Risks and benefits of investment in emerging markets

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1. Introduction

According to the definition of International Monetary Fund (2004, p. 5), “emerging markets are in transition in several senses. They are almost always transitioning in important demographic characteristics, such as fertility rates, life expectancy, and educational status. Typically also, they are transitioning in the nature and depth of their economic and political institutions. Finally, and of special relevance, is the transition to greater interaction with international capital markets”. In other words, emerging economies are in transition phase from developing economies into developed economies, and it has transition in all aspects of life such as economy, society and politics. Nowadays, emerging economies such as Brazil, India, Russia, China, (or BRIC nations), Vietnam, Chile, Africa,… have become attractive investment destinations for developed countries investors. The rapid development of the emerging economies is generating significant changes in economic order and global politics. According to Sauvant, Mascheck and McAllister (2010), investors from developed countries have invested FDI much into four emerging countries: Egypt, India, South Africa and Vietnam. These are potential markets with high growth opportunities in the future.

This essay provides overview, risks and benefits of investment in emerging markets. Therefore, investors in developing countries should invest in the emerging markets to make profits from the economic abundance of these countries that are growing strongly.

2. Developed economy investors invest in emerging markets

2.1. Overview of investing in emerging markets

Capital flows from developed countries play a key role in the flow of capital to emerging economies. Since the 1990s, investors in the developed countries have paid attention to the investment of capital into emerging markets such as Brazil, China, Korea, Soth Africa … (Kaminsky, Lyons, and Schmukler, 2001)

According to a recent survey conducted by KPMG LLP (2013) – audit, tax and consulting company in the United States, the revenues of 90% of American business executives involving in strategic business development and corporate development has increased in the high – growth and emerging markets over the last year and expected to increase in the coming months. Mr. Mark Barne – leader of rapidly emerging markets department in the United States of KPMG said: “The growing and emerging markets are considered as the most important content in the agenda of the business, and companies are now investing in markets outside the BRIC countries. Notably, more and more investors are interested in investing in emerging countries such as Vietnam, Chile, Argentina, Malaysia, Indonesia and South Africa (Estrin, Meyer 2004). And everything has good reasons: the markets like Vietnam, Nigeria and India are expected to have the highest growth rate at 6 – 7% for coming years and decades”.

An overwhelming proportion of executives (about 84%) said that emerging countries have an important role for the growth and strategy of their company – a significant increase compared with 37% of survey KPMG last year. There are more companies (29%) which expect to achieve a higher percentage of sales ($31 – $50 million) from those countries in their global sales increasing by 17% compared with survey results years ago.

In addition to the BRIC countries, Chile, the Philippines, Argentina, Indonesia and Vietnam are gained greater interest of the executive officers in the past year. Some companies have plans to invest over $5 million in Vietnam in the next 12 months increased from 7% to 9%.

According to the data of the S&P, the total capital investing in emerging markets of developed economy investors was increasing sharply, during the period 1990 – 2010 increased approximately 7 times (showed in table 1).

Table 1: Capital investing in emerging markets of developed economy investors (Unit: $ billions)

Year Country 1990 1995 2010

Brazil 16 148 709

Korea 111 182 718

Mexico 33 91 204

South Africa 138 280 352

Taiwan 101 187 638

(Source: S&P/Citi Global BMI Index, 12/31/10)

According to the report of Templeton Emerging Markets Group (2014), Mark Mobius’ Investment Group, this year will be a critical year for many emerging markets, tends to shape the development of the remaining period of this decade. According to them, the emerging countries are likely to lead to profound changes in 2014.

2.2. The risks of investing in emerging markets

According to a report of CNNMoney (2014), there are four major risks that developed economy investors must be very careful when investing in emerging markets:

 Monetary tightening policy of Fed: The emerging markets have been “colds” at the end of last year due to fears that investment flows will revert to the property of the United States when the Federal Reserve (Fed) began collecting in low cash flow. However, the bond-buying program the Fed may end up in the remaining months of this year and investors will be watching for clues to find the schedule of raising interest rates of the United States.

 Political risk: In the developing economies such as Indonesia, Turkey and Brazil, have taken place a number of important elections.

Accordingly, presidential elections took place in Indonesia on July 9th. The referendum showed that the candidate who supported businesses – Joko Widodo (or Jokowi) – was facing an election closely. Jokowi’s failure could trigger a strong wave of selling stocks of investors.

