Emerging Market

Defining Emerging Market ?

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Can anyone define an emerging market?.

There are numerous definitions and little consensus on the meaning of “emerging markets” which mean different things to different people.  The proliferation of terms is increasingly bewildering for those managers who are attempting to prioritize their resources and maximise returns.

In this blog I look at some of the many definitions that have contributed to the confusion.  I also offer some practical advice for navigating through the hogwash that has kept so many analysts and academics gainfully employed for such a long period of time.

One definition I like, even if rather wordy, is by the economist Vladimir Kvint who defines an emerging market as a society transitioning from a dictatorship to a free market-oriented economy, with increasing economic freedom, gradual integration within the global marketplace, an expanding middle class, improving standards of living and social stability and tolerance, as well as an increase in cooperation with multilateral institutions.”

By this definition, 81 countries out of 192 country-members of the U.N. can be categorized as emerging markets.  The territory of these countries occupies 46% of the earth’s surface and accommodates 68% of the global population. These economies account for nearly half of the gross world product and attracted about $600 billion of foreign direct investment last year. On this basis the role of emerging market countries in the world would be difficult to overestimate.

Of course, 81 countries is hardly helpful to those business managers looking for their next handful of markets to expand into which has led to various subsets of terms.

For example, most people will be familiar with the term BRIC which is used to describe the largest developing countries of Brazil, Russia, India and China although some may be less familiar with BRICS (BRIC + South Africa), BRICET (BRIC + Eastern Europe + Turkey), BRICK (BRIC + South Korea), the Next Eleven(Bangladesh, Egypt, Indonesia, Iran, Mexico, Nigeria, Pakistan, Philippines, South Korea, Turkey, and Vietnam) and CIVETS (Colombia, Indonesia, Vietnam, Egypt, Turkey and South Africa). These countries do not share any common agenda, but some experts believe that they are enjoying an increasing role in the world economy and on political platforms.

Recently Jim O’Neill, the Goldman Sachs Group economist who coined the term “BRIC”, announced another variation by uniting the BRIC economies with those of Mexico, South Korea, Indonesia and Turkey under the title “Growth Markets”.

Another term is the “Big Emerging Market (BEM)” economies which are Brazil, China, Egypt, India, Indonesia, Mexico, Philippines, Poland, Russia, South Africa, South Korea and Turkey.

There is also now a group of “Newly Industrialised Countries” which is an intermediate category between fully developed and developing countries.  These countries are emerging markets whose economies have not yet reached first world status but have, in a macroeconomic sense, outpaced their developing counterparts.

There is also the term “Rapidly Developing Economies” which is used to denote emerging markets such as the United Arab Emirates, Chile and Malaysia.

Then there are “Frontier Markets” which are considered to offer more upside than their emerging market and developed market cousins. The term “Frontier Markets” was coined by the International Finance Corporation (IFC), a private sector arm of the World Bank Group, to reflect a specific subset of emerging market economies.

Institutions such as the IMF are also adding to the contagion of confusion.  In the IMF’s “Global Financial Stability Report”, emerging market countries are listed by continent and include Hong Kong, Israel, Korea, Singapore and Taiwan Province of China. In another IMF report, the “World Economic and Financial Surveys”, the category “Advanced Economies” includes several countries that are categorised in other reports as emerging markets including Hong Kong, Taiwan, Korea, Cyprus and Israel! The same category also includes Portugal, Greece, Spain and Ireland, which many agencies still consider to be emerging markets.

Later in the same report, some countries, which were previously classified as emerging markets are evaluated as developing countries, including those that are obviously emerging markets, like China, India and Turkey. These emerging market countries are included in the same category, as all sub-Saharan African states despite the fact that many of the sub-Saharan countries clearly belong to the category of developing countries. Some are definitely emerging markets, like South Africa, for example, but many of them are still underdeveloped.

In the same report, a different category appears later called “Countries in Transition”. This category includes Central and Eastern Europe, the Commonwealth of Independent States (CIS) and Mongolia. It is not clear why Mongolia is grouped with these countries. The same mix of countries with different levels of economic maturity (underdeveloped, developing and emerging market countries) in the same category can be found in the majority of U.N. reports.

