4 Factors Driving Emerging Market Performance

A junk (boat) in Victoria Harbour, Hong Kong, China

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Emerging markets are volatile, compared to developed markets such as the United States or Europe. Learning the four key factors that affect emerging markets can help you avoid poor choices. Not all risk can be forecast, but this knowledge can help predict the long-term movements of emerging markets relative to other asset classes.

Learn here about the four major factors that affect emerging market performance and what they mean for international investors.

Key Takeaways

  • Emerging markets often evolve from exporting to developed countries due to the demand for their cheaper labor and products.
  • Emerging markets may evolve from domestic demand due to a large population, then begin to export goods and services.
  • Emerging markets often use debt issued by developed market countries. This devalues their currency if the other country's rises in value.
  • Globally, many commodities come from emerging markets. Market swings in the importer countries affect the emerging market.

Developed Market Demand

Many emerging market countries make products and/or sell services to developed market economies. For instance, China makes all kinds of goods for the United States and Europe, while India is a leading exporter of information technology services. A downturn in developed economies can, therefore, hurt emerging markets that rely on demand to bolster their economic growth.

Many developed countries struggled to return to normal growth rates after the 2008 financial crisis. Yet, things have turned around globally since the pandemic. The Organisation for Economic Cooperation and Development (OECD) projects global nominal gross domestic product (GDP) will hover between 4% and 5% through 2023, up from a pre-pandemic 2.3% at the end of 2019.

Domestic Economy Performance

Many emerging market countries are driven by domestic demand rather than export demand. For example, exports (goods and services) to the United States accounted for just $87.4 billion of India’s $2.9 trillion (nominal) economy in 2019—or less than 1% of its total economic output. China’s $615.2 billion in exports (goods and services) to the U.S. accounted for less than 1% of its $14.1 trillion (nominal) economy in 2020. Domestic factors—such as consumption and politics—have big influences on these emerging markets.

Growth rates have generally stayed the same since 2011, demonstrating a continuance of emerging market performance.

Often, emerging market economies evolve from an export-driven economy to a domestic-focused economy. China’s transition took growth rates from more than 10% in 2010 to less than 3% by 2020. The upshot is that domestically powered economic growth is widely viewed as more stable than export-driven growth, since it doesn’t depend on external factors.

Currency Market Dynamics

Many emerging market countries have unstable local currencies. They must issue debt in dollar-denominated bonds. When the U.S. dollar value rises, these debts may become more costly to service for emerging markets that earn revenue in local currency. A higher dollar valuation also implies higher interest rates. This tends to draw capital away from emerging markets, making it cost more to raise future capital.

For example, the U.S. dollar has witnessed a long-term increase in purchasing power parity (PPP, measured in national currency per U.S. dollar ) in emerging markets (Brazil, Russia, India, and China). There has also been a decrease or flatline in developed markets (Germany, Canada, the UK, and Denmark) over the long run.

An increase in purchasing power parity makes it harder for emerging markets to raise funds via debt instruments. Their currency is losing buying power, compared to developed markets.

Commodity Performance

Many emerging market countries are net exporters of commodities. This makes them sensitive to changes in commodity prices. Russia, for instance, is a large exporter of natural gas to Europe. Brazil exports iron ore, soybeans, coffee, and crude oil to China and the United States. A downturn in these commodities could have a major impact on the revenue generated by state-owned and private enterprises in these countries.

Commodity prices were falling throughout much of the 2010s due to slower end-market demand. But the global economic recovery following the pandemic (coupled with persistent supply chain issues) is boosting demand and commodity prices.

The Bottom Line

Emerging markets are a great way to diversify any portfolio. Know the underlying drivers to improve your chances of success. Strong (though volatile) performance in the decade between 2010-2020 suggest those without emerging market holdings may want to add the asset class as these trends play out.

Article Sources

  1. Organisation for Economic Cooperation and Development. "Nominal GDP Forecast."

  2. Office of the United States Trade Representative. "India."

  3. Office of the United States Trade Representative. "The People's Republic of China."

  4. The World Bank. "GDP Growth (Annual %)- China."

  5. Organisation for Economic Cooperation and Development. "Purchasing Power Parities (PPP)."

  6. Reserve Bank of St. Louis. "Global Price Index of All Commodities (PALLFNFINDEXQ)."