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Emerging markets are economies of developing countries that are progressively becoming more integrated into the global markets. They constitute nations that are likely to become developed in the near future as well as those that were developed in the past.
Emerging markets generally display most (not all) of the characteristics of developed nations. They are essentially ‘nations on the move’, transitioning from low income and less developed, traditional economies to industrialised, modern economies capable of sustaining higher standards of living as well as mixed/free markets. Emerging markets generally feature high growth rates, but this rapid economic growth also comes with inherent risks.
The risks range from general volatility to socio-political instability. Nonetheless, emerging markets have played an important role in stimulating the global economy since the term was coined in the early 1980s. In fact, it is estimated that emerging markets constitute about 80% of the global economy. This is because large countries, such as China and India, are also referred to as emerging markets owing to their overreliance on exports as well as the availability of cheap labour.
The currency crisis of 1997 saw major steps taken by major financial institutions, such as the IMF (International Monetary Fund), to help emerging markets have more sophisticated economies and financial systems. During the turn of the millennium, the term BRICS has been used to refer to the biggest emerging markets that are set to have a significant influence on the global economy by 2050. BRICS represents the nations of Brazil, Russia, India, China, and South Africa.
Another term is the ‘N-11’ or ‘Next Eleven’, which constitutes nations such as Egypt, Iran, Bangladesh, Indonesia, Mexico, Turkey, Nigeria, Philippines, Pakistan, Vietnam, and South Korea.
There is also MINT, which refers to the nations of Mexico, Indonesia, Nigeria, and Turkey. These terms are usually coined to distinguish countries that share unique investment opportunities available to foreign investors.
The constitution of emerging markets is very controversial. There is no general consensus on absolute metrics that can be used to classify emerging markets. There are, however, at least 20 emerging markets in the world; with the IMF classifying 23 countries, the MSCI (Morgan Stanley Capital International) classifying 24 countries, and the Dow Jones classifying 22 countries. The metrics used to classify emerging markets include GDP per Capita, Macroeconomic and Political Stability, Investment Regulations, Business Opportunities, and Growth Rate.
Characteristics of Emerging Markets
Here are some of the characteristics of emerging market economies:
High Economic Growth Rates
Emerging markets typically see their economies grow by around 6% to 7% annually. It is not uncommon for the economies to even post double-digit growth rates. In contrast, developed countries typically post economic growth rates of below 3%. This means that the GDP growth rates of emerging markets will consistently outperform those of developed countries.
Immature Capital Markets
Emerging markets typically have liquid local equity and debt markets. However, unlike in developed nations, their capital markets are still immature such that it can be daunting to gain reliable and relevant information on companies trading on their exchanges. It can also be difficult to sell debt products such as bonds.
High Investment Potential
Emerging markets have high investment potential, with opportunities particularly attractive as the transition is made from closed economies that are predominantly mining and agriculture-based to more open economies that facilitate international trade. Compared to developed nations, emerging markets offer the potential for higher returns despite inherent risks.
Instability and Volatility
Emerging markets are characterised by instability and volatility. These nations are vulnerable to fluctuations in the values of commodities such as oil and food products as well as major currencies such as the US dollar (USD) and euro (EUR). Locally, they are also affected heavily by changes in inflation levels as well interest rates.
Main Emerging Markets Currencies
Here are examples of some of the most popular emerging market currencies:
- Brazilian Real (BRL)
The BRL is the official currency of Brazil and ranks as the 20th most traded currency in the global foreign exchange markets as of September 2021. The BRL was introduced in July 1994 as Brazil sought to address rampant hyperinflation in the country as well as to stabilise and grow its economy. The country has a well-diversified economy: it is a major exporter of hard and soft commodities and also boasts a booming services sector. In recent years, the USDBRL pair has oscillated between 3.00 and 6.00, with driving factors being commodity prices and political anxieties.
- Russian Ruble (RUB)
The RUB is the official currency of the Russian Federation and ranks as the 17th most traded currency in the global forex markets as of September 2021. The modern RUB was introduced in 1991 following the collapse of the Soviet Union. The Russian economy is massively dependent on the exportation of petroleum and natural gas products to mostly fellow members of the European Union. The RUB is very volatile and has even earned the title of ‘the most volatile currency in the world’. The USDRUB pair has oscillated between 55.00 and 80.00 in recent years, with oil price fluctuations and US sanctions responsible for its high volatility.
- Chinese Renminbi (CNH or CNY)
Often referred to as the ‘yuan’, the CNH is the official currency of the People’s Republic of China and ranks as the 8th most traded currency in the global forex markets as of September 2021. In nominal GDP terms, China is the second-largest economy in the world, behind only the USA. This makes the economy the most impactful emerging market, by far! The USDCNY* pair has traded between 6.0000 and 7.2000 in recent years, with the source of volatility being Chinese monetary policies as well as the international debt market.
- Indian Rupee (INR)
The INR is the official currency of the Republic of India and ranks as the 16th most traded currency in the global forex markets as of September 2021. The INR traces its roots to the 16th century, while the Indian economy has registered the fastest growth in the 21st century. India is predominantly a service-based economy, but also boasts robust agricultural and export sectors. The USDINR pair has traded between 60.00 and 80.00 in recent years, with volatility triggers being central bank interventions as well as changes in commodity prices.
How to Trade Emerging Markets Currencies
Emerging markets currencies have unique characteristics that as well come with unique opportunities and unique risks. Compared with currencies of developed markets, they are relatively illiquid, highly volatile, and trade at low volumes. They also feature wider spreads.
Here are some of the best strategies to take advantage of opportunities in the price action of emerging markets currencies:
Emerging markets’ currencies are sometimes influenced by commodity prices and monetary policies. Prolonged trends in the commodity markets combined with a pursued monetary stance (fundamental analysis) can inspire extended trends in emerging markets’ currencies. When trend trading, traders identify the prevailing trend and then take long or short trades depending on whether the market is bullish or bearish.
The inherent instability and volatility of emerging markets economies mean that prevailing market patterns can be distorted and open up money-spinning reversal opportunities. Breaching of support or resistance lines could be a source of lucrative breakout trading opportunities. With this strategy, the challenge is always filtering out valid and fake breakouts in the market.
Range trading can offer many opportunities when trading emerging markets’ currencies. For instance, China allows its currency to trade in a 2% moving range against a mid-point it sets daily. This fundamental information exposes great opportunities for range-bound plays in the market. The strategy would simply be to buy at or near defined support levels and to sell at or near defined resistance levels.
Emerging markets typically have higher interest rates compared with developed markets. This opens up carry trade opportunities where investors can borrow low-interest currencies so as purchase high-interest currencies. With this strategy, you get to earn the interest rate differential. In the leveraged forex market, the high-interest rate differential between emerging markets currencies and developed markets currencies can be very attractive.
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