Emerging market complexities

Historically, the definition of an emerging market has changed considerably over the years. They’ve developed a great deal, and vary vastly today from when the term was first coined in the 1980s

 
Former Chinese President Hu Jintao (left) and Chinese President Xi Jinping. China is still part of the BRICs nations, but its position as an emerging market is questionable and complex 

Undoubtedly, if you read the news, financial or otherwise, you have likely heard of emerging markets, but you may be hard-pressed to find an accepted definition. Even stranger, some countries currently categorised as such by conventional definitions may, in fact, not be emerging.

The lexicon regarding emerging markets has transformed over the years. Originally, Antoine Van Agtmael from the World Bank coined the emerging market term in the early 1980s. In the latter part of that same decade, the roaring economies of eastern Asia – specifically Hong Kong, Singapore, South Korea, and Taiwan – sparked the term ‘Asian Tigers’. The terminology and categorisation continued to evolve alongside world financial systems when, in 2001, the then Chief Economist of Goldman Sachs Jim O’Neill christened the widely-used BRICs acronym, representing Brazil, Russia, India, and China – a key set of emerging market countries.

Each country within the BRICs group was envisioned to have a separate, but complementary role in the group’s growth. China rapidly grew its manufacturing base and aggressively developed infrastructure projects, while India became a substantial offshoring centre and a strong consumer of Western products. Meanwhile, Russia and Brazil fuelled the development of China and India, and thereby their own growth with the robust development and trade of natural resources. The expectation of these four economies was a symbolic shift in global economic power away from the traditional, more developed G7 economies. This optimism was reflected in the financial markets, as investment in emerging markets boomed throughout the early 2000s.

Yet again, the investment climate in emerging markets has evolved fairly noticeably over the past few months and years

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In 2005, investment flows began to slow. However, asset prices continued to climb, according to the MSCI Emerging Markets Index, and it became one of the best returning asset classes over the proceeding several years – then the 2008 financial crisis struck. Despite the crash, emerging markets returned to the top of investors’ lists, and capital once again rolled in from investors looking for higher return potential than economies that had cut interest rates to near-zero levels. This trend reversed when in May of 2013, the then Federal Reserve Chairman Ben Bernanke announced tapering of quantitative easing with the potential for interest rates, to thereby increase the worth of the US dollar.

Yet again, the investment climate in emerging markets has evolved fairly noticeably over the past few months and years. The present and forecasted slowdown in global demand is now impacting these economies more meaningfully than many developed nations, and we are still seeing these effects play out. In addition to the volatility from projected slower growth, unforeseen geopolitical risks have also surfaced, including sanctions against Russia as well as monetary and fiscal policy shifts in China.

These political and monetary events in emerging countries did not always have the same impact on the world economy as they do today. Globalisation has accelerated dramatically over the past few decades, much of which is due to technological advancement, and has played a significant role in the movement to a more integrated, singular global economy – this evolution is not just through financial markets, but also through trade, communication, policy, and even culture. This same integration has been a boon for advanced economies such as China and other high-growth nations that have taken over manufacturing and production to meet the demand from more service-driven economies.

This dynamic is likely to shift again, and relatively soon. According to forecasts from the Brookings Institute, the growth of the middle class in the two most populous countries in the world – China and India – may reach 72 percent and 79 percent respectively. By 2030, the most present-day forecast from 2013 shows the middle class at around seven percent of the total population of India and 18 percent of China. Each of these countries has a population exceeding 1.25 billion people – keep in mind, the population of the US is just over 300 million. The economic impact of the ‘baby boomer’ generation in the US will pale in comparison to the urbanisation and middle class growth of these behemoth populations.

Socioeconomic improvements – like an expanding middle class – are considered to be a trademark of an emerging economy, according to some definitions. Though, therein lies the problem, these explanations are a topic of debate – there is not a generally accepted definition for an emerging market, let alone a developing or developed economy. The term ‘emerging markets’ is losing, or has already lost, relevance in this day and age. Even the United Nations has no established convention for the designation of ‘developed’ or ‘developing’. Academics have continually proposed multiple characteristics for a definition of a country’s industrial phase, typically attempting to categorise through economic criteria involving gross domestic product, level of industrialisation, infrastructure, and standard of living.

Developing to developed
If the classification of ‘emerging’ is not formally recognised, then how can a currently branded ‘emerging economy’ progress to be an ‘advanced’ or ‘developed’ economy? Surely South Korea, a G20 member, and 13th ranked largest economy in the world by the International Monetary Fund  (IMF) as well as the World Bank in 2014, which boasts a median income that is the highest in Asia according to Gallup, and home to some of the world’s largest companies like Samsung, must be a developed economy. Unfortunately, this would be incorrect: South Korea is defined by Morgan Stanley Capital International (MSCI), as well as by Russell Investments, as an emerging market, both of which include the country in their respective emerging market indices along with China.

India’s global middle class

2010

50 million

2015

120 million

2020

200 million

2025

310 million

2030

470 million

Source: Transparency International
Notes: Post-2015 figures are IEMS estimates

If economic growth and size were the deciding factor, China would conclusively be a developed economy. No other economy has ever grown as swiftly, but it seems to require more deliberation on its categorisation when compared to other countries. The published economic growth in China is extremely high and has been a key driver for the global economy. The industrialisation that has taken place in China, again, is extreme; their growth in manufacturing and production is significant. Infrastructure in the country – yet another topic of debate – was uncompromisingly pursued by the Chinese government, to the point where rumours of ‘ghost cities’ started to arise. The struggle for China becoming a developed economy likely lies in their lack of openness in financial policy.

China employs a managed float system for the yuan, and has long sought to be included in the IMF’s foreign exchange reserve, to be an international reserve currency along with the likes of the US dollar. However, foreign officials and investors have frowned upon the constant meddling in the currency’s value. The government has also taken an unparalleled stance in intervening in its stock markets – the concept of a Chinese free-market, and therefore its prospects for developed status, is currently dubious.

Current definitions are scattered and may not truly incorporate all factors that make an economy developed. Though strides towards more established and recognised categorisations are being made, it has been a slow process. The United Nations’ Human Development Index may be the most promising gauge, using a single measure that takes into account life expectancy, education, and per capita income – attributes outside of merely economic production. The index can also include an ‘inequality-adjustment’ to remove any biases. A new classification system will be necessary going forward, and many emerging economies may not truly be emerging any longer. The implications of completely reinvented categories may be staggering for investors, and would result in substantial changes to the investment process today.

Jim O’Neill – who coined the BRICs acronym – is also quoted in saying that the group, along with Korea and Mexico, “should not be really thought of as ‘emerging markets’ in the classical sense, as many still do. We regard these countries as a critical part of the modern globalised economy”. For now it seems that the definition for emerging economies takes on a ‘we can’t define it fully, but we know it when we see it’ approach to categorisation. Whether these nations are considered developing, emerging, or developed, their importance to the world economy is undeniable as will be their impact on both global politics and global investment markets over the years to come.

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