Counting the investor vote: political business cycle effects on sovereign bond spreads in developing countries
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Counting the investor vote: political business cycle effects on sovereign bond spreads in developing countries Paul M Vaaler1, Burkhard N Schrage2 and Steven A Block1 1 The Fletcher School of Law and Diplomacy, Tufts University, Medford, MA, USA; 2Singapore Management University, Singapore
Correspondence: PM Vaaler, The Fletcher School of Law and Diplomacy, Tufts University, Medford, MA 02155, USA. Tel: þ 1 617 627 2243; Fax: þ 1 617 627 3712; E-mail: [email protected]
Abstract International business research has paid scant attention to whether and how electoral politics and economic policies affect foreign investment risk assessment, particularly in developing countries, where the last decade has seen both considerable foreign investment and domestic progress toward democratization and electoral competitiveness. We respond with development and testing of a framework using partisan and opportunistic political business cycle (PBC) theory to predict the investment risk perceived by investors holding sovereign bonds during 19 presidential elections in 12 developing countries from 1994 to 2000. Consistent with our framework, we find that bondholders perceive higher (lower) investment risk in the form of higher (lower) credit spreads on their sovereign bonds as right-wing (left-wing) political incumbents appear more likely to be replaced by left-wing (right-wing) challengers. For international business research, our findings illustrate the promise of PBC theory in explaining the election-period behavior of sovereign bondholders and, perhaps, other investors who also ‘vote’ in developing country elections and can substantially influence the price and availability of capital there. For developing country investors and states, our findings highlight the financial effects of democracy in action, and underscore the importance of state communication with investors during election periods. Journal of International Business Studies (2005) 36, 62–88. doi:10.1057/palgrave.jibs.8400111 Keywords: elections; developing countries; risk; sovereign bonds; spreads
Introduction
Received: 10 October 2003 Revised: 9 June 2004 Accepted: 3 July 2004 Online publication date: 23 December 2004
RECOMMENDATION: WE CONTINUE TO RECOMMEND CLIENTS REDUCE EXPOSURE AHEAD OF THE ELECTIONy The steady decline in Brazilian bond prices turned into panic selling last week. The sovereign spread (or risk premium) on Brazilian USD debt gapped out from 1250 basis points (bps) on Monday (June 17) to 1700 bps by the close on Friday (June 21). Brazilian spreads are now wider than during the country’s currency crisis in January 1999y Bond investors are clearly worried about the outcome of the presidential elections in October. Worker’s Party (PT) candidate Lula continues to lead in opinion pollsy The widespread perception among market participants seems to be that a Lula presidency would put Brazil on a path towards defaulting on its external debt. Excerpt from Credit Suisse Pri
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