The changing face of emerging markets

In many ways, emerging markets represent a different world than 10 or 20 years ago. In some respects, EM has become so differentiated, that the term “emerging market” can seem more akin to a benchmark classification rather than a common factor binding these markets. With EM’s evolution, investors should recognize the changing risk and reward dynamics that come with accelerated change and development. Understanding how these markets are evolving can be crucial to uncovering opportunities.

In this Insight, we explore:

  • How emerging markets have changed, looking at larger measures by decades
  • Key forces – the massive and growing EM population, a burgeoning middle class, and technological advances – that are transforming these markets
  • China’s influence on the EM environment and the impact of China A shares and trade tensions.

EM, then and now

In recent years, emerging economies have been important engines of economic growth globally. The economic rise of China in particular has been a major factor in reshaping markets worldwide and transforming the EM landscape in the last two decades. For some, China’s rapid rise has even called into question the status of China as an emerging market. (See below, “Is China even an emerging market anymore?”) The EM evolution is illustrated in this chart of gross domestic product (GDP) in purchasing power parity, with the largest seven economies changing roles, in some cases dramatically, over time.

EM has changed the global GDP map: GDP in $US billions of purchasing power parity

GDP in $US billions of purchasing power parity GDP 2017

Sources: International Monetary Fund (IMF) and UBS, as of 2018.

Chart shows the top seven economies in 2000, by GDP measured in $US billions of purchasing power parity, and how the list changed in 2017, with China having the largest economy by this measure. Purchasing power parity is a theoretical exchange rate that indicates how much goods and services would cost, if each country used US dollars, as a way to measure the size of economies.

Transformational forces

Of the many secular growth factors driving change in emerging markets, three have surfaced in recent years to become what we believe are truly transformational forces.

Population growth. Of the 7.5 billion people in the world, 6.4 billion – or 85% – are in EM and developing countries (source: IMF, 2017). This sheer size and scale represent great potential, which can easily be overlooked as EM is often typically less allocated in investor portfolios. However, the population in these markets may mean more than simply numbers of people. It has led, in many countries, to development of businesses and industries, better paid workers, and more demand for consumer products – in short, the development of a growing EM middle class that may increasingly dominate global consumption.

Top countries by population

  Country 2018 population Population growth rate World %
1 China 1,427,647,786 0.43% 18.59%
2 India 1,352,642,280 1.02% 17.71%
3 United States 327,096,265 0.60% 4.27%
4 Indonesia 267,670,543 1.10% 3.51%
5 Pakistan 212,228,286 2.04% 2.81%
6 Brazil 209,469,323 0.75% 2.74%
7 Nigeria 195,874,683 2.60% 2.61%
8 Bangladesh 161,376,708 1.03% 2.11%
9 Russia 145,734,038 0.09% 1.89%
10 Mexico 126,190,788 1.10% 1.65%

Source: United Nations, 2019.

Burgeoning middle class. Perhaps the biggest driving force we see transforming EM demographically has been the growth of the middle class. The Organisation for Economic Co-operation and Development (OECD) noted recently that by 2009, the global middle class comprised 1.8 billion people, with even some of the most underdeveloped areas exhibiting noticeable increased domestic consumption. The organization expects the global middle class to continue to expand, to 3.2 billion in 2020 and 4.9 billion by 2030. (Source: OECD, “An emerging middle class,” 2019.) As seen in the chart below, large gains are expected in key emerging market countries over the next decade, creating opportunities for businesses to tap into this growing consumer population (source: Brookings Institution).

A rapidly growing middle class: Middle-class growth as % of population

Middle-class growth as % of population graph

Source: Brookings Institution, as of 2017 (most recent available data).

Technological innovations. Wireless and Internet technologies have begun to ramp up in several EM countries. Some have made great progress and, as in the case of South Korea, have caught up and surpassed developed economies. It may be surprising to some that South Korea was the first country to launch the 5G broadband network as well as leading in a number of science and technology areas, evidenced by the country’s lead spot in the 2019 Bloomberg Innovation Index (source: Bloomberg). Conversely, in the chart below, we see how other major EM countries trail the US in Internet usage.

Devin Dougherty, product manager for Macquarie Investment Management, noted that “it’s understandable why investors are excited by US Internet companies. However, EM is arguably stronger in this area, with countries like Brazil perhaps just five or six years behind the US.” Meanwhile, China and India, with populations of 1.4 billion and 1.3 billion respectively, are just getting started and have room to run. (Source: World Bank.) These levels of technological innovations represent key areas of EM opportunity for investors.

Tech opportunities: % of population using the Internet

% of population using the Internet graph

Source: The World Bank, as of August 2019.

The China factor behind EM shifts

While secular forces affect a number of EM countries, perhaps no country is exhibiting more of an impact than China.

Economic growth continues to slow. China, the economic growth engine for the region for the last two decades, has been gradually cooling. China’s official statistics put the 2018 real GDP at 6.6%, the lowest rate since 1990 (source: CEIC). Consensus forecasts expect GDP growth between 6.0% and 6.2% in 2019 – still considered strong growth, both in absolute terms and compared with developed economies (source: McKinsey).

