What is an emerging market? | CNBC Explains

What is an emerging market? | CNBC Explains

What does Indonesia have in common
with countries like India, Brazil and Russia? They’re all classified
as emerging markets. It’s a term that originated in the 1980s
and has stuck around since then. Two of the most important reasons why? Well, these countries are crucial when it
comes to driving global economic growth. And their financial markets can
be goldmines for investors, especially those with an
appetite for higher risk. So what makes an
emerging market today? And why do investors have such a
love-hate relationship with them? The term "emerging markets" was coined by a
World Bank employee Antoine van Agtmael. The finance arm of the World Bank wanted to get
more foreign investment into third world countries, but didn’t think the term “third
world” really inspired investors. To make it sound more attractive, van Agtmael
coined the term “emerging markets.” But if you want a definitive list
of emerging markets, good luck. The list varies depending
on who you ask. The IMF classifies 96
countries as emerging. It uses criteria such as how much citizens of that
country earn, how diverse the country’s exports are, and how sophisticated
its financial system is. That’s one measure. But investment research firm MSCI,
which creates stock indexes, classifies 24 countries
as emerging markets. Okay, but what’s an index? Essentially, it’s a list of stocks that
measures certain features. For example, if you want to look at how
the biggest U.S. companies are doing, you could look at the Dow Jones Industrial
Average, which covers 30 household names. The MSCI is known for its Emerging
Markets Index, which shows us how emerging countries like
Brazil, China and Turkey are doing. Unlike the IMF, the MSCI uses how
investable a country’s stock market is to determine whether
it's an emerging market. That’s important, because this influences how
much foreign investment a country can get. You may be wondering how such a diverse group
of countries could possibly be grouped together. Despite their many differences, there are a few
characteristics that they do tend to have in common. Let’s take a look at the first one. The term “emerging markets” was
initially used for developing countries, which meant that the average person living there tends
to earn less than someone in a developed country. Economists call this a
lower income per capita. But that’s not always true today. Some countries, like the United Arab Emirates
and South Korea are considered emerging markets, but they have higher income per capita than some
developed countries, like Spain and Portugal. An investor’s goal is to make money.
For that, you need growth. And emerging markets are
known to do just that, rapidly. Fast growth is our
second characteristic. One report found that one out of
every four emerging economies outperformed its peers
and developed countries. Of these 18 outperformers, seven exceeded annual per
capita GDP growth of 3.5 percent for a 50 year period. They include China, South
Korea and Indonesia. The other 11, which include India, Ethiopia and
Cambodia, have enjoyed more recent gains, growing at about five percent or higher over the past
20 years. That’s 3.5 percentage points above the U.S., and enough to lift themselves into
a new income bracket for countries. That growth comes with a lot of risk. And that brings us to our next
characteristic, high volatility. And if you need an example
of volatility, just look at this. The MSCI index, which shows total returns, shows
emerging markets had been doing pretty well, until January 2018, when
things began to sour. We’ve seen their currencies fall to
historic lows against the U.S. dollar. That’s bad news for countries
trying to pay off their debt. It’s a problem because a lot of that
debt is held in foreign currencies, particularly in the strengthening U.S. dollar.
That makes paying off debts an uphill battle. Not ideal when emerging markets have seen their total
debt rise from $21 trillion in 2007 to $63 trillion in 2017. Emerging markets crises are
worrying, because they affect multiple countries and tend
to work in a vicious cycle. First, the currency falls rapidly. Countries then struggle to raise funds due to their
less mature capital markets and investors flee. This affects the country’s assets
and currency, and can sometimes damage the country’s banking
system and even the economy. It’s important to note that an emerging
market’s status can come and go. That could mean a step up as a developed
nation, or a step back as a frontier nation. Despite all the uncertainty, one thing is
for sure, investors will continue to watch emerging markets closely, as the countries
continue to expand their role in the global economy. Hi everyone, it's Xin En.
Thanks for watching. If you want to check out more
of our videos, click here. Feel free to leave any suggestions for
future videos in the comments section. That's all for now, see you next time.


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