US President Trump’s shift to a less liberal stance on trade (specifically altering the narrative of trade relations with China), the dismantling of the Iran nuclear deal and the unilateral withdrawal from multilateral agreements have increased investment risks in emerging markets. In these respects, if Trump is impeached or loses the 2020 election then that might be a positive for emerging markets. Any subsequent President, whether Republican or Democrat, may at least be no worse for emerging markets.
But relations with China are likely to get worse as superpower rivalry increasingly cuts across matters of trade, investment (BRI), technology and territory. For example, disputes in the South China Sea have grabbed less of the spotlight under Trump, but that does not mean a stable equilibrium exists or that countries like Vietnam and the Philippines have had to do more to find their own local solution (e.g. confrontation by Vietnam, negotiation by the Philippines). Relations with Iran (and, by implication, the GCC, Israel and Turkey) and US engagement in multilateral agreements and organisations may change under a new President, but the damage done to the credibility of the US to a signed deal will likely persist.
In other respects of substance (rather than style), Trump does not represent a break in US foreign policy; i.e. there are areas where his actions have not changed the investment risks associated with emerging markets. Trump's compromises on ethics-based foreign policy and his inconsistent treatment of allies are arguably not new features of US foreign policy. And although he has pledged to reduce US active involvement overseas ("the endless wars"), the patchy public data available suggests this has not been the case as yet: e.g. in Afghanistan the number of US armed forces, US national private contractor personnel and US airstrikes (including drones) was higher in 2018 (under Trump) than in 2016 (Obama's last year).
One aspect, which garners a lot of attention but is largely irrelevant in terms of emerging market investment risk, is the highly personalised style – sometimes abrasive and sometimes charming – with which Trump has conducted foreign policy.
If Trump wins a second term, on the other hand, could emerging market risks get worse? If he can achieve a certain level of agreement with China, Iran, North Korea, the Taliban in Afghanistan and Venezuela (even if any new deals end up delivering, in the long-term, less benefit than the status quo he inherited) then there is an argument that Trump may move on and allocate less of his attention in his second-term to foreign policy. It is too early to say, but our base case is to expect more of the same should he win re-election. For example, we would not expect a relaunch of the US involvement in the Trans-Pacific Partnership (as a means to lock in alliances in the far east), the initiation of new major military interventions (e.g. in Ukraine or Venezuela), the abandonment of Israeli security, or a greater diplomatic and trade focus on Africa (there is already a heavy military one which Trump inherited).
Source: Bloomberg, Reuters, Tellimer Research
What has Trump done differently on emerging markets trade and foreign policy?
With or without a partisan bias, it is clear that some of the substance and much of the style of US foreign policy under the Trump administration has been a stark departure from the practices of its predecessors.
(1) Confrontation with China over trade and technology (less so, over territory) – The trade war has directly impacted global growth negatively, with knock-on hits to commodity producers and China supply chain partners alike. An already anaemic growth environment has been rebased lower.
(2) Confrontation with Iran over its regional actions, using sanctions rather than military deployment – Iran has continued to engage in the wider region, core Saudi economic assets have been attacked (at the very least by allies of Iran, if not Iran itself), the “pragmatic conservative” camp within Iran which pursued the JCPOA (Joint Comprehensive Plan of Action, also known as the Iran nuclear deal) has lost ground to the hardcore, divisions in how to deal with Iran have opened up between the US and the likes of the EU and India, and Iran has been pushed back closer to Russia. Whether the JCPOA sets the MENA region on a path to a stable balance of power remains debatable, but does not appear as if that path is any clearer as a result of the US abandonment of the JCPOA.
(3) Weaponisation of aid and trade policy – Apart from China and Iran, aid (e.g. Pakistan), tariffs (e.g. India, global steel and aluminium) and sanctions, or the threat thereof, (e.g. Turkey) appear to have been used in a more forthright manner as a tool of foreign policy with allies and rivals alike.
