Emerging Market Risk Analysis Must Focus On Resilience (Not Just Disruption)
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Since 2017, the world has seen 135 significant protests against the political and economic policies of host governments. A review of news articles during this six-year period reveals myriad headlines imploring investors to “run for the hills.” Using the buzz words of “political instability” and “volatile emerging markets”, on-air pundits often urge investors to sell off their investments that are most affected by the civil unrest. Chaos in the streets today means currency devaluation and capital flight tomorrow. Before investors make any rash decisions, there are a few questions they should ask themselves and/or their advisers.

The following uses the recent unrest in Peru as an example. Nearly two months ago, protests broke out in Peru, following what many qualified as a coup attempt and subsequent ouster of a democratically elected President, (US News and World Report) and now investors are considering their options in the short, medium, and long terms.

What is an Emerging Market and the assumptions we hold that frame our beliefs?

Currently, there is no universal definition of this term. According to the MSCI
equity index, there are 26 emerging markets and 32 frontier countries. On the other hand, the IMF’s index comprises 155 countries that are “emerging and developing” based on measures of social and economic development. Regardless of the number, there is a thread that runs through common understandings of such countries: they possess markets with endemic graft, underdeveloped infrastructure and economic dependence on the developed world. While Peru is an emerging market in both lists, it is incumbent on investors to make sure that the specific countries in which they have investments are actually considered as developing.

Is the specific data on government institutions consistent with the stereotypical understanding of emerging markets?

The reality is that we cannot draw conclusions about a host country’s investment climate without taking a look at the data that explains its specific social, economic, and political dynamics. However, the number of disruptions to the political and economic order is not the most accurate measure of country risk over time. Rather, it is the host government’s ability to weather imminent storms and prevent irreversible damage. For this reason, it is helpful to not only look at conventional metrics of a host country’s such as political and economic stability ,but the more specific factors that reveal its economic and social/political resilience.

What are its economic resilience Scores?

Economic resilience refers to the a country’s ability to recover quickly and withstand a shock.. Two of the most common factors for understanding an economy’s ability to endure are income inequality and economic diversification. The political fault lines in countries with significant financial differences among classes are far more likely to rupture than those in nations where there is more equity. Where there is a more equal distribution, the body politic is likely to be more stable and harmonious. Additionally, countries with economies comprised in many different industries are more likely to maintain order because downturns in one or two industries can be counterbalanced by others that are unaffected.

Peru’s income inequality rankings (Global Finance)

World: 23rd out of 169 (23rd most unequal); Latin America: 5th out of 20 (5th most unequal)

Peru’s Economic diversification ranking (The Global Economic Diversification Index)

World: 66th out of 89 countries ranked; Latin America: 9th out of 10 countries ranked

What are its social resilience scores?

While such data about the number of protests in a host country is helpful in determining the possibility of shock developments, consideration of a host country’s social resilience helps investors understand the medium- and long-term prognosis. Most measurements of social resilience focus on the dynamic between government and voters. A review of the extent to which civil liberties in a given country are eroding helps determine the social contract between government representatives and the

Peru’s Civil liberties (World Population Review)

World 50 out of 165; Latin America: 5 out of 16

Peru’s Positive Peace Index (Resource Watch)

World: 66th out of 163; Latin America: 7th out of 16

The countries where voters respect the integrity of officials and the government respects the rights of its people are less likely to experience unrest in the medium and long-terms.

In Latin America it is nearly impossible to avoid truncated presidential terms and efforts to change the wording of constitutions. Political turbulence will continue to worsen while a review of government institutions reveals that the country’s economy will not rebound from high inflation and other problems any time soon. Investors who are thinking about moves need to consider their appetite for risk and the ongoing political and economic problems in the short-term and medium-term.

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