Financial factors
Expansion of credit
Expansion of credit in the context of emerging markets implies increased lending by banks to the private sector and consumers. A sound and well-regulated banking system facilitates private sector growth and increased domestic consumption through wise lending practices.
Non-performing loan ratio
This ratio is defined as total non-performing loans divided by total loans. This metric is derived from Bloomberg where it is calculated by taking an average of figures from the country’s top five banks as defined by market capitalisation.
Foreign exchange (F/X) volatility
This is the volatility of a currency derived from a time series of spot prices over a specified historic time horizon. The three-month historic volatility on Bloomberg has been used.
5YR CDS rates
CDS stands for credit default swap. It can be thought of as insurance against the possibility of a credit event occurring in the future. The buyer of the protection pays a premium to the seller, and this premium is called the CDS spread. For example if a CDS has a spread of 950 basis points for a five-year China debt it means that default protection for a notional amount of $1 million costs $95,000 per year.
Sovereign rating
The sovereign rating is the credit rating of a country. The ratings from Fitch have been used. With Fitch, ratings from ‘AAA’ to ‘BBB’ are considered investment grade and ratings from ‘BB’ to ‘D’ are considered speculative grade.
4. Trade
Since ancient times, trade has been the primary vehicle by which great nations have risen and prospered. In that sense, little has changed over time, as international trade continues to be a key driver in the growth of emerging market economies. Just as before, nations play to their strengths by offering the goods and services that give them the greatest advantage. Yet today, the dynamics at work – everything from currency depreciation and tariffs to trade pacts such as NAFTA and ASEAN – have led to an environment that is fiercely competitive.
In the recent past, emerging markets were often characterised by what many considered to be unfair trade policies. While this stigma still persists, the fact that most of the emerging markets discussed in this book have become members of the World Trade Organization (WTO) has created a legal mechanism to redress grievances by members. This has made the trade wars of the past much less frequent between states today.
In a recent McKinsey study of 720 companies around the globe (in both developed markets and emerging markets) data from 2227 separate market segments was analysed. It was found that companies in emerging markets could deploy changes at a faster rate, cater to local markets more efficiently and, above all, were far more effective at innovating. This analysis was not subjective; it was on full display in the bottom line. According to the analysis, emerging markets had overall revenue growth rates of almost 24%, while developed markets had growth rates of less than 11%.
As emerging market nations continue to reduce overall imports and increase exports (and increase reserves), they are well-positioned to avoid the fate of the developed world, where payments for imports require high deficits, generosity or optimism of foreign investors, exports, or foreign earnings repatriated by citizens abroad.
Trade factors
The following factors will be considered when it comes to trade and trade policies.
Share of world exports
An emerging economy’s increasing share of world exports brings it much needed foreign currency, which can pay for valuable imports and support its own currency in case of an external shock. An emerging economy can also insulate itself from external shocks with a diversified basket of exports.
Trade balance (surplus/deficit)
When a country has more exports than imports, it is said to have a trade surplus. On the flip side more imports than exports implies a negative balance of trade and therefore a deficit. While a trade deficit or surplus is not good or bad per se, large deficits are not sustainable in the long run. A prolonged trade deficit essentially makes a country a net debtor and erodes demand for goods produced by domestic industries. Countries that have had a prolonged trade deficit with no plan to fix the situation are looked upon unfavourably.
Trade barriers
Economic research has proven that trade barriers like quotas and import tariffs restrict economic growth. Open trade helps countries diversify their economies, reduce costs, improve productivity and reduce poverty. Countries that take concrete steps to reduce trade barriers and participate in open trade globally are looked upon favourably.
Dependence on exports
Countries like Brazil and Australia have boomed in recent times thanks to commodity exports to China. But their abundant natural resources also hold them hostage to a Chinese slowdown. Countries that are highly commodity or export driven must make efforts to diversify their economies and reduce their exposure to the possibility of a global slowdown.
Reserves-to-import ratio
This ratio is defined as total reserves divided by total imports. The more reserves a country has relative to its imports the better. Once reserves are exhausted a country has to borrow to pay for imports, which would put it in a precarious financial position.
5. Political stability and governance
Political stability (or lack thereof) has been a major factor in the unwillingness of many to invest their capital in emerging markets. When one looks back at some of the social unrest, corruption and conflict that used to plague many of these nations, one can hardly blame investors for their apprehension.
This outsider perception is certainly not lost on the majority of emerging market nations. Having come to realise that political balance sheets are just as important to their nation’s well-being as financial balance sheets, public leaders have placed a great deal of importance on achieving and maintaining political stability.
Another factor helping to promote political stability is the proliferation of 24/7 news media. There are armies of political scientists, analysts and hundreds of organisations watching the developments within these countries. The channels of information, in other words, are much more difficult for a government to muzzle than say the local press, which in the past would often kowtow to political heavyweights.
It should be noted that political stability is not equated to democracy because democracy is not always a good indicator of economic potential. China is clearly an example of a society that is not democratic, while India is. Yet China has consistently achieved higher growth rates. The obvious difference is that China has a controlled society with market access and has been able to channel its resources effectively to increase jobs, exports and industrialisation. India, a vibrant democracy, still has a partially closed economy with limited access and is focused on internal consumption.
There are many examples of dictatorships that have done reasonably well economically and, of course, many democracies that have failed miserably. Indonesia, Philippines, Turkey, Thailand and Argentina all had dictatorships during their recent history and delivered above average economic benefits for their citizens, though they certainly curtailed personal freedoms.
The purpose here is not to pass moral