Published on January 20, 2014
WHAT IS AN EMERGING NATION An emerging nation is a country that is on its way to becoming an industrialized nation. An emerging nation is a developing country that has achieved some industrial capacity like Brazil and India. Countries that are no longer poor developing countries, but haven’t yet joined the richest industrial nations, are called ―emerging nations‖ or ―newly industrialized countries‖ (NICs). This means they are on the way to becoming fully industrialized. Emerging countries at present include Thailand, South Korea, Taiwan, Brazil and Mexico. The economies of China (Excluding Hong Kong and Macau, as both are developed) and India are considered to be the largest. The largest emerging and developing economies by either nominal or inflation-adjusted GDP are the BRICS countries (Brazil, Russia, India, as MIKT (Mexico, Indonesia, South-Korea and Turkey). China and South Africa), as well
WHAT IS THE DIFFERENCE BETWEEN A DEVELOPED, EMERGING, AND FRONTIER MARKET? DEVELOPED MARKETS As the phrase itself implies, these countries are usually the most advanced economically. They have highly developed capital markets with high levels of liquidity, meaningful regulatory bodies, large market capitalization, and high levels of per capita income. Developed markets are found mostly in North America, Western Europe, and Australasia, including nations like the U.S., Canada, Germany, the U.K., Australia, New Zealand and Japan. Different entities have different definitions as to what constitutes a developed market, which can make the issue somewhat confusing. As a result, a given country can be a developed market according to one firm and an emerging market according to another.
EMERGING MARKET An emerging market is, in short, a country in the process of rapid growth and development with lower per capita incomes and less mature capital markets than developed countries. It includes the famed BRICs, Brazil, Russia, India, and China; and even the PIIGS (Portugal, Ireland, Italy, Greece, Spain – also known by the more politically correct moniker GIPSI). FRONTIER MARKETS A frontier market is a subset of the emerging market category. In other words, frontier markets are emerging markets, but not all emerging markets are frontier markets. Specifically, a frontier market is one with little market liquidity, marginally developed capital markets, and lower per capita incomes vis à vis the more developed emerging markets like Brazil and China. They tend to be even less-developed and have higher levels of risk than emerging markets. MSCI has Qatar and the United Arab Emirates under review for moves to emerging market classification.
Frontier markets include the CIVETS (Colombia, Indonesia, Vietnam, Egypt, Turkey, and South Africa) and places like Nigeria, Bangladesh, and Botswana. Like with the distinction between developed and emerging markets, the difference between a traditional emerging market and a frontier market can differ based on the entity making the distinction. For example, Colombia is considered just an emerging market by some, and a frontier market by others. A few countries are in transition: South Korea and Taiwan have been under review by MSCI for a couple of years for a potential move to developed status. Morocco is under review for a potential downgrade to frontier market status.
Emerging markets differ from their "developed" market counterparts in four main ways. They have: Low household incomes Structural changes occurring, such as modernization of infrastructure or moving from a dependence on agriculture to manufacturing Economic development and reform programs under way Stock and bond markets that are less mature in functioning, rules of conduct, and liquidity
Emerging markets—countries undergoing rapid economic growth and industrialization—are becoming bigger players on the world stage. These countries make up 82% of the world's population and 36% of the world's economic output. And they are growing fast. Emerging market economies are expected to grow an impressive two to three times faster than their developed counterparts, according to the International Monetary Fund (IMF) estimate. Indeed, these countries deserve to be noticed. Consider China: Despite its status as the world's secondlargest economy, China is still defined as emerging due to low household income levels, which are nearly one-tenth of those in the United States.
FINDINGS To get a better sense of the difference between emerging and developed markets, take a look at the table. Three of the countries in this table, Brazil, China and India, are considered to be emerging markets, while South Korea is being considered for a move to developed status. We notice that emerging markets have lower income per person (GDP per capita) than the developed, or "advanced," markets, such as the United States, Canada, Germany and Japan. We can also see how two countries, China and India, account for 38% of the world's population but only 12% of the world's economic output (GDP). Contrast that to the United States, which has 5% of the world's population and 21% of the world's economic output.
