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Global Macro Editions

2019 Global Macro Outlook
Environmental, Social and Governance Factors in Global Macro Investing
The Fed’s Long Unwinding Road
Inflation: Dead, or Just Forgotten?
Emerging Markets: Mapping the Opportunities

TGM’s ESG philosophy and process

Before delving into the specific scores, we would like to summarize a few key points on how TGM views our internal ESG process. These points also reflect how TGM believes ESG can be best utilized by investors in the sovereign space.

1. ESG is most effective when fully integrated into the other components of research, including traditional economic analysis and on-the-ground visits. These issues contribute to core macroeconomic views on a country. ESG factors are then expressed through analysis of economic issues such as growth and inflation.
2. We focus on forward-looking data points. Rather than current ESG performance, which is strongly correlated with income levels, TGM believes that momentum, or change in score, is the measure that truly matters for both potential investment performance and for determining where capital could be deployed for the greatest positive impact.
3. ESG is an important tool for identifying investment opportunities in addition to highlighting areas of risk. TGM is most interested in the “tails” signaling major ESG shifts in either direction.
4. In order to benefit from ESG analysis, investors must have a sufficiently long time horizon. ESG factors guide a country’s fundamentals, which can be overshadowed in the short term by cyclical or temporary conditions. We believe conviction in the view and patience to see that view come to fruition are requisites to successful ESG investing.
5. Emphasis on a country’s long-term fundamentals provides an effective base for TGM to open communication with policymakers interested in discussing best economic practices. This dialogue is important for our ability to serve clients, and for government officials interested in the perspectives of private markets.

TGM-ESGI: Methodology and scores

The TGM-ESGI is a composite of 13 subcategories (see GMS-9, page 4) determined to be material to macroeconomic performance, scored from 0–100.1 The research team assigns numbers by overlaying their views on a benchmark created by global indexes for current scores. Analysts then provide projected numbers in anticipation of how conditions will change in the medium term. The final scores are calculated with weightings of 40% for governance, 40% for social and 20% for environment. The environment receives a lower weighting because its effects on macroeconomic performance take place over a significantly longer-term time horizon. The change in score, the metric TGM places the greatest emphasis on, is simply the projected score minus the current score.

The results from our February 2019 scoring are shown in Exhibits 1 and 2. We have expanded the number of countries to 56 from 44 previously.

Environmental, social and governance scores by country (TGM-ESGI)

Exhibit 1: TGM-ESGI Scores: Current (As of February 2019)

Exhibit 2: TGM-ESGI Scores: Projected Change (As of February 2019)

Source: Calculations by Franklin Templeton Capital Market Insights Group using data sourced from Bloomberg, Central Bank News.

Case Studies

As stated earlier, what TGM pays greatest attention to are the “tails,” countries in which there is a drastic change with regards to projected ESG scores in either direction. We have highlighted six of these countries, three showing projected improvement and three showing expected deterioration.

Three countries with improving projected ESG scores

1. Indonesia

• President Joko Widodo looks poised to win a second term, reflecting public support for his reform agenda and rejecting the elite background and nationalistic rhetoric of his rival, Prabowo Subianto.
• We expect further progress on president Widodo’s reform agenda following elections. This includes building infrastructure, reducing regulations on businesses and fighting corruption. There will also likely be an emphasis on reducing poverty and inequality.
• Economic management has become increasingly orthodox, with an emphasis on prudent budgets and consistent monetary policy. The number and quality of technocrats within the administration have strengthened.
• Social cohesion in Indonesia is expected to deteriorate with the rise of fundamental Islamic groups and their greater influence over politics.

2. Brazil

• Recent elections in Brazil represent a new direction for the country, including a firm rejection of systemic corruption under ex-President Luiz Inacio Lula da Silva and the Workers Party (PT). The cleanup of Lava Jato— a corruption scandal also known as Operation Car Wash—and public enthusiasm for its efforts has empowered the judiciary to launch a campaign against graft.
• The administration has assembled a capable economic team that is intent on addressing fundamental challenges facing Brazil, notably social security reform.
• The business climate in Brazil is expected to improve significantly with reduced red tape and corruption, along with the administration’s push for the privatization of state-owned enterprises and reduction of trade barriers.
• We are cautious of potential deterioration in certain ESG factors due to the current administration’s inclinations, paying particular attention to institutional strength, social cohesion and unsustainable practices.

3. Argentina

• Argentina has maintained commitment to politically challenging but necessary reforms in order to rebalance its economy. Decisions to float the exchange rate, enact pension reform and reduce subsidies have caused short-term economic pain but are critical to the country’s long-term potential.
• Despite a tougher economic environment, including recession and high inflation, President Mauricio Macri’s government has continued to navigate Congress and pursue orthodox economic policy, including passing a balanced primary budget for 2019.
• President Macri and his Cambiemos party have retained core public support. We continue to expect a Cambiemos victory in the October presidential elections on this base and the split in the Peronist party, but are carefully monitoring developments.
• The government has moved to rectify many of the previous administration’s corrupt practices by publishing accurate economic statistics and punishing corporations that engage in graft with public officials.
• Energy security in Argentina is expected to improve as a free-floating currency will encourage investment within the natural gas industry, reducing the country’s reliance on expensive imports.

Three countries with deteriorating projected ESG scores

1. Italy

• Elections in March 2018 cemented populist leadership with unprecedented victories by the League and the Five Star Movement, bringing Italy into the growing ranks of euroskeptic countries within the European Union (EU).
• The new government stands for populist measures such as tax cuts, anti-immigration efforts and the abolishment of pension reform. These policies, while popular, are counter-productive in the face of Italy’s challenges with high debt levels and low productivity growth.
• Italy is set up for increasing conflict with Brussels as its government seeks less EU oversight into its domestic affairs. While the first major clash, on the 2019 budget, was resolved, we can expect further confrontations down the road.
• Social discord and support for hard-right parties can only be expected to increase as both Italian and broader euro area growth are slowing.

2. Turkey

• Institutions have been broadly weakened under the executive presidency, including abolishment of the office of prime minister, the right to dismiss senior civil servants and the ability to appoint judges.
• The numerous purges since 2015 have dismissed tens of thousands of individuals from the civil service, military, judiciary, media and academia—intimidating and severely damaging the capacity of those institutions.
• Economic policies have consistently been misguided, including the erosion of central bank independence and over-extension of credit. Government spending has also been pro-cyclical, concentrated in construction and defense, adding to the overheating.
• Volatile political and economic conditions in Turkey have eroded its credibility among foreign investors. Escalating tensions with the US and European countries will also likely have negative impacts on Turkey’s attractiveness as an investment destination.

3. South Africa

• Economic fundamentals are gradually deteriorating, including poor fiscal management and deindustrialization in the face of increasing reliance on commodities. The government does not have sufficient political capital to engage in an orthodox reform agenda.
• Low growth and significant inequality have caused greater public demand for redistribution rather than growth. An example is the debate over land expropriation without compensation. This leaning toward populism has damaged business confidence, which has been on a declining trend.
• The African National Congress (ANC) continues to battle factionalism between the supporters of President Cyril Ramaphosa and ex-President Jacob Zuma. This is particularly damaging to administrative effectiveness as the ANC governs by collective policymaking. There are also significant tensions between the ANC and its coalition partners, SACP and Cosatu.
• The Ramaphosa administration has worked to fight corruption and graft. The government has turned over the heads of the state security agency and the Hawks, a specialist anticorruption police unit, and dismantled the Gupta empire.