Storm over Bangkok

Politics redraws the investment map in Southeast Asia

The investment landscape of Southeast Asia is being transformed. And one key factor above all is driving the tectonic shifts in market perceptions — politics.

Thailand, the archetypal Asian tiger that has long been a favored destination for global conglomerates and emerging markets investors, is increasingly being viewed as the region’s basket case, as chronic political conflict batters its image.

Meanwhile, as protesters paralyzed central Bangkok in a long standoff that exploded into gun battles and arson attacks in the heart of the business district, the Philippines was surprising everyone with the smooth election of a market-friendly president.

“A strong president, restart of infrastructure spending, and a traditional relief rally should provide fuel for the markets,” J.P. Morgan said in a research note after the election.

Indonesia has already experienced a profound shift in how it is viewed by fund managers and multinationals.

A decade ago it was regarded as among the world’s riskiest countries, riven by sectarian and ethnic violence, and crippled by corruption. Even 18 months ago, in the global panic after Lehman Brothers collapsed, investors desperate to lower their risk exposure dumped the rupiah and local stocks.

Now Indonesia is on course to achieve sovereign investment grade and widely regarded as deserving inclusion in the BRICs bloc of emerging markets that investors cannot afford to ignore.

Across the region, whether driving markets up or down, political risk is back at the top of the investor agenda.

“As sovereign debt concerns in Europe unfold, risk aversion is spreading across global financial markets, and political events in Asia are likely to receive more scrutiny than usual,” Standard Chartered said in a research note this month.


While it is clear that political risk is central to market performance in Asia, quantifying it and predicting its impact on asset prices is far from straightforward.

One of the most respected gauges of political risk is the World Governance Indicators dataset produced annually with the support of the World Bank. They aggregate a large number of risk ratings from several sources. And they paint a telling picture.

In 2002, they rated Thai political stability at 59.1 out of 100. By 2008, the latest year for which data is available, it had dived to 12.9. Events since then will have dragged it even lower.

Over the same period, Indonesia saw strong gains. The Philippines drifted sideways.

Those trends have been broadly mirrored in flows of portfolio funds and foreign direct investment. Following the re-election of the reformist President Susilo Bambang Yudhoyono last year, Indonesia has seen a surge in inflows. Thailand saw the reverse.

The WGI are a key component of the Growth Environment Score that Goldman Sachs uses to model the long-term potential of emerging markets. Many other investment banks calculate their own ratings — on a scale of zero to 20, Morgan Stanley puts Thai political risk at the maximum 20, with the Philippines at 18, Indonesia at 10, and Malaysia at 8.

Deutsche Bank, in a report this month on the region that focused heavily on politics, ranked Thailand as the least attractive of the major regional markets.

“Our pecking order: Indonesia, Philippines, Singapore, Malaysia and Thailand,” it said.

Sovereign ratings are another key gauge.

Indonesia is being steadily upgraded toward investment level while Thailand risks further downgrades. Moody’s has a negative outlook on its Baa1 rating on Thailand and warned on Monday that “a protracted undermining of investor sentiment would have adverse effects on Thailand’s longer term credit fundamentals.”


Some analysts argue that investors need not focus unduly on politics. There are two main planks to this argument.

Firstly, some economies manage to power ahead despite instability, offering bumper returns to investors willing to brave risky markets. This is certainly true in many cases — Thailand’s export-oriented economy for example has shown strong growth in recent quarters despite enormous political upheaval.

“In essence, the bull case contends that politics is noise and that other factors matter more for the economy and earnings,” said Credit Suisse in an analysis of Thailand this month.

Secondly, some argue that political risk is already priced in — hence Thailand’s cheap valuations, for example. Investors, they say, can assume that the political risk level has already been discounted, and so this limits the downside for markets.

Valuations clearly remain central to investment decisions — Indonesia’s bullish growth story and improving stability has pushed up valuation ratios to expensive levels by regional standards and some argue the market is overbought.

Yet assuming prices reflect all risks could be dangerous.

The reason lies in the distinction between risk and uncertainty. Risk can be quantified, and therefore priced. But uncertainty describes situations where the outcomes are so diverse, cloudy and complex that pricing them is impossible.

Thailand, for example, could follow any one of a plethora of highly diverse scenarios. It could come back from the brink with a peace deal that ends years of political conflict and sends markets surging. It could continue to stay mired in instability as it has for five years. Or it could topple toward war.

“The current situation offers very little visibility, with extreme binary outcomes possible,” Credit Suisse said.

How can markets price such complexity? The answer is — with great difficulty. In February and March, Thai markets strongly outperformed the region, attracting a wave of heavy foreign buying by investors who thought the cheap valuations on offer made it a compelling bull story despite political instability.

Now, after weeks of mayhem, and fighting between soldiers and anti-government protesters that killed more than 80 people, equity prices have tumbled and foreign investors are now net sellers for the year. Those who thought the politics could be ignored have found this proved to be a very costly mistake.