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Banking on Democracy

Banking on Democracy: Financial Markets and Elections in Emerging Countries

Javier Santiso
Copyright Date: 2013
Published by: MIT Press
Pages: 336
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  • Book Info
    Banking on Democracy
    Book Description:

    Politics matter for financial markets and financial markets matter for politics, and nowhere is this relationship more apparent than in emerging markets. In Banking on Democracy, Javier Santiso investigates the links between politics and finance in countries that have recently experienced both economic and democratic transitions. He focuses on elections, investigating whether there is a "democratic premium" -- whether financial markets and investors tend to react positively to elections in emerging markets. Santiso devotes special attention to Latin America, where over the last three decades many countries became democracies, with regular elections, just as they also became open economies dependent on foreign capital and dominated bond markets. Santiso's analysis draws on a unique set of primary databases (developed during his years at the OECD Development Centre) covering an entire decade: more than 5,000 bank and fund manager portfolio recommendations on emerging markets.Santiso examines the trajectory of Brazil, for example, through its presidential elections of 2002, 2006, and 2010 and finds a decoupling of financial and political cycles that occurred also in many other emerging economies. He charts this evolution through the behavior of brokers, analysts, fund managers, and bankers. Ironically, Santiso points out, while some emerging markets have decoupled politics and finance, in the wake of the 2008--2012 financial crisis many developed economies (Europe and the United States) have experienced a recoupling between finance and politics.

    eISBN: 978-0-262-31370-4
    Subjects: Finance, Business

Table of Contents

  1. Front Matter
    (pp. i-vi)
  2. Table of Contents
    (pp. vii-viii)
  3. Acknowledgments
    (pp. ix-x)
  4. Introduction
    (pp. xi-xxxii)

    Politics matter for financial markets, and the reverse is also true: financial markets matter for politics. This book is about the intricate links between the worlds of finance and politics and focuses on elections in emerging markets—one of the major critical junctures of modern democracies. A core question that is addressed, using unique and unexploited databases, is whether a democratic premium exists. In other words, do financial markets and investors (more generally bankers, portfolio managers, or foreign donors) tend to react positively to elections in emerging markets and democracies? This question is explored here in emerging economies that have...

  5. 1 Emerging Markets: Inside the Black Box
    (pp. 1-44)

    The novelist Stefan Zweig spent the last years of his life in Brazil. There he wrote an essay, a rumination on a broken and outdated Europe, which he contrasted with a country that astonished him with its vitality and potential—Brazil. He praised that enormous country as the land of the future. Developing countries, like Brazil, have long been the countries of the future. Today their promise finally appears to be materializing. Many are no longer spoken of as developing but instead are seen as emerging countries.

    In this chapter, I put into perspective the massive global rebalancing and shift...

  6. 2 The Brazilian Confidence Game
    (pp. 45-92)

    In a brief but stimulating essay, Paul Krugman (2000a, 2000b) criticized the double standard that is enforced by financial markets. Simply put, policies that would have been regarded as completely unsustainable and perverse at home are advocated for emerging-market economies. One decade later, it looks like emerging markets and OECD countries are becoming increasingly normalized. In 2010, although OECD countries such as Greece and Hungary faced major financial disruption in the wake of presidential elections and government changes, emerging nations such as Brazil and Colombia had smooth election processes. In less than a decade, some aspects of the confidence game...

  7. 3 Brokers and Elections
    (pp. 93-126)

    In Brazil, as is discussed in the previous chapter, political outcomes such as presidential elections have been perceived as critical junctures that can have great resonance on financial markets. But elections have also acted as confidence multipliers in financial markets in other emerging markets. The case of Brazil is not unique.

    In the Brazilian case study, uncertainty plays a key role in the negative overshootings of financial markets before elections. Political events, even recurrent and normal ones like elections, can increase uncertainty and therefore decrease investment (or increase risk premiums).

    There also are various forms of politically induced uncertainty. Uncertainty...

  8. 4 Fund Managers and Elections
    (pp. 127-156)

    Previous chapters examined the evolving relations between financial markets and elections in emerging democracies, based on a study of analysts and investment-bank economists who work in the sell side of the industry (brokers). But what about the buy side of the industry—the fund managers who buy from these brokers? Do they also overreact to regular elections in the same way that bankers from the sell side do?

    Rather than the previous chapter’s focus on sovereign debt, this chapter expands the scope to consider both equities and bonds. The assumption is that asset-allocation decisions are made in a similar fashion...

  9. 5 Political Budget Cycles
    (pp. 157-190)

    Financial markets tend to become nervous before and after elections. Brokers frequently downgrade their recommendations to their clients, and fund managers tend to follow the herd. As has been shown, these overshooting reactions have tended to change over the years and particularly over the past decade.

    Such behavior and negative (or positive) confidence multipliers are seen around election times because both brokers and fund managers have good reasons to worry. In emerging markets, crises tend to be synchronized with political cycles. With or without a crisis, election years tend to boost public spending, worsening fragile fiscal positions of emerging markets...

  10. 6 Bankers and Elections
    (pp. 191-230)

    As shown in the previous chapters, brokers and fund managers who are active in capital markets tend to get nervous around election times, and their nervousness is partly justified due to the historical pattern of fiscal deteriorations before presidential elections in emerging countries. But we are living in changing times with a (partial) decoupling of financial and political cycles in (some) emerging markets. This trend is explained by policy-management improvements in emerging markets, among other more anchored and sound fiscal policies.

    Policy uncertainty surrounding election time has been a key driver of the swings and negative confidence multipliers at work...

  11. Conclusion
    (pp. 231-250)

    Major changes in international economics and finance have occurred over the past decade. Once considered to be an exotic asset class, emerging economies are now becoming a more normalized asset class (UBS 2010b), the “new-normal” (El-Erian 2009). The frontier between OECD and emerging markets is eroding, and the core-periphery model is collapsing (Booth 2010).

    One paradox of the new century is that developed economies are showing a resurgence of sensitivity to politics and emerging countries have been experiencing a partial decoupling between financial and political cycles. In the past, fiscal adjustments and budget discipline were closely watched by financial markets...

  12. References
    (pp. 251-282)
  13. Index
    (pp. 283-318)