The term “emerging markets” refers to the economies of countries that are undergoing industrialisation as they become more developed, and the share of global GDP of these nations is growing rapidly. As of 2020 the 37 markets covered by OBG accounted for around 21.6% of the world’s population and roughly 9.6% of global GDP, as represented by the “yellow slice” of the pie in Figure 1.
These are typically the most dynamic growth markets and therefore present an exciting – high-risk, high-return – opportunity for investors. GDP within the yellow slice was initially predicted to grow by approximately 4.4% per year between 2021 and 2023; the outbreak of the Covid-19 pandemic, however, stymied growth across all economies. According to the IMF’s World Economic Outlook update from October 2020, emerging market and developing economies’ GDP will contract by 3.3% in 2020 before rebounding to 6% and 5.1% expansion in 2021 and 2022, respectively.
There is not one, absolute definition or categorisation of an emerging market: some economists employ a formula using a country’s GDP and per capita income, while other indices consider a combination of factors including size, liquidity and market accessibility to determine whether a market is emerging, or to predict whether it will become emerging.
However, emerging markets typically have a set of common characteristics, which often include introducing regulatory reforms to progress towards developed country status. Generally speaking, these economies are characterised by an increasing reliance on industrialisation and manufacturing, a shift that is often designed to reduce their dependence on agriculture, energy and other natural resources or raw materials. These markets often focus on bolstering exports and reducing imports to create a more favourable balance of trade and ensure food security. Many emerging economies have crafted national development plans to guide their progress towards these aims. Government reforms may liberalise, diversify and formalise a frontier market sufficiently for it to gain emerging market status.
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Emerging markets have changed considerably in the decade leading to 2020: financial inclusion widened and technology penetration increased, most notably as governments introduced regulatory reforms to promote growth and mitigate risk.
Emerging markets lag behind more developed economies in terms of their financial sectors, in particular. Indeed, many emerging economies are typified by historically low levels of financial inclusion. In recent years, many governments in emerging markets liberalised a range of sectors and introduced a host of reforms, including regulations surrounding financial services. For example, Argentina regained emerging market status in 2018 after its government removed foreign exchange restrictions and capital controls, eliminated cash reserves and monthly repatriation limits in the equity market, and abolished lock-up periods for investment.
Globally, foreign ownership restrictions have been relaxed across a host of sectors, including real estate, banking and education, and many governments have targeted improvements in the ease of doing business. This allows for greater foreign participation and often presents an opportunity for partnerships with domestic companies.
Technological development is also enabling a transformation of emerging economies. In addition to facilitating entrepreneurship and innovation, increasing mobile penetration and app-based payment services have widened financial inclusion, which in turn benefits more sectors than just financial services. For example, there is considerable potential for the growth of e-commerce in emerging economies, particularly as they begin to move away from cash and reduce their preference for pay-on-delivery payment methods.
The factors influencing growth in emerging markets have changed in the 21st century. Crucially, trade has been a key driver of the rise of emerging markets in recent years, aided by falling manufacturing costs. This is set to continue against a backdrop of reduced transport and logistics costs.
Trade blocs act as a catalyst for the movement of goods by increasing the ease of cross-border commerce and reducing associated tariffs. Agreements that create these blocs are therefore an attractive path to unlocking economic development.
Economic diversification has also been an important driver of emerging market growth. Diversification typically refers to generating economic output from a wider range of sectors, such as industry, in order to reduce reliance on traditional and often lower-value-added pillars of the economy, such as agriculture and natural resources.
More recently, amid global trade disputes and Covid-19-related disruptions to logistics, diversification has proven important not only in terms of GDP makeup, but also for trade routes and supply chains. Diversification of these factors will therefore be crucial for many emerging economies in order to address trade imbalances and reduce their susceptibility to economic headwinds, both externally and internally.
At the same time, rapid technological innovation is disrupting traditional business models, allowing emerging markets to leapfrog established development stages and placing increased focus on upskilling the labour force. As part of the so-called Fourth Industrial Revolution, which is based on the application of new digital and automated technologies in production processes and service delivery, the development of human capital has been prioritised.
Many emerging markets are characterised by a large and growing young population, which makes it even more crucial that they advance their education systems – which may lag behind global standards – in order to develop an adequately skilled workforce and prevent high levels of unemployment. Universities in emerging economies are playing a central role in the response to the Covid-19 pandemic through research and development, as well as innovative approaches to learning. Indeed, strong education systems can help emerging markets maintain economic expansion by sustaining productivity if supported by a pro-growth agenda and innovation to encourage investment inflows and spending.
Among the factors that pose the most notable risk to emerging markets are fluctuating commodity prices, currency instability and current account deficits. Ongoing additional challenges may include low ease of doing business, insufficient domestic regulation – which may lead to questions surrounding quality and reliability – or the potential for socio-political instability. Many also struggle with debt management, an issue exacerbated by the pandemic. As such, in October 2020 the G20 announced it would extend a debt-suspension initiative.
Despite the economic effects of the Covid-19 pandemic, emerging markets will remain of interest to investors in 2021 and beyond because of the high reward potential offered by their rapid development.
The economic agenda is often prioritised by government bodies in these countries. Market opportunities are presented by their expanding and youthful demographics, increasing levels of urbanisation and rising household purchasing power. Rapid technological development leaves the door open for these emerging economies to leapfrog development stages and make up lost ground relative to more advanced economies.
Emerging markets are also diversifying investment offerings, with some – including Egypt, Saudi Arabia and Indonesia – issuing green bonds.
Markets in Asia are set to benefit from the creation of the world’s largest trade bloc in November 2020, the Regional Comprehensive Economic Partnership. Meanwhile, the African Continental Free Trade Area comprises 54 out of 55 African countries as of June 2020, and has encouraged regional trade since 2019.
The emerging markets that are growing the most rapidly depend to a large extent on demographic advantages, as well as government priorities and regulations.
In addition to navigating the most severe economic effects of the Covid-19 pandemic, this means the most promising emerging markets for 2021 will include those where high-potential sectors have been clearly identified by policymakers and an ecosystem has been created to allow them to flourish. This makes emerging economies a particularly exciting investment opportunity for investors seeking to diversify their portfolio.
Examples of high-growth sectors in emerging economies include e-commerce in Indonesia, which benefits from a large domestic market, improvements in infrastructure and rising discretionary spending power; and the automotive and aerospace industries in Mexico, which have been bolstered by favourable regulations and trade deals.
You can explore each of the markets OBG covers by sector here.
Read our internationally acclaimed intelligence on regions that are shaping the future balance of economic power, and explore a range of videos with key players in emerging economies.
You can also visit the MCSI Emerging Markets Index to access equity market information. This is often used as a performance benchmark for mutual funds and market growth.
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