What are emerging market economies and how can you trade them?

Emerging markets present a range of opportunities to take advantage of volatility and growth across stocks, indices and currency pairs. Discover how to recognize an emerging market and what you should know before trading emerging market assets.

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What is an emerging market?

An emerging market is a nation that is growing in productive capacity and is moving away from its traditional agricultural economy. An emerging economy is thought to be on its way to becoming a developed market, creating higher living standards, industrializing rapidly and adopting a free market economy.

The leaders of developing countries will be aiming to become more engaged with global markets, by becoming a more attractive investment opportunity for companies and investors alike.

There are over 150 emerging markets according to the International Monetary Fund (IMF). However, the definition of what constitutes an emerging market is somewhat up for debate.

The four most well-known developing economies are: Brazil, Russia, India and China. Although these are some of the largest countries in the world by GDP, the living standards within each economy are so varied that they’re often considered emerging markets. For example, China has the second largest GDP in the world but its GDP per capita puts it at 79th, and India ranks fifth by GDP but its GDP per capita has it at 122nd.

The characteristics of an emerging market economy

While each emerging market is different, there are few common denominators:

  • A negative relationship to the US dollar
  • A low income per capita
  • High growth potential
  • Market volatility

Emerging markets and the US dollar

Exchange rate fluctuations against the US dollar are an important factor shaping the outlook in emerging market economies, as much of their credit, trade, and debt is priced in dollars.

Typically, when the US dollar rises in value, emerging market currencies decline in value as their exports become less competitive and foreign investors go into a ‘risk-off’ state. A weak dollar on the other hand tends to boost emerging market currencies, giving them more freedom to adjust their fiscal policies.

Steep swings in exchange rates in emerging markets are often linked to capital outflows, tighter financing conditions and increased financial instability. However, the drivers of those moves are difficult to unravel, as global and national forces jointly determine the relative strengths of these currencies.

  • Emerging markets and income per capita

Emerging markets have lower-than-average per capita income. As the government pursues industrialization and manufacturing activities, it’s hoped that the per capita income will increase with GDP. But as we’ve already seen for countries like China and India, this isn’t always the case. In a lot of emerging markets, the wealth disparity between the rich and the poor widens as the country grows.

This leads us to a common denominator of low income per capita, which is political instability. Overcoming this problem is one of the biggest challenges for an emerging economy.

Growth potential of emerging markets

The great growth potential of an emerging market economy is usually based on progressive industrialization. In general, average growth will continue to be higher than in most developed markets. This is because the governments in emerging markets tend to implement policies that favor industrialization and rapid economic growth. These policies lead to lower unemployment and better infrastructure.

This growth requires a lot of investment capital, but markets are less mature in these countries than they are in developed markets. This is why in the transition from an agriculture-based economy to a developed economy, countries often require a large inflow of capital from foreign sources due to a shortage of domestic capital.

Countries with a higher rate of industrialization are more attractive to foreign investors due to the high return on investment they can offer.

Market volatility in emerging markets

The monetary policies in a lot of emerging market economies will make them vulnerable to volatility because they lack liquidity in their assets, causing slowdowns and sudden changes that can discourage investments. The volatility exposes investors to the risk of fluctuations in exchange rates, as well as poor market performance.

Volatility can be caused by a range of factors, such as political instability and supply and demand shocks due to natural calamities. When emerging market leaders undertake the changes necessary for industrialization, different sectors of the population suffer, such as farmers. Over time, this could lead to social unrest, rebellions, and regime changes. Investors could lose everything if industries are nationalized or the government defaults on its debt.

The currencies of emerging markets are more susceptible to volatile exchange rate fluctuations. A clear example is that of the Argentine peso, which has been devalued against the US dollar at values ​​higher than the country's inflation itself.

Emerging market currencies are also vulnerable to changes in commodities, such as oil or food stuffs. That's because the countries don't have enough power to influence these movements. For example, when the United States subsidized corn ethanol production in 2008, it sent oil and food prices skyrocketing. That sparked food riots in many emerging market countries.

