Emerging Markets Under President Trump

As US Administration Takes Shape, Emerging Markets Watch

Jan Dehn, head of research at emerging market specialist investment management firm Ashmore, recently discussed US President Donald Trump’s attempt to make Mexico pay for a proposed wall along the US-Mexico border and whether this ambition will be his downfall. Dehn also examines tax amnesty schemes which are currently being launched across Emerging Market (EM) countries, highlighting that the quality of governance in emerging markets is steadily improving. The following is an abridged version of a recent interview and research note.

Will President Trump’s Mexican Border Wall Be His Downfall?

Jan Dehn: The Danish King Canute, the protagonist of the apocryphal anecdote, who ruled over Denmark, Norway, and England in the eleventh century so believed in his own powers that he thought he could command the tide. The futility of his vainglorious effort to stop the tide has seen Canute go down in history as a ridiculous figure, a latter-day example of what today we would label someone suffering from a narcissistic personality disorder.

It remains to be seen if Trump’s Mexican Wall will also be Trump’s fall, that is, the new US president’s King Canute moment.

Certainly, it was Mexico, which emerged a winner of sorts after diplomatic skirmishes, as Trump was forced to agree not to discuss in public the funding of his proposed 3,000-mile wall along the US-Mexican border.

Trump’s climb-down was the eventual outcome of a mini diplomatic storm, which had been kicked off by Trump himself, when, to great fanfare, he signed an executive order to commence work on the wall. Mexican President Enrique Peňa Nieto responded by canceling a planned visit to the US. This then prompted Sean Spicer, Trump’s spokesperson, to announce a 20% tariff on Mexican exports to the US. Soon, however, it transpired that many Mexican exports have no obvious substitutes in the US, wherefore most of the tariff would probably be passed to US consumers in the form of higher prices.

Spicer was soon forced to retract his tariff threat and Trump had to concede to Peňa Nieto’s proposal to stop talking about funding of the wall in public.

Meanwhile, Speaker of the US House of Representatives, Paul Ryan, announced that he would find money in the federal budget to pay for the wall, which means that US taxpayers will, in turn, pay for it. Peňa Nieto received widespread support from Mexicans for his stance, thus aiding his own position at home where, prior to the incident, his approval rating had fallen to just 12 percent. Peňa Nieto also received public support from other Latin American governments, including Peru and Colombia.

The big remaining question is this: Will China publicly support Mexico?

China may have many good reasons for doing so. For example, if the rift between Mexico and Trump’s America can be turned into a major headache for the Trump administration then the latter may have second thoughts about engaging in a similar spat with China. China could, for example, offer Mexico a very large swap line in CNY. Mexico already has about 25 percent of GDP in FX reserves, including an 85 billion-dollar Flexible Credit Line from the International Monetary Fund (IMF).

Tax Amnesty: Improving Emerging Market Governance

A number of countries across the emerging market universe have launched tax amnesty schemes. What is prompting them to do so and how successful have they been? There is a growing realization in a number of EM countries that enormous quantities of wealth reside outside the countries much of which has never been declared for tax purposes. Governments are implementing tax amnesties in order to encourage this money to be declared for tax purposes. This helps to widen the tax base and therefore increase tax revenues permanently going forward, despite the upfront amnesty.

In Latin America, Argentina and Brazil have both implemented successful tax amnesties and on January 18th, Mexico became the latest country to introduce such a scheme. Indonesia has also successfully implemented a tax amnesty for overseas wealth. The fact that such amnesties are proving successful fundamentally reflects that the quality of governance in emerging markets is improving because otherwise, no one would agree to declare their overseas wealth.

The big stashes of overseas wealth is a legacy of much worse times in EM’s distant past when truly no one trusted local banking institutions and where there were no decent investment opportunities and no credible financial assets to invest in within emerging market countries. These conditions were particularly pronounced during the Cold War period, but things have changed sharply in the last couple of decades.

Most emerging market economies, including most Latin American countries, now have deep domestic bond markets and equity markets, while macroeconomic conditions are far more stable. Many emerging market economies are now fully integrated into major fixed income and equity benchmark indices. This is why the time has come to get the rump of high net-worth assets to go home.

The amnesty schemes are generally good news from a bond holder’s perspective. The government’s tax base widens, so public finances become healthier. Also, the inflows associated with the amnesty tend to support currencies.

Finally, some of the declared wealth will go into local bond and equity markets.

This is the first in a series concerning emerging markets under the new US Administration.