Emerging Financial Markets

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Emerging Financial Markets
1. Growth and Prosperity
Prof. J.P. Mei
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• V-Violence
• AL- Incorrect Politically
• AC-Adults only, Very Challenging

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Historical Roulette

• 3000 BC, Kingdom of Egypt
• 2500 BC, The Greek Civilization
• 2000 BC, Shang Dynasty in China
• 500 BC, The Roman Empire
• Middle Ages China, Aztec in Mexico and
  the Incas of Peru
• 1500 AD, Spanish Adventurers
• 1700-1900 AD, British Empire
• 1900 AD - ?, The United States of America

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1. 3000 BC, Kingdom of Egypt
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4. 500 BC, The Roman Empire
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The Definition Of Emerging Markets

• The IFC Definition Income less than 9,000
• 21 GDP, 85 Population, 76 Area, And 11 Market
  Capitalization in the World (1995)
• Higher growth rates high mean returns in many
  countries
• Time Taken to Double Per capita Output (10 years
  but unstable)

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The Emerging Markets
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Annual Real GDP Growth1987-1996
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Average Annual Returns for theTwelve Years Ended
December 1998Source International Finance
Corporation. Returns include capital gains and
dividends.
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The Lucas Growth Model The Puzzles of Economics
Growth

• Why growths differ across countries? (India vs.
  China)
• Why growths do not always translate to stock
  (investment) returns? (Korea)
• Why capital flow is so small?

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Privatization and Incentives

• Studies have shown a high correlation between
  economic freedom and growth.
• Privatization of SOEs leads to great improvement
  in efficiency and profits.
• Low Tax Rates provide more incentives for
  entrepreneurs.
• Free trade and market opening allows
  multinationals to leverage their strength,
  outsourcing production, and expand their markets.

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Effective Corporate Tax RatesData Source
Goldman Sachs
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An Educated And Low Cost Labor Pool

• Low Literacy Rates Make Training Less Costly.
• Young and Energetic
• Cost Of Labor Is Low
• Technology Leap-frog Allows for Dramatic
  Improvement in Efficiency.

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Domestic Savings And Foreign Capital Flow (FDI)

• People are thrifty (high saving rates) in many
  markets. But high domestic savings can not fully
  cushion the flow of foreign capital.
• FDI flows have increased rapidly.
• Equity flows are rising but not steady.
• The composition of capital flows are more healthy
  (more private than public flows) but there is a
  problem of duration mismatch.

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Economic Impact On Developed Countries

• Raising demand of baby boomers in EM vs. falling
  demand in many western countries
• Rising demand for western technology
• Badly needed infrastructure projects create huge
  demand for capital and expertise.

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Comparison of Population GrowthData Source
United NationsOver the last five years, Japans
population grew only at a miniscule 0.2 a year.
In comparison, the population of other Asian
grew at much higher rates, with some growing at
over 2 a year.
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Annual GDP Growth Projection 2000-2025Data
Source Asias Bright Future (Steven Radlelet
and Jeffrey Sachs ), United Nations, and
Financial Times
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What can go wrong

• Paul Krugman Little TFP increase.
• Past Success has little persistence (Brazil
  Korea).
• Excessive public and private borrowing increase
  the risk of financial crisis.
• Currency instability resulted from week financial
  system.
• Overbuilding of production capacity leads to low
  returns. (Real estate speculation)
• Strong special interest groups can block badly
  needed reform.

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Will Asia Follow Japans Fate?

• Population growth create demand
• Still in catch-up mood
• Low taxes create strong incentive
• Valuation reasonable before the crash (The bubble
  was small)
• Weak currency boost competitiveness
• Good fiscal and monetary condition

• Weak legal institutions
• New development strategy
• Market panic
• US market crash

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Dramatic Improvement in Current Account

• Population growth create demand
• Still in catch-up mood
• Low taxes create strong incentive
• Small family business (except Korea)
• Valuation reasonable before the crash (The bubble
  was small)
• Weak currency boost competitiveness
• Good fiscal and monetary condition