MANILA Spiralling political violence and the introduction of a new voting system have raised the risk that national polls in the Philippines in May produce the outcome markets fear most of all — a failed election that nobody wins.

Asset prices in the Philippines are generally very resilient to violence and lawlessness, particularly in the restive southern islands. And investors have long become accustomed to the “guns, goons and gold” culture of elections in the archipelago.But even markets that generally take unrest and insurgency in stride would be unsettled by one particularly dangerous scenario, in which the elections do not give any candidate a credible mandate. That could lead to months of uncertainty and further delay overdue efforts to reduce the fiscal deficit.

The risk of this scenario becoming a reality remains relatively low. But with political killings running at an unprecedented level, and doubts surrounding the implementation of automated voting, it cannot be ruled out. And the uncertainty is likely to act as a drag on markets in the months ahead.

“The constraint we face is that even if we see risk aversion offshore dissipate, the election risk premium may curtail any bullish (sentiment) or optimism in the local market,” said Jun Trinidad, economist at Citigroup in Manila.

Nearly 90 people were killed in politically motivated killings across the country last year, even before the start of the 120-day election period that began early this month. The death toll was well above the single-digit level of killings that preceded the election period in previous polls.

Some fear that the new system of automated vote counting, aimed at preventing fraud, could stoke increased violence.

“The automation process has changed the rules of the game and politicians who fear they could no longer manipulate poll results are more tempted to eliminate each other,” said Benito Lim, political science professor at Ateneo de Manila University.Some politicians may also use intimidation to scare voters on election day, resulting in low turnout, he said.

A high level of violence will not, by itself, be a major shock for markets — they are used to it. The average death toll for the four-month election period every three years in the Philippines is around 100, government records show.

Risk discount

But if unrest reaches a level that threatens the legitimacy of the election, or if automated vote tallying proves problematic, it would be a different story.

That would impose a much higher risk discount on Philippine asset prices, analysts say. Investors would shun long-term debt papers and shift to short-term holdings or sell altogether and the credit default swap spread would widen.

Antonio Herbosa, managing director at the Centre for Global Best Practices, a financial advisory firm, said if the elections failed, the stock market's main index could tumble below 2,600 points to the lowest levels since July 2009. The index is currently trading around 2,940 points.

The peso, which has been strengthening against the dollar in line with other risky but bullish Asian currencies, would also take a hit, analysts say.

If an election failure was solely due to technical problems, the impact on markets would be limited, Herbosa said.

“It would be totally a different story if the failure is in the context of the incumbent perceived to be wanting to stay in power,” he said.

Concerns that President Gloria Macapagal Arroyo might try to hang on to power beyond the constitutional limits of her term have unsettled markets at times over the past year. Most analysts believe it highly unlikely that she would seek to exploit any problem with the elections to remain in office, however.

Arroyo says she shares concerns that the May 10 polls could face problems. Asked by a group of foreign correspondents over dinner at the presidential palace last week if she was worried about the possible failure of the polls, she replied “Yes”.“It's something that has never been tested,” Arroyo said of the computerised tally. But she added “It might fail in some areas, but not in a national scale.”

Manila has yet to launch a comprehensive and effective educational campaign on the new system, with thousands of uneducated voters expected to be disenfranchised. That increases the risk of violence on and after election day on May 10.

Rule of law

Security officials say more than a third of the country's 1,600 cities and towns are prone to election violence due to the presence of Maoist-led and Muslim separatist rebels, Islamic militants, and armed groups of political warlords.

The Philippines is perceived by investors and multilateral financial institutions to have done little to impose the rule of law, especially in rural areas, where private armies dominate.

That contributes to an image of uncertainty and insecurity for investors that hurts the long-term economic prospects of the country. The World Bank's World Governance Indicators, widely watched by investors, have recorded a sharp drop in the image of the Philippines over the past decade.

The Rule of Law indicator has dropped from 52.9 in 1998 to 39.7 in 2008. Indicators are on a scale of 1 to 100, and the lower the number, the less the rule of law is upheld.

The decline in the Rule of Law rating for the Philippines puts it below Malaysia at 64.6, Thailand at 54.1, and even Vietnam at 41.6. Among major regional competitors only Indonesia fares worse at 28.7, but the Indonesian rating has been rising steadily as the rating for the Philippines falls.

To address poll-related violence caused by private armies under the control of political warlords, Arroyo has mobilised the army and police to dismantle about 170 armed groups.

She imposed martial law for more than a week in December on the lawless southern province of Maguindanao to dismantle the 2,000-member civilian militia force of her political ally, the Ampatuan clan, who helped her win the 2004 presidential polls.

Some members of the clan face charges for the November murder of 57 people, including 30 journalists, who were attacked on their way to witness the filing of nomination papers in what was the country's worst poll-related crime.

Arroyo also ordered authorities to collect more than one million unregistered small arms nationwide, about a third of them in the troubled southern island of Mindanao.

But no administration since the Philippine independence in 1946 had succeeded in dismantling private armies and in collecting loose firearms in the hands of civilians, and sceptics doubt Arroyo will succeed in her campaign.

“The level of violence and political killings in this country is just horrendously unacceptable,” said Peter Wallace, head of Wallace Business Forum consultancy.—Reuters