Emerging Markets - The New "Beacon of Hope” for Investors?

Posted in Finance Articles, Total Reads: 3411 , Published on 23 November 2012
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The European crisis’ root problem is that the southern European economies have become fundamentally uncompetitive – their wages rose too quickly during the boom years, which led them to import a lot more than they exported, and borrow the difference. The southern economies’ excessive debts, persistent excessiveness and resulting need to continue borrowing, coupled with Germany’s reluctance to give them the money –is what has driven the financial panic that has made it much harder for southern European governments to and banks to borrow from markets.

image:freedigitalphotos.net

Wikipedia defines Emerging Markets as “nations with social or business activity in the process of rapid growth and industrialization”. Though there is no specific list maintained, but considering nominal GDP/PPP, the seven largest emerging and developing economies are China, Brazil, Russia, India, Mexico, Indonesia and Turkey. According to the World Bank report issued in May 2011, BRIC (Brazil, Russia, India, and China) countries plus South Korea and Indonesia will lead the world’s economy with more than a half of all global production by 2025. Considering all these, this dissertation will be labeling BRIC countries, Mexico, S.Korea, Turkey and Indonesia as the Emerging Markets and the analysis will be in the same vein.

Figure 1 below compares the annual growth rate of GDP amongst the EU, the USA, the UK, the emerging markets and the global average over the last decade. While the EU has been on a downward trend, most of the Emerging Markets are on a upward trajectory and are infact some of the fastest growing economies globally.

Figure 2 above is a snapshot of the debt situation in the Euro zone over the period 1999-2011. One can distinctly notice that after remaining nearly constant for the 1st half of the 2000’s, the consolidated debt as a % of GDP has shot up drastically for many of the EU countries, most notably Portugal, Ireland, Greece – coincidentally, the precipitators of the ongoing Euro crisis.

A correlation analysis was carried out between EU’s share of the global FDI and the corresponding figures for the Emerging Markets combined and showed that the respective FDI shares of the EU and the emerging markets are negatively correlated. Figure 3 below is a further corroboration of that.

Another correlation test was run on the respective shares of the EU and the emerging markets of World GDP between 1989-2010 and they were found to be negatively correlated. The same data was plotted in the Figure 4 above to showcase the observed trend.

European Crisis’s effect on the Emerging Markets

As per World Bank data, the Euro zone crisis poses a greater threat to developing economies than the 2008 financial crisis and has had already had a negative impact on trade finance and remittances. Total global trade finance volume has fallen to $26.8 bn in the first quarter of 2012, down 18% year-on-year. As per International Finance Corporation’s data, gross capital flows to developing countries in the 2nd half of 2011 was $170 bn – just over half the amount received in the same period in 2010. Besides, steps taken by the emerging market economies such as interest rate cuts haven’t been able to ease financial conditions significantly enough to offset the broad-based economic slowdown in the developed world. As a consequence, credit standards have tightened around the world for the sixth straight quarter and have been more pronounced in the emerging Asian economies despite relatively strong demand.

To analyze investors’ confidence in the Emerging Markets in the wake of the European crisis, a study was conducted on how the BRIC countries fared in terms of returns on investment and share price volatility on their leading share price indices.  Data was collected for a period from July 2009 to September 2012 and was bifurcated into two periods: (i) “Normal period”-10 months (July 2009-April 2010) i.e. prior to onset of European crisis, (ii) “Turbulence period”- 29 months (May 2010-September 2012). A Student’s ‘t’ Test was performed to see if the returns in these indices had varied significantly as a result of the European crisis.

T-Test results

N

Mean %

Std. Devn. %

F-value

t

P value

Brazil

BM & F Bovespa The New Exchange

Period (i)

10

1.87

5.05

0.007

1.22

0.221

Period (ii)

29

-0.66

5.58

1.264

Russia

RTS Exchange

Period (i)

10

2.72

6.37

0.776

0.703

0.487

Period (ii)

29

0.32

9.24

0.801

India

National Stock Exchange

Period (i)

10

2.49

5.03

0.314

1.274

0.212

Period (ii)

29

-0.18

5.88

1.339

China

Shanghai Stock Exchange

Period (i)

10

-2.39

12.27

0.458

1.227

0.229

Period (ii)

29

-1.07

6.1

1.216

Table 1: Results of the Student’s ‘t’ Test

From Table-1 above, we can conclude that the BRIC nations haven’t been much affected by the EU crisis.

Factors affecting FDI in Emerging Markets

Assuming FDI in Emerging Markets follows the following model:

FDI = α + β1CGDP + β2 DI + β3 CA + β4 EXD + β5 OPEN + β6 GDPD + β7 EXT + β8 STLIV + β9 URB + β10 SCH + β11 LF + β12 TR + β13 ID + β14 W

[CGDP-Real Gross Domestic Product per capita; DI – Real gross domestic investment as % of CGDP; CA- Current account as % of GDP; EXD – External debt (long-term & short-term); OPEN- Trade openness (imports+exports as % of GDP); GDPD – Inflation represented by GDP deflator; EXT – Govt.’s expenditure on transport and communications; STLIV-Standards of living (public consumption+govt.consumption-military expenditure); URB-Extent of urbanization (urban population/total population); SCH-Secondary School Enrollment; LF-Labor force; TR-Total tax revenue of govt. as % of GDP; ID-Import duties imposed as % of GDP; W-Monthly wages as average of all workers in the manufacturing sector]

The model is estimated using panel data approach for the identified emerging countries in the dissertation viz. BRIC, South Korea, Indonesia, S.Korea and Turkey. As FDI is a long-term phenomenon, so, data was collected for a 20 year period (1991-2010) to effectively capture the relevant factors. Country dummies were used to account for the effect of country specific characteristics on FDI.  Using regression tests and collinearity tests, it was determined that the major determinants of FDI inflow into the Emerging Markets are:

Labour Force (LF), Trade Openness (OPEN), Inflation Deflator (GDPD), Standard of Living (STLIV), External Debt (EXD), Monthly wages (W), Real gross domestic investment (DI)

Thus, it is concluded from this model that countries should provide incentives and undertake efforts for greater trade openness, higher domestic investment and low debt. They should also take effective steps to reduce external as well as internal imbalances and further, try to provide a stable political environment for attracting greater FDI.

What’s in store for the Emerging Markets?

Table 2: Emerging Markets’ current standing vis-à-vis factors for attracting FDI

Table 2 (above) shows how the Emerging Markets fare on the factors identified in the previous section as pivotal for attracting investment. The positioning of the different countries was arrived at by looking up the corresponding country’s data for the different categories and the relevant average figure a country should have to be on the path of economic development and consequently, be attractive to investors.

From the above table, we can see that the Emerging Markets seem to have in general, good performance in a majority of the factors and are in a transitionary phase for the positive in quite a few of the remaining. Thus, the Emerging Markets do seem to be on the cusp of becoming the investor’s darlings and the only thing these countries need to do is sustain/improve on their economic indicators to provide a catalyst for further investor confidence and overall global economic recovery.

This article has been authored by Soumya Sarthak Mishra from IIM Rohtak.


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