I. GLOBAL EMERGING MARKET ECONOMIC CONDITIONS
1.1 Emerging market performance was strong across all asset classes in FY07. High levels of capital
inflows and strong macroeconomic fundamentals continued to underpin favorable and broad-based gains
in asset prices across most markets. While equity markets continued to rally for the fourth consecutive
year (slowed only by a sharp, temporary sell-off in the third quarter), spreads of emerging market debt
remained at historically low levels despite an increase in aversion to risk in debt markets related to the
sub-prime housing market in the U.S.
1.2 The positive trends observed in equity markets since 2003 continued in FY07. Strong local
macroeconomic conditions (linked to high commodity prices and strong foreign and domestic demand
environments) coupled with high global liquidity and appetite for emerging markets exposure, generated
record high annual returns of 43% for the S&P/IFCG Emerging Markets Composite index in FY07, as
shown in Figure 1-1. Latin America and Asia (with annual returns of 68% and 58%, respectively)
followed by emerging Europe (29%), were the leading regions in terms of market performance.
1.3 The expectation of higher interest rates and lower economic growth in OECD countries at the end
of FY06, which generated portfolio equity outflows and a decrease in emerging market indices, dissipated
completely by the end of the first quarter of FY07 due to mixed signals about the U.S. economy growth
perspectives. The Chinese market correction of February 2007, which spread across emerging markets,
did not have a permanent effect on investors’ risk appetite for emerging markets exposure in the months
Figure 1-1: Total Return of S&P/IFCG Equity Indices by Fiscal Year (FY97 – FY07)
Asia Europe Latin America Middle East & Africa Composite
FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07
Source: Standard & Poor’s
1.4 Figure 1-2 shows the overall market performance for a selected group of countries. Emerging
economies, with the exception of Jordan and Lebanon, had positive returns in FY07 (the majority above
20% in both local currency and US dollars terms). It is worth noting that most countries show lower
returns in local currency due to appreciation of local currencies against the US dollar in the past year
(with Colombia, Hungary and Poland showing the highest currency appreciation effects on returns).
Bangladesh, China, Nigeria and Peru were the top performers with annual returns above 90% in local and
US dollar terms.
Figure 1-2: Total Return of S&P/IFCG Country Equity Indices for FY07
( %) Local Currency
120 US Dollars
Source: Morgan Stanley
1.5 In regard to borrowing conditions for emerging markets, JP Morgan Bond Index Stripped Spreads
over U.S. Treasury Bonds (Figure 1-3) continued decreasing for most of the fiscal year. While the spread
between the EMBI+ and U.S. Treasury bonds decreased by more than 500 basis points between 2001 and
2006, the overall decrease in FY07 was of at least 40 basis points in all regions (103 bps in Asia). 1
1.6 However, this trend started inverting in June 2007 across all regions, with a significant widening
of spreads over U.S. treasuries. By July 2007, Africa and Asia spreads were only about 25 basis points
below their value one year before, while the spreads for Latin America and Europe had already surpassed
their observed levels at the beginning of the fiscal year. Given the strong fundamentals of most emerging
economies in the past years and looking ahead, the behavior of emerging market bond index spreads over
treasuries (in particular, the continuity of the widening trend observed by the end of FY07) may be
closely tied to developments within the U.S. economy.
1.7 Country risk ratings have, in general, improved for emerging markets. An average measure of the
risk ratings from independent agencies (such as OAS Bid Rating, S&P, Moody's, Institutional Investor,
Euromoney and Fitch), indicates that during FY07, 99 of 131 developing countries (76%) improved their
average risk ratings. Moreover, 19 countries within IFC’s top 20 individual country exposures for FY07
improved their average risk ratings.
JP Morgan Emerging Market Bond Index Plus (EMBI+). This index represents US dollar emerging market
sovereign debt. The Stripped Spread on sovereign debt, the difference between a Brady bond's stripped yield and
the US Treasury yield of equivalent duration, is used as an indicative measure. Stripped yield is the yield on the
cash flow from the part of the Brady bond that is not guaranteed by U.S. zero-coupon bonds, ie. the implied
sovereign yield of a bond.
