Emerging markets can tend to get ahead of themselves and overheat for many reasons, but are still showing fundamental growth, Frederic Sicre, Executive Director, Abraaj Capital, tells Financial Review
The rise of emerging markets is one of the key themes resonating through the global economy, much like the advent of high-tech during the 90s. So are they the next bubble story, or a comparatively safe haven in troubled times for developed-country finance?
Do you see the profile of emerging markets finally breaking through on the global investment stage?
In the absence of a crystal ball, one thing is for sure, emerging markets are on the global investment stage like never before, both in terms of FDI flows into their own economies but also in some cases in terms of the dollar spend they are undertaking outside their own markets such as the Chinese or the GCC states.
We are living through a paradigm shift which has been driven by developing markets working towards establishing sound macro-economic fundamentals, understanding the importance of new technologies and improving business environments through economic and social reforms.
How significant are these markets in terms of their contribution to global growth?
Global growth over 2006 and 2007 has been around 4.5 per cent. According to the IMF, 50 per cent of global growth in 2006 was due to India, Russia and China , the latter growing at 11.5 per cent in the first half of 2007.
Whereas Western economies grapple with structural challenges and ageing populations who are increasingly weary and seeing jobs being exported outside their borders, emerging markets are creating new conditions for their predominantly young populations, who are demanding more globalisation rather than less, while the growing middle classes see their spending power on the increase.
Economic growth has definitely slowed in Europe and Japan, and the credit crunch in the USA will certainly impact growth there to under two per cent in 2008, according to the IMF.
So, take your pick: Africa at five per cent (witness the recent $5 billion investment by China into South Africa's Standard Bank, the largest foreign investment the continent has ever seen), China at 11.5 per cent, the GCC hovering between 9 per cent and 11 per cent.
Investors simply will not ignore those numbers, just as they will not ignore large existing markets such as the USA or Europe. It's all about allocation strategies, and diversifying portfolios based on risk and return ratios.
What are some of the drivers behind the attractiveness of these markets? What is going to sustain them?
Major emerging equity markets have risen 366 per cent on average over the past four years, and the foreign currency reserves of emerging markets have more than tripled to $3,000 billion according to Prannoy Roy, the President of New Delhi Television.
Speaking in Davos earlier this year he mentioned that equity market capitalisation in the developing world stood at 20 per cent of GDP versus 70 per cent in the developed world, demonstrating the potential room for continued growth.
I would like to think that one of the drivers behind emerging market attractiveness is the gradual decrease of the risk premium, which investors pay close attention to.
Emerging markets are learning from their mistakes of the past, and a new generation of leaders in business and governments are undertaking and pushing for reforms to improve the investment climate.
As reforms are pursued by policymakers, global and emerging market business leaders are extending their hands.
According to the World Bank, 200 reforms were recorded over the last year in 98 countries. A recent survey studying the ease of doing business in countries around the world concluded that in 2007 Eastern Europe and the former Soviet Union came on top of East Asia in terms of creating a business-friendly environment.
In fact, many of these countries ranked above Western European economies in this respect. This same survey ranked Egypt as the top reformer in the world for 2006/2007, which has resulted in a sharp increase of foreign and domestic investments there.
The same source awards Saudi Arabia with the prize for having enacted the boldest reform by having eliminated the minimum capital requirement needed to set up a business ($125,000) which was the fifth highest in the world.
This highlights a key objective for emerging markets wishing to create a sustainable growth path moving forward. High prices of commodities, currently fuelling a substantial amount of growth, will not last forever.
Emerging economies need to ensure that growth is not overreliant on export growth. Dubai is a prime example of success in this area, as oil revenues account for only five per cent of its GDP.
Colombia is another interesting example, where GDP growth is expected to reach eight per cent this year based on a new surge in manufacturing in the country and a fast-growing tourism sector.
Brazil is benefiting from a consumer-driven boom, with a 16 per cent consumption growth rate. Thirty IPOs have been announced, and the Sao Paulo stock exchange sees $14 billion traded daily, placing it third after Shanghai and Hong Kong.
If growth in emerging markets is sustained, we will continue to see a rise in the spending power of consumers, and middle classes will continue to grow. Domestic consumption provides a sustainable base for growth, and gives added protection to external shocks.
At Abraaj Capital, our region is Middle East North Africa South Asia (MENASA), which has a population of 1.8 billion people. It has vast potential on our investment map, a market larger than the USA, Europe - larger than China!
Are there any particular sectors or other countries to mention in respect of your optimism?
Investing in education, liberalising economies, privatising state assets, implementing technology platforms, and focusing on healthcare services are all areas which most emerging markets are engaging in.
A quick snapshot at healthcare provides yet another reason why developing countries are increasingly being looked at by foreign and national investors.
Developing countries account for 84 per cent of global population, 90 per cent of global disease burden, 20 per cent of global GDP but only 12 per cent of global healthcare spending.
As lifestyles improve and emerging market populations live longer, the upside for healthcare providers remains very attractive. We should share reasonable optimism in terms of seeing the current growth trends in emerging markets as sustainable.
In Asia we are just starting to discover Vietnam, which is poised for phenomenal growth. In our region we are starting to discover Algeria, a nation five times the size of France with a $54 billion infrastructure expenditure program.
We are living through an exciting period, an era where new power centers are emerging which is leading to a shift of economic power from the developed world to the emerging world and new frontiers. The next question is: how will the West respond?
What kind of tension can you identify between the performance of emerging stock markets and that of the underlying economies themselves?
Emerging markets can tend to get ahead of themselves and overheat for many reasons, such as sudden changes in availability of liquid funds.
Look what's happening in India right now, where the inflow of foreign funds due to subprime crash in the West has caused a major surge in prices.
Sometimes it is due to 'irrational panic', as seen by the falling and then rising of the Indian market by 10 per cent two weeks ago on successive days with the news that the Indian government might like to impose some requirements for transparency and information on foreign banks and investors.
However, on most occasions these 'artificial' surges have been corrected in the past, as seen in the Middle East (two) years ago. Now we are at a point where the GCC markets are quite fairly priced relative to the growth potential.
One cannot deny that emerging markets tend to exhibit more volatility and sometimes liquidity issues for reasons such as lack of institutional research coverage or predominantly retail focus of the market, but if one looks over a longer period of time, the average valuation levels are in line with the fundamental growth experienced by these markets.
In the long run stock prices reflect underlying fundamentals, of which the most important is corporate profitability, and the fact of the moment is that an incredible fundamental growth is being experienced in these economies (India, China and Middle East), and that's where we as a PE fund see true value.
Let me also add that private equity can also be seen as a great hedge against public market volatility. Private equity investing is long-term, patient capital which is put to work over a period of years and as such can outlive temporary market outbursts or downturns.
Top-quartile private equity firms have consistently delivered returns over and above public markets.
Interview by Gaurav Ghose, Financial Reporter