What are the advantages of investing in emerging markets?

It is important that we ask ourselves the following question: why focus on emerging markets assets?

One of the main advantages is possible growth. The national companies, and foreign firms that take advantage of the landscape, will likely see gains as the company becomes more established. And as the economy stabilizes and grows, the national currency will also strengthen.

International positions can be a good diversifier for your trading account or investment portfolio, as economic downturns in one country or region, including the US, can be offset by growth in another.

It’s important to remember, that when you trade with CFDs, you’ll be able to speculate on whether emerging market currencies are going to rise or fall. So, you can take advantage of the growth, and any volatility, that comes each country’s way.

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What are the risks of investing in emerging markets?

While emerging markets offer exciting opportunities, it is important to be aware of the different risk factors too. These include:

  • Political risk: Emerging markets can have unstable, even volatile governments. Political unrest can have serious consequences for the economy and investors
  • Economic risk: These markets can often suffer from insufficient labor and raw materials, high inflation or deflation, unregulated markets, and weak monetary policies. All these factors can present challenges for investors
  • Currency risk: The value of emerging market currencies compared to the dollar can be extremely volatile. Any profit can potentially be diminished if a currency devalues ​​or falls significantly

List of emerging markets

Here’s the total list of emerging markets as set out in the International Monetary Fund World Outlook 2021.

Emerging markets by region

Asia

Bangladesh

Bhutan

Brunei Darussalam

Cambodia

China

Fiji

India

Indonesia

Kiribati

Lao PDR

Malaysia

Maldives

Marshall Islands

Micronesia

Mongolia

Myanmar

Nauru

Nepal

Palau

Papua New Guinea

Philippines

Samoa

Solomon Islands

Sri Lanka

Thailand

Timor-Leste

Tonga

Tuvalu

Vanuatu

Vietnam

Europe

  1.  

Albania

Belarus

Bosnia and Herzegovina

Bulgaria

Croatia

Hungary

Kosovo

Moldova

Montenegro

North Macedonia

Poland

Romania

Russia

Serbia

Turkey

Ukraine

Latin America and the Caribbean

  1.  

Antigua and Barbuda

Argentina

Aruba

The Bahamas

Barbados

Belize

Bolivia

Brazil

Chile

Colombia

Costa Rica

Dominica

Dominican Republic

Ecuador

El Salvador

Grenada

Guatemala

Guyana

Haiti

Honduras

Jamaica

Mexico

Nicaragua

Panama

Paraguay

Peru

St. Kitts and Nevis

St. Lucia

St. Vincent and the Grenadines

Suriname

Trinidad and Tobago

Uruguay

Venezuela

Middle East and Central Asia

  1.  

Afghanistan

Algeria

Armenia

Azerbaijan

Bahrain

Djibouti

Egypt

Georgia

Iran

Iraq

Jordan

Kazakhstan

Kuwait

Kyrgyz Republic

Lebanon

Libya

Mauritania

Morocco

Oman

Pakistan

Qatar

Saudi Arabia

Somalia

Sudan

Syria

Tajikistan

Tunisia

Turkmenistan

United Arab Emirates

Uzbekistan

West Bank and Gaza

Yemen

Sub-Saharan Africa

Angola

Benin

Botswana

Burkina Faso

Burundi

Cabo Verde

Cameroon

Central African Republic

Chad

Comoros

Democratic Republic of Congo

Republic of Congo

Cote d'Ivoire

Equatorial Guinea

Eritrea

Eswatini

Ethiopia

Gabon

The Gambia

  1.  

Ghana

Guinea

Guinea-Bissau

Kenya

Lesotho

Liberia

Madagascar

Malawi

Mali

Mauritius

Mozambique

Namibia

Niger

Nigeria

Rwanda

Sao Tome and Principe

Senegal

Seychelles

Sierra Leone

South Africa

South Sudan

Tanzania

Togo

Uganda

Zambia

Zimbabwe



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