The Emerging Markets Handbook. Pran Tiku
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years and as the average age gets closer to 40 an emerging market moves beyond a stage where it can reap a demographic dividend. Therefore countries with large populations with an average age between 25 to 30 have an edge over other countries with smaller populations or higher average ages.
Dependency ratio
The dependency ratio is defined as the ratio of non-working people to working people. The greater the dependency ratio, the greater the burden on an average working adult. A low dependency ratio means there is a large pool of young working adults capable of supporting the dependent population. This means there is higher tax revenue and lower spending for the government, which in turn means less pressure on government finances.
Rate of migration to cities
Increased migration to cities is a sign of growing economic opportunities in urban areas and a transition from an agrarian economy to an industrial base. Historically, migration to cities has resulted in better distribution of wealth and narrower income gaps. As the world becomes a service-oriented economy, there will be rapid urbanisation and more people migrating to cities to take advantage of new economic opportunities.
Unemployment projection
This metric helps us understand whether job creation is growing at a quicker pace than the rate at which a country’s youth are entering the workforce. It also helps us achieve an understanding of whether the young adults graduating from education have the skills necessary to be employable in the modern workplace.
2. Economic conditions
Economic and fiscal conditions are the building blocks of any economy. While it is useful to evaluate economic conditions based on top-line GDP numbers, there are other ways to evaluate a nation’s economic conditions, including debt rates, savings rates, inflation and overall competitiveness. Criteria such as these help one determine whether a nation’s growth is sustainable, whether the growth is driven by exports or by internal consumption, and how well the economy is responding to changes.
Many emerging market economies are currently transitioning away from high growth rates based on the export of goods and services (on the backs of cheap labour) to a more balanced rate of growth based on innovation and internal demand. China, Brazil and Indonesia are likely to be great illustrations of such a transition.
In the past, emerging markets have – almost without exception – experienced untold misery because of extremely high inflation rates. For nations with higher than normal savings rates (again, true for almost all emerging market nations) this robs savers of their purchasing power and causes great stress for the aspiring middle class. Today, we see these nations adopting policies to prevent such occurrences from happening, along with a focus on managing deficits and curtailing subsidies.
Despite some challenges, emerging markets have shown they can produce 3% to 4% higher growth rates than developed markets and there is a high likelihood that these advantages can be sustained.
Economic factors
The key factors at work in the realm of economic drivers include:
GDP year-on-year growth
Consistent year-on-year growth in GDP is crucial for emerging markets to create jobs and raise millions out of poverty.
GDP per capita
This measures the output of a country. It takes a country’s GDP and divides it by the number of people in a country. Most nations grow quickly until they reach a GDP per capita of $5000. At this point most tend to fall into a so-called middle income trap, defined as GDP per capita between $5000 and $15,000. At this level, economic growth tends to decelerate to around 5% per annum.
For our purposes, we will compare the GDP per capita on a purchasing power parity (PPP) basis. PPP states that exchange rates between currencies are in equilibrium when their purchasing power is the same in each of the two countries. It is based on the assumption that in the absence of duties, transaction costs and other curbs, identical goods should have the same price in different countries when expressed in the same currency.
PPP is used here because it is a simpler way of comparing economic output between two countries. It removes the distortions that come with inflation and other transaction costs, which otherwise make the price of an identical product differ between two countries.
The World Bank data used in the charts is based on gross domestic product converted to international dollars using purchasing power parity rates.
Inflation forecast
Inflation is forecast with the help of the consumer price index (CPI) that measures the weighted average of prices of a basket of consumer goods and services. Higher inflation leads to a weaker currency and a lower return on investments.
Foreign reserves
Foreign reserves are the amount of foreign currency held by a country. Emerging markets holding large reserves are better able to withstand global recessions and stabilise their currencies. Ideally, a country must have at least six months of currency reserves to cover their imports.
Investment as a percentage of GDP
This benchmark shows the value of investment (gross capital formation) as a percentage of GDP at market prices. It is therefore a relative comparison of the value of investment. The larger the percentage, the larger the value of investment relative to GDP. A larger number demonstrates that a country is catching up in terms of R&D investment and gross capital formation. It also shows that by investing in new technology a country is on its way to being internationally competitive.
Debt-to-GDP ratio
This is the ratio of a country’s national debt to GDP and measures the ability of the country to pay back its debt. The higher the ratio, the greater the risk of default and associated chaos in the financial markets.
External/foreign debt-to-GDP ratio
External debt is debt owed to outside governments and corporations. The accumulation of external debt can have a negative impact on economic growth and private investment. While external debt is not bad per se, the inability of a country to service external debt can be a sign of trouble.
3. Financial
Financial management has played a pivotal role in the recent success of emerging markets. While sustainable growth and moderate inflation have certainly been a part in this success, they mean little without sound financial practices and institutions. Take the banking sector for example. As the rate of non-performing loans has fallen, so have borrowing costs. These are reflected in the cost of insuring loans (credit default swap rates), which has consistently improved over the years. Across the spectrum of emerging markets, trends such as these are becoming the norm, not the exception.
Today, many emerging market nations have investment grade debt ratings. This would have been unthinkable just a short time ago. In the past many of these countries, particularly in Latin America and Southeast Asia in the late 1990s, had their economies collapse due to large amounts of foreign debt denominated in dollars, pounds or Deutschmarks. Foreign investors would find reasons to panic (sometimes rational, sometimes not) and demanded payment. This, of course, created a run on the local currencies and subsequently the economies would collapse. These scenarios played out in strikingly similar fashion in Argentina, Mexico and Russia during the 1990s. They were textbook cases of how financial mismanagement can wreak havoc on an economy and cripple an aspiring middle class.
Lessons were learned in the process. Today most of these countries have taken serious steps towards