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CHAPTER 4. Emerging Markets and Liquidity

We have reached a point in our narrative where we have introduced the role and activities of development banking, the fundamentals of discounting, and the fundamentals of credit. Before moving on to the topic of debt, we pause to discuss a topic that is important in a geographical and a conceptual way.

Emerging markets are not only important in being the geographical area where development banking plays its principal role, they are also a showcase of specific financial features that are not found elsewhere. We shall focus on these because each of them is, in a way, a manifestation of credit that is and remains our principal focus. We introduce the concept of liquidity, present the difference in trade maturities between developed and developing markets, discuss the explicit higher credit risk of emerging market entities; and finally, raise the specific topic of capital control.

We will conclude the chapter with an example of the involvement of development banks in emerging markets in terms of borrowing and lending, the latter with the help of a few realistic case studies.


Paraphrasing St. Augustine, we could say: what then are emerging markets? If no one asks me, I know what they are. If I wish to explain it to him who asks, I do not know. The term was coined by Antoine Van Agtmael, an economist at the World Bank, in the 1980s, and particularly in financial as opposed to economic terms, it should describe countries that are developed enough so as to have at least a rudimentary financial market.

An emerging market is developed enough, but it is still a long distance away from a fully developed economy. This entails many differences, which we will describe in detail throughout this chapter.

Many indices of emerging markets are published by, among others, Dow Jones, Standard and Poor's, and MSCI, but they do not all agree on its members. Trading desks at investment banks might include countries that appear nowhere on more official lists. For example, South Korea is on a recent MSCI list, Taiwan is on the FTSE, MS l, and Standard and Poor's lists, but Israel is not on any of those. However, on some trading desks Israel is considered an emerging market. They all have a similar GDP per capita. Portugal also has a similar GDP per capita but is not considered an emerging market (the fact that it has adopted the Euro complicates things as far as definitions are concerned but, as of 2011, Greece is considered by FTSE as an advanced emerging market).[1]

Before the beginning of the sovereign debt crisis in Europe we could have defined an emerging market, as opposed to a fully developed one, by answering the simple question: When things go bad do people look for safety in government debt? If the answer was yes, then the country was a developed one, otherwise it was an emerging market.[2] Events have caught up with this definition, making things more complicated: While we have seen Greece defined as an advanced emerging market (although it lacks the growth potential of proper emerging countries), it would be difficult to consider Italy or Spain (or even France, whose bond prices wobbled when fear took control of the markets) as emerging economies.

Emerging markets are particularly important for our discussion for two reasons, which we shall explore in detail in Section 4.3. They are important for any treasury operation because part of debt raising is finding new investors or offering new products to current investors: emerging markets are usually rich with cash that needs to be invested or are usually attractive, if risky, opportunities for investors in developed economies. They are important for development banking because, although possessing an embryonic financial market, this might not be sufficiently large for all the needs the country has. The government might still turn to a development institution, particularly to fund large projects.

Probably the best definition comes from observing one by one those characteristics of a financial market where the difference between an emerging market and a fully developed one are most striking. We shall treat them as issues in the sense that they might constitute a challenge to the practices we are used to.

  • [1] The case for Greece is a bit different, though. Even if we have not introduced the characteristics of emerging markets yet, it will not come as a surprise the fact that in general they are countries where investments are risky but potentially lucrative because of the vast reservoir of growth in the economy. To talk of Greece as possessing a vast reservoir of growth would be bringing denial to an unprecedented level.
  • [2] Since the question implies tradable debt, it excludes countries that have not even reached the minimum level of development needed to be considered as emerging.
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