By Sam Goh

Over the past two decades, we have witnessed many different multinational corporations (MNCs) increasingly looking to emerging markets (EMs) in the developing world for investment and growth opportunities due to the saturation of established market economies. These emerging markets include Brazil, China, India, Indonesia and Mexico. Some of these multinational corporations (MNCs) have even labelled these emerging economies as key locations for future growth and expansion plans. In other words, emerging markets (EMs) have created some of the most exciting investment opportunities across the global globe.

As a result of it, some of the emerging economies in Latin America and Asia managed to register superior economic growth rates as compared to the developed and matured economies, paving the way for trade liberalization (reforms) and further Western investments into these emerging
economies. In this context, what were the implications that arose due to this economic phenomenon seen in these emerging economies? Well, buoyant economic growth of these emerging economies have led to increased urbanization and gave rise to the growing affluence of the middle class families within these economies. This created consumer demand for both consumer durable and non durable goods with strong infrastructure support required to sustain the new-found lifestyles of these consumers. Hence, companies that were able to take advantage of this economic trend pattern managed to generate profits and generally saw their share prices soar in value. Therefore, as a result of these developments, investors investing into these companies saw their investment appreciated in value. At the same time, they were able to enjoy a period of exceptional returns across major asset classes with close correlation to these economies.

In present day context, emerging economies may probably provide a different investment value proposition to investors. Why is this so?

The fundamental reason is that some of these emerging economies have managed to position themselves as having major roles to play in shaping the global economy today. As compared to the developed economies and/or the Western economies, some of the emerging economies have younger and hungrier work forces, superior resources and stronger financial & fiscal positions (balance sheets). For instance, according to a recent research report by Goldman Sachs on emerging economies, China and India together comprise three times the population of the entire advanced world1. Emerging markets now represent 86% of the world’s population, 75% of the world’s land mass and resources and account for 50% of world GDP at purchasing power parity (PPP), yet account for just 12% of the global equity market capitalization on a float-adjusted basis2. With hindsight, it is also very important to highlight that emerging economies themselves do differ with regard to their respective economic dimensions and structures. For example, countries like South Korea and those countries of the frontier markets of Africa.

Earlier, I mentioned that emerging economies have generally managed to register better economic growth rates as compared to the developed and matured economies. One of the economic indicators used to measure the economic growth rates of these emerging economies is to look at their GDP per capita. Here, there are some interesting and worthwhile findings to highlight with regard to the GDP per capita of the various emerging economies. The first finding is that India, despite being labelled as one of the major emerging giants, possesses a low GDP per capita of just $1,2003. The second finding is that there seems to be a major and wide divergence with regard to the GDP per Capita of the Middle East (Saudi Arabia, Kuwait etc) and African emerging economies. In this case, it is worthwhile to note that some of the African emerging economies’ GDP per Capita ranges from $300 to $10004. The third finding is the variation of the projected GDP growth of emerging economies. For instance, Middle East countries such as Kuwait and Qatar are expected to grow at an annualised GDP growth of 10% – 15%5 for the next ten years while Eastern emerging economies such as Hungary and Czech Republic are only expected to grow at an annualised GDP growth of 1% – 5%6 for the same period of time.

Taking into consideration what was discussed above, what are some of the lessons that we can derive with these findings?

First and foremost, it is very important to note that the fundamental drivers of GDP growth/GDP per Capita of emerging economies vary according to each country’s economic dimension and structure. In other words, there are no correlations or a single fundamental driver/factor that will
lead to similar or correlated economic growth. For instance, emerging economies such as South Korea and Taiwan’s economic performances are more likely to be influenced by the overall global economic performance, while other emerging economies such as China and India’s economies are more likely to be driven by internal domestic consumption.

Another lesson that we can derive is that an economic slowdown in emerging economies differs from an economic slowdown in mature and developed economies. A very good example to illustrate the point will be a projected economic slowdown in China. Here, an economic slowdown refers to a decline of 1-2% GDP growth rates from 10% to 8% BUT does not warrant a potential economic recession. On the other hand, an economic slowdown in mature and developed economies generally refers to a decline in GDP growth by about 1-2% AND may probably signal or imply a potential economic recession taking place across these economies in the near future.

With these lessons in mind, are there any other considerations that investors should take note of when investing into these emerging economies?

One of the key considerations will be the development of the legal framework (corruption) as well as the financial systems (corporate governance) of these economies. This will be vital in determining the performances of these emerging markets’ stock performances. Why is this so? The reason is because the presence of a sound legal and financial system (high standards) within an emerging economy will lead to higher and stronger valuations, boding well for stock markets while the reverse holds true as corrupt emerging countries tend to register lower valuations.

Another key consideration that investors should take note of when investing into these emerging economies pertains to the issue of liquidity. The issue of liquidity has been a traditional major drawback for many retail and institutional investors with liquidity needs. A very good case in point will be the Vietnamese stock market with its relatively small overall market capitalisation and illiquidity. In the context of this article, one key factor pertains to state ownership, which reduces the size of the free float and also affects standards of governance. Generally, larger emerging economies such as China and South Korea possess liquid markets and relative ease of capital flows. Illiquid emerging markets refer to frontier countries such as Vietnam, Philippines and Bangladesh etc. Therefore, investors who wish to invest into emerging economies but possess liquidity concerns should consider investing into large market capitalisation companies in liquid emerging markets. At this point of time, a minor case in point is to pinpoint the issue of volatility with regard to the fluctuation of the stock prices in these emerging markets. In general, emerging markets are regarded to be more volatile as compared to mature and developed markets. This is especially so during adverse times.

Moving forward, it is worthwhile to note that emerging economies’ rapid recovery from the 2008 credit crisis was one of the most convincing measures and indicated their newfound global statures as the future economic growth anchors in shaping the overall economic climate for the
next few decades. On the other hand, mature and developed economies’ recovery had been nothing more than lacklustre. It is with this proposition that perhaps, we should start to pay close attention to this economic convergence between emerging and developed economies by looking at emerging economies from a different angel and dimension.

Footnote:
¹ Goldman Sachs Investment Research
² Goldman Sachs Investment Research
³ UBS Asset Management – Investment Research
⁴ JP Morgan Research
⁵ BNP Paribus Investment Research
⁶ BNP Paribus Investment Research