Political Stability and Financial Performance: The Puzzle of Singapore and Thailand

Traditional finance and economic theory suggest that politically unstable countries often create greater market volatility, Beta, thereby devaluating their Sharpe Ratio vis-à-vis their regional peers. This would render investment in these countries unattractive, lest returns can justify such a risk. This is best reflected in the realm of fixed income. As such, we see sovereign bonds in Emerging Markets commanding a significantly higher yield than those being traded in Developed Economies. On general, the yield spread is 400 basis points, essentially the same level as speculative corporate bonds in the US. The more politically stable a country is, the reverse is likely to happen. Lower instability attracts investors, resulting in higher investment rates and therefore lower yields. This is equally applicable to public equities. Higher systemic volatility raises the weighted average cost of capital (WACC), effectively increasing the discount rate for future cash flows and thereby decreasing enterprise valuations. The P/E ratio of the MSCI Emerging Countries Index, which tracks the large and mid-cap stocks of 24 countries, is almost half (15x) that of the S&P 500. The more stable a country is, the less significant the political risk premium will be. Investors can invest with greater precision, and foreign investors do not need to worry about the risk of sudden exchange rate volatility.

This, however appealing it might sound at first sight, is simply not true in Southeast Asia. Politically unstable countries such as Thailand (the country has a new constitution on an average of 4.5 years) has performed exceedingly well in their stock markets, if we ignore recent trends. Conversely, Singapore, one of the most politically stable countries in the world, seemed to not fare up to expectations compared to its peers, which are often seen to be on a different level of economic development.

Fig 1.1 Thailand’s stock market performance (blue) vs Singapore’s stock market performance (white) last 10 years; surprising results. Source: LSEG Workspace

Additionally, the historical P/E ratio (5Y average) of the SGX hovers around 20.3x , roughly similar to that in Thailand (Bloomberg). On the fixed-income side, we glimpse a similar narrative when we compare Thailand to Singapore.

Fig 1.2 SG 10 year bonds and Thai 10 year bonds compared in the SR. Source: LSEG Workspace

Maybe the correlation can be explained by idiosyncratic events, such as the lowering of policy rates in either of these countries (exchange rate manipulations in the case of Singapore) to bolster the economy. This has been seen in Thailand recently as it tries to combat low consumer sentiment and raise policy rates to the range of 2%. Doing this would decrease bond yields as short-term policy rate decreases would spur greater demand in bonds, reducing the yield as prices rise. However, how do you explain this?

Fig 1.3 Yield spread between sovereign 10 year bonds in the LR; Evident incoherence of traditional finance theory on Emerging Markets. Source: LSEG Workspace

The yield spread is not sufficient to justify the economic development of these two countries. How do you explain to an investor that Thailand, a country that has experienced multiple coups and protests in the last 20 years, seems to exhibit greater macroeconomic stability by looking at financial indicators, than Singapore?

The first step would be to recognize the over-simplicity embedded in traditional finance theory. Country risk premium—while a contributing factor—cannot explain everything. Poor equity market performance in Singapore can be attributed to an array of factors. The small population, even if the nation punches above its weight economically, results in poor liquidity and insufficient scale for promising companies to list there. This creates a negative flywheel: poor liquidity will further deter institutional investors since transaction costs would erode the Sharpe ratio, which would exacerbate low trading volumes. Singapore’s stock market turnover ratio—a key indicator for liquidity—is extremely low (16% in 2019), even lagging that of Vietnam’s, whose stock market was still classified as “Emerging” by MSCI. Additionally, the stock market is dominated by large blue-chip enterprises key to state function. These include the “Big Three” banks and government-linked companies such as Singtel, Keppel Corp., and CapitaLand. Slow, stable growth of these companies deflate P/E ratios, while high-tech, fast-growing companies listed on the catalist board are largely unprofitable, resulting in “zombie” firms that do not get removed due to certain incentive structures (Financial Sponsors for catalist listed companies are compensated by the very companies they supervise, thereby reducing interest to delist laggards). Other potential reasons also come into play. The risk-averse nature of financial institutions investing in public equities worsens existing problems of scale. Having one of the largest Asian REIT markets (12% of total SGX capitalization) also drags down on the exchange’s liquidity, since REITs often have a much lower turnover ratio by virtue of their high dividend-paying nature. Despite having one of the most efficient and well-oiled government systems in the world, Singapore has an anemic stock market that is in stark juxtaposition with its branding as a Global Financial Center.