WHICH COUNTRIES ARE CONSIDERED EMERGING MARKETS? As of June 2012, MSCI (Morgan Stanley Capital International), the industry standard for measuring foreign market performance, listed these countries as emerging: Brazil, Chile, China, Colombia, the Czech Republic, Egypt, Hungary, India, Indonesia, Malaysia, Mexico, Morocco, Peru, the Philippines, Poland, Russia, South Africa, South Korea, Taiwan, Thailand, and Turkey MSCI uses the guidelines below to categorize emerging vs. developed countries. To move up from emerging to developed status, countries need to meet these criteria: Economic development: The country must have income levels 25% above $12,276 (the World Bank high income threshold) for three consecutive years. Size and liquidity requirements: The local stock exchanges must have at least five companies with market capitalizations of roughly $1.8 billion each and the amount of trading volume must be significant. Market accessibility: The country must be open to foreign ownership, allow capital to flow freely, and have stable, efficient markets.
WHY CONSIDER EMERGING MARKETS? Growth potential Emerging economies are expected to grow an impressive two to three times faster than developed nations, according to April 2012 IMF estimates. As an investor, this is important because corporate revenues have the potential to grow faster when economic growth is higher. However, it's important to keep in mind that bottomline profits also depend on keeping expenses low. Diversification By investing in emerging markets, you help diversify your portfolio, as emerging markets can perform differently than developed markets. Potential to discover up-and-coming companies This is because emerging markets tend to have less-efficient markets where information is not as readily available and there are fewer stock analysts. Diligent investors who are willing to research and invest directly in individual companies may be able to find investments with the potential for higher returns.
WHAT'S ENABLING EMERGING MARKET GROWTH? While there are country-specific differences, compared to developed economies, emerging market economies as a group have: Young working-age populations. This tends to add to economic growth, while retiree populations generally subtract from growth due to less economic output, higher health care costs and the need for government services. For example, India and Brazil have high ratios of working-age to retired populations. Export strength. Labor costs tend to be lower in emerging markets, driving growth in manufacturing and exports. For example, the Philippines has developed electronics manufacturing and call center industries based on its labor resources. Low levels of government debt. Emerging nations tend to produce more than they buy, resulting in trade surpluses. Large state-owned companies involved in exporting are often sources of government revenues, keeping government debt levels low, and funding infrastructure spending or programs to help raise living standards. Low levels of consumer debt. Debt at the consumer level is also low in many emerging nations. For example, China has strong foreign trade and a low government deficit, as well as low debt levels at the consumer and business level.
Growing household income. Rising household incomes afford consumers the ability to have income available for discretionary purchases, resulting in the emergence of a middle-class consumer sector. Indonesia and the Philippines are examples of countries with strong domestic economies and growing consumer classes. Natural resources. Emerging market countries have a disproportional share of natural resource wealth (although exceptions exist, such as Australia, Canada and Norway). Countries rich in natural resources tend to benefit as emerging markets industrialize. For example, Brazil should continue to be self-sufficient in oil over the longer term and has the largest farmable area in the world. Prudent fiscal policies. Many emerging market countries have endured economic crises in the past, instituting strong fiscal discipline well before the 2009 global recession. For example, Brazil has made major strides since 1994, with inflation falling from triple-digit levels to an average of 5.4% over the past five years, and decreasing government debt levels have resulted in an investment-grade credit rating.
EMERGING MARKETS ARE BECOMING A LARGER SHARE OF GLOBAL GDP
FINDINGS As a result of higher economic growth, emerging markets account for a growing share of global economic output or GDP. In contrast to the developed world, emerging market economies as a whole have the flexibility to expand fiscal policy, while growth in most advanced economies is likely to be constrained by reduced government spending and tax increases.
WHAT ARE SOME OF THE RISKS? In addition to the higher growth potential, emerging markets also have higher risk. As you'll see, emerging markets share the same risk categories as developed markets, but risk levels tend to be heightened and include: Potential for political instability. Emerging market governments can be less stable politically, and events such as external conflicts, coups, and internal tensions can create a difficult operating environment for companies. Financial conditions. Emerging market countries that do not have sound fiscal and monetary policies are subject to a number of risks. For example, growth can be undercut. Inflation can rear its head— impairing the ability of companies to keep up with input price trends, hurting consumer's purchasing power and potentially destabilizing the country's currency. Currency fluctuations. There's the possibility that the currency of your investment will fall relative to the US dollar, lowering the return after it's translated back into dollars.
Regulatory environment. The rules and regulations of emerging market countries tend to be under development. As a result, market regulation, corporate governance, transparency and accounting standards may not be as reliable or mature as in developed countries. Some countries have restrictions on how freely businesses operate, impacting their ability to earn profits. Volatility. Shares on emerging market exchanges can be more volatile and trading can be less liquid (fewer shares changing hands). Emerging market investor sentiment can shift quickly with changes in global growth forecasts, magnifying performance on both the upside and downside. Higher costs to invest. Investing internationally can bring additional fees and emerging markets tend to have higher fees relative to the broad foreign universe related to processing trades. This is the reason most emerging market mutual funds cost investors a bit more than their broad international or domestic counterparts.