So the IMF appears to be as confused as the rest of us. Making an exact list of emerging markets seems to be more of an art rather than science.  This has led to some authors referring to emerging markets as “all those countries not considered developed”.  Not very helpful, perhaps, but a workaround nevertheless.

 What normal business people might say

If you ask a conference room full of business executives how they would distinguish emerging markets from developed economies, you will hear a variety of views. Emerging markets such as Brazil, China, India and Russia, some will certainly say, are emerging by virtue of their recent fast economic growth.

But China, considered by many as the darling of the emerging markets sector, has seen an about turn in its fortunes. Since the beginning of the global recession in October 2008, China has failed to outperform the composite emerging markets index.  Brazil has underperformed the composite indexes over the past four years too – by 20%. In the first half of this year, even beleaguered European stocks did better than the Brazilian EWZ stock market. So does this mean that China and Brazil are no longer emerging markets?  Probably not.

Other executives focus on emerging markets as emerging competitors. On the macro level, a landmark 2003 Goldman Sachs report forecast that the economies of Brazil, China, India and Russia could grow to be collectively larger than the G6 economies (United States, Japan, United Kingdom, Germany, France and Italy) before the middle of the twenty-first century.

Others see the rise of emerging markets as a transformative, tectonic shift in the distribution of global power. Companies based in these economies, meanwhile, are already challenging multinationals based in the developed world – and not only in their home emerging markets. China-based Lenovo’s purchase of IBM’s personal computer business in 2004 and the acquisition of Jaguar and Land Rover by India’s Tata Motors in 2008 are only two examples of the increasing global mergers and acquisitions activity by emerging market-based firms. Some observers see the financial crisis of 2008–2009 as an inflection point, accelerating the emergence of these markets as dominant players in the global economy.

A deeper discussion might elicit a list of the persistent headaches of doing business in emerging markets. These markets, the executives might say, are prone to financial crises. Intellectual property rights are insecure. Navigating government bureaucracies can be thorny. Product quality is unreliable. Local talent is insufficient to staff operations. Reliably assessing customer credit is difficult. Overcoming impediments to distribution can be frustrating. Sorting through investment opportunities or performing due diligence on potential partners is often a guessing game. Others might throw up their hands and say that corruption is so endemic in emerging markets that the risks simply outweigh the potential rewards.

Based on many of these signs of emergence, some might say, emerging markets are not distinctly different from other markets; rather, they are simply starting from a lower base and rapidly catching up. Indicators such as the growing numbers of emerging market-based companies listed on LSE or the growing ranks of billionaires from emerging markets listed annually illustrate this trend.

All these criteria are important features of many emerging markets, but they do not delineate the underlying characteristics that predispose an economy to be emerging, nor are they particularly helpful for managers who are seeking to address the consequences of emerging market conditions.

A key characteristic of emerging markets is that they are transactional arenas where buyers and sellers are not easily or efficiently able to come together. Ideally, every economy would provide a range of institutions to facilitate the functioning of markets, but developing countries fall short in a number of ways. These institutional voids make a market “emerging” and are a prime source of the higher transaction costs and operating challenges in these markets.

By relying on outcome criteria to assess markets, managers often overlook the ways in which emerging markets operate differently than do developed economies. Ranking the world’s economies by per capita gross domestic product would suggest that the United Arab Emirates, for example, is among the world’s most developed economies, but it is an emerging market nonetheless because of its market structure.

Intuitively, managers know that operating a business in an emerging market is different from doing so in a developed economy. It is tempting to chalk up these differences simply to country context. Indeed, market structures are the products of idiosyncratic historical, political, legal, economic and cultural forces within any country.

By developing a granular understanding of the underlying market structure of emerging economies and not only cataloging symptoms to be incorporated in an overall risk assessment companies can tailor their strategies and execution in emerging markets to avoid mistakes and outcompete rivals.

Practical implications

At the end of the day many of these discussions might be academic.  Perhaps the practical approach, and one which I subscribe to, is to be guided by investment information sources such as Morgan Stanley Capital International which publishes its well-known MCSI Indexes.  Three are of particular interest:  the MSCI Frontier Market Index, comprising 25 countries (the top four being Kuwait, Qatar, Nigeria and the UAE) with a total market capitalisation of $96 billion and an average yield per country of $3.8 billion.

