What does Indonesia have in common with countries like India, Brazil and Russia?
They’re all classified as emerging markets.
It’s a term that originated in the 1980s and has stuck around since then.
Two of the most important reasons why?
Well, these countries are crucial when it comes to driving global economic growth.
And their financial markets can be goldmines for investors,
especially those with an appetite for higher risk.
So what makes an emerging market today?
And why do investors have such a love-hate relationship with them?
The term "emerging markets" was coined by a World Bank employee Antoine van Agtmael.
The finance arm of the World Bank wanted to get more foreign investment into third world countries,
but didn’t think the term “third world” really inspired investors.
To make it sound more attractive, van Agtmael coined the term “emerging markets.”
But if you want a definitive list of emerging markets, good luck.
The list varies depending on who you ask.
The IMF classifies 96 countries as emerging.
It uses criteria such as how much citizens of that country earn, how diverse the country’s exports are,
and how sophisticated its financial system is.
That’s one measure.
But investment research firm MSCI, which creates stock indexes,
classifies 24 countries as emerging markets.
Okay, but what’s an index?
Essentially, it’s a list of stocks that measures certain features.
For example, if you want to look at how the biggest U.S. companies are doing,
you could look at the Dow Jones Industrial Average, which covers 30 household names.
The MSCI is known for its Emerging Markets Index, which shows us
how emerging countries like Brazil, China and Turkey are doing.
Unlike the IMF, the MSCI uses how investable a country’s stock market is
to determine whether it's an emerging market.
That’s important, because this influences how much foreign investment a country can get.
You may be wondering how such a diverse group of countries could possibly be grouped together.
Despite their many differences, there are a few characteristics that they do tend to have in common.
Let’s take a look at the first one.
The term “emerging markets” was initially used for developing countries,
which meant that the average person living there tends to earn less than someone in a developed country.
Economists call this a lower income per capita.
But that’s not always true today.
Some countries, like the United Arab Emirates and South Korea are considered emerging markets,
but they have higher income per capita than some developed countries, like Spain and Portugal.
An investor’s goal is to make money. For that, you need growth.
And emerging markets are known to do just that, rapidly.
Fast growth is our second characteristic.
One report found that one out of every four emerging economies
outperformed its peers and developed countries.
Of these 18 outperformers, seven exceeded annual per capita GDP growth of 3.5 percent for a 50 year period.
They include China, South Korea and Indonesia.
The other 11, which include India, Ethiopia and Cambodia, have enjoyed more recent gains,
growing at about five percent or higher over the past 20 years. That’s 3.5 percentage points above the U.S.,
and enough to lift themselves into a new income bracket for countries.
That growth comes with a lot of risk.
And that brings us to our next characteristic, high volatility.
And if you need an example of volatility, just look at this.
The MSCI index, which shows total returns, shows emerging markets had been doing pretty well,
until January 2018, when things began to sour.
We’ve seen their currencies fall to historic lows against the U.S. dollar.
That’s bad news for countries trying to pay off their debt.
It’s a problem because a lot of that debt is held in foreign currencies,
particularly in the strengthening U.S. dollar. That makes paying off debts an uphill battle.
Not ideal when emerging markets have seen their total debt rise from $21 trillion in 2007 to $63 trillion in 2017.
Emerging markets crises are worrying, because they affect
multiple countries and tend to work in a vicious cycle.
First, the currency falls rapidly.
Countries then struggle to raise funds due to their less mature capital markets and investors flee.
This affects the country’s assets and currency, and can sometimes
damage the country’s banking system and even the economy.
It’s important to note that an emerging market’s status can come and go.
That could mean a step up as a developed nation, or a step back as a frontier nation.
Despite all the uncertainty, one thing is for sure, investors will continue to watch
emerging markets closely, as the countries continue to expand their role in the global economy.
Hi everyone, it's Xin En. Thanks for watching.
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