Emerging markets democracy: better than you think

June 2024 / 3 minutes

Explore the recent elections in Mexico and India to understand what it means for EM investors.

The UK has held three general elections since 2015, with the next one scheduled for 4 July 2024. As one of the world’s most established democracies, Britain also has one of the highest election frequencies over the past decade.

In contrast, younger democracies in emerging markets have demonstrated their ability to execute smooth electoral transitions in recent years. The past month witnessed two major elections in the emerging world. In Mexico, Claudia Sheinbaum led her Morena Party to a surprising landslide victory, while in India, Narendra Modi’s Bharatiya Janata Party (BJP) massively underperformed the hyped-up expectations placed upon it.

These are markedly different electoral results - one exceeding expectations, the other falling short – both unsettled investors initially. So, what really matters?

Capital at risk.


Our contention is that emerging markets investing is always a specialist discipline. The ability to understand macro drivers and political implications is critical when thinking through how portfolios are best constructed. This is not only about avoiding the rare catastrophic downfalls, when politics drags an EM country completely off the track. It is also about not overreacting to short term political events, which tend to loom large and are often exaggerated by market commentators who search for definite implications too quickly.

In our view, neither election result from Mexico nor India is likely to fundamentally alter the investment cases for these countries.

In Mexico, Sheinbaum inherits an economy in reasonable shape: public debt to GDP is 50 per cent, it runs a manageable current account deficit of one per cent of GDP, and it has ample foreign exchange reserves of more than US$200bn. While seen as a protégé of outgoing president Andrés Manuel López Obrador (AMLO), there are reasons to believe that Sheinbaum may be able to adopt a more flexible and technocratic approach. She has pledged to maintain fiscal austerity and facilitate private investments. Both are needed to prevent the country from sinking deeper into debt, especially given PEMEX, the state-owned oil company, has more than a $100bn debt burden.

Another aspect to consider is the question whether Sheinbaum will leverage her stronger personal mandate to chart her own path. A climate scientist-turned president, Sheinbaum has promised to advance Mexico’s transition to green energy during her campaign – a critical area that stagnated during AMLO’s statist leadership. Plentiful clean energy is essential to spur economic growth, attract FDI and relieve the strain on an overburdened power sector.

Our view on investing in Mexico hasn’t changed, with selected exposures in the financial and consumer sectors, including the likes of Banorte and FEMSA. The recent election is unlikely to significantly change either the nearshoring dynamic or US relations. In the long term, Mexico’s ability to capitalise on the nearshoring trend will highly depend on who occupies the Oval Office when the United States-Mexico-Canada Agreement is up for review in 2026. This is expected to have a larger impact on Mexican assets than the worry of any potential shift further to the political left domestically.

India's electoral story was more surprising. The Economist called it 'a rebuke for the BJP, a triumph for Indian democracy’. While Modi will retain power for another five years, he must now govern through a coalition. This will make politics messier, but also reduces the risks of overly centralised power.

Under Modi’s leadership thus far, India’s economy has doubled in size. The fundamentals remain intact, but sustaining this momentum will depend on the government’s policy going forward. The fear is that the BJP, now politically more vulnerable, might resort to fiscal populism - diverting funds from investments in vital infrastructure to more immediately popular social handouts.

However, if the government can resist the pull of welfarism, as it largely has during Modi’s previous terms, India is still likely to achieve an average real annual growth of 6-7 per cent over the next five years. This would allow its economy to surge past Germany and Japan, and to rank third globally by the time of the next election.

It is worth noting that the substantial infrastructural progress over the past decade has laid a solid foundation for future growth: the GST (good and service tax) reform has turned India’s 27 disparate states and territories into one national market through the digitalisation of tax collection. The biometric Aadhar platform streamlined subsidy payments directly to recipients, reducing corruption. Additionally, the Modi government has made remarkable progress in road, rail and metro infrastructure development.

That said, we should remember that the private sector has also played a crucial role in India’s development. Some of the portfolio holdings have made significant impact there. Notably, Reliance Jio has revolutionised India’s telecom sector, and the country now boasts a first-class (and affordable) digital infrastructure.

Our long term view on India remains optimistic for stock picking, though we are selective and cautious regarding valuations in the small and mid-cap segments. The ongoing bull market is the second-longest in India’s history. While it has lasted 80 per cent as long as the leading bull market, its cumulative return is less than a third of that period.

Historical performance also indicates that Indian asset prices have fared well during previous coalition governments. For instance, under the Congress-led coalition, the MSCI India index returned 200 per cent in 2004-2014, similar to the performance seen during Modi’s first two terms with a single-party majority. This highlights that politics may have less impact on long term stock markets returns than commonly perceived. Our stance remains prioritising researching and identifying the best growth opportunities at a company level.

Perhaps the biggest takeaway from these two elections, however, is simply that they passed with little incident. In addition, let’s not forget that Mexico has just elected its first female president, a significant milestone. We can add to this list the elections we have seen in Taiwan, Indonesia, and South Africa, which all similarly saw a peaceful, orderly transition of power. At a time when populism and fragmentation are challenging the West’s political fabric, the progress being made in emerging markets is worthy of note. The bond markets have recognised the stability and predictability presented in emerging markets, with their sovereign yields now close to those in developed markets. We perhaps shouldn’t be surprised by this. It’s easier to embrace democracy in an environment of broad-based and steadily improving living standards; this is also an environment that would typically yield strong investment returns. 


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