Emerging Markets

The term emerging markets typically refers to a distinctive financial asset class among international investors and financial firms and designates countries perceived as transitioning from developing to developed economies (often countries that were formerly part of the Third World or the communist bloc). The term emerging markets was coined in 1981 by Antoine van Agtmael, the then director of the Capital Markets Department of the International Finance Corporation (IFC), the private sector development arm of the World Bank Group, which created emerging markets as a financial asset class when it developed the first emerging market investment fund (the Korea Fund, in 1984) and provided the seed money for that fund. Between 1984 and 1994, the IFC underwrote and invested in more than 30 emerging market portfolio investment funds before spinning them off to private investment firms. There are now more than 600 equity emerging market investment funds, with most of the capital originating from international and domestic U.S. funds, offshore accounts, hedge funds, and insurance companies.

The countries designated emerging markets are not fixed as the criteria for defining them vary among investors and financial firms. However, the following IFC/World Bank criteria are typically used in identifying emerging market countries. They have experienced 3 yrs. (years) or more of rapid economic growth (based on gross domestic product [GDP] figures) yet remain low- or middle-income economies according to the World Bank. They have implemented liberal economic policies and practices such as adopting international financial standards and broad-based discriminatory controls for nondomiciled investors. They do not exhibit financial depth (i.e., the ratio of the country's market capitalization to its GDP is “low”) and hold high levels of foreign debt and are subject to currency risks. They have a functioning stock market but often inadequate regulatory oversight, lack of transparency and liquidity, and broker, settlement, and custodian risks. Finally, emerging markets are typically considered risky investments because they are countries often considered economically, institutionally, and politically unstable.

Emerging markets represent more than 12% of world market capitalization. Overall private capital flows to emerging markets, as a percentage of their GDP, are now more than four times net official aid flows to those same nations. The issuance of international securities by emerging market sovereigns and corporations has increased from a level of $325 million in 1995 to roughly $700 million by 2003. By 2006, emerging market securities had increased in value by 243% compared with the United States, which had increased only 34%. Net equity flows (foreign direct investment and portfolio flows) to emerging markets have grown [Page 891]to roughly $200 billion per yr. By 2006, emerging markets (led by China, Taiwan, and Korea) held more than 75% of all foreign exchange reserves, while the largest emerging markets (the so-called BRIC countries of Brazil, Russia, India, and China) now hold foreign reserves totaling more than double their foreign debts. The holding of foreign currencies is considered indicative of high levels of international trade and market integration. Economic integration has also produced a heightened tendency toward financial volatility and crises as the frequency of financial crises in emerging market economies since 1973 has become twice that of the Bretton Woods period.

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