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What is an Emerging Market Economy (EME)?

An Emerging Market Economy (EME) is defined as an economy with low to medium per capita income. It is a nation whose economy mimics that of a developed nation but does not fully meet the requirements to be classified as such.

The term emerging markets was coined in 1981 by Antoine W. Van Agtmael of the International Finance Corporation of the World Bank.

Key points to remember

  • An Emerging Market Economy (EME) is a nation with a low to medium per capita income economy that is growing or once was.
  • Emerging market economies are moving from a closed market system to an open market system while developing economic reform programs.
  • EMEs realize increases in local and foreign investment.
  • Emerging market economies carry great risk for investors as they are not yet stable or proven.

Understanding Emerging Market Economies (EME)

Although the term “emerging market” is loosely defined, countries of varying sizes that fall into this category are generally considered emerging because of their developments and reforms. Therefore, even though China is considered one of the world’s economic powers, it is lumped into this category alongside much smaller economies with fewer resources, such as Chile.

China and Chile both fall into this category because they embarked on economic development and reform programs and began to open their markets and “emerge” on the world stage. EMEs are considered to be fast growing economies. Morgan Stanley Capital International (MSCI) publishes a market classification annually that includes developed markets, emerging markets and frontier markets.

EMEs are referred to as transitional, which means that they are moving from a closed economy to an open market economy while increasing accountability within the system. Examples include the former Soviet Union and the Eastern Bloc countries.

As an emerging market, a country embarks on an economic reform program that will lead it to stronger and more accountable levels of economic performance, as well as transparency and efficiency in the capital market.

An EME will also reform its exchange rate system as a stable local currency builds confidence in an economy, especially when foreigners plan to invest. Exchange rate reforms also reduce the desire of local investors to send their capital abroad (capital flight). In addition to implementing reforms, an EME is also very likely to receive assistance and advice from large donor countries and / or global organizations, such as the World Bank and the International Monetary Fund (IMF).

Characteristics of an emerging market economy

A key feature of EME is an increase in local and foreign investment (portfolio and direct). The growth of investments in a country often indicates that the country has increased confidence in the local economy.

Additionally, foreign investment is a signal that the world has taken notice of the emerging market, and when international capital flows are directed to an EME, the injection of foreign currency into the local economy adds volume to the stock market. country and long-term investment. to infrastructure.

For foreign investors or companies in developed economies, an EME offers an outlet for expansion by serving, for example, as a new location for a new factory or new sources of income. For the beneficiary country, employment levels increase, manpower and managerial skills are refined, and technology sharing and transfer occurs.

In the long run, global EME production levels are expected to increase, increasing its gross domestic product (GDP) and ultimately narrowing the gap between emerging and emerging worlds.

Portfolio investment and risks

Because their markets are in transition and therefore unstable, emerging markets provide an opportunity for investors looking to add risk to their portfolios. The possibility for some economies to fall back into an unresolved civil war or a revolution triggering a change of government could lead to a return to nationalization, expropriation and the collapse of the capital market.

Since the risk of investing in EMEs is higher than investing in a developed market, panic, speculation and gut reactions are also more common. The Asian crisis of 1997, when international portfolio flows to these countries began to reverse, is a good example of how EMEs can be high risk investment opportunities.

However, the greater the risk, the greater the reward. Investments in emerging markets have thus become common practice among investors who wish to diversify while increasing risk.

Local politics vs global economy

An emerging market economy must take into account local political and social factors as it attempts to open its economy to the world. Residents of an emerging market, used to being protected from the outside world, can often be wary of foreign investment. Emerging economies can also often face issues of national pride, as citizens may be against outsiders owning a part of the local economy.

Moreover, opening up an emerging economy means that it will also be exposed not only to new ethics and labor standards, but also to new cultures. The introduction and impact, for example, of fast food restaurants and music videos in some local markets has been a by-product of foreign investment. Over generations, it can change the very fabric of a society, and if a population is not completely confident in the change, they can fight back fiercely to stop it.

The bottom line

While emerging economies may hope for better opportunities and offer new areas of investment for foreign and developed economies, local EME officials need to consider the effects of an open economy on citizens.

In addition, investors should consider the risks when considering investing in an EME. The emergence process can be difficult, slow and often stagnant. And while emerging markets have survived global and local challenges in the past, they have had to overcome significant hurdles to get there.