IS IT POSSIBLE TO REDUCE THE RISKS? Have a long-term perspective. Investors should be willing to invest for a long time horizon to ride out short-term price moves. Diversify your holdings by country and sector. An individual country index may have a high concentration in a particular sector or company. For example, the Russian MICEX Index has more than a 50% weight in energy as of June 30, 2012. This, in addition to company-specific risk, is one reason we believe investors should have a diversified portfolio when investing internationally. Limit exposure. Aggressive investors limit their emerging-market exposure to a maximum of 5% of the stock portion of their portfolios. In addition, they also might want to review the foreign mutual funds, as many allow allocations to emerging markets as part of their fund.
TYPES OF GROWTH OPPORTUNITIES IN EMERGING MARKETS Emerging and frontier markets have opportunities for growth that often aren’t available in more developed economies. These come from three main sources: new, pervasive technologies; the improved spending power of a growing middle class; and gains from greater trading activity with other countries. When you look at investments, you want to look at how these changes create growth opportunities. LEAPFROGGING TECHNOLOGIES In a developed economy, incredible investments in technology are in place and are fixed. However, one of the greatest opportunities in emerging markets is to be on the ground floor of companies that are working on technologies, that aren’t yet economically feasible for big multinational corporations to try: Markets for machinery: Products manufactured in emerging markets often are smaller and more basic than the products in developed economies. They may seem like a step backward to people in developed countries, but they can be vital to making life better for those living in less-developed countries. Computer and software technology: Companies have taken advantage of the high education rate and low cost of living in emerging markets. Customers for emerging-market high-technology services are
But lesser-developed countries needing technological assistance turn to their emerging-market brethren for more affordable expertise. GROWING THE MIDDLE CLASS To a certain extent, an emerging market is really a market where a middle class is emerging. As jobs and opportunities are created, more people move out of poverty and into a comfortable middle zone where they can afford some luxuries that were previously unimaginable. They go out and spend their money, creating more economic activity. The middle class isn’t the only beneficiary. As a country’s economy improves, the poorest people tend to become less poor, and even they have more money to spend. Even a small improvement in income represents a huge increase in purchasing power. Yes, the money goes to subsistence needs, especially food, but even that spending power represents an improvement in an economy and in the health of the people.
BETTER TRADE OPPORTUNITIES Trade benefits both the importer and the exporter. It lets people capitalize on their skills. If they’re good at making something, they can keep doing that even if they make more of a good than people at home can use. And if they need something, they can buy it from those who produce it, wherever they are. Finding a comparative advantage A reality of emerging markets is that they don’t produce all goods as efficiently as people do in developed markets. It may take more time to complete a product, and some of the output may have to be rejected. But because wages are low, the value of the acceptable goods produced per dollar spent on wages is often higher. If a nation’s businesses can produce something at a lower cost than it can be produced elsewhere, even after adjusting for extra time and higher error rates, the country is going to benefit from trade. And that’s where emerging markets find their niches.
Free trade If trade is restricted, it’s harder to get people the goods and services they need most at the most efficient price. That’s why a key focus in the world is free trade — trade between nations free of quotas and tariffs. In addition to tariffs, governments sometimes protect local industries through regulation. Because trade moves better when it’s free of restrictions, 153 nations have joined the World Trade Organization, which negotiates the rules of trade among nations and settles disputes as they arise. Free trade can be controversial because some people lose when they have to compete with imported goods. However, free trade is good for people overall, and a commitment to free trade can also help emerging markets grow faster. Fair trade Some people have greater access to the market than others, either because of their technological sophistication and business acumen or because of the infrastructure of the country where they operate — or both.
Fair trade is a movement to give producers of agricultural products and handicrafts in developing nations some of the advantages of their competitors in developed countries in order to make the terms of trade equal. Some international federations are trying to improve markets and to create branding that would attract buyers in developed countries.
Definition of emerging nation: Developing country which has achieved industrial capacity and is on the path to becoming an industrialized nation.
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Emerging Markets by Each Group of Analysts; Country IMF BRICS+ Next Eleven FTSE MSCI S&P EM bond index Dow Jones Russell Columbia University EMGP Argentina
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