
While the political changes in these two countries certainly give reason for prudence, they also serve to highlight the important role that the strength and depth of democratic institutions can play in curbing wholesale changes that could threaten longer-term debt sustainability.
Last year’s election result in Ecuador, where Correa’s brand of populism seemed unassailable, showed how voters can tire of populist regimes – often accompanied by authoritarianism and rising corruption – and shift back to the centre. After the first round of Ecuador’s general election in February 2021, the market began pricing in a win for opposition candidate Andres Arauz, whose rejection of the country’s deal with the IMF alarmed investors. However – and after years of a far-left leaning administration – a few months later the electorate surprised the market by electing a market-friendly centre-right candidate, Guillermo Lasso. This helped Ecuador’s hard currency bonds to rebound strongly, providing investors with some of the highest returns across the EM debt universe over 2021. Since the election, reform momentum in the country has been positive, as the Lasso administration continues to work under an IMF programme.
Costa Rica is another Latin American market that shifted back to the centre, with the move being quickly rewarded by strong outperformance relative to the rest of the EM universe. When Costa Ricans cast their votes in February 2022, polls were very divided and concerns lingered over the potential for a strong performance by left-wing candidate Villalta, who would make the continuation of Costa Rica’s IMF program much more difficult. Fortunately, two market-friendly candidates made it to the April run-off, with centrist PLN's candidate Jose Maria Figueres facing right-wing PSD's Rodrigo Chaves. Chaves won and he is expected to take a hawkish stance on fiscal policy and support an IMF programme.
While it can be difficult or impossible to predict election outcomes with any degree of certainty, that should not equate to inaction by investors in the run up to elections. Scenario analysis is key to assessing risk/reward under various potential outcomes and then considering current market prices in this context. While this is a continually evolving process in the run up to any election, here we share a current snapshot of our views on Colombia to illustrate such an approach.
Scenario analysis – Colombia
Source: Ninety One, May 2022.
Based on the above, we believe the risk premium in hard currency sovereign spreads is excessive, making valuations attractive given the balance of risk, but the Colombian peso is vulnerable to negative event risk.
Earlier this year, left-wing candidate Senator Gustavo Petro came out on top in the primary election, in line with expectations. But centre-right candidate Federico 'Fico' Gutierrez performed a lot stronger than expected to become the main contender against Petro. In the election for Congress, Petro’s left-wing party won more seats than expected but not enough to get a majority – leaving the legislature still split, with the centre right retaining a blocking share. Later, Petro appointed a vice-presidential candidate who is perceived to be quite radical; in contrast, Fico’s vice president appointment has good links with the country’s liberal party, suggesting that a Fico victory would herald a centrist administration. A recent poll showed that Gustav Petro is still in the lead going into the first-round presidential elections at the end of the month, despite Fico receiving support from the liberals – an important political party in the country. While Petro has suggested that he would pursue a number of concerning policies, we feel confident that the institutions in Colombia are strong and that Congress, the Senate and the Constitutional Court will balance the executive branch’s power. The other contender to watch is the independent candidate, Rodolfo Hernandez; while we consider his probability of success relatively low, his strong momentum in the last round of polls warrants consideration.
Another key forthcoming election for the region is Brazil’s presidential election. President Bolsonaro is known globally as a populist, but socially conservative, right-wing president. But his popularity is at all-time lows, due to his mismanagement of the pandemic and abrasive style. While his finance minister, Paulo Guedes, managed to pass some key market-friendly reforms early in the administration, the agenda has stalled, and the pandemic provided cover for a breach and weakening of the all-important fiscal spending cap rule.
While it is too early to predict the outcome of the October elections, Brazil’s ex-President Lula is leading in the polls by a wide margin. The main question is what kind of president would Lula be now? His openness to running in tandem with a centrist candidate (former Sao Paulo governor, Alckmin) is encouraging. However, his policy proposals are light on detail, and he is considered unlikely to abide by the spending cap rule. Therefore, the risk of continued fiscal slippage is quite high, especially since Congress has not traditionally provided a strong check against profligate policies.
Elsewhere, polls currently indicate that in the 2023 presidential elections in Argentina, we may see another political pendulum swing – in this case from the left to the right. Given the clumsy performance of the Alberto Fernandez administration, ruling in coalition with the ‘kirchneristas’ (Cristina Kirchner is Vice President), there is evidence of a move back towards the centre-right party of ex-President Macri and surging support for radical, libertarian candidate Javier Milei.
Many emerging countries, much like their developed market counterparts, are in an era of heightened political uncertainty characterised by a broad distrust of the establishment. This has led to a rise in populism, and with it, a general tendency of moving towards the left of the political spectrum. However, investors should consider the nuanced picture beneath the headlines. Even if a far-left administration gains power, recent events have shown that the negative fiscal impact may be significantly smaller than initially feared (and priced) for a variety of reasons, not least the important role of democratic institutions in curbing damaging shifts in Latin America. The diversity and complexity of this investment universe makes a selective and nimble approach vital, with scenario analysis a useful tool for investors, potentially revealing market mispricing of political risk at the individual country level.
Emerging market: These markets carry a higher risk of financial loss than more developed markets as they may have less developed legal, political, economic or other systems.
All investments carry the risk of capital loss. The value of investments, and any income generated from them, can fall as well as rise and will be affected by changes in interest rates, currency fluctuations, general market conditions and other political, social and economic developments, as well as by specific matters relating to the assets in which the investment strategy invests. If any currency differs from the investor’s home currency, returns may increase or decrease as a result of currency fluctuations. Past performance is not a reliable indicator of future results.