BMI View: Political risk has consistently been a major factor affecting the growth outlook for infrastructure companies and feeds into their stock prices. This year, we have already seen its effects on companies operating in India and Thailand, and we also expect political risk to materially impact growth expectations for infrastructure companies in Indonesia.
We have long highlighted the importance of political risk to infrastructure as it has frequently played a major role in shaping the infrastructure landscape for investors. Political risk not only affects the viability of new and existing infrastructure investments, but also the amount of growth opportunities in a country's infrastructure market. This is particularly so among Asian economies. Political systems in the region are relatively immature, and a majority of the infrastructure opportunities on offer across the region are generated from fixed asset expenditure by the domestic public sector.
| Primarily Public-Funded |
|Selected Asian Countries - Fixed Capital Formation Spending, 2014f, % of GDP|
Within BMI's Infrastructure team, we have primarily discussed the effects of political risk to infrastructure in two ways:
Its impact on the creation of a conducive business environment for infrastructure investment and development;
And its impact on short-term political stability, which we define as the government's ability to propose, pass, implement and enforce its chosen legislation over the next two calendar years.
These effects of political risk typically arise from a number of potential changes in a country's political landscape such as a transfer in political power (election, succession, coup, and revolution), security threats (such as domestic and regional conflicts), as well as threats to social stability (such as public unrest and unemployment) and to the policy-making process (such as a fragmented parliament).
These changes to the political landscape have the potential to increase or decrease political risk in a country's infrastructure market, which in turn affects the market's outlook. For example, an increase in political risk typically increases security threats to project sites, and requires the public sector to divert considerable resources and attention away from the infrastructure sector to address any upheavals. This often results in construction works and project negotiations being stalled or cancelled. A change in regime also poses significant political risks, as it could lead to a review of infrastructure projects approved by the previous incumbent. This often results in new feasibility studies and financial schemes being conducted and crafted respectively, which could lead to project delays, revisions, or worse, cancellations.
On the other hand, a decrease in political risk typically leads to pro-business reforms being implemented and a sustainable increase in new infrastructure opportunities. This often results in an improvement in project execution and greater willingness by the private sector to provide infrastructure financing.
Political Risk Hits India/Thailand
We therefore believe that political risk has a material impact on the future growth outlook of any country's infrastructure market, and this in turn affects the outlook for the companies operating in that particular market. While the effects of political risk typically do not manifest immediately in the financial performance of an infrastructure company, its effects on a company's stock price are frequently immediate as stock prices are a function of investor sentiment towards a company's future growth outlook.
This year, we have already seen the effects of political risk on stock prices for infrastructure companies operating in India and Thailand.
In India, the country held its general (Lok Sabha) elections between April 7 and May 12, which culminated to a historic win by the pro-business Bharatiya Janata Party (BJP, see 'Modi's Victory No Panacea For Construction', June 22 2014). The victory gave the BJP a strong mandate to implement its policies, with infrastructure development highlighted as one of the party's top priorities for India's future. This significantly boosted investor sentiment towards the growth prospects for infrastructure companies in India. For example, two major infrastructure companies operating in India, Larsen & Toubro and Reliance Infrastructure, have seen their stock prices surge by more than 36% and 76% respectively since the start of elections.
| Benefited From Political Risk |
|India - Larsen & Toubro And Reliance Infrastructure Stock Prices, INR|
Meanwhile in Thailand, the decision by the former ruling party the Puea Thai Party to amend the constitution to allow ousted former prime minister Thaksin Shinawatra back into the country on November 1 triggered anti-government protests across major cities in Thailand.
The political crisis continued to escalate into 2014. The dissolution of parliament and the annulment of the legislation to raise funds for infrastructure development had negatively affected investor sentiment towards the growth outlook for infrastructure companies operating in Thailand ( see 'Long Term Weakness For Infrastructure Construction', March 23 2014). For example, two of the largest Thai infrastructure companies, CH Karnchang and Sino-Thai Engineering & Construction saw their stock prices plunge by more than 32% and 45% respectively between November 7 and January 1. Investor sentiment only significantly improved after a military coup took place on May 22, ensuring political stability over the short-term. This resulted in the stock prices for both Thai companies surging by around 20% between May 22 and July 8.
| Hit By Political Risk |
|Thailand - CH Karnchang And Sino Thai Engineering & Construction, THB|
We believe the next major manifestation of political risk on an Asian infrastructure market will occur in Indonesia. The country completed legislative elections on May 9 and is set to hold presidential elections on July 9. The presidential elections are particularly pertinent as it will be the first time presidential powers will be handed over from one directly-elected leader to another. The incumbent, Susilo Bambang Yudhoyono, is the country's first directly elected president, and he is constitutionally prohibited from standing for the presidential elections after serving two terms. The significance of the elections has already prompted infrastructure investors to wait for greater political clarity before taking on new projects, and the Indonesian government to put on hold key decisions on large-scale infrastructure projects (such as project awards and approvals) until after the ballot box.
At present, our Country Risk team considers the Democratic Party of Struggle (PDI-P)'s presidential candidate Joko Widodo (Jokowi) as the frontrunner in the upcoming July 2014 elections, and we believe his victory will significantly improve investor sentiment towards the growth outlook of Indonesia's infrastructure sector. Beside Jokowi, the other presidential candidate is Prabowo Subianto from the Great Indonesia Movement Party (Gerindra).
| Upside Potential |
|Indonesia - Adhi Karya and Wijaya Karya Stock Prices, IDR|
Although both candidates have stated intentions to focus on accelerating infrastructure development if elected, Jokowi has been viewed as more pragmatic and market-friendly, while Prabowo is seen as more fiercely nationalistic. So far, Jokowi's proposed policies have resonated more strongly with investors, with rising optimism towards a Jokowi victory already leading to a surge in stock prices for major Indonesia-based infrastructure companies. Between July 1 and July 8, stock prices for Adhi Karya and Wijaya Karya, rose by around 10% and we believe there is scope for further upside if Jokowi secures the presidency.
| Policy Inertia May Continue |
|Indonesia - Proportion Of Seats In Parliament, By Main Parties And Coalition Partners*, % of Total|
That said, we highlight that this upside could be tempered by the decision from the second and third largest political parties (Golkar and Gerindra, respectively) to align together in support of Prabowo ( see 'Golkar-Gerindra Tie-Up Complicates Jokowi's Ascendence', May 27 2014). The tie up between Golkar and Gerindra ensures that their coalition has the largest number of seats in the Indonesian parliament, giving them sufficient clout to stonewall Jokowi's legislative agenda if he secures the presidency. Although there is the potential for existing parliamentary coalitions to change after the presidential elections, the current state of things suggests that policy inertia could continue to persist in Indonesia, resulting in a lack of resolution over the numerous business environment issues that continue to delay infrastructure development in the country.