In Turkey, Recep Tayyip Erdogan, the Prime Minister won the presidential election on August 10th. Prior to that, Mr. Erdogan’s confrontation with the anti-government protesters led to the panic of the market. Reportedly, Mr. Erdogan is known for intervening in the decisions of the central bank of the country.

The election of the President of Brazil in October is also made investors cautious. According to expectations, Dilma Rousseff can win at a second term, but economists warned her fate will depend on the outcome of the Brazil soccer team at the World Cup. If Brazil loses, this could fan the flames of anger about the huge cost for this tournament.

 Economic uncertainty: The persistent difficulties in the economy such as slow growth, high inflation and dependence on foreign capital flows can become an obsession for some emerging markets in the coming months. Last year, Stanley (2013) used the term “Fragile Five” for Brazil, India, Indonesia, Turkey and South Africa as these countries were facing similar risks. Until now, the situations in these five countries have not changed much. However, India’s economic outlook has improved after Prime Minister Narendra Modi won the election thanks to the reform commitments. Currently investors are watching the dynamics of the new Prime Minister when his first budget was announced on July 10th. Besides, an additional risk that the emerging markets are facing is the increasing reliance on credit in countries such as China, Brazil and Thailand. As remembered, the cooling down of the real estate market in China has been adversely affecting commodity exporters in Latin America and some areas of Africa.

 The increase of oil prices: It seemed that investors were less worried about the prolonged crisis in Iraq. It is known that oil prices fluctuated sharply last June when the Islamic extremist rebel advance into Iraq northern, but then the fuel has fallen back sharply, partly because of information that Libya can re-export oil. Any serious disruption to oil exports from Iraq, the 2nd largest oil producer of the Organization of Petroleum Exporting Countries (OPEC), also causes the increase world oil prices and the bad impact on momentum of global economic growth. According to Botham (2011), an economic expert on emerging markets at Schroders, emerging markets have been heavily dependent on imported oil activities, such as Turkey and India, will be most affected.

2.3. The benefits of investing in emerging markets

According to Bace (2010), there are two benefits of investing in emerging markets: Investors in the developed economies are attracted by strong and long-term growth of emerging markets. Further, the growth of emerging economies has been increasingly less dependent on developed countries, mainly relied on domestic demand and exports, and high prices of commodities. Derrabi & Leseure (2002) also offer two benefits of investing in emerging markets, they are: potential returns and reduction of risk by diversification. Although two above opinions are different, they admit the possibility of a profit quickly and stable long-term growth while investing in emerging economies.

By extension, Basu & Media (2012) give four benefits for developed economy investors when they invest in emerging markets: Diversification; Growth; Currency; and Consideration. According to them, diversification will help businesses avoid risk and protect them against bad situations occurring in one or a few particular markets, not all. Further, the emerging economies have high growth rates of economic; stable legal, political, encouraging foreign investment, which create conditions for business investment from developed countries develop strongly. Jobs and income for local people, are raised, which help purchasing power go up, thereby, providing high returns for investors. Investors in developed countries can also gain benefit when foreign currencies strengthen USD. Finally, investors should choose the emerging markets that have the best conditions for investment because the markets are not always same. They need to think carefully before investing in any market in order to bring the highest efficiency for their businesses.

Figure 2: European firm’s emerging market sales by region

According to annual report of Morgan Stanley (2013), since 2005, the European countries have started to pay attention to investing in emerging countries such as BRIC countries, their capital has poured into these countries more and more. As shown on the above chart, the total sales that the European nations gained since investing in emerging markets from developing countries in Asia, followed by Latin America, the Middle East and Africa have also changed markedly, while emerging European region have not increased very significantly. Actually, the chart showed the tremendous benefits of investing in emerging countries of European investors. That is really the driving factor of the strong investment of developed economy investors into these markets.

2.4. Developed economy investors should invest in emerging markets

With these benefits are achieved when investing in emerging economies, investors in the developed economies should really invest in these markets. According to Cornelius (2007), developed economy investors are interested in investing in emerging markets due to four important reasons: the ability of commercial development in size and scope is very large in emerging countries. Next, there are many companies that are managed and financed well, therefore they can overcome challenges easier than ones in developed markets. Further, some companies in emerging countries have many competitive advantages such as location, resource (Russia), cheap labor cost (India),… Finally, when developed economy investors invest in emerging markets, they can gain higher investment results than they can do in developed countries due to reduction of risk. We can see that emerging markets are really attractive environments that are not existed in developed countries for investors.

Figure 3: GDP growth of advanced and emerging countries

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