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 controlling inflation, avoiding foreign debt and promoting robust savings rates. The result has been a substantial increase in FDI inflow to support domestic investment.
Financial factors
Expansion of credit
Expansion of credit in the context of emerging markets implies increased lending by banks to the private sector and consumers. A sound and well-regulated banking system facilitates private sector growth and increased domestic consumption through wise lending practices.
Non-performing loan ratio
This ratio is defined as total non-performing loans divided by total loans. This metric is derived from Bloomberg where it is calculated by taking an average of figures from the country’s top five banks as defined by market capitalisation.
Foreign exchange (F/X) volatility
This is the volatility of a currency derived from a time series of spot prices over a specified historic time horizon. The three-month historic volatility on Bloomberg has been used.
5YR CDS rates
CDS stands for credit default swap. It can be thought of as insurance against the possibility of a credit event occurring in the future. The buyer of the protection pays a premium to the seller, and this premium is called the CDS spread. For example if a CDS has a spread of 950 basis points for a five-year China debt it means that default protection for a notional amount of $1 million costs $95,000 per year.
Sovereign rating
The sovereign rating is the credit rating of a country. The ratings from Fitch have been used. With Fitch, ratings from ‘AAA’ to ‘BBB’ are considered investment grade and ratings from ‘BB’ to ‘D’ are considered speculative grade.
4. Trade
Since ancient times, trade has been the primary vehicle by which great nations have risen and prospered. In that sense, little has changed over time, as international trade continues to be a key driver in the growth of emerging market economies. Just as before, nations play to their strengths by offering the goods and services that give them the greatest advantage. Yet today, the dynamics at work – everything from currency depreciation and tariffs to trade pacts such as NAFTA and ASEAN – have led to an environment that
