One definition of an emerging market is “a country where politics is more important than economics,” Theresa Barger ’82 said at the Future of Finance conference, quoting political scientist Ian Bremer. By that definition, Yale SOM’s David Bach joked, many so-called developed countries may qualify as emerging markets. The moment of levity also pointed at the deeper truth that all markets exist in a political context.
Barger, the co-founder and senior managing director of Cartica Capital, which invests in emerging markets, was a panelist in a September 9 discussion on global markets, moderated by Bach, Yale SOM’s senior associate dean for executive MBA and global programs. One of the themes of the wide-ranging discussion was the role of governments in guiding financial markets—and the wisdom, or lack of it, with which they do so. Bach put it this way to the panelists: “Are we beyond the phase where governments use the design of financial markets and financial institutions to drive political objectives?”
In Russia, said Paolo Zannoni MA ’87, MPhil ’87, the chairman of Goldman Sachs Italy and co-CEO of Goldman’s Moscow office, the answer is usually no. “The major characteristic of Russian capitalism is the integration of financial institutions, the oligarchy, and the political party,” he said. “The trend is toward more integration, or at least more influence, with one potential exception.”
That exception is a recent reform to the pension fund industry, lifting restrictions that limited funds to investments in fixed-income securities and prevented them from investing in equities.
“The pensions were supporting the system; they were not entering the capital markets in a significant way,” Zannoni. The reform, he said is “probably going to create an independent pool of capital that’s not directed by the oligarchy. It might be the only good news coming out of Russia recently.”
A reform in Italy will also modernize and open up the financial sector, Zannoni added. Earlier this year, Italy revised its law overseeing cooperative or mutual banks, which hold about 25% of assets there. Previously, each stockholder in these banks had a single vote in governing the bank, regardless of the size of its holding, an arrangement that kept out foreign capital and allowed small stockholders to block mergers and other reforms. Under the new law, the banks will be converted into joint-stock companies with proportional representation.
“So the two-tier system is going to be eliminated,” Zannoni said, “and the inefficiency and closedness of these cooperative banks should be broken, and they should be open to international capital markets.”
This reform is also a good sign for Italy’s political process, he added. “I’ve been around the Italian business environment for more than 35 years, and there’s always been talk about reforming this structure, which is very obsolete and very inefficient.”
This time around, he said, the government “was able to beat the lobbyists in parliament that have thwarted every attempt to reform it.”
The most dramatic government intervention in the financial markets this year, of course, came from China, which a few weeks before the conference had stepped in to prop up a declining stock market and devalued its currency, setting off declines in markets around the world.
Eddie Tam ’93, CEO of the Hong Kong-based Central Asset Investments, said that China had invested too much of its own political capital in the rising stock market and “bungled” its response.
“China has a very short history in capital markets,” he said. “The government has never tied itself so closely, in terns of its own prestige and face, their own credibility, to the fortunes of the markets.”
After a rapid rise in Chinese stocks—the Shanghai Composite Index rose 150% between mid 2014 and its peak in August 2015—a correction was to be expected, Tam said. But, he added, “China has seen many boom-bust cycles before, so the question that everyone is asking is, why is the government so keen on intervening so early, supporting the market at such a high level, and in a manner which is so violent and so vast in magnitude?”
The shock to the rest of the world, Tam said, came not from the collapse of the stock market itself, but from the devaluation of China’s currency, the renminbi.
“The interconnection between the Chinese financial system and the rest of the world is not very great, but the contagion effect comes from the renminbi. When China makes a move, like it or not, the world is extremely sensitive,” he said, citing data suggesting that a 1% devaluation of the renminbi corresponds to a drop in equities around the world of 3 or 4%.
So why did China devalue the renminbi? China has a very large trade surplus, Tam pointed out, “so theoretically, there should be upward pressure on the renminbi, not the other way around. I think it’s because of the bungling of the market-rescue operation.”
Observers estimated that China bought $200 billion worth of stocks in the rescue operation. “They obviously had to find the money somewhere,” Tam said. “Where do you find $200 billion to buy the stock market? Well, either they diverted money from other projects or they printed some fresh money for that… The rescue operation precipitated the devaluation of the renminbi.”
From the point of view of an investor in emerging markets, Barger said, China’s intervention in the market is only part of the problem. The ongoing concern is the inconsistent application of market regulations and laws.
“People who were tunneling, asset stripping, robbing minority shareholders of business opportunities, having false accounts—those people didn’t go to jail,” she said. But in its attempts to prop up the stock markets, China has instead cracked down on legitimate activities. “Now we’re seeing a lot of activity where they’re going in with a heavy hand on short sellers, making journalists self-confess, etc.”
China wants to have active equities markets, but doesn’t seem inclined to take the steps to create the underlying institutional basis for them, she said.
“Does China want to have a legal system that’s impartial, that’s fair, that’s well known?” she asked.
In Brazil and India, she added, there have been some high-profile prosecutions of insider trading but enforcement has remained inconsistent. “China is so much bigger and so much more powerful that it serves as an example, but every emerging market has the same issues.”
Expanding on Bremer’s definition of emerging markets, she said, “It’s less catchy, but I would say that emerging markets are countries that have shallow and insufficient institutional basis. It’s that lack of institutional depth that is the key thing that we have to work around as investors in emerging markets.”