Have emerging markets emerged

April 17, 2011

As a young commodity trader living and working in Singapore in 1986 I recall an incident during the visit of the then Prime Minister of New Zealand, David Lange.

His illustrious Singaporean count-erpart, Lee Kuan Yew, was negotiating for a continuation of certain preferential trade benefits, arguing that Singapore’s ‘emerging market’ status entitled it to these benefits. 

Lange retorted that as a cup of coffee in Singapore cost more than his ‘developed’ New Zealand surely Singapore could not be considered an emerging market. In spite of Lange’s astute observation on the price of a cup of coffee, Singapore in 1986, was, by anyone’s standards, an emerging economy.  

At some point in the next decade or so, without any fanfare, Singapore slipped out of the rank and file of the emerging markets to take its now rightful place in the list of the world’s developed economies.

Today, in the slipstream of the worst global economic freefall since the Great Depression, some observers are raising the question as to what constitutes an emerging economy and whether some of these emerging nations should join their erstwhile colleague, Singapore, in the family of developed nations.

As the first small fires of the soon to be conflagration began in the USA in 2007, a growing band of economists and financial gurus started bandying around the ‘decoupling’ theory.

Emerging markets, they claimed, with their unique financial systems underpinned by pent-up domestic demand, were decoupled from any potential problems in the North American and European markets.

This was one rationale towards elevating some of the larger emerging economies up in to the ranks of the developed world; after all if a country could avoid the contagion of the western world and Japan’s economic disease, then surely it deserved to be considered ‘emerged’. This wishful thinking continued well into the summer of 2008 as developed market stock indices came off the boil whilst emerging market indices continued to froth.

The rest, as they say, is history, and the ‘theory of decoupling’ was proven to be mumbo-jumbo as emerging market stocks crashed in the aftermath of the Lehman Brothers bankruptcy.

There are, however, more valid reasons for considering if certain emerging markets have emerged: size of the economies, reserves, size and development of the financial markets, corporate development. 

Some emerging economies are simply too large to ignore. Four emerging economies are in the world’s top nine in terms of gross domestic product on a purchasing power parity basis: China in second place, India in fourth, Russia in seventh and Brazil in ninth.  In total the emerging economies generate about 50 per cent of global output.

Emerging nations have been the world’s savers and have accumulated vast foreign currency reserves. About 60 per cent of global foreign currency reserves are held by emerging nations, with China, India, Brazil, Russia and Saudi Arabia accounting for the lions share (40 per cent of global reserves). China itself holds an astounding US$2.1tn or 25 per cent of the world’s reserves. 

The size of domestic financial markets, primarily stock exchanges, and their smooth functioning under the rule of law is another key consideration when differentiating between emerging and developed economies.

The developed stock markets are today seven times the size of the stock markets in the 22 countries that form the MSCI Emerging Market Index. Incredibly, only 20 years ago, the developed stock markets were 99 times the size of the MSCI emerging markets. China has recently overtaken Japan to slot behind the USA as the nation with the second largest market capitalisation. 

This mammoth growth in the market capitalisation of traded stocks in emerging economies has been precipitated by events such as China’s free market policies since the 1980s, the collapse of the Iron Curtain, India’s liberalisation drive in 1991, and the end of apartheid in South Africa in 1994.  

Along with this growth in the size of financial markets there has been a marked improvement in transparency and corporate governance in emerging stock markets. Perhaps one of the best reflections of this is in the narrowing of volatility between developed and emerging stock markets.

The past few years have seen some eyebrow-raising financial news headlines as emerging market corporations have gone on shopping binges. Tata of India had the cheek to acquire some of the West’s oldest and most favourite brands Jaguar, Land Rover and Tetley Tea.

Cemex, the Mexican cement giant, doubled its size in 2005 by acquiring RMC of the UK and is now the world’s third largest cement company. Chinese state-owned companies have gone on a global buying spree this year for mining and raw material businesses.  Can this type of corporate development be synonymous with the ‘emerging market’ tag?

The one key factor that continues to distinguish raffish emerging markets from their stuffier developed cousins is growth. The emerging economies as a bloc will grow this year, led by China and India, whilst the advanced economies will contract. The engines of growth for the foreseeable future will be the emerging nations.

Does all of this imply that certain emerging markets have finally emerged? There is indeed a strong case, from an investor point of view, to consider some of the larger emerging markets in the same light as some of the developed markets. If a cup of coffee or tea in an emerging market costs more than in Wellington, than perhaps that market has already quietly crossed the threshold into the developed world.