Figure 1-3: Emerging Markets Bond Index Stripped Spread vs. U.S. Treasury (2000 – 2007)
basis points EMBI Africa
1250 Asia Europe
Source: JP Morgan
1.8 Consistent with the behavior of equity returns and debt spreads since 2003, strong private sector
flows to emerging markets were supported by a number of factors including ample liquidity and robust
economic growth. Foreign Direct Investment (FDI), portfolio equity and private debt inflows to emerging
markets kept increasing in 2006 to record highs, as shown in Figure 1-4. While FDI inflows increased
from $290 to $310 billion in the period 2005-2006 (7% growth), portfolio equity inflows increased 39%
(from $66 to $91 billion). Private debt inflows increased as well (by 25%), from $245 to $307 billion in
the same period. 2
Figure 1-4: Developing Countries Debt and Equity Inflows
Foreign Direct Investment Portfolio Equity
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007e
Source: International Financial Statistics (IMF), Institute of International Finance (IIF)
Private Debt refers to the sum of the following Balance of Payments accounts: Portfolio Investment Debt
Securities Liabilities + Other Investment Banks Liabilities + Other Investment in Other Sector Liabilities
1.9 Estimates for 2007 suggest that FDI inflows will continue to increase but, that portfolio equity
and private debt inflows will be slightly below 2006 levels.3 The latter expectations may be associated to
the significant surge in equity valuations observed in the past years and the widening trend of debt
spreads observed by the end of FY07 and as mentioned above.
1.10 While FDI and portfolio equity flows showed sustained levels during the first two quarters of
FY07 relative to FY06 figures, private debt flows peaked in the second quarter (Figure 1-5).4 The sudden
shift in market sentiment in February/March 2007, associated with the Chinese market sell-off,
temporarily slowed flows; but momentum quickly recovered and it is expected that flows for 2007 are
likely to reach the record levels achieved in 2006.
Figure 1-5: Developing Countries Debt and Equity Inflows (FY06 – FY07)
Foreign Direct Investment
-20 Portfolio Equity
Private Debt FY 05-06 FY 06-07
2005 Q3 2005 Q4 2006 Q1 2006 Q2 2006 Q3 2006 Q4
Source: International Financial Statistics (IMF)
1.11 The economic performance of emerging markets in 2006 and in the first half of 2007 was in
general superior, compared to the already outstanding figures of 2005. Economic growth continued
accelerating in most countries thanks to a solid global economic environment, high commodity prices and
strong domestic demand. Price stability has played an important role, as most countries have managed to
grow at high rates under controlled inflation.
The estimate for 2007 is computed using IIF (Institute of International Finance) forecast trends on IFS
(International Financial Statistics – IMF) data.
All forms of private debt increased substantially and inflow movements from a few countries explain the total
change. Private debt securities increased from $11.3 to $31.2 billion (Mexico accounting for 60% of the change);
banks other debt increased from $16.1 to $45.5 billion (Russia’s flows increased by $10 billion, while Kazakhstan’s
and Turkey’s increased by around $5 billion each); and private sector other debt increased from $14.2 to $41.1
billion (with flows increasing in Russia and Brazil by $18.4 and $10.9 billion, respectively).
1.12 Table 1-1 shows GDP growth and inflation rates for the current top ten IFC country exposures.
While the average growth rate in the period 2001-2005 was higher than that observed for the period 1996-
2000 in most cases, only Nigeria in 2006 shows a slightly lower growth rate compared to the 5-year
average of the preceding period. With the exception of Brazil, these countries showed growth rates close
to, or above 5%, in 2006 (and actually 5 out of 10 had growth rates above 6.5%). With regard to price
stability, most countries had a reduction in inflation rates in the period 2001-2005 compared to 1996-
2000; this reduction cut inflation by half in Colombia, Indonesia, Mexico, Russia and Turkey. This
decreasing trend in price growth continued in most countries in 2006 (with the exception of China, India
and Nigeria). During the first two quarters of 2007 some countries started showing inflationary pressures
(Colombia, China and India), which demanded tighter monetary policy actions that have so far, kept
inflation from increasing further.
