Innovations In Emerging Markets

India And China First Among BRICs

In the past few years, the BRICs – Brazil, Russia, India, and China – have become the favorites of emerging market investors and politicians, notes a Financial Times op-ed. But out of the four, China and India have the competitive edge. Those two countries are competing with the West for “intellectual capital,” investing in education and technology, and using their expatriate citizens to generate business in the home country.

But Russia and Brazil – two nations propped up by high commodity prices – haven’t invested in long-term economic development in the same way. Russia’s natural resources are increasingly concentrated in state hands, which puts off foreign investors. Brazil is slow to make changes that would positively affect the economic outlook across a broad range of sectors. Both countries have poor infrastructure systems.

As emerging economies change the face of the global political and economic order, business leaders should concentrate on China and India.

Emerging Markets Status Report: How Are Banking Systems Performing?

Since the 1990s and the banking crises in emerging markets, selected countries have made a lot of improvements, thanks to changes in banking structures, performance, and risk management capacity. That is the overall conclusion of a recent Bank for International Settlements article, entitled: "The Banking System in Emerging Economies: How Much Progress Has Been Made?".

The paper provides an all-too-rare comparative glimpse into the health of banking systems across emerging economies. Because it relies on a series of contributions by senior central bank officials, it lacks some perspective and falls short of providing country data specifics. On the other hand, it takes a thematic approach, drawing helpful general conclusions on five questions relevant to observers of the global financial markets architecture.

From the standpoint of an international financial institution such as IFC, the most interesting question is the one related to recent trends in the availability of bank credit in emerging economies. The paper argues that the share of bank credit to the business sector has in fact declined over the past decade. Why? Because, the paper says, lagging investment spending has curbed corporate loan demand and financing in bond and equity markets has become more available.

There are similarly insightful takes on several other topics, including the pace of structural change, the evolution and management of risks, the prevention of systemic banking crises and the impact of changes in financial intermediation.

Islamic Financing Innovations Establish Malaysia as Financial Hub

Malaysia is fast becoming the world's most innovative country in the area of Islamic financing. Malaysia's central bank governor recently described the strides made by the country's financial sector in a recent speech carried by the Bank for International Settlements.

Despite these recent successes in the financial sector, small Malaysian firms have not regained their pre-Asian crisis levels of energy, a recent IMF study shows. The study finds that low profitability and financing constraints are two reasons Malaysian firms have failed to reclaim their lead as the source of Malaysia's growth before the Asian crises of the 1990s.

Whether the new Islamic financial instruments will attract foreign investors from Asia and the Gulf states and help re-energize the local financial markets and businesses remains to be seen.

How India's Companies Can Add Value To The Local Economy

India's private sector companies need a more market-oriented playing field in order to contribute fully to the national economy, a McKinsey Quarterly article says. It notes that India's private firms are more productive than their Chinese counterparts, but are hobbled by interest rates that are, on average, twice as much as those in China. Why? Because India's financial system remains under tight government control, suffocating economic performance, the article says.

"...The financial system is inefficient in both of its main tasks -- in mobilizing savings and allocating capital -- Indian borrowers pay more for capital and depositors receive less than they do in comparable economies."

As painful as financial reforms are for India to contemplate, the authors say they are the only way the country can "complete its transition from a poor economy dominated by agriculture to a prosperous one led by services and manufacturing."

African Bourses Mostly Insulated from Recent Turmoil In Emerging Markets

African frontier markets -- including Nigeria, Mauritius, and Ghana -- continue to be largely exempt from the recent downturns that have been jostling other emerging markets, the Financial Times reports. That's because those exchanges are relatively illiquid and less developed and are not necessarily in sync with what's going on in other developing economies, according to a report by Investec Asset Management.

Investec noted that it will be another five years or so before these markets catch up and become more integrated and more vulnerable to broader trends. But right now, the isolation from the broader EM downturn enjoyed by frontier markets in Africa make them an investment opportunity.

In contrast, the region's more developed bourses -- in particular, South Africa, Egypt, and Namibia -- all took the hit that battered global emerging markets in May and June.

Watchwords for Emerging Markets Investing Remains "Cautious Exuberance"

Investors in emerging markets have had a rough ride over the past few weeks. One Financial Times article summarized just how rough: "The South African rand has tumbled, Hungarian bonds have been sold, and the Turkish stock market has crashed 41 percent in dollar terms in seven weeks."

Amidst the general stomach-churning among investors interested in emerging markets, a Wharton Alumni forum in Instanbul on the prospects of emerging markets provides useful perspective. One Wharton alumni of note, former IFC Acting Executive VP Assaad Jabre, told the forum: "Emerging markets will be the winner of the globalization process. A few years ago, many people were saying that developing countries would be the victims. We know that won't be the case. China, India, Turkey, and others are success stories." Jabre says a major reason is the growth of the private sector in those countries.

