Election risk ahead

Geopolitical risk is rising around the world. But domestic political and institutional risk is on the rise also, in response to structural economic challenges and political polarisation.

One of the major themes of 2024 is that it is a year of big elections; see our 2024 outlook note.  And almost halfway into 2024, the consequential nature of these elections is clear – both politically and economically.  The experience of the past fortnight is instructive for thinking about the impact of the major elections remaining this year, most notably the US Presidential election.

Emerging markets

Last week, markets responded violently to election results in India and Mexico.  In India, the world’s largest democracy, equities first surged on (wildly inaccurate) exit polls that suggested a strong result for PM Modi’s BJP; and then sank when it turned out that the BJP had lost seats and would have to govern in a coalition.  Investors – domestic and foreign – are positive about the policies that PM Modi has implemented, which have helped India to become one of the fastest growing emerging markets – and attracted significant capital.

The reduced BJP vote share – partly reflecting voter concerns about sectarian and authoritarian tendencies – and the accompanying constraints on governing were initially interpreted negatively.  But markets are now trading higher than immediately prior to the election, on a view that reforms are likely to continue – and that institutional constraints may be good for the quality of policy.

The economic importance of political institutions can also be seen in Mexico.  Claudia Sheinbaum, the successor to President Andres Manuel Lopez Obrador, won a stronger than expected vote share.  And her Morena party also won a supermajority in the House as well as control of the Senate.  The absence of meaningful institutional checks and balances because of this strong result reinforced concerns in the business community about the policy outlook – and the risks to the Mexican growth model.  There will be less ability to oppose policies that weaken the business environment and that compromise other institutions (such as judicial independence).

Mexico has been one of the better-performing equity markets globally, as it positions as a production hub close to the US (see my last note).  But investor concerns about the quality of policies and institutions under the new President led to equity markets immediately selling off by ~6%; and they remain down a week after.  The Mexican peso is down by ~10% against the USD since the election.

The market reaction to these elections shows that political institutions matter: markets care about the ability of the government to pursue a credible, coherent economic programme as well as adherence to political institutions.  Strong institutions are valued by markets.  Strongman leadership can generate good economic outcomes for a period, but the distribution of outcomes increases markedly: poor outcomes become more likely in the absence of constraints. 

The full note is available here: https://davidskilling.substack.com/p/election-risk-ahead