This book will examine mature-stage investments into countries and sectors that present longer-term improvements in fundamentals that are likely to reward investors.
Chapter 2: Reasons to Invest in Emerging Markets
This chapter establishes the main arguments for investing in emerging markets. It explores the factors that are likely to propel emerging market economies forward. It is doubtful that all countries stand to advance at the same rate, and some may not advance significantly from their current position, but the factors outlined here and the ten drivers of growth detailed in the next chapter reveal opportunities for many of these emerging countries.
Later chapters will examine individual countries in greater detail.
Key areas of development
Demographics
Between 1980 and 2010, the working age population in emerging markets increased from 1.6 billion to 3.2 billion. Simultaneously, the overall population of developed market countries increased from 713 million to 836 million. What’s even more striking is that these trends continue to strengthen in the emerging market countries. The youth populations of emerging market nations are on pace for further increases – without any significant migration patterns – while the developed world ages. The implications are obvious. As emerging markets continue to grow, so too will their share of global consumption.
Rising middle class
Middle class populations in most emerging markets are increasing dramatically. By the next decade the middle class in China will be more than 300 million (perhaps higher than the entire US population), with more than 200 million in India and millions more in Indonesia and Brazil.
Consistency of growth
Growth in emerging markets has, for the better part of two decades, consistently outpaced that of the developed markets. According to a recent report by the Economic Intelligence Unit (of The Economist magazine), for the next five years only China and India are projected to have economic growth rates above 7%, followed closely by Vietnam, Indonesia and Colombia. In comparison, all of the G7 nations are projected to have subpar growth around 2%. The World Bank has stated that since 2008 emerging markets have accounted for almost 70% of the global economic growth.
Better fiscal conditions
Many emerging markets are fiscally healthier than developed markets and have shown significant improvement over time. Looking at metrics such as the debt ratio, and in particular the foreign debt-to-GDP ratio, emerging markets seem to be in a much better position than many developed countries.
Better inflation targeting
Many, if not most, emerging markets are aware of the havoc runaway inflation can wreak on their economies and have taken that lesson to heart. Many of the countries have inflation targets with independent central banks as guardians.
Rising currency values
As economies grow and keep inflation under control, their currencies generally become stronger over time. This is a reflection of confidence in such growth being sustainable. This can provide investors with additional rewards.
Better banking systems
In the past emerging markets have suffered dramatic collapses because of failing banking systems that were over-leveraged with foreign denominated loans and non-performing assets, with insufficient regard for risk. The times have changed. The collapse of the 1990s banking system in Asia, Latin America and even Russia undeniably taught these countries a lesson that subpar banking systems can topple an economy and that international borrowers can be merciless.
The countries have therefore enforced strong discipline and the results are quite impressive. In the last recession of 2008 to 2009 – while the banks of developed countries were on the brink of failure, only to be rescued by the state – the emerging market countries had strong balance sheets, less leverage and much higher reserves.
Open trade
Many emerging market countries are WTO members. They have opened up their economies to foreigners and now are less dependent on exports alone. There are many trade pacts between emerging market countries and developed countries and increasingly there are many trade pacts between emerging market countries themselves. All this is bolstering trade, which is the lifeblood of many of these emerging economies.
Today’s emerging market countries are competing in world markets and many have attained household status. Samsung in Korea now rivals Sony and Apple. Embraer, an aircraft manufacturer from Brazil, is now one of the world’s leading producers of airplanes. And Tata is the new owner of Jaguar and Land Rover. These are just a few examples of companies that were hardly known to the world a few years back, but are now household names thanks to open trade policies.
Consumption and investment
In many emerging market countries there is now a balance between domestic consumption and investment, leading to more sustainable growth.
Better political governance
Many emerging markets want to attract foreign investors. They are eager to open their doors and meet the conditions that foreign investors require, such as better property rights and accurate disclosures. Governance and political stability is still an issue for investors and businesses located in emerging markets, but not nearly as much as it was previously. There is more of an institutional framework today than ever before, aimed at better disclosure, transparency and investor rights. Legal frameworks are now firmly in place and although they are still sometimes bureaucratic and cumbersome, these nations are clearly on the right path, giving investors added confidence that their investments are not at the mercy of bureaucrats or politicians.
More privatisation
Many emerging market countries are on a sustained path of transferring state-owned institutions to private hands. In some cases, progress is slow, but the trends are positive for many countries. This will likely create more competition and higher productivity as well as helping to achieve more transparency and less bureaucracy.
Urbanisation
Urbanisation is the major movement of our times. This is the likely path of countries like China and India, and many other emerging market nations. For example, 57% of China’s population, 70% of India’s population and 73% of Vietnam’s population still reside in rural areas. Compare this to the United States, where roughly 12% of the population resides in rural areas. Industrialised movements are initiated by the mass migration of populations to cities – away from low productivity farm occupations to higher productivity jobs in industry.
The proportion of the annual gross domestic product of the United States generated in agriculture is less than 2%, while in India it is 17% and China it is 11%. The shift away from agriculture to industry is likely to take decades. This in turn will result in higher incomes and higher domestic consumption in countries such as China, India, Indonesia, and others.
Technology and innovation
Technological staples in developed countries are becoming more accessible in emerging market nations, from cell phone penetration to internet usage. This is reshaping industries and the lives of the people who are the beneficiaries of this dramatic change. Whether it’s mobile applications in India that allow farmers to get a better price for their crops or the development of low-cost solar power in Africa, the spread of technology and innovation is having a major impact on the productivity (and