“There’s no question that China’s growth is slowing. The trick for them is making sure it doesn’t slow too fast,” Dougherty said. “China is trying to manage this through policy and stimulus efforts, but it’s a large ship that’s difficult to steer. It will likely take time for stimulus to flow through, given the lag effect.”

Another concern that the Chinese government has been trying to address to help further sustain the economy can be found in areas such as shadow banking and other lending practices. Even with attempts to control shadow banking (lending and other activities conducted by unregulated institutions, or unregulated off-balance-sheet operations by traditional banks), overall debt levels remain high. The broadest measure of new borrowing in China, known as Total Social Financing, was pegged at $1.2 trillion in the first quarter of 2019, and bank lending was at a record high $865 billion during the period (source: People’s Bank of China).

Moving to China 2.0. While slowing China economic growth and exports have been the narrative of headlines, the Chinese domestic consumer continues to show strength. As seen in the chart below, Chinese household spending has been keeping pace with the US over the last two decades – in fact, 76% of China’s 2018 GDP growth came from consumption (source: OECD).

China growth driven by household consumption

China Growth Graph

Source: World Bank, as of April 2019.

“What we’re seeing is a shift from the old China growth model, which was focused on areas like infrastructure and real estate, to a new, more consumer-driven model,” Dougherty said. This has been supported by wage growth combined with a change in buying behavior, with Chinese consumers more willing to spend. The result, he said, is creating significant potential opportunities for consumer-oriented companies.

Another notable shift is China’s emphasis on higher-skilled areas of manufacturing, which can also help the Chinese economy overcome the often-discussed “middle-income trap.” This is an economic phenomenon often seen in developing nations, where the trajectory of economic growth plateaus once wages rise. Avoiding the middle-income trap is part of China’s economic vision plans such as Made in China 2025, which is a plan to shift the economy away from low value-added, low-wage industries such as textiles, and move to advanced technology and other higher-skilled industries. China’s methodical planning appears intended to avoid situations such as the middle-income trap, but it remains to be seen how it plays out.

More to the China trade story?

It is not only large secular forces causing the face of EM to change significantly. EM also has been affected by current events – such as the trade tensions between China and the US. We’re seeing effects of the trade war on EM countries in the region. For example, growing numbers of companies are considering relocation of manufacturing operations from China, often to southeast Asian countries. (Source: American Chambers of Commerce, China and Shanghai, 2019 survey showing 40% of 250 companies are considering or already relocated Chinese production.) More than 50 multinational companies including Apple are also reportedly moving operations out of China, and even some Chinese companies are moving manufacturing to countries such as Vietnam and Thailand (source: Nikkei Asian Review, July 2019).

While the swirl around the trade war continues, exports have developed, ironically, into less of a driver of the Chinese economy. Household consumption is playing a larger part as seen in the chart above on China growth.

“China has been trying to rebalance its economy from a predominantly export base to a more domestically focused economy,” said Gabriel Wallach, portfolio manager with the Macquarie Global ex-US Equity team. About 20% of China’s GDP comes from exports – and 19% of total exports are to the US – but exports have dropped to 2000 levels (source: World Bank). The chart below, based on IMF data, shows China’s net trade reverting back to the mean.

China’s net trade as % of GDP

China net trade as % of GDP graph

Source: IMF, as of August 2019.

Instead, there’s evidence that domestic consumption is having more of an impact on China’s economy than before. The annual growth of Chinese private consumption during the 2000s outstripped developed markets, as this chart shows.

Domestic consumption annual growth rate, 2000–2018

Annual growth of private consumption, 2000-2018 chart

Source: IHS Markit.

With China’s growing middle class and urban consumers, discretionary income – income spent on travel, education, healthcare, and other areas – has been rising. According to government data, China’s per capita disposable income in 2018 was up 6.5%. However, this was off the 2017 pace of a 7.3% increase in disposable income. (Source: China NBS.) “With the economy slowing, Beijing appears to be turning to the country’s consumer base to cushion that downturn,” Wallach said. “But some may be tightening their belts a bit, and perhaps buying fewer cars and electronics.”

The trend away from exports and the growing number of middle class more inclined to travel may potentially lead to deficits and the prospect of China competing for foreign capital inflows the way it has done for global trade. Despite some US perceptions, China is no longer a nation that sells abroad but buys little in return – exemplified by the more than 160 million Chinese visiting foreign countries in 2018, and spending $237 billion on those trips (source: Bloomberg). This led to a drop in China’s current account balance, with the current account surplus shrinking in 2018 to just 0.4% of its GDP (source: Bloomberg).

What kind of impact would all of this have on other EM economies? “Emerging markets are hoping that China’s rising tide will continue to lift all boats, but that remains to be seen,” Wallach said.

Is China even an emerging market anymore?

With the impact of its economic engine in recent decades, China can seem on the surface to be “outgrowing” its emerging market status. Other emerging market countries, often riding China’s economic coattails, may appear overpowered by China’s importance, just as developed economies have been influenced by the post-war economic leadership of the US.

