Emerging Markets: Where Next For Economic Development, ESG and FDI? - Emerging Market Views

Emerging Markets: Where Next For Economic Development, ESG and FDI?

With a correction taking hold of financial markets that near bear territory, some form of global recession is seemingly all but on the immediate horizon. These market moves, coupled with the pressures affecting international trade, geopolitical volatility and domestic political unrest around the world, mean emerging markets (EM) face some tough times ahead.

Amongst this backdrop, foreign direct investment (FDI) and cross M&A deals have become economically more important for countries – not just EMs – to attract, they have also become, and will realistically continue to be so, more cautious processes for investors and businesses around the world to undertake, even if the desire to invest in EMs remains presently strong.

Yet this outlook could well change as economic sentiment erodes, and investors weigh up favorable foreign exchange dynamics such as US dollar and EM spreads, against the declining macroeconomic environment and the availability of qualified firms to buy because they are affected by worsening consumer outlooks.

Investors will also be aware that for all of the institutions, indices, and desire that exists to facilitate EM investment, there is far from a one-size-fits-all model used by EMs or their investment agencies to attract it – a blessing and a curse.

However, despite countries having attracted huge debt, equity and FDI investment over the past two decades, the experience of Singapore, Hong Kong, and the United Kingdom who increasingly face a variety of political, economic, trade and health-related threats, is not dissimilar EM positions. Additionally, both emerging and developed markets have arguably placed too much reliance on private market and infrastructure investment from businesses and sovereign wealth funds from China and GCC countries.

With markets having now turned, collapsing oil futures and oil prices – their biggest one-day fall since 1991 will compress oil revenues and have a double-sided effect. Namely, hugely limiting OPEC CapEx and increasing the importance of sovereign wealth fund returns from existing portfolio holdings to balance domestic spending desires and smooth out reductions in overall GDP growth resulting from the global bear market. Elsewhere, the fallout from Russia’s and Saudi Arabia’s disagreement at OPEC, and China’s lessened demand for oil, are further considerations.

What this really means though, is that few EM investments seem likely to be made by China (due to Covid-19 and demand declines) or GCC nations in the near term, so the importance of attracting private and institutional investments has therefore grown significantly as a consequence.

In addition, given the market volatility, EMs must, therefore, look beyond the likes of China, the GCC, and the private investors who reside in them. The same is true for the finance hubs of New York and London, because where do you go when doors close, quite literally, from a combination of COVID-19 and recession spreading into real markets.

At its core, emerging markets must find ways to position themselves for continuing economic development, FDI, and equity market investment in spite of the world’s new bear market, but doing so when a recent World Bank Report explains in great detail that the economic positions of EMs are weaker than they were pre-2008 across a variety of economic and financial indicators and with fewer levers to use, is particularly challenging.

Consequentially, in the wake of this bear market, EMs would benefit from establishing new approaches to working with key stakeholders: Investors, businesses, investment banks to address critical concerns–Robert Quartly-Janeiro

In liquid investments, it is perhaps timely that one consequence of the market downturn is how positions in equities and indices are being replaced by sell-and-run to safe-haven assets: hard currencies, gold, and bonds.

As a result, EM markets need to do some soul searching in order to answer a critical question going forward: whether future investments will be attracted because of investor sentiment and contrarianism, or because EM governments will be the ones to get investors over the line?

A Reality Check

Tellingly, it is arguably the case that few EMs have, since the Global Recession, truly developed successful FDI and investment promotion programs that attract tangible interest beyond a free lunch. Yes indices have raised money, and private equity funds and impact investors have played their part, but have EMs truly a) built trust between would-be investors and host nations that be nurtured over a long time frame, or b) focuses on economic development so that their reliance on countries like China for exports or the USA for debt finance in times of market correction is not such an issue.

Parallel to this, emerging markets such as India and Turkey are parting with millions for paid media adverts, and China’s Belt & Road develops entire sectors and cities. Yet it hasn’t been possible to escape or answer questions around the legitimacy of these actions, the economic dependency B&R is creating, and the credit risks that lurk in EMs. Elsewhere, where a once miracle 86 percent growth rate was envisaged in Guyana in 2020, that now looks greatly over-egged.

In many ways, Turkey is a useful if not unfortunate example because between an attempted coup, economic contraction, rising interest rates, and food costs, a falling lira, and geopolitical dimensions in Libya and Syria, the country’s perceived risks to travelers and investors play heavily on the opportunities that may exist.

Consequentially, in the wake of this bear market, EMs would benefit from establishing new approaches to working with key stakeholders: investors, businesses, investment banks to address critical concerns.

Sure enough, this bear market environment necessitates more adequate funding levels and strategy from EMs around investment attraction and investor relations. This will be vital in ensuring that EM giants and frontier market minnows can grow out of recessional head wides as they arrive or perhaps even increase levels of FDI as a result.

At practical levels, although it may sound obvious, that means clearly communicated materials, focused investment prospectuses, fully-costed investments, more detailed coverage on ESG & impact factors, and greater honesty on political risk factors, as just some metrics.

As underlying these actions is the financial bear market filters into the real economy – as it is already – the effects on consumer activities, pressures on earnings and debt serviceability mean that EMs ultimately face a perfect storm on debt, eroding corporate earnings, international sector sell-offs and, in relevant countries, a tourism black hole.

Economic Development And ESG

Brushing the gloom aside, optimism for emerging markets should not be lost by institutional investors, funds, and sophisticated investors willing to focus on transparency, feasibility, and investment realism in EM allocations, especially when concentrated across economic development and ESG focused investments.

Why? Because EM economic growth, once markets find their floor, should become a focus for investors that are seeking yields and ESG impact from their money – some 25 percent of all global private investment allocations, and rising.

What is more, EMs focusing or willing to focus their efforts on ESG and economic development will likely not only boost EM attractiveness but save time in due diligence and more accurately present investment proposals – bypassing ill-conceived and unfeasible vanity investment projects, to focus on where money will do the best, an issue discussed in detail by Farid Baddache in his article Using ESG Criteria for Investment Decisions in Emerging Economies.

Moreover, at a time when allocators are focused on responsible investment, ESG, and green finance bonds, EM and frontier markets are essential to well-balanced portfolio growth and positioning – particularly when advanced economies are stalling.

Consequentially, as yield-starved investors seek a winning cocktail of returns, impact and planetary good, EMs are uniquely placed to benefit from investors utilizing economic development and ESG to achieve this – Nigeria’s traffic system, sanitation, and water supply seem like good places to start – in private markets and public ones too.

Interestingly, the spread of ESG credentials across EM listed firms has perhaps been undervalued by investors who, as part of the market sell-off, have sought safety instead of sticking with EM indices and growing ESG credentials reflected in the MSCI EM Index.