Foreign Investment

Overseas Investment in Emerging Markets

Overseas Investment in Emerging Markets

Investors are constantly looking for possibilities to invest in an opportunity that gives them a sizable return on their money. Because they have the potential to generate significant profits, emerging markets might be appealing investment opportunities. In making overseas investment decisions, it’s essential to be aware of the numerous advantages and hazards of investing in an emerging market.

From a business standpoint, economies that frequently go unnoticed might be the most rewarding. Emerging markets typically experience lesser levels of economic success and peace, and as a result, investors pay them less attention globally. According to the World Bank[1], returns on investments are higher in nations with lower levels of investment than those with higher ones.

Overseas Investment in Emerging Market

The investment made by individuals, firms, or institutional investors from one country into financial markets or businesses of emerging market economies is referred to as an overseas investment in emerging markets. Countries with developing or transitioning economies that have growth potential and attractive investment prospects are considered emerging markets.

Overseas investment is a crucial component of emerging markets for development. It can help recover from the institutional, economic, and infrastructure destruction that many low-peace nations endure during and after conflict.

The local workforce can be elevated and empowered for long-term economic success through the acquisition of new skills, exposure to new technology, and exposure to management competence. The rising market is propelled towards independence and ambitious economic activity by capital infusion, a growing tax base, and integration with the global economy.

Emerging Market Economies

Emerging markets are those that are only starting to create a stable political environment that fosters the expansion of businesses. The majority of developing markets are characterised by rising GDPs and a young, growing labour population. With emerging markets, investors might benefit from higher returns by accepting greater volatility. However, by adequately allocating assets, this volatility can be reduced.

Understanding Emerging Markets

According to the International Monetary Fund (IMF), emerging markets and developing economies account for about 80% of global economic growth, nearly doubling their proportion from two decades ago. They also represent more than twice as much consumption growth as they did in the 1990s. Emerging markets don’t have a single definition, but they’re typically described as having:

  • Unstable Marketplaces: Compared to developed markets, emerging countries typically see more boom-and-bust business cycles, partly because these economies primarily depend on the export of commodities, which have their own cycles.
  • Increased Investment and Growth Potential: Emerging markets enjoy a competitive edge as suppliers of inexpensive raw materials to richer countries. To draw in foreign investment, many have enacted policies that are beneficial to the market.
  • More Economic Expansion: As they transition away from being exporters of primary raw materials, the governments of several of these nations promote industrialisation. Compared to industrialised economies, they frequently have younger populations, and public and private expenditures in infrastructure, education, and technology can support economic growth.
  • Growth Component: Strong growth tends to be a feature of emerging markets. Therefore, investors should expect larger returns from these assets than developed markets during rapid economic expansion. 
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Benefits of Investing In Emerging Markets

Investing in emerging markets has a variety of advantages for investors. The considerable potential for growth in an emerging economy is one of the main benefits. It may eventually result in investors seeing a sizable return on their investment. The benefits of investing in an emerging economy can outweigh the dangers when caution is exercised. The economies that are expanding the fastest will have the most growth and the highest-returning stocks despite their volatility. Limiting yourself to sensible risks is the key to incorporating growth from emerging markets into your investment portfolio. 

  • Diversification – Diversification of a portfolio is another significant advantage. International investors can take advantage of this since it means that if one country or region experiences an economic slump, it can be compensated by expansion in an emerging market. Compared to investing in more developed economies, stock investing in developing economies is anticipated to offer greater growth and greater profits.
  • Geographical Expansion – The performance of the Indian markets has an impact on the returns on an investor’s portfolio that includes Indian stocks. However, including exposure to these funds broadens the investor’s portfolio’s geographic diversification. Additionally, it enables investors to profit from the economic cycles of developing nations.  
  • Professional Management – A fund manager can invest an investor’s money wisely with the aid of precise data, technical know-how, and international investing experience. Any new investor can use an emerging market fund to take advantage of this opportunity in emerging markets.

Risk and Challenges of Investing in Emerging Markets

Although overseas investment in emerging markets might present appealing development potential, it also carries particular dangers and difficulties. Before making an investment, investors must carefully weigh these variables. The following are some significant dangers and difficulties connected with investing in emerging markets:

  • Risk of Foreign Exchange – Bonds and stock purchases made abroad often results in local currency returns. Investors will thus need to exchange this local cash back for their own currency. Therefore, changes in the exchange rate could affect the investment’s overall return.
  • Lack of Liquidity – Markets in emerging countries tend to be less liquid than those in developed markets. Higher broker costs and more pricing unpredictability are the results of this market flaw. Investors who attempt to sell stocks in a market with little liquidity run a significant risk of having their orders not filled at the present price and having their transactions only complete at a disadvantageous level.
    Brokers will also demand more commissions because finding counterparties for deals require more work on their part. Investors are unable to benefit from quick transactions in illiquid markets.
  • Difficulty in Obtaining Capital – Businesses won’t be able to acquire the capital they need to expand if the banking system isn’t well developed. The weighted average cost of capital (WACC) for the business will typically increase as a result of the high necessary rate of return on acquired capital.
    Fewer initiatives will give a high enough return to produce a positive net present value when the WACC is high. Because of this, businesses in developed countries are not able to engage in a wider range of profitable ventures.
  • Poor Corporate Governance – Positive stock returns are associated with any organisation’s having a strong corporate governance system. In some cases, weaker corporate governance structures exist in emerging economies, giving management or even the government a stronger influence in the company than shareholders.
  • Chances of Bankruptcy: The likelihood of business insolvency is increased by insufficient accounting audit procedures and a weak system of checks and balances. Of course, every economy faces the possibility of bankruptcy, but these dangers are more prevalent outside of the industrialised world. Businesses in emerging markets have more freedom to falsify financial records to provide a more expansive view of prosperity. Once the company is revealed, its value suddenly declines.
    Emerging markets are required to issue bonds that pay higher interest rates since they are thought to be riskier. The likelihood of bankruptcy is strengthened, and the rising debt burden further raises borrowing rates.
  • Political Danger: Political risk is the unpredictability of unfavourable government choices and actions. While enterprises in emerging markets are frequently privatised on demand, developed countries typically adhere to a free market discipline of little government intervention.
    Political risk is further influenced by the likelihood of war, tax rises, subsidy losses, market policy changes, incapacity to control inflation, and regulations governing resource extraction. Civil war and the shutdown of an industry can also come from severe political instability when workers either refuse or are unable to perform their duties.
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Conclusion

An investor’s portfolio can earn significant returns by making overseas investments in emerging markets. Investors must understand, though, that any large returns must be evaluated in the context of risk and reward. Investors must figure out how to profit from an emerging market’s expansion without being exposed to its volatility and other downsides.

The dangers described above are some of the most common ones that need to be considered before investing. Unfortunately, rather than being established on a firm basis, the premiums associated with these risks are sometimes only able to be anticipated.

Read Our Article: Overview of Foreign Exchange Management (Overseas Investment) Regulations 2022

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