What are emerging markets

What is an emerging market?

An emerging market is a nation that is growing in productive capacity and is moving away from its traditional agricultural economy. An emerging economy is thought to be on its way to becoming a developed market, creating higher living standards, industrialising rapidly and adopting a free market economy.

The leaders of developing countries will be aiming to become more engaged with global markets, by becoming a more attractive investment opportunity for companies and investors alike.

There are over 150 emerging markets according to the International Monetary Fund (IMF). However, the definition of what constitutes an emerging market is somewhat up for debate.

The four most well-known developing economies are: Brazil, Russia, India and China. Although these are some of the largest countries in the world by GDP, the living standards within each economies are so varied that they’re often considered emerging markets. For example, China has the second largest GDP in the world but its GDP per capita puts it at 79^th, and India ranks fifth by GDP but its GDP per capita has it at 122^nd.

The characteristics of an emerging market economy

While each emerging market is different, there are few common denominators:

• A negative relationship to the US dollar
• A low income per capita
• High growth potential
• Market volatility

Emerging markets and the US dollar

Exchange rate fluctuations against the US dollar are an important factor shaping the outlook in emerging market economies, as much of their credit, trade, and debt is priced in dollars.

Typically, when the US dollar rises in value, emerging market currencies decline in value as their exports become less competitive and foreign investors go into a ‘risk-off’ state. A weak dollar on the other hand tends to boost emerging market currencies, giving them more freedom to adjust their fiscal policies.

Steep swings in exchange rates in emerging markets are often linked to capital outflows, tighter financing conditions and increased financial instability. However, the drivers of those moves are difficult to unravel, as global and national forces jointly determine the relative strengths of these currencies.

Emerging markets and income per capita

Emerging markets have lower-than-average per capita income. As the government pursues industrialisation and manufacturing activities, it’s hoped that the per capita income will increase with GDP. But as we’ve already seen for countries like China and India, this isn’t always the case. In a lot of emerging markets, the wealth disparity between the rich and the poor widens as the country grows.

This leads us to a common denominator of low income per capita, which is political instability. Overcoming this problem is one of the biggest challenges for an emerging economy.

Growth potential of emerging markets

The great growth potential of an emerging market economy is usually based on progressive industrialisation. In general, average growth will continue to be higher than in most developed markets. This is because the governments in emerging markets tend to implement policies that favour industrialisation and rapid economic growth. These policies lead to lower unemployment and better infrastructure.

This growth requires a lot of investment capital, but markets are less mature in these countries than they are in developed markets. This is why in the transition from an agriculture-based economy to a developed economy, countries often require a large inflow of capital from foreign sources due to a shortage of domestic capital.

Countries with a higher rate of industrialisation are more attractive to foreign investors due to the high return on investment they can offer.

Market volatility in emerging markets

The monetary policies in a lot of emerging market economies will make them vulnerable to volatility because they lack liquidity in their assets, causing slowdowns and sudden changes that can discourage investments. The volatility exposes investors to the risk of fluctuations in exchange rates, as well as poor market performance.

Volatility can be caused by a range of factors, such as political instability and supply and demand shocks due to natural calamities. When emerging market leaders undertake the changes necessary for industrialisation, different sectors of the population suffer, such as farmers. Over time, this could lead to social unrest, rebellions, and regime changes. Investors could lose everything if industries are nationalised or the government defaults on its debt.

The currencies of emerging markets are more susceptible to volatile exchange rate fluctuations. A clear example is that of the Argentine peso, which has been devalued against the US dollar at values higher than the country's inflation itself.

Emerging market currencies are also vulnerable to changes in commodities, such as oil or food stuffs. That's because the countries don't have enough power to influence these movements. For example, when the United States subsidised corn ethanol production in 2008, it sent oil and food prices skyrocketing. That sparked food riots in many emerging market countries.

What are the advantages of investing in emerging markets?

It is important that we ask ourselves the following question: why focus on emerging markets assets?

One of the main advantages is possible growth. The national companies, and foreign firms that take advantage of the landscape, will likely see revenue increases and share price gains as the company becomes more established. And as the economy stabilises and grows, the national currency will also strengthen.

International positions can be a good diversifier for your trading account or investment portfolio, as economic downturns in one country or region, including the US, can be offset by growth in another.

It’s important to remember, that when you trade with CFDs or spread bets, you’ll be able to speculate on whether emerging market assets - including shares, currencies and indices - are going to rise or fall. So, you can take advantage of the growth, and any volatility, that comes each country’s way.

Open an account to start trading or practise your emerging market trading in a risk-free demo account first. 

What are the risks of investing in emerging markets?

While emerging markets offer exciting opportunities, it is important to be aware of the different risk factors too. These include:

• Political risk: Emerging markets can have unstable, even volatile governments. Political unrest can have serious consequences for the economy and investors
• Economic risk: These markets can often suffer from insufficient labour and raw materials, high inflation or deflation, unregulated markets, and weak monetary policies. All these factors can present challenges for investors
• Currency risk: The value of emerging market currencies compared to the dollar can be extremely volatile. Any profit can potentially be diminished if a currency devalues or falls significantly

List of emerging markets

Here’s the total list of emerging markets as set out in the International Monetary Fund World Outlook 2021.