Aston Lloyd - How to Spot an Emerging Market
The term ‘emerging markets’ was first coined in the 1980s, by an economist at the World Bank in Washington, Antoine van Agtmael.
It is used to describe a nation’s social or business activity during rapid growth and industrialisation. It is not constrained to geographic or economic strength, but details a country making the transition from developing to fully developed. There are currently 28 countries defined as emerging markets, including China, India, Mexico, Brazil, the Middle East, Bulgaria, Turkey and parts of Africa. Emphasising the fluid nature of the category, political scientist Ian Bremmer defines an emerging market as “a country where politics matters at least as much as economics to the market.”
Emerging markets have, in the past decade, gained increasing prominence as investors start to realise the value inherent in rapidly developing economies. These regions, more than any others, follow the golden rule of investing, buy low and sell high. Prices of stock, assets, and especially property are starting from a very low base, providing an entry point from where the economy, and therefore the value, can only go upwards. There are a number of ways investors can get involved in emerging markets. Grouping the countries performance into funds, with the Morgan Stanley Capital International (MSCI) emerging market index tracking the performance of 25 key markets, is one popular way. However, there is criticism of this technique, as the index includes countries such as South Africa, Brazil and Argentina, which some analysts consider to be already developed.
By far the most popular and effective way of benefiting from the emergence of these economies has been through he purchase of property. The majority of these destinations have operated a closed property market for many years. Those that they have opened up internationally, offer substantial value with low land and property prices, and more importantly, offer considerable returns not seen in most developed countries hurt by the economic crisis.
What makes an Emerging Market
Emerging markets share a number of major characteristics. First, they are regional economic powerhouses with growing populations, huge resource bases, and developing financial systems. They tend to be transitional societies that are undertaking domestic economic and political reforms. Finally, they have replaced their traditional state interventionist policies with open door policies, and as a result can produce sustainable economic growth.
The main cause for the creation of emerging markets tends to be the failure of state-led economic development and the need for capital investment. For example, in Eastern Europe the majority of the countries originally fell under the control of the Soviet Union, and were operated from a centrally-planned economy. Closed off to foreign investment and development, the region experienced zero growth. Following the collapse of the Soviet Union, these countries found themselves making the switch to a free market economy. In making the transition, they receive help from global financial agents such as the International Monetary Fund (IMF) and the World Bank in the form of long-term loans, which allow the countries to function in a market economy.
In recent years, emerging market economies have repaid their loans, and have moved into a phase of rapid growth. Put off by high prices in developed economies, multi-national companies are moving into emerging markets to set up factories, warehouses, offices etc. The attention from big business has helped such countries to build the workforce, raise salaries and provide the population with disposable income. This in turn has boosted the property markets.
Analysts estimate that over the next two decades, over 75% of the expected growth in the world’s trade will come from emerging markets (US Department of Commerce, 2009). While developed markets exhibit low, single-digit growth rates, many emerging markets sustain high levels of GDP growth and foreign direct investment (FDI), and along experienced a developing middle-class.
According to a report by Arthur Andersen LLP, “the existence of a middle-class is the most important factor in determining whether a country will sustain rapid growth.”
This growth has also proved to be worth more over the long term than the growth in developed economies. The MSCI emerging markets index has gained more than 600% in the twenty years since its launch in 1988, beating the Standard & Poor’s developed ‘Top 500’ index by 200% (Financial Times, 2008). The lack of correlation with developed economies also means emerging markets do not suffer in the same way when there are global issues, such as the financial meltdown which hit traditional markets in 2008.
By analysing the growth of these countries, in particular the source, investors can spot strong emerging markets, and conversely, see which ones carry too much risk, and should be avoided.
Growth in an Emerging Market
From 2004 to 2008, emerging markets have represented half of nominal growth in worldwide GDP. As growth slows in developed economies, emerging ones are looking set to represent even more over the coming years (Forbes, 2009).
In fact, the long-term economic outlook for the emerging markets is generally considered by most analysts to be significantly brighter than for most developed countries. Using the MSCI index as a basis for what constitutes an emerging market (excluding China and India), the CIA World Factbook has calculated that 49% of the world’s population, or 3.2 billion people, live in emerging markets. This is a huge market that is looking (or will in time) for a developed standard of living.
