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EM elections: Turkey, Mexico & Brazil take centre stage

Turkey, Mexico and Brazil all face elections this year, with their outcomes set to have a big impact on political directionality. Elections can bring increased market dispersion and generate alpha opportunities – we will be closely monitoring proceedings in these markets to determine optimal portfolio positioning.

While 2017 was the year of unusually low volatility, the hallmark of 2018 is set to be elections. More than a billion people are due to cast their vote across the emerging markets (EM), with common campaign topics focusing on economic reform, trade and tackling corruption.

Turkey is the surprise calendar entry of the year. The general election, originally scheduled for November 2019, will now be held in June this year, with Erdogan defending his presidency. Few expect a fair race but some anticipate this being the catalyst that ultimately creates the conditions for regime change in the country. Mexican elections will follow with Obrador firmly entrenched in the lead, while the Brazilian election brings up the rear, promising to add volatility to the EM landscape.

News of a snap election on 24 June – more than a year earlier than planned – caused a market rally in Turkey. President Recep Tayyip Erdoğan, founder of the Justice and Development Party (AKP) has enjoyed a 15-year run of power, having served as prime minster before taking on the presidency in 2014. This time around Turkey will jointly hold elections for parliament and a new enhanced executive presidency following revisions to the Constitution agreed in a referendum in April 2017. The consensus is another win for Erdogan and the AKP, reflecting Erdogan’s strong personality, leadership and campaigning skills – he is a great orator and a tried-and-tested leader: the AKP government has created 1.5 million jobs during its period in office.

Counting against Erdogan and the AKP is a mix of gripes from different groups with shared frustration over the centralising of powers around Erdogan; concern about events in Syria; rising nationalism; a shift east in terms of geopolitics orientation; unorthodox economic policies; and a more authoritarian and illiberal atmosphere at home. Erdogan looks set to be run hard by two secular candidates: Meral Akşener, who recently broke away from the Nationalist Movement Party (MHP) and created her own party, the IYI, or Good party; and Muharrem Ince, the candidate from the Republic Peoples Party, the CHP. For the first time, Erdogan is facing a significantly united opposition, seemingly willing to back each other in a second round run-off contest with Erdogan.

In our view, the snap-announcement market rally reflects the hope that early elections would reduce uncertainties. Turkey has been in a state of emergency since 2016. It faces huge economic challenges – the PKK, Syria, strained relations with the West and clearing up after the failed 2016 coup attempt. There is hope that a new government will be in place by late June/July, and better positioned to address entrenched simmering markets risks, including:

  • double-digit, sticky inflation
  • a current account deficit of close to 6% of GDP and rising
  • a wide external financing gap (USD220 billion+) and low FX reserve cover (<50%).

But what about the markets and how will they react to all this?

It is clear that markets hate uncertainty, which suggests that they will likely trade up in the short term should Erdogan and the AKP win both the presidency and the parliamentary vote, on the hope that in his new presidency he will normalise policy, be that towards the West or more broader macro. But even an opposition win might also be viewed positively as it might suggest a move back more firmly into the Western orbit and more policy orthodoxy. The worst-case outcome would likely be a slim win (sub-1%) for Erdogan, as this would risk claims of election rigging and might provoke social unrest with potentially unpredictable outcomes. The other uncertain outcome would be cohabitation, where Erdogan and the AKP secure either parliament or the presidency, and the opposition the other.

1 July will host both the presidential and legislative elections in Mexico. The current presidential front runner is the left-of-centre candidate Andrés Manuel López Obrador – commonly known as AMLO – and his National Regeneration Movement (MORENA); the market is beginning to price in heightened political risk.

Mexico is governed by a bi-cameral system under which a president is elected every six years and serves a single ‘sexenio’, imposing a degree of inertia on the economy. It is not in the interest of opposition parties to cooperate with the president, which makes it more difficult to pass legislation and enact structural reform. Historically, presidents have focused more on promoting their own interests/policies, given that they will not stand for re-election.

Economically, Mexico has entered into a more challenging period. Diplomatic relations with the US – its main trade partner – have deteriorated. The country is facing a time of transition, with the key election issues being:

  • NAFTA negotiations with the US and Canada
  • maintaining structural reform momentum around the energy, education and telecoms sectors
  • fiscal discipline.

AMLO’s agenda aims to end the privatisation of Mexico’s electricity industry alongside the state-owned oil company, and bring a more orthodox policy structure. His main opposition are Anaya and Meade.

Ricardo Anaya represents ‘For Mexico in Front’ – a three-party right-to-left coalition. Polling in second place, Anaya is calling for strong corruption investigations, while his PAN party is regarded as business-friendly. In third place is the current president’s choice successor and nominee of the ruling Institutional Revolutionary Party (PRI), Jose Meade.

Possible outcomes and investment implications:

AMLO win

  • Knee-jerk reaction in markets – peso sells off but limited by existing hedges.
  • AMLO proves to be better than feared but policy gradually drifts in less market-friendly direction.
  • Risk that NAFTA deal is set back, and even potentially derailed.
  • Energy reform stalls and Mexican participants in past auctions at risk.

Anaya win

  • Knee-jerk reaction in markets – peso rallies as AMLO hedges are unwound.
  • Stricter fiscal discipline – hard currency bonds and local rates should do well.
  • Key to watch will be inter-party dynamics – can the PAN and PRI overcome campaign fighting to rebuild a governing coalition.

Meade win

  • Continuity candidate – reform implementation will continue.
  • Strong technocrats will continue to serve in Hacienda and Pemex.
  • Governability will be tested by low popularity inherited from Peña Nieto administration.

It’s early days in Brazil on the election front, with the nation currently more interested in its performance at the World Cup than politics. But by the time of the cup final, momentum should be starting to build, with the parties being required to announce their official candidates in July.

The field is currently fragmented, with a strong anti-establishment theme. This reflects Brazil’s poor economic performance in recent years, and is exacerbated by the ongoing ‘lava jato’ (‘Operation Car Wash’) corruption investigation. Billed as the biggest corruption scandal ever, and resulting in the incarceration of businessmen and politicians alike – the most high-profile being former president Luiz Inácio Lula da Silva – it’s unsurprising traditional politicians are failing to gain traction with the electorate.

This mood is reflected in the current front-runner – Bolsonaro – a far-right fringe figure, popular with the anti-establishment crowd. He’s not a traditional politician and has no big party backing, so may fade in popularity once the campaigning heats up.

The dominant factor in Brazilian elections is the publicly funded candidate TV time, aired nationally during August and September. With lava jato making it more difficult for candidates to use private money to finance their campaigns, the publicly funded exposure will likely matter more this year than ever before. Candidate TV time is allotted according to the number of seats each party has in Congress, so we expect the traditional parties, dominated by the centre-right, to regain influence once the TV campaigning begins.

Our base case is that the next Brazilian president will govern at the head of a broadly market-friendly coalition in Congress, and accordingly pass much needed structural reform, particularly of the pension system. But it’s early days and much could happen between now and polling day; our eyes are on the markets watching for signs of rising dispersion.

The currencies of each country are likely to remain the main bellwether for sentiment, hence we will be looking to trade them tactically. We are more sanguine about the hard currency bond market in each case – Turkey’s debt burden remains fairly low, Brazil’s is higher but largely domestic, and Mexico is in between but buttressed by a stable fiscal outlook even under AMLO, in our view.