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Political woes pervade emerging and developed markets

Istanbul women solidarity members leave shoe boxes and picture of Turkish Prime Minister Recep Tayyip Erdogan next to riot policeshields read during an anti government protest.
Ozan Kose | AFP | Getty Images
Istanbul women solidarity members leave shoe boxes and picture of Turkish Prime Minister Recep Tayyip Erdogan next to riot policeshields read during an anti government protest.

A rapidly escalating corruption probe that is undermining Turkey's government; large-scale demonstrations in Ukraine and Thailand; growing anti-establishment and anti-German sentiment across the euro zone; and a lack of leadership on the big issues facing the global economy.

If there is a common thread running through these challenges, it is that in both developing and developed economies there is a severe deterioration in the political conditions for managing the effects of the global financial crisis and undertaking much-needed reforms.

Political risk became much more pronounced in 2013 and is likely to prove more of a concern for investors in 2014 as the U.S. Federal Reserve begins to withdraw monetary stimulus - the main pillar of support for financial markets.

(Read more: Euro zone's 2014 pressure point—politics)

As countries' fundamentals start to become more important -- and investors become more discriminating about where they choose to park their money -- the political determinants of sovereign risk will come into sharper focus.

Emerging markets will give investors plenty more to fret about in 2014 - although differentiation will remain the watchword.

Turkey will stay in the spotlight because of its severe balance of payments weaknesses, which render it vulnerable to a rise in U.S. Treasury yields. But it is domestic factors which are likely to have a stronger bearing on investor sentiment. A country with one of the deepest and most liquid bond markets among developing economies has lost one of its prized commodities - political stability - at a particularly inopportune time. Turkey's prime minister, Recep Tayyip Erdogan, is fighting for his political survival.

(Read more: Thank Turkey for the euro's spike versus dollar)

India is another emerging market knee-deep in political uncertainty. Amid a backlash against the establishment - in particular the ruling Congress party - and a dramatic slowdown in the economy, Indian politics is in a state of flux. Arvind Kejriwal, the head of Aam Aadmi, the country's new anti-corruption party, has just been sworn in as chief minister of New Dehli's government in what could be a foretaste of things to come in parliamentary elections due by May.

Even if Narendra Modi, the prime ministerial candidate for the opposition BJP party, assumes the premiership, he is likely to lead another messy coalition government which drags its feet on much-needed structural reforms, putting yet more pressure on India's central bank to maintain confidence in the economy.

(Read more: Why a new government may not boost India's reform prospects)

The politics of reform are also stymieing attempts to shore up the ill-managed euro zone. The conspicuous failure to create a credible banking union to help sever the pernicious link between vulnerable sovereigns and banks stems from the lack of support within the bloc for a political and fiscal union. Indeed, Germany is not only unwilling to share more risks but is also reluctant to cede regulatory powers over its regional savings banks to the European Central Bank.

The political imperative of maintaining economic sovereignty is becoming more pronounced, particularly in France and Italy, presaging increased tensions between Brussels and national capitals in 2014. Financial fragmentation, which includes the "re-domestication" of euro zone peripheral government debt markets, has its political equivalent: a rise in anti-German and anti-EU sentiment.

The woeful lack of growth in the euro zone is accentuating the political and economic disintegration of the bloc. The trend is towards greater divergence, boding ill for the convergence of bond yields across the bloc.

Nicholas Spiro is Managing Director of Spiro Sovereign Strategy

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