Then there is the MSCI Emerging Markets Index with 21 countries (Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Morocco, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, and Turkey) and a total market capitalisation of $3.3 trillion yielding an average per country market capitalisation of $160 billion.

Last, and usually for comparison purposes is the the MSCI Developed Market Index, comprising of 24 countries (the top four being the US, the UK, Japan and Canada), a total market capitalisation of $23 trillion and an average per country market capitalisation of $1 trillion.

While the MSCI indices are a useful way of understanding emerging market momentum they have two problems: first, markets may be maintained in an index for continuity, even if the countries have since developed past the emerging market phase – South Korea and Taiwan being possible examples.  Second, is that small countries, or countries with limited market liquidity are often not considered.

In the meantime countries benefit by being categorised as emerging markets given investor interest and the hype around racy returns, both of which are an effective means of attracting foreign investment. So it is not surprising that people are maneuvering around the definitions in an attempt to get their country included.  I am sure this will persist as world market dynamics continue to change. In the meantime I am happy to be guided by MCSI.  I have too many other things to worry about to get hung up about specifics.  And whether or not a country is classified as an emerging market will not preclude me from doing my market research and satisfying myself that there really is a market for my products and services in the first place.

Indian Budget 2013-14 Quick Highlights

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Here are some quick pointers from common man’s perspective for Budget 2013-14. I have added my thoughts in italics.

Income Tax:

  • No revision in income tax tax rates. The tax slab remains the same as of last year. Click here to view the Tax slabs for FY 2013-14 (same as FY 2012-13).
  • Education cess to continue.
  • Tax credit of Rs 2,000 for income up to Rs 5 lakh. 
  • Surcharge of 10% on Rs 1 crore plus income earners. Raised surcharge for only one financial year. Fact: Only 42,800 people with taxable income over Rs 1 crore in India.
  • The much awaited DTC (Direct Tax Code) remains work in progress.

RGESS (Rajiv Gandhi Equity Savings Scheme):

  • RGESS will be liberalized & the investor will be allowed to invest in mutual funds.
  • The investor will be able to do this for a period of 3 successive years.
  • The limit for investors wanting to invest in RGESS raised from Rs 10 lakh to Rs 12 lakh.

This is good move and would be safer for new investors.

Housing:

  • People taking a home loan in 2013-14 for an amount up to Rs 25 lakh will be allowed an additional deduction of Rs 1 lakh. Hopefully would give push to affordable housing.
  • Immovable Property transaction: TDS of 1% to be levied on transactions above Rs 50 lakh. Government is trying to curb black mney generation in property deals.

Banking:

  • India’s first women’s Public sector bank to be set up. Woman’s bank license to be in place by Oct, 2013
  • All PSU banks branches to have ATMs by March, 2014
  • KYC of banks will be sufficient to acquire insurance policies

Tax Free Bonds:

  • Tax Free Bonds – Will allow some organisations to raise funds strictly based on need.

Inflation Indexed Bonds:

  • In consultation with RBI, the FM proposes to introduce inflation indexed bonds or certificates.
  • The details will be announced later.

This is good move and hopefully would benefit retail investors and reduce investment in Gold to an extent.

Stock Markets:

  • Pension funds will be allowed to invest in ETFs. This would give a boost to stock markets and also give higher returns to pension funds.
  • STT (Securities Transaction Tax) rates cut on equity futures to 0.01% from 0.017%

Duties and Indirect Taxes:

  • One time amnesty scheme for service tax defaulters due from 2007
  • Higher customs duty on set top boxes from 5% to 10%
  • Excise duty on SUVs raised from 27% to 30%. Will not apply to SUVs registered as taxis
  • Customs duty unchanged for non agri products
  • Extend tax benefit to electrical vehicles
  • Increase in import duty on high end motor vehicles from 75% to 100%; and on motor cycles from 60% to 75%
  • Service tax to be levied on all air conditioned restaurants
  • Excise duty raised by18% for cigarettes
  • For phones priced at more than Rs 2,000, the duty is increased to 6%
  • To exempt vocational courses, testing services from Service Tax
  • Gold duty free limit raised to Rs 50,000 for men and to Rs 1 lakh for women travellers

Others:

  • To launch two new industrial cities in Gujarat and Maharashtra
  • Indian Institute of Biotechnology will be set up at Ranchi
  • To expand private FM radio to 294 cities