Trending Leaders and Soaring Markets

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Piyush Kumar's picture

 

The line which separates politics from economics is often thin or at times, non-existent. Asset markets have generally focused on the economic prospects of a nation – indicators like GDP growth, employment rates, trade terms, etc. Post-2008, the outlook has completely changed. Scepticism over relying on growth models that give too much emphasis to commodity prices and interest rates have led to the shift of focus to other factors that shape the environment for investment[1]. One of them (and a major one at that) being political processes.

It is no surprise that investors look forward to elections and the competing agendas at play since their portfolio allocations are contingent upon the government’s economic policy.  The greater interference of central banks in national economies and their increasing control over fiscal policy and macroprudential measures has also made policy decisions of the government an important variable for asset investors [2]. Another reason why politics has become so important to the markets is that free elections and free markets have become increasingly ubiquitous in recent decades. These are significant factors as investors prefer stability and flexibility in policy-making.  Since the 1970s, the number of countries holding free elections has almost tripled.

It is also the case that the fortunes of political leaders are dependent upon the performance of asset markets [3]. The collective decisions of investors are a reflection of what the markets think about the political scenario.  These decisions are crucial since any shift in asset prices can either sustain the growth momentum in the economy or completely stifle it.  For instance, an increase in borrowing rates in the bond market can put any government in a compromising position in terms of limiting policy flexibility – which could possibly lead to, say, blocking initiation of new public initiatives and social security cuts, that could make the incumbent government increasingly unpopular and possibly its exit in the next elections. Hence politicians, taking into account what the possible market reaction could be often adopt policies and institutions that favour the interests of asset owners. Even citizens often take market reactions into account and vote for policies that cater to the market [4]. Deeper financial integration has led to a situation where a cross-border political shock affects the ability of politicians to remain in office. This makes politicians vulnerable to the unpredictability of foreign political events, making their own positions in office more precarious. These potentially negative political consequences may provide incentives for politicians across highly integrated countries to pursue common packages of institutional reform to protect their own positions [5].

 

In the past few years, stock markets in emerging economies like Mexico and India have rallied behind few political leaders seemingly amenable to interests of international financial capital. Until May 2014, the benchmark indices in India rose by around 20% in the expectation of a landslide victory of Narendra Modi who has been widely perceived as a pro-investment and pro-business leader. In October, stocks tumbled over the re-election of left-leaning Dilma Rouseff. In November the Greek stock market had plunged 11.2 per cent – the biggest tumble since December 1987 – after investors were worried over the ascent of the radical left Syriza party to power in Athens. The year that went by gave sound evidence for the fact that investors do care about partisan concerns [6].

 

The partial success of Abenomics illustrates the case succinctly. Thrust with a mission to save an economy troubled by “15 years of deflation”[7], weak household consumption and low growth (even negative in some years), Prime Minister Shinzo Abe was forced to adopt a strategy (now popular as Abenomics) that has led to recovery of growth but not allayed concerns completely. The very fact that Mr. Abe was able to achieve victory in the snap elections shows the popular support for his strategy that involves ‘three arrows’[8]:

  1. monetary reforms that involve quantitative easing through Bank of Japan (BoJ) to make exports competitive and achieve an inflation rate of 2% thereby putting an end to the long cycle of deflation,
  2. fiscal reforms to boost real demand
  3. structural reforms that would involve creation of a growth package, massive deregulation  and improving the participation of women in the labour force

 

The Bank of Japan began its QE programme in April 2013 whereby it bought bonds worth 60 to 70 trillion Yen a year[9] and announced an expansion in October 2013 whereby it would buy bonds worth 80 trillion Yen a year [10].

By December 2013, the Abenomics policy led to a dramatic weakening of the Japanese yen and a 22% rise in the TOPIX stock market index. The unemployment rate in Japan fell from 4.0% in the final quarter of 2012 to 3.7% in the first quarter of 2013, continuing a past trend. By May 2013, the stock market had risen   55 percent and consumer spending had pushed first quarter economic growth up by 3.5 percent annually. Though exports became competitive and growth recovered, fiscal policies and structural reforms hadn’t got off ground. In April 2014, a hike in sales tax expected to stabilize social security ( Abe is committed to increased public spending) from 5% to 8% hit the Japanese economy hard, leading to a growth contraction in the secong quarter by 6%- the worst since the 2011 earthquake [11]. A second round of hike was then deferred until 2017 in view of the snap polls. However, the downgrade of Japan’s sovereign rating by Moody’s (from Aa3 to A1 with a stable outlook) raises other concerns [12]. Firstly, there is heightened uncertainty over the achievability of fiscal deficit reduction goals. Secondly, there is uncertainty over the timing and effectiveness of growth-enhancing policy measures against a background of deflationary pressures and also the increased risk of rising Japanese government bond (or JGB) yields and reduced debt affordability over the medium term. There are also worries over misdiagnosis of the lower consumer demand by the Japanese government as many experts say this could be because of its rapidly ageing population [13]. Moreover, the commitment to spend more on subsidies, prisons and health can potentially harm the fiscal health and raise risk premiums for Japanese bonds as the country already has a public debt-to-GDP ratio of 240%[14]. However, Abenomics has delivered results and can lead Japan back to recovery.

In general, the increasing convergence of policies and institutions that cater to international finance may not threaten the nature of democratic politics as many fear it would.  Today’s losers might be tomorrow’s winners. Leaders need to accommodate diverse interests within the constraints that global financial capital presents to policymaking. The world economy is undergoing a doubtful recovery after the crash of 2008. As conventional parameters fall apart, all eyes are upon individuals who not only control governments and its finances but also the destinies of nations.