21 May Why a post-pandemic landscape is a good time to invest in emerging markets
At Red Ribbon, our focus is to create wealth in responsible ways. Our investment strategy covers both mainstream impact investment and growth markets. By investing in projects that deliver identifiable positive environmental and social impact, we ensure market rate returns are still possible.
In this blog, I’ll explain what investors need to know about emerging markets. We’ll look at exactly what they are and why they are worth including in an investment portfolio. I’ll also touch on the changes that the pandemic has brought to the fast growth of emerging markets, and what it could mean for investors.
Investing in emerging markets pre-pandemic
The term ‘emerging markets’ is used widely and freely. However, it remains loosely defined. For us, emerging markets describe economies that aren’t quite at the same level as developed economies but are clearly exhibiting some of their traits.
Contextually, there are three economic categories:
- Developed or advanced economy.
- Emerging economy.
- Frontier economy.
We can therefore see that an emerging market economy is measured by its progression towards becoming developed. This entails a market exchange, sufficient regulatory bodies and a level of liquidity in its equity and debt markets.
An important differential between an emerging market and an advanced market can be seen in the level of regulation. Emerging markets don’t have the same level of oversight, regulation or market efficient as developed, so it’s not just about how well the economy is doing. It’s also about whether it’s being developed and reformed in ways that will eventually lead it to be categorised as advanced or developed.
While a developed market delivers reliable, steady growth, an emerging market is growing faster and is more volatile. The poorest countries achieving neither rapid growth nor in the process of opening their economy are categorised as a frontier market. In other words, this is the preceding stage to an emerging market.
What defines an emerging market for an investor?
The biggest defining characteristic of an emerging market from an investor point of view is that they offer quicker growth than advanced markets. This naturally comes with more risk and volatility.
Among the emerging markets at the end of 2019, there are seven that stand out according to the International Monetary Fund (IMF):
- China (GDP $15.5tn)
- India (GDP $3.2tn)
- Brazil (GDP $2.3tn)
- Russia (GDP $1.8tn)
- Mexico (GDP $1.3tn)
- Indonesia (GDP $1.2tn)
- Turkey (GDP $961bn)
These growth markets tend to follow these characteristics:
- Industrialisation is ongoing.
- An above-average period of economic growth.
- Below average income per capita when compared with developed economies.
- An emerging middle-class.
- Fast increasing population.
- Reforming exchange rate mechanisms to stabilise volatile currencies.
- Encouragement of investment from overseas.
- Plans are underway for economic reform towards an open market.
Before COVID-19, we expected to see growth in emerging markets eventually outpace developed markets. This would effectively close the economic gap between emerging and advanced markets in terms of income per capita and GDP. Pricewaterhouse Cooper’s end of 2019 predictions for the main seven emerging economies is that they will achieve an average growth of 3.5% annually up to 2050.
COVID-19 and the impact on emerging markets
Emerging markets are under unprecedented stress in 2020 due to the effects of the pandemic. Many countries around the world (including developed) are dealing with high economic and health costs of COVID-19. Emerging markets are struggling to stimulate their economies, and many are suffering from the double challenges of limited testing capacity and higher debt.
Many countries with low or middling economies are dealing with worse than average outbreaks of COVID-19. This includes Brazil, Russia, Chile, Peru and Colombia. However, some emerging market countries have bucked this trend. For example, Malaysia, Nigeria and Thailand have fewer confirmed cases than even Japan and South Korea.
The drop in GDP for many emerging economies has been drastic. Between Q4 2019 and Q2 2020, Mexico lost more than 15% in real value GDP. Just a few emerging markets posted relatively small losses for Q1 2020 – Vietnam with just 2.9% fall in GDP. Most emerging markets implemented relatively modest fiscal stimulus plans. The IMF says that direct spending in Mexico will be 0.7% of the GDP, and India just 1.7%. Those countries that have implemented bigger stimulus packages (Thailand, Poland, Brazil and Chile) can expect larger debt gains.
Each emerging market’s economy and position before COVID-19, along with the state of its exports, will affect how well it recovers. Businesses operating within emerging markets face potential uneven demand, financial market volatility and commodity price swings as the global economy pulls out of the pandemic.
New investment opportunities arising from the pandemic
Investors are now considering their options in the face of the pandemic’s impact on emerging markets. But now is the time for investors to address the infrastructure problems that COVID-19 has uncovered in emerging markets. This means investing for a greener, sustainable future.
COVID-19 has interrupted the fast growth of emerging markets and applied an unexpected brake to their pre-2020 predictions. But even under these circumstances, this is an opportunity for international investors to bridge the infrastructure problems.
Trade, tourism and commodity prices are all hugely impacted (international tourist arrivals dropped by 80% this year) and remittances are also down. But with governments keeping a lid on inflation, keeping the fiscal deficit low and ensuring the maintenance of floating exchange rates, core inflation stays as low as can be expected.
The important thing to remember for investors is that central banks and governments have held off a financial crisis. When deciding which emerging markets are the best options for investment, it’s important to consider which governments offer the likelihood of properly following through on reforms. We must look for long-term vision and planning. Creativity and flexibility are needed now for investors in emerging markets. The pandemic confusion will pass, and while the emerging market landscape will be different, there absolutely will be opportunities for the long-term.