When financial markets misread politics

Well as they say money has no color. Financial markets are pretty notorious for saluting the rising sun no matter how scorching the heat of the sun is likely to be. As this sun descents, the markets quickly shrug off the baggage and ride on to the next rising sun.  All this happens without minimal fuss and behaving as if nothing has happened.

Dani Rodrik has a piece on financial markets responding to Turkey elections:

When Turkey’s Justice and Development Party (AKP) defied pundits and pollsters by regaining a parliamentary majority in the country’s general election on November 1, financial markets cheered. The next day, the Istanbul stock exchange rose by more than 5%, and the Turkish lira rallied.  Never mind that one would be hard pressed to find anyone in business or financial circles these days with a nice thing to say about Recep Tayyip Erdoğan or the AKP that he led before ascending to the presidency in 2014. And make no mistake: Though Turkey’s president is supposed to be above party politics, Erdoğan remains very much at the helm.

Indeed, it was Erdoğan’s divide-and-rule strategy – fueling religious populism and nationalist sentiment, and inflaming ethnic tension with the Kurds – that carried the AKP to victory. Arguably, it was the only strategy that could work. After all, his regime has alienated liberals with its attacks on the media; business leaders with its expropriation of companies affiliated with his erstwhile allies in the so-called Gülen movement; and the West with its confrontational language and inconsistent stance on the Islamic State.

And yet financial markets, evidently placing a premium on stability, hailed the outcome. A majority AKP government, investors apparently believed, would be much better than the likely alternative: a period of political uncertainty, followed by a weak and indecisive coalition or minority administration. But, in this case, there was not much wisdom in crowds.

It is true that the AKP had a few good years after first coming to power in late 2002. But the party’s room for mischief was constrained by the European Union and the International Monetary Fund abroad and secularists at home. Once those limits were removed, Erdoğan’s governments embraced economic populism and authoritarian politics. Investors’ apparent optimism following the AKP’s victory recalls Einstein’s definition of insanity: doing the same thing over and over and expecting a different outcome.

🙂 How similar all this resembles India’s politics as well!

Prof Rodrik says this does not apply to Turkey alone:

Turkey certainly isn’t the only case where financial markets have misread a country’s politics. Consider Brazil, whose currency, the real, has been hammered since mid-2014 – much worse than most other emerging-market currencies – largely because of a major corruption scandal unfolding there. Prosecutors have revealed a wide-ranging kickback scheme centered on the state-owned oil company Petrobras and involving executives, parliamentarians, and government officials. So it may seem natural that financial markets have been spooked.

Yet the most important outcome of the scandal has been to highlight the remarkable strength, not weakness, of Brazil’s legal and democratic institutions. The prosecutor and judge on the case have been allowed to do their job, despite the natural impulse of President Dilma Rousseff’s government to quash the investigation. And, from all appearances, the probe has been following proper judicial procedures and has not been used to advance the opposition’s political agenda.

Beyond the judiciary, a slew of institutions, including the federal police and the finance ministry, have taken part and worked in synch. Leading businessmen and politicians have been jailed, among them the former treasurer of the ruling Workers’ Party.

Financial markets are supposed to be forward-looking, and many economists believe that they allocate resources in a way that reflects all available information. But an accurate comparison of Brazil’s experience with that of other emerging-market economies, where corruption is no less a problem, would, if anything, lead to an upgrade of Brazil’s standing among investors.

This emphasised bit is what textbooks usually preach. But political economy of finance (the real world finance) is much different. Here, how financial markets align themselves to ruling political party is as important. How they eulogize the political leader and build grand narratives over big bang reforms and so on is quite a story by itself

He also picks examples of other countries and finally ends:

We know from painful experience that financial markets’ short-term focus and herd behavior often lead them to neglect significant economic fundamentals. We should not be surprised that the same characteristics can distort markets’ judgment of countries’ governance and political prospects.

Well said.

As they say, the show must go on. Not many have mastered the phrase as financial markets have done..

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