The optimism of the Istanbul forum speakers is in synch with the "cautious exuberance" that World Bank Group and other emerging markets experts have expressed since the beginning of the year. Our earlier posts reflect the prevailing views: Fall in Emerging Markets Financial Vulnerabilities Not Temporary, and Speed Bumps on the Road to Emerging Markets, among others.

Speed Bumps on the Road to Emerging Financial Markets

Amid the euphoria regarding emerging markets and predictions of solid performance for the foreseeable future, it is easy to overlook the cautionary notes. And there have been several over the past week or so, ranging from articles in the Financial Times to statements by IFC's executive vice president at "The Future of Asia’s Emerging Markets” conference in Hong Kong recently.

Unfortunately, access to most of the FT articles is closed so a short round-up of the "speed bumps" on the road to foreign investments in emerging markets is called for.

Speed bump no. 1: Watch out for lumping good performances in individual countries into one regional basket. As the FT's Florian Gimble puts it: there is no such thing as an "Asian fund market." So investments in local operations may not reap the benefits expected at the regional level.

Speed bump no. 2: Have a short-term investment outlook? Emerging markets may not be for you. With a few exceptions, many regions have few viable quoted companies, says Phil Davis of the Financial Times, and the dominant type of invesments -- private equity-- may take up to 10 years to mature.   

Speed bump no. 3: Concern about governance at the national, fund, and portfolio company levels continues. A recent Emerging Markets Private Equity Association survey reports this factor is acting as a brake to greater invesment in emerging market funds, although institutional investors polled expect the record-breaking fundraising for private equity in emerging markets to continue.

Speaking at the conference on the future of Asia's markets, IFC EVP Lars Thunell was quite specific: “Private investors are not flocking to places like Cambodia, western China, eastern Indonesia, Laos, Papua New Guinea, or Timor Leste.”

India and China Entrepreneurs -- Who Has the Real Stuff?

In the long term, Indian entrepreneurs might have an edge over their Chinese counterparts, argued some experts in emerging markets attending a recent Wharton Private Equity Conference. Panelists bullish on Indian entrepreneurial potential noted the overseas experience of many working for Western companies, as well as their closer ties and partnerships with U.S. firms. Softer attributes such as a democratic government and a free press will stand Indian firms in good stead over the long haul, another conference participant argued.

China, by contrast, continues to be more attractive in the short term. The combination of a government which has embraced Western-style capitalism, cheap labor, and entry points to a wider range of industries led by a globally dominant manufacturing sector will ensure that Chinese firms remain ahead as a favorite destination for foreign direct investment in the foreseeable future.

On the risk side, India and China present different sets of problems for investors. In India, an evolving but still deliberate regulatory system, inadequate infrastructure, and overwhelming poverty are all part of the investment risk picture. In China, concerns focus on the legal and political systems.

All in all, however, the real drag on the performance of entrepreneurs in both countries is neither political nor economic. At least one expert noted that the real Achilles heel of both systems is the environment.

Here at IFC, we would agree that among the greatest long-term challenges to firms --let alone society-- in those countries is the deteriorating environmental conditions. In light of that, it would appear that a major piece missing from the Wharton conference discussion is an in-depth look at environmentally sustainable investments. It's time to address those issues so that investors can get a truly comprehensive handle on the prospects for investment in those two key Asian emerging markets.

Corporate Governance: What Separates Asian Financial Markets from the Best

The latest "it" thing in Asian countries, eager to attract a greater share of global capital market deals, is to develop international financial hubs in the region, says Financial Times columnist Guy de Jonquieres. Before building those "fields of dreams", de Jonquieres cautions, Asian countries would do well to set up the prerequisites of a modern financial market. Corporate governance is one such prerequisite. So is efficient capital allocation, as well as transparent and competitive market practices.

How far are Asian markets from matching the global reach and depth of New York and London? Not even in the ballpark, de Jonquieres argues. He adds: Asia has some hard work ahead to institute good corporate governance practices, among others. The payoff, however, will be well worth it and measured in better, sustainable economic performance.

For IFC activities on corporate governance, click here.

Fall in Emerging Markets Financial Vulnerabilities Not Temporary

The financial vulnerability of emerging market economies has decreased dramatically in the past four years, and the trend is not temporary, an International Monetary Fund official said at the April launch of the institution's Global Financial Stability Report. Emerging market economies have their macro-economic fundamentals on the right track, the IMF says, but risks still exist.

For fIrms, there is one note of caution: the increase in corporate borrowing might lead some to find themselves in trouble if profits fall short of expectations.

More on emerging market financing flows in the appendix of the Report's first chapter. Credit markets and emerging sovereign debt are discussed in chapters II and III, respectively.