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"Fragile Five" Polls Add To 2014 Risks For Emerging Mkts

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Elections in all the "fragile five" emerging economies next year, along with the thorny topics of Syria and Iran, will make life tricky for investors trying to steer through political risks in developing markets after a hairy 2013.

The withdrawal of US monetary stimulus will set the backdrop for the year, particularly for these big developing economies that depend heavily on foreign investor inflows.

Investors in companies or banks or other institutions agreeing contracts in emerging markets can buy insurance policies covering them against specific risks such as political violence, expropriation or contract renegotiations by governments or local private companies. Institutional investors may also use credit default swaps to hedge against the possibility of a government not paying its debts.

The size of the political risk insurance market jumped 33 per cent to record highs of $100 billion last year, according to data released earlier this month by the World Bank's political risk arm, which said it expected similar growth this year.

Investors fretted about the Middle East and North Africa, expropriation risk in Latin America and general capital constraints, the report from the World Bank's Multilateral Investment Guarantee Agency (MIGA) said.

The Fed's decision this week to reduce the money-printing that has fuelled demand for risky assets is expected to drag on growth in emerging markets next year, with Brazil, India, Indonesia, South Africa and Turkey seen as especially vulnerable to a sudden withdrawal of foreign cash.

But with elections due in all of the "fragile five" next year, politicians are likely to spend money to try to keep voters sweet rather than taking a more cautious approach.

"These are all the countries where markets have wanted to see small twin deficits - elections make that hard to achieve, at least on the budget side," said Charles Robertson, chief economist at Renaissance Capital. "There is lots of potential for markets to be jittery over these countries in 2014."

Emerging markets have already suffered from expectations of a tapering of the Fed's bond-buying programme, which has been on the cards for more than six months. Stocks are in the red for the year, heavily underperforming developed markets.

But with the reduction in US stimulus likely to be a theme for the whole of 2014, politicians will be wary of voter reaction over jobs or services.

The greater wealth that recent rapid growth has brought has pushed popular demands beyond basic human needs, political risk analysts say, a thread that runs from the Arab Spring uprisings of 2011 through to this month's protests in Kiev.

"The frustration that spilled onto the streets was driven by middle-class people beginning to assert themselves politically," said Christopher Torrens, director of global risk analysis at Control Risks, which sees next year as "particularly challenging".

Turkey turned from being an investment darling to an investment pariah in the space of a few weeks this year after the rough treatment of protests over a park in Istanbul, while a corruption probe this week has increased tensions.

Brazilian commuters protested about bus fares, and Ukrainians sought closer links to the European Union.

South Africa and India hold parliamentary elections in 2014, while Brazil and Turkey have presidential elections. Indonesia has both.

South Africa, Nigeria
In Syria, the nearly three-year revolt against President Bashar al-Assad suggests to investors that the Arab Spring is not yet over, particularly as Tunisia and Egypt remain unstable.

Political risk brokers say there has been an increase in interest in protection for this region.

"The (Syrian) conflict ... is spilling over into neighbouring countries, worsening an already-frail security situation," MIGA said in its report.

Across Africa, a rash of elections in the past year went off smoothly, notably those in Kenya, where the previous vote was marred by post-election violence in 2008.

But elections next year in South Africa - and in Nigeria in 2015 - are worrying investors.

"Expectations are for policy deterioration in South Africa over the first half and for Nigeria in the second half," Philippe Pontet, director for Africa at political risk firm Eurasia, told a recent conference call.

Risk can also come from the handover of power if a long-standing president such as Zimbabwe's Robert Mugabe dies.

"There are countries where, if the one strong man moves on, you end up with a vacuum, that's where you have uncertainty," said Peter Jenkins, co-head of political and credit risk at insurance group Brit.

Iran and the West last month made an interim agreement to end the stand-off over Iran's nuclear programme, designed to allow the lifting of sanctions imposed on the Islamic Republic.

But for Francois Savary, chief investment officer of Swiss private bank Reyl, that only adds to the risks.

Top officials in Sunni Muslim-ruled Saudi Arabia are furious that senior US officials held secret bilateral talks with Shi'ite Iran before the agreement.

"We do not like what's happening in the Middle East, the reaction of Saudi Arabia to US foreign policy," Savary said.

"This region remains under the radar."

Savary is enthusiastic about emerging markets as a whole for next year, but is avoiding investment in the Middle East, including market star Dubai, because of the potential risks.

But the uncertainty can offer opportunities.

Opposition parties in India and Brazil, for example, are seen as more business-friendly.

"(Fragile five) could be the most profitable markets to be in, because of the potential volatility," said Robertson.

And Julian Mayo, co-chief investment officer at emerging market fund manager Charlemagne Capital, welcomed recent steps to quicken the pace of market reform in China.

"In China, political risk has clearly fallen. In Brazil and India, things are better than six months ago - political risk is if anything going down."