Additionally, a massive 31% of this population are under the age of 15, and only 6% are over the age of 65, for companies, as there is now a large proportion moving into an age bracket where they will generate income and in turn spend; significantly contributing to economic growth. In contrast, only 17% of those living in developed economies are under the age of 15 and those over the age of 65 account for 16%. These favourable demographic trends enable above-average economic development for emerging markets (Forbes, 2009).
The structure of the financial systems in these countries means that they have a population and a government with low debt levels. Looking at a list of countries by current account balance finds the top half dominated by emerging markets.
China leads the table with US$371.833bn, and countries such as Bulgaria and the United Arab Emirates (UAE) have firm grips on their governmental balance. By contrast, the bottom four of the table are:
· Australia (-US$56.342bn)
· United Kingdom (-US$105.224bn)
· Spain (-US$145.141bn)
· United States (-US$731.214bn) (IMF, 2008)
The lack of debt paves the way for a favourable business environment for companies looking to expand or relocate. Gross fixed investments in emerging markets have consistently risen in recent years, averaging 23.4% of GDP over the last five years, versus only 19.4% for the developed economies. Labour cost per hour is also low, at US$4.70 on average compared to US$27.80 in the developed economies. Thus, foreign companies interested in lower production costs are looking to emerging markets when setting up manufacturing plants (Forbes, 2009).
The population is also saving. In the last five years, those living in emerging markets have saved 24.7% of their incomes, while their counterparts in the developed economies saved only 19%. In fact, the savings/investments ratios in emerging markets average a huge 103%, indicating that capital spending programmes have been financed mainly by savings rather than foreign debt, leading to a boom which is not only growing, but growing sustainbly (Forbes, 2009).
Case Studies
Bulgaria
The spark for Bulgaria’s property industry happened when it exited the collapsed Soviet Union and joined the EU, adopting a free market economy. The government undertook a rigorous programme of economic reform to reduce inflation, and GDP is continuing to grow at a record rate, registering 6.2% in December 2008 (National Statistical Institute, 2008).
Residential property has seen a 26.8% property price growth according to the most recent statistics, pushing Bulgaria to the top of the global house price growth index three quarters in a row (Knight Frank, Global House Price Index, December 2008). This growth has resulted in a number of international companies moving in, especially into the capital region of Giorgio Armani are just some of the global brands that have invested in the region. The result is salary growth and increased demand for rising standards of living, fuelling property investment.
Most analysts recommend avoiding the tourist areas, such as Bankso that may become overdeveloped. Conversely, property investors are encouraged to invest in the thriving region of Sofia. The size of the capital city is expected to double in five years, and property is still considered under-priced.
Turkey
Turkey has seen a dramatic increase in tourism figures, with a 30% increase in arrivals from Britain and Ireland alone (Turkish Ministry for Tourism, 2008). The country registered 6% GDP growth in 2008, considerably higher than developed economies (OECD, 2008). The year-round sunshine and the fact that the country has recently opened itself up to foreign investment has resulted in an influx of interest to the region. Large golf developments and resorts are planned, and a combined study between Knight Frank and the Financial Times put it in the top ten places to invest in 2009 (Financial Times, January 2009).
Latvia
Latvia suffered from extreme economic mismanagement in stage three of its property cycle. At one stage the country had the fastest GDP growth in the EU, with 12.2% (IMF, 2009). The government, however, was unable to stop the economy overheating and inflation hit 15.9% in 2008 (IMF, 2008). The population built up a huge debt burden, and there was a mass withdrawal of cash from its largest bank, Parex, following rumours that the debts on its books were too high. The IMF was forced to bail-out the country and the government refused to devalue the lat, keeping it artificially high. This meant that many goods and services became overpriced, deterring investment (BBC, Latvia Economic Report, December 2008).
Residents were also encouraged by banks to borrow up to 10 times their salary from the foreign banking sector feeding off the global supply of cheap credit. The business environment is still too weak and investors are not willing to enter the country.
Latvia is now the sixth biggest debtor to the International Monetary Fund, and because of this, the country has to cut spending and raise taxes, at a time when other countries are doing exactly the opposite (Economist Intelligence Unit, December 2008).
