LONDON, Jan 15 (Reuters) - The threat of social unrest is growing across emerging markets as the financial crisis boosts unemployment and economic pain, with both the instability itself and government reactions threatening foreign investors.
Demonstrations were reported turning violent in Bulgaria and Latvia this week as well as China, potentially a sign of more to come with ruling coalitions coming under threat and future policy becoming unpredictable.
Analysts say governments from Eastern Europe to Asia are already bracing themselves for potential social upheaval, with more authoritarian leaders most willing to use force to hold their position but with investors also facing a range of policy shifts that could endanger their positions.
At the same time, if governments fail to contain discontent then that too would be negative for foreign money managers who have already yanked record amounts of money out of emerging markets last year giving emerging stock markets their worst performance on record.
"At a time when there is already less money in the system, this will really put people off," said Lars Christensen, head of emerging markets research at Danske Bank. "These events are happening because of the financial crisis but in some of these markets they are also going to make it worse."
Some governments such as Ukraine have already upped capital controls as they try to protect faltering or freefalling currencies or prevent capital flight, cutting off investors from their money and prompting some to try and get out of such markets before it is too late.
Desperation to avoid a sudden mass devaluation of Russia's rouble -- which would slash the savings of Russian individuals -- has been the defining factor in Russia's scheme to make a series of "mini-devaluations" and spend roughly a quarter of its reserves defending the currency.
That has inevitably unnerved investors who had been counting on those reserves to insulate the country, prompting them to question its creditworthiness.
UNPAID WORKERS RIOT
"It's a short-term approach," said Andrew Brown, who helps manage $7-8 billion in emerging markets for Aberdeen Asset Management and is underweight on Russia. "It's bad for foreign investor sentiment because they should be focusing on improving domestic demand instead of propping up the rouble."
He was much more positive about China's attempts to stave off unrest with a $585 billion stimulus package aimed at the wider economy.
With hundreds of unpaid workers reported clashing with riot police in eastern China on Thursday [ID:nPEK154989], even authoritarian states may see unexpected changes.
Some analysts even ask whether, as the economic crisis touches ever more Russians and falling oil prices bite, it could begin to erode the two-man "tandem" of Prime Minister Vladimir Putin and President Dmitry Medvedev [ID:nLC264659].
But most expect the government to take a strong line with any demonstrations, with the arrest of dozens in Russia's eastern port of Vladivostok after a demonstration against car import tariffs seen as a potential sign of things to come.
It is unclear whether investors would be more spooked by increased demonstrations or a greater clampdown, with the mass exodus of funds that followed war with Georgia in August a clue to the possible reaction to either.
Russia had one of the worst performing stock markets
in emerging markets last year, damaged by worries of political interference, slumping oil prices as well as the more general shift in sentiment against emerging markets. Most still see it as one of the riskiest in 2009.
Analysts say the Russian state will likely as a result boost its support for strategic industries such as state gas giant Gazprom and defence industries, possibly also bring in other industries under the state in an attempt to boost employment.
"That is likely to be bad news for small to medium-sized firms," said Tsymur Huseynov, head of the Eurasia desk at risk consultancy Executive Analysis. "And it will be even worse news for foreign firms who have factories or investments there."
Whether a poorer, more troubled Russia will be more likely to be a more destabilising or more conciliatory influence is almost impossible to say, analysts warn.
REPEATING 1930s MISTAKES?
The Georgia war cast a long shadow across investment in the region, marking the beginning of a sharp deterioration in Ukrainian assets and a repricing of risk as far as Poland.
"On the one hand, it might lead to the Russian leadership becoming more aggressive towards their neighbours," said Danske's Christensen. "On the other hand, with less money they may decide they need the West more."
More fluid democracies such as central and eastern Europe may have more mechanisms to release tension and unrest but the risk of coalition collapse or drastic policy shifts after elections makes it difficult for investors to predict policy.
While the key economies of Poland and the Czech Republic are seen surviving largely intact, more economically and politically vulnerable countries such as Hungary and Romania have already seen their currencies fall roughly 6 percent since January 1.
Looking back to the lessons of the last Great Depression of the 1930s, Goldman Sachs warned some emerging economies were already repeating a previous generation's mistakes by moving towards at least light protectionism.
Russia has announced tariffs on imported cars, Brazil and Argentina are also considering raising tariffs, Indonesia has slapped restrictions on at least 500 products and India imposed duties on soya bean imports to protect domestic farmers.
"One of the key lessons of 80 years ago is that freeing up trade, rather than restricting it, would more likely help a fragile world economy," Goldman Sachs said in a research note. (Editing by Andy Bruce)
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