Can Emerging Markets Purge Corruption? by Shamaila Khan, AllianceBernstein
Emerging-market (EM) assets have had a rough ride lately, but we think the medium-term outlook is brighter. The reason: some governments are getting serious about tackling corruption.
From Asia to Latin American, governments have been trying to crack down on corruption and make politics and business more transparent. In Brazil, for example, a bribery scandal involving state-run oil company Petrobras has resulted in formal charges against some senior politicians and jail terms for some top executives.
Ironically, the attempt to root out fraud, bribery and other corrupt practices has been a big contributor to the volatility in EM corporate bond markets. That’s because jailing politicians or corporate executives usually leads to short-term political turmoil, policy paralysis, slower growth—and, for investors, sleepless nights.
In Brazil’s case, the Petrobras scandal has complicated the government’s much-needed fiscal reform efforts and worsened the near-term economic outlook. Standard & Poor’s responded by stripping Brazil of its investment-grade-credit rating. Investors responded by punishing Brazilian assets.
Moving Toward Better Corporate Governance
Market participants are pricing in these short-term risks across the emerging world. Many local currencies have declined sharply and volatility has soared.
But so far, investors have overlooked the medium-term benefits that we expect anti-corruption campaigns to deliver. These include better corporate governance, financial disclosure for investors, independent judiciaries, and a free and vibrant local media.
Despite its struggles over the last few months, the JPMorgan EMBI Global, an index of dollar-denominated EM sovereign bonds, has delivered a 5.1% annualized return in the two years to August 31, 2015. That makes it a top performer among fixed-income assets.
Over the same period, the JPMorgan CEMBI Broad Diversified, an index of EM corporate debt, was up almost 5.3% on an annualized basis. We think that moves toward a more transparent political and business environment will improve the investment climate in many EM countries in the years ahead.
People Taking to the Streets
Why have anti-corruption efforts in countries as diverse as China, Brazil, India, Malaysia and Guatemala finally started to gain traction?
It’s not because foreign investors have pushed for them. We and countless other asset managers have urged EM policymakers for years to focus on transparency and good governance—mostly to no avail.
Here’s what’s changed: average people in many countries have started to demand more from their leaders. They’ve called for crackdowns on bribery and fraud and urged politicians to get serious about important issues such as pollution, social welfare and economic opportunity.
When people take to the streets to protest—as they have in Brazil, Guatemala and elsewhere—and when the local media reports daily about corruption, leaders suddenly start to listen. Brazilian President Dilma Rousseff, for example, has seen her approval ratings slip to the single digits and has had to parry calls for her impeachment from voters and political opponents.
Increasingly, investors are also demanding proper financial disclosure from companies—be it a commodity company in Hong Kong or a construction firm in Mexico—and from governments.
For example, global investors have worried for years about the reliability of Chinese economic data. As China’s growth has slowed, this has become a more pressing concern—particularly when it comes to issues such as gross domestic product growth or the amount of bad loans on the books at Chinese banks.
When they don’t feel the official story is the real story, investors start pricing in a worst-case scenario for Chinese growth. That has an impact on commodities as well as on the countries and companies that are sensitive to commodity prices.
Caution Still Required
None of this means that emerging markets can solve their problems overnight. Not all countries are targeting corruption with the same vigor. Yet even in those that aren’t, we think political and business leaders are watching developments closely and learning valuable lessons.
Investors, as always, should approach emerging markets carefully and deliberately with a company-by-company and country-by-country approach. But they shouldn’t overlook the significant cultural change that’s under way in many EM countries.
In the short run, that means more volatility and uncertainty—and probably slower growth. But over the longer haul, we expect improvement in EM corporate governance. At some point, it may be a good investment decision to stop punishing the countries that are serious about cleaning up their acts.
This article previously appeared in Citywire.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.