Some analysts go so far as to say that, “Latvia could go bankrupt within two years.” (Marge Tubalkain-Trell, Russian Business Portal, 2009). Latvia is a prime example as to why it is important for investors looking to buy in emerging markets to do their research.
Risk
One of the key issues facing emerging markets is the problem of inflation. Often the countries grow very rapidly and need to reign in growth to stop inflation running too high, but they also have to be careful to not put into place too many measures that may restrict growth.
In the late 1990s, average inflation in emerging economies was around 13% compared to the G7 group, which registered 1% inflation (IMF, 2009). Since then, a number of international efforts have curbed this growth, with some markets seeing the effects more successfully than others. For example, in the case of the UAE, the high price of oil pushed inflation high, as the majority of their economy is built on the oil industry. The UAE saw levels reach 12.5% in 2008, dragging up the average of the emerging market index (Economist Intelligence Unit, 2009).
In Latin America, rapidly rising food costs led to inflation in countries such as Venezuela reaching a massive 29.3% in 2008 (Intelligence Unit, 2009). In comparison, many Eastern European countries are managing inflation reasonably well, and seeing year-on-year drops. Turkey has a 4% target for 2009 through to 2011 and analysts agree it is achievable (OECD, 2008).
The other major concern is that these countries will simply not have the infrastructure to cope with the rapid growth of their cities. When doing research into emerging markets, investors should consider this as one of the most important issues to look at. With commodity prices rising sharply over the last few years, economies in emerging markets that are rich in resources have been benefiting greatly.
In fact, in some markets located in Latin America or Africa, there isn’t enough electricity to meet the demand, triggering power outages. Additionally, the airports and roads are overcrowded and it is becoming increasingly difficult for companies to get their employees in and out of the locations they need. Meanwhile, there are different kinds of infrastructure risks in Asian markets. China has invested heavily in transportation and energy, but not on quality control, leading to highly publicised defects in manufactured products. The infrastructure required to increase this quality control will take many years to implement.
In these situations, EU countries benefit greatly. Bulgaria, for example, needed to expand the transport system in Sofia to meet growth. The European Investment Bank (EIB), was apparent when they invested €105m on expanding its metro system out to the rapidly growing suburbs, as well as pouring money into its road system (EIB, 2009).
Hotspots
Sofia Bulgaria
Major companies are still pouring into the capital of Bulgaria, boosting investment as the unemployment levels drop and the extra workers demand properties. The infrastructure system has had major investments and it lies on an important trading route between Europe and Asia. The growth in Sofia is sustainable due to its business strengths, and with some of the most successful universities in Europe it is producing a skilled workforce.
Antalya, Turkey
This picturesque region in Turkey has been called a model for sustainable tourism from the government. It has not become too overdeveloped like much of coastal Spain, and has consistently gained in popularity with international visitors. The region of Antalya receives 25% of all tourism in Turkey, which is already one of the most popular destinations in the world (World ravel and Tourism Council, 2008).
Abu Dhabi, UAE
Less brash and overdeveloped than neighbouring Dubai, Abu Dhabi is growing at a speed less likely to burst. It sits on 90% of oil reserves for the region, so is not starting to run out of money. Despite this, the government have put in place structured plans to make sure the city develops into the future and diversifies as to provide multiple levels of sustainable growth.
Bratislava, Slovakia
A rapidly growing city which is boosted by the fact that it is only 40 minutes from Vienna in Austria, but on average half of the price. With a number of multi-national companies making Bratislava their home in Eastern Europe, and the tourist hotspots along the banks of the Danube River and skiing in the mountains, Bratislava has an enduring appeal that should enable its rapid growth to be sustainable. It achieved 31.2% residential property price growth in the most recent index, second highest in the world (Knight Frank, Global House Price Index, December 2008).
Buying Guide
· It is especially important in emerging markets to hire an English speaking lawyer who is well-versed in the often complicated legal systems of these economies.
· Investors should check that the UK and the country they are investing in have a reciprocal taxation agreement, or they could end up paying tax twice Buying guide.
· Be aware of lingering corruption in some of these markets. Most have made strides, but as Romania and Latvia particularly have a history of corruption, investors should check legal documents carefully.
· In these economies, political issues matter almost as much as economic ones, look out for countries with unpopular political leaders, as this can de-rail a property market.