Yet in certain key measures considered indicative of EM economies, China still qualifies. One of those measures is GDP per capita, and China’s GDP per capita is relatively low at $US8,827, slightly below Brazil’s $US9,821, and above Vietnam’s $US2,343 (source: World Bank, 2017). Also, as noted, China’s GDP growth rate for 2018 was 6.6% (source: China National Bureau of Statistics). While that was China’s slowest pace since 1990, it still was seen as a significantly higher rate than developed countries. By comparison, US GDP growth increased at an annual rate of 3.1% in the first quarter of 2019 (source: US Bureau of Economic Analysis).

It’s worth noting that the major EM index providers, MSCI and FTSE Russell, still officially consider China as an emerging market.

A shares help to broaden Chinese investment

China already makes up approximately a third of the EM indices. We are seeing this weighting increase with the inclusion of mainland China stocks, known as “China A shares,” in both the FTSE Russell and MSCI indices. These mainland China equities trade on the two China stock exchanges, the Shanghai and Shenzhen stock exchanges. Previously, these companies were only available to mainland Chinese citizens due to tight restrictions on foreign investment.

MSCI, in addition to beginning to add these shares to its indices in 2019, has started taking steps this year to increase the weight of China A shares, by increasing the inclusion factor for mid- and large-cap stocks from 5% of total market capitalization to 20%. In the MSCI Emerging Markets Index, the weight of China A shares would go up to 3.3% by the end of 2019. With this action and with A shares added to the FTSE Emerging Index, global asset managers who are linked to these indices may need to purchase shares of Chinese companies to match the changing index. While it may be a difference of a few percentage points, the result may help further shift the balance of investing for emerging markets. (Sources: MSCI, Wall Street Journal.)

With the dynamism of EM comes volatility – and optimism

Because emerging markets are dynamic, so can be the performance of EM equities. Their historical volatility can lead investors to discount the asset class as risky and to avoid including in their portfolios. However, this view may overlook the opportunities of EM and its historical capacity to outperform over longer periods. The shift in EM equity performance from the first decade of the 2000s, compared with the last nine years, shown in the table below, illustrates how EM can differ from world stock and from the S&P 500® Index. An investment portfolio that did not include EM equity exposure over these periods would have missed this performance.

EM equity performance shifts over time

Index Average returns in 2000s: Jan. 1, 2000, to Dec. 31, 2009 Average returns in 2010s: Jan. 1, 2010, to June 30, 2019
MSCI Emerging Markets Index 10.11% 3.49%
S&P 500® Index -0.95% 13.08%
MSCI World Index (net return) -0.24% 8.98%

Sources: MSCI and FactSet. Returns calculated in US dollars.

The emerging markets picture continues to evolve. But with longer-term social aspects affecting EM economies, such as the consumer purchasing power of a growing middle class, it’s easy to see why many EM investors see the possibilities and are optimistic about this asset class. Those investors willing to take a measured, strategic approach may see continued potential opportunities in emerging markets, viewing EM as driven by significant economic and social forces.


Investing involves risk, including the possible loss of principal.

The views expressed represent the investment team’s assessment of the market environment as of October 2019, and should not be considered a recommendation to buy, hold, or sell any security, and should not be relied on as research or investment advice. Views are subject to change without notice.

Past performance does not guarantee future results.

Diversification may not protect against market risk.

International investments entail risks including fluctuation in currency values, differences in accounting principles, or economic or political instability in other nations.

Investing in emerging markets can be riskier than investing in established foreign markets due to increased volatility and lower trading volume.

The MSCI Emerging Markets Index represents large- and mid-cap stocks across emerging market countries worldwide. The index covers approximately 85% of the free float-adjusted market capitalization in each country. Index “net” return approximates the minimum possible dividend reinvestment, after deduction of withholding tax at the highest possible rate.

FTSE Emerging Markets indices are part of the FTSE Global Equity Index Series, which includes large- and mid-cap securities from advanced and secondary emerging markets. The FTSE Emerging Index provides a means of measuring the performance of the most liquid companies in the emerging markets.

The S&P 500 Index measures the performance of 500 mostly large-cap stocks weighted by market value, and is often used to represent performance of the US stock market.

The MSCI World Index represents large- and mid-cap stocks across 23 developed market countries worldwide. The index covers approximately 85% of the free float-adjusted market capitalization in each country. Index “gross” return approximates the maximum possible dividend reinvestment. Index “net” return approximates the minimum possible dividend reinvestment, after deduction of withholding tax at the highest possible rate.

Indices are unmanaged, and one cannot invest directly in an index.

The Bloomberg Innovation Index is a measure of the top 60 most innovative economies as determined by Bloomberg, with the measure tending to focus on the value added by manufacturing. The 2019 Innovation Index listed South Korea as most innovative for the sixth straight year.

All charts are for illustrative purposes only. Charts have been prepared by Macquarie unless otherwise noted.

All third-party marks cited are the property of their respective owners.

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