SHULI REN: And the biggest risk to emerging markets is ...
'China's Minsky moment is coming. Bonds sold by local government financing vehicles, to fund projects for which municipalities have insufficient budgets, will start to mature this year'
Riots, drought, social instability: Emerging markets are never easy. Now investors face a potentially bigger test - they must decide whether President Xi Jinping's determination to remain in power in China is a risk-on or risk-off moment for the whole asset class.
The Communist Party is set to repeal presidential term limits this month in a step that would allow the 64-year-old to rule beyond 2023, and perhaps for life.
One potential positive for investors is that the calculation of political risk in China becomes much simpler. Guanxi, or connections, has long played a key role. Companies associated with the political families of former leaders Deng Xiaoping, Jiang Zemin and Wen Jiabao have flourished.
Anbang Insurance Group Co., whose chairman Wu Xiaohui was married to one of Deng's granddaughters, quickly rose to become China's third-largest insurer by selling as much as 87 percent of its products through bank channels. Competitors, lacking that short-cut, had to deploy the standard sales-agent model and grew much more slowly.
Amassing assets amounting to almost 3.4 percent of China's GDP, Anbang was so aggressive in buying bank shares in public markets -- and using its sway over those institutions to sell even more insurance products -- that the China Banking Regulatory Commission in January had to rush out an "interim measure" banning insurers from owning more than 5 percent of a bank's shares.
Now, only one political connection matters: the president himself. So we're less likely to see an Anbang posing systemic risks to China's already fragile banking system.
Optimists might see Xi using his consolidated power to push through the changes necessary to get China's debt-bloated state enterprises and local governments on a more solid footing.
This matters, because China's Minsky moment is coming. Bonds sold by local government financing vehicles, to fund projects for which municipalities have insufficient budgets, will start to mature this year. According to Bloomberg data, LGFVs have issued at least 4,000 bonds, totaling $168 billion -- backed by just $9.7 billion annual earnings.
Pessimists need to ask if investors have priced in enough political risk.
Over the last year, emerging markets - a hard sell four years ago - picked up along with the global economic outlook. Lured by earnings growth estimated to be 23 percent this year, investors pushed the MSCI Emerging Markets Index to 16.7 times historic earnings, well-above the 10-year average of 13.6 times.
Meanwhile, developing nations from default-prone Argentina to Ivory Coast (which survived an army mutiny) met robust demand for long-dated bonds.
Are we being too complacent in a space that now has one key-person risk? China isn't Argentina or Ivory Coast. Four years ago, the country accounted for just over 15 percent of the MSCI Emerging Markets Index; this year, it's one-third.
If China sneezes, the whole asset class catches a bad cold.
So far, Xi has largely stayed on the sidelines in economic matters, other than pushing his beloved Belt and Road program, which encourages the development of emerging markets' infrastructure with tight strings attached.
Don't forget, though: Russia tumbled into a recession in 2015 after the international community sanctioned Vladimir Putin's invasion of Crimea; the Turkish lira weakens every time Recep Tayyip Erdogan picks fights with the central bank on interest rates and inflation. Both presidents have stayed beyond their constitutional terms.
So while traders who weren't adults when the Soviet Union collapsed may be inclined to cheer for Xi, they should take note of this large new key-person risk.