For decades, investors in advanced economies (AEs) have shaped the evolution of global markets. Research shows that advanced economy investors tend to hold diversified portfolios that include significant investments in equities. Over the past decade, these pools of wealth have been growing at a much slower rate than emerging economies (EMs). With their rapid growth, emerging market economies are becoming important factors that shape global financial systems. More important, the integration of emerging market economies into the global economy has a significant impact on international financial markets. This month, we take a look at just what that means and how global spillovers from these market economies can impact other countries.
According to the International Monetary Fund (IMF) and its Global Financial Stability Report (2016), the rising financial integration of emerging market economies has a growing impact on global markets.
“Over the past two decades, the share of emerging market economies in global output, trade, and financial systems has risen substantially. Emerging market economies have contributed more than half of global growth over the past 15 years, and the share in global GDP has risen to 38 percent.”
Moreover, the report finds that financial integration of EMs into the global economy is a key factor responsible for increasing financial impact on other countries. Also, this research finds that among the largest emerging market economies, China’s economic growth has a significant role and rising impact on global equity prices. The report states that two factors are driving the growth in financial “spillovers” to other countries. First, those emerging market economies with high debt levels and low liquidity are more susceptible to large spillovers. And, second emerging economies with large financial institutions tend to experience spillovers as well.
“Purely financial spillovers from China are still very small but likely to grow considerably as China gradually continues to integrate into the global financial system” stated Gaston Gelos head of the Global Financial Stability Analysis Division at the IMF.
Another factor impacting the nature and size of financial spillovers is the significant growth of mutual fund investing. In response to losses in other countries and high withdrawal rates by investors, mutual fund companies are selling investments in various countries which in effect is causing a certain degree of portfolio contamination. It appears that the equity markets are the ones hardest hit. There are also other factors reducing interests in equities particularly in AEs such as aging populations; shifts in types of retirement plans; alternative investment strategies; regulatory changes for financial institutions; low returns and high volatility. More important, over the next decade, these trends will create a growing “equity gap” between the type of equities investors prefer and what companies will need to fund growth. So, companies may have to resort to using more debt to finance growth.
Research also reveals that the financial assets of investors in EMs will rise from 21% to 36% of the global total by 2020. But, unlike AEs, the financial assets of these investors are in bank deposits. For these investors, the advantages of investing are doubtful because of the number of recent corporate scandals and the perception that markets may no longer serve the needs of private investors. Other factors influencing these trends include exchanges controlled by state-dominated companies that offer limited shares for public trading (exposing investors to high levels of volatility) and limited visibility or accountability to public shareholders. In a recent survey, investors in emerging Asian economies stated they prefer to keep their savings in deposits rather than mutual funds or equities.
As a result, the IMF report suggests that policymakers use due diligence to safeguard the financial stability of their own countries.
“The evidence underscores the need for policymakers to take into account economic and policy developments in emerging market economies when assessing their own countries’ prospects” stated Gelos.
The report also calls for enhanced international and “macroprudential” policy cooperation between countries. Further, the IMF recommends action that EMs should consider which include the development of domestic investor bases, timely communication of policy decisions, transparency, adopting measures to limit excessive increase in corporate debt, and improving data on cross-border financial flows for banks, investment funds and large institutional investors. IMF head Christine Lagarde stated at Goethe University in Frankfurt, Germany that “if policymakers can confront the challenges and act together, the positive effects on global confidence, and the global economy will be substantial.”
Roxburgh, C., Lund, S., Dobbs, R., Maniyka, J., and Wu, Haihao. (2011) The emerging equity gap: Growth and stability in the new investor landscape. Washington D.C., McKinsey Global Institute; Brainard, L., Martinez-Diaz, Leonardo, Eds. (2009) Brazil as an Economic Superpower? Understanding Brazil’s Changing Role in the Global Economy. Washington D.C., Brookings Institute. International Monetary Fund. (2016). Emerging Economies Affect Global Financial Changes. Global Financial Stability Report.