On the other hand, we can explain the relatively pricy exchanges in Thailand by other dynamic factors excluded in the calculation of country risk. Thailand, despite its constant constitutional revisions, has shown surprising economic resilience. Its export-oriented economy is relatively insulated from internal politics, which would always seek to uphold existing trade relations and export revenue to ensure political legitimacy. On a more fundamental level, Thailand's political economy is intricately interwoven, fostering a structural inertia wherein economic elites perpetually retain influence irrespective of political fluctuations. Even the watershed moment of the 1997-1998 Asian Financial Crisis did not destabilize Thailand's elite to the extent seen in Indonesia. Credit Suisse’s Global Wealth Report 2018 testifies to such a phenomenon: It was estimated that the top 1 per cent of population owns a staggering 66.9 per cent of total wealth in Thailand. These family-owned business dynasties—often ethnically Chinese—dominate the country’s economy. The Chirathivat family, for example, started off as a retail store that branched out into a diversified conglomerate worth more than $10 billion. Other dynasties monopolize entire verticals: The Yoodhiyva and Chearavanont families (food and beverage) and the Sirivadhanabhakdi and Chirathivat families (real estate). Even politically sensitive industries such as energy have significant presence of family dynasties: The Ratanavadi family (Gulf Energy Development) and The Link Family (B.Grimm Group). Despite political turmoil, internal economic stability has brought about greater investor confidence in the exchange than one would have expected. Additionally, the Thai Stock Exchange benefits from its large population and more active involvement from non-bank, domestic financial institutions that actively invest in local enterprises. Such dynamism partially offsets the apparent risk of investing in a politically unstable regime.

We can also explain this paradox in the fixed-income scene. Lower sovereign bond yields in Thailand can be explained by the stronger interventionist approach adopted by the Thai government in regard to monetary policy. The government adjusts policy rates by conducting Open Market Operations, which will increase/decrease liquidity in the financial system, thereby affecting rates. This is complemented by stricter regulations for financial institutions to buy up domestic bonds, which would further depress the yield rate. Such strong emphasis on a captive domestic demand seems to be a response to The Asian Financial Crisis, which originated in Thailand. Low yield rates would ensure credit safety for the Central Bank even in times of capital flight—a common occurrence in Emerging Markets—since a large portion of the assets of key financial institutions would be tied to The Central Bank. Singapore’s yield curve, on the other hand, is much less subject to government interventions. Singapore has famously chosen to concede monetary policy autonomy for exchange rate flexibility in the “Impossible Trinity” due to its small size and trade-oriented economy. The government is therefore unable to freely intervene in the bond market, and the yield curve therefore experiences less downward pressure. More importantly, Singapore’s yield curve is heavily influenced by global market sentiment. Using the US 10-year yield as a benchmark, Singapore’s 10-year bond yield closely tracks its movements while consistently maintaining a modest risk premium.

Fig 1.4. SG 10 year yield rate closely mirrors that of its US counterpart; High correlation indicates greater investor sentiment at action. Source: LSEG Workspace

The negative yield spread between Thai 10 YR bonds and Singaporean 10 YR bonds after mid-2022 can therefore be explained. The Federal Reserve’s aggressive hiking during that time has “pulled up” the SG 10 YR bond yield rate, creating a peculiar scenario whereby Thailand, a nation with developing economic infrastructure, commanded higher sovereign debt prices than Singapore, a country who’s GDP per capita is roughly 9x that of Thailand’s.

While it is intuitive to think about emerging markets investing through a lens of risk premiums contingent on political structures and economic infrastructure robustness, it is an error to only adopt such a perspective when analyzing sovereign profiles for investment opportunities. Other important factors—economic policies, political economy, stock exchange regulations—must be considered as well for a more holistic and accurate assessment of risk.