(4) Stated aim to draw-down international deployment of US troops – Dating back to the 2016 election campaign, Trump has pledged to reduce the deployment of US troops in “endless wars” overseas in Afghanistan, Syria and Iraq, for example.
(5) Withdrawal from multilateral agreements – Apart from the JCPOA, the US has withdrawn from the Paris Climate, Intermediate-range Nuclear Forces, North American Free Trade and Trans-Pacific Partnership agreements, as well as the Transatlantic Trade and Investment Partnership discussions. It is likely that Iran is not alone in questioning whether the US signature on any future multilateral agreement is binding.
(6) Departing from the established norms of international dialogue and diplomacy – Policy announcements and developments via Twitter (e.g. China trade talks), contradictory announcements within a short space of time (e.g. Turkey-Syria), a coarser form of language (“rocket man” when referring to the leader of North Korea) than traditionally associated with foreign policy (let alone, diplomacy), and an explicitly transactional tone to foreign policy (e.g. Saudi) are, in style at least, breaks from the past. As such, they have often driven material reaction, albeit temporarily, in the market price of assets. This change in style has been on display in dealings with long-standing allies (e.g. NATO) as much as with less and non-aligned countries. The one example, where this approach appears to have helped initiate dialogue is North Korea.
(7) Multiple personnel changes – Flynn, McMaster, Bolton, and O’Brien as National Security Advisor; Tillerson and Pompeo as Secretary of State; Priebus, Kelly, and Mulvaney as Chief of Staff. All are examples of changes of personality in what are presumably key contributors to foreign policy formulation and implementation.
Has Trump increased the intrinsic risk of emerging markets, as a whole?
(1) Trade – yes, emerging market risks have increased, but any future President cannot easily resolve the underlying tensions (particularly with China)
The China trade war and the withdrawal from TPP has damaged the growth prospects of emerging markets as a whole (because of the damage to global growth in general, which hurts manufacturing and commodity exporters, and those emerging markets which fill in some of the shortfall from China, e.g. Vietnam, carry the risk that it may only be a matter of time before the trade surplus they run with the US comes under scrutiny). Throughout its history, the US has oscillated between periods of foreign interventionism and isolationism. Under the "America First" banner, Trump seemingly tilted towards isolationism. But for a global power there are limits to how far both interventionism and isolation can go and Trump's clarification in early 2018 that "America First does not mean America alone" would appear to reflect this.
Since the early 1930s (following the Reciprocal Trade Agreements Act of 1934), the US has generally pursued trade liberalisation, whether via global (GATT, WTO), regional (NAFTA) or bilateral (e.g. Bahrain, Chile, Colombia, Jordan, Morocco, Oman, Peru, Singapore, South Korea) agreements. Trump has reversed this, not merely with China but to differing degrees with, for example, the EU and India. To the degree that trade, particularly the holy grail of job-creating manufacturing exports, is a key plank of a sustainable macroeconomic growth story, any moves by the largest economy in the world to regress free trade is a clear negative.
The protectionist shift and the trade war with China, in particular, are not going away soon. Trump is not the only advocate of revisiting trade rules, particularly with China. Both the Republican (Cruz) and Democrat (Sanders) runners-up in the nomination process supported reviewing trade rules. And, from the Chinese side, although Chinese exports to the US are much larger as a percentage of Chinese GDP (4% in 2018) compared to US exports to China as a percentage of US GDP (25bp in 2018), the Chinese likely bargain on the basis that they are able to withstand domestic political repercussions from the economic damage of the trade war more robustly than his democratically-elected US counterpart. (See our report, Trade wars and the Emerging Markets impact - Identifying the winners and losers, 10 July 2019.)
Source: IMF, Tellimer Research. In this chart, China includes HK, index weighted average calculated using the largest five or six country constituents of respective MSCI indices.
(2) Foreign policy – risks have increased in the GCC after abandoning the Iran deal, but elsewhere not so much because of Trump specifically (he has adhered to realpolitik and the constraint of domestic opposition to more wars, but with a different style to his predecessors)
In terms of foreign policy, the one area which has grown significantly riskier during his term is the GCC. Our interpretation of the Iran nuclear deal was that if it did establish the first step towards re-integrating Iran back into the regional and global economy, that economic benefit to Iran would embolden the “pragmatic conservative” camp rather than provide the funding for the hard-line conservative (e.g. the Revolutionary Guard) ambition to build regional proxies. As such, this was a viable way to progress towards a regional balance of power, relative stability and greater intra-regional trade. Abandoning the deal has, in our view, sent this process into reverse and made it even harder to get the Iranians back to the negotiating table or Iran’s regional rivals to believe they cannot pressure a reversal of a future negotiated deal. (See our report, Iran: Trump withdraws, stormy times ahead, 9 May 2018.)
Apart from the GCC, we do not view the rest of Trump’s foreign policy choices as representing a major break with the past: realpolitik has always mattered more than ethics, most alliances have been fleeting, the launch of new military campaigns (involving large active troop deployment) in new countries was already on the wane under Obama (and in places like Afghanistan, deployment has intensified under Trump) and aid, trade and sanctions have long been intertwined with foreign policy (again under Obama, prior to JCPOA, Iran sanctions were the most draconian which had been imposed up until that time and Trump has used sanctions on Iran, of course, as well as Cuba and Venezuela). And while the style with which Trump has conducted foreign policy is very different, we suspect this will not have a lasting impact on the risk one associates with emerging markets. (It is just that investors will go back to monitoring Bloomberg and Reuters more than they monitor the US President‘s Twitter account.)
In our view, realpolitik has always been the final determinant of foreign policy, not ethics; for example, the US has a long history of supporting governments, which by most measures would be described as authoritarian, when interests were aligned – the Cold War era is replete with examples of this, as is the period that has followed (even where authoritarian practices have existed under democratic systems of government, e.g. Bangladesh, Colombia, Egypt, Nigeria, Philippines and Turkey). Furthermore, much of the recent criticism of Trump for abandoning the Syrian Kurds, in terms of the negative signal it sends to any future military ally, forgets this same charge could be levelled, for example, at Reagan and the Mujahideen in Afghanistan, Bush Snr and the Iraqi Kurds.
Some of his critics argue that rivals and enemies have been emboldened under Trump when he has not engaged in new major military deployments (e.g. in North Korea or Venezuela). Yet this shift to trying to avoid new major entanglements was already underway during Obama's era (for example, when there was very little effort to arm Syrian rebels, let alone get directly involved). Furthermore, it is not at all clear that previous US military action in the emerging markets has consistently resulted in a lower risk environment. The resulting radicalisation of elements of the population in or near those countries attacked (either because they were directly under fire or because the governments in the region enlisted to support the US military have received effective cover for an authoritarian style of government) has substantially raised the risk for some of these countries in the long-term. Iraq (which is still struggling to establish social cohesion and basic public services) and Saudi (where the presence of US forces created a recruitment slogan for radicals during the first Gulf War against Saddam) is a case in point, and Afghanistan (which, like Iraq, is struggling with the same basics) and Pakistan (where the influx of refugees across a porous border compounded insecurity) is another.
Source: TBIJ, US DoD, NYT, WSJ, WP, Centcom
(3) Credibility in multilateral settings – emerging market risks have increased because Trump has undermined the largest player's credibility in multilateral agreements, and this cannot be won back quickly or easily
Arguably already one of the lasting parts of Trump's legacy, which any new President would find it hard to roll back, is the hit to US credibility when participating in multilateral negotiations. The exit from a raft of agreements has likely seen to this. Global security and economic growth (or financial stabilisation) have generally benefited from multilateral agreements and organisations (however imperfect, a cooperative equilibrium among multiple players is usually more efficient than a non-cooperative one) and given the US is the largest part of any multilateral setup then its loss of credibility matters most. This is damaging for all economies, developed or emerging.