Table 1-1: Economic Growth and Inflation Indicators
Real GDP Growth (%) CPI Inflation (%)
Average Average Average Average
1996-2000 2001-05 2006 1996-2000 2001-05 2006
Argentina 2.7 2.3 8.5 -0.3 12.3 9.8
Brazil 2.0 2.8 3.7 5.9 9.1 2.7
China 8.6 9.6 10.7 1.4 1.3 2.8
Colombia 1.0 3.4 6.8 14.8 6.3 4.5
India 5.9 6.9 9.4 5.4 4.3 6.5
Indonesia 1.0 4.7 5.5 20.9 10.2 6.6
Mexico 5.5 1.8 4.7 16.7 4.5 3.9
Nigeria 3.5 5.6 4.8 10.2 14.9 15.4
Russia 1.8 6.1 6.7 34.8 13.6 9.0
Turkey 4.1 4.5 6.1 71.3 25.6 9.7
Source: Institute of International Finance (IIF)
1.13 The external position of most emerging markets continued improving in 2006, supported by high
commodity prices and strong exports (particularly in the agricultural, mineral and energy sectors), and
increasing flows of remittances to many countries. In the past year current account balances improved,
accumulation of foreign reserves continued, while levels of external debt as a percentage of GDP
decreased. Table 1-2 compares external indicators for IFC top ten country exposures in 2006 with the
preceding 5-year average. In 2006, 6 of 10 countries had a current account (CA) surplus. Compared to the
2001-2005 average, Brazil passed from a CA deficit to a surplus and Mexico reduced its CA deficit by
three fourths; while Colombia and Turkey were the only countries with increased CA deficits.
1.14 External debt as a fraction of GDP decreased in all ten countries in 2006. While Argentina and
Brazil cut their ratios in half in the past year compared to the 2001-2005 average, Nigeria’s Debt/GDP
ratio is a tenth of the preceding 5-year average. As for the share of short term debt in total external debt,
most countries maintained in 2006 the observed average level of the past 5 years (except China, Indonesia
and Turkey with a 40% increase; and Russia with 30% increase in 2006 compared to the 2001-2005
Table 1-2: External Indicators
Current Foreign Exchange External Debt / Short Term Debt as
Account/GDP Reserves (US$ bn) GDP (%) % of Total External
Average Average Average Average
2001-05 2006 2001-05 2006 2001-05 2006 2001-05 2006
Argentina 3.8 3.3 17.4 32.0 107.3 58.5 10.7 11.6
Brazil -0.3 1.2 45.8 85.6 36.8 18.7 10.4 10.2
China 3.5 9.5 470.2 1,068.5 13.0 12.3 37.5 51.8
Colombia -1.3 -2.1 12.0 16.5 42.6 29.5 6.2 6.5
India 0.6 -1.1 103.1 192.4 21.3 19.6 11.7 12.1
Indonesia 2.4 2.3 32.2 40.6 60.9 36.4 13.6 19.4
Mexico -1.6 -0.4 58.5 76.1 24.6 19.8 21.3 20.9
Nigeria 0.6 11.1 14.0 39.5 53.0 5.1 8.9 N.A.
Russia 9.3 9.6 90.6 296.2 37.4 28.7 20.7 27.0
Turkey -2.7 -7.8 33.1 60.8 61.8 54.6 23.0 31.6
Source: Institute of International Finance (IIF)
International Financial Statistics (IMF) for Short Term Debt as % of Total External Debt in Nigeria
1.15 The increasing ability of emerging markets to manage an eventual significant reduction in global
liquidity is summarized in Table 1-3. The External Vulnerability Indicator, which compares the size of
short term external liabilities and obligations relative to foreign reserves, continued decreasing in 2006 for
all countries. The largest improvement in this indicator, when compared to the 2001-2005 average, was in
Russia (74% change), followed by Argentina and Brazil (50% change). Finally, Table 1-3 also shows the
level of foreign reserves in terms of months of imports. By far, the highest improvements in 2006 are
observed in Nigeria and Russia (with 80% increase relative to the 2001-2005 average level), followed by
Argentina and China (with 35% increase).
Table 1-3: External Vulnerability Indicators
External Vulnerability Foreign Reserves
Indicator (*) (# Imports Months)
Average Average Average Average
1997-2000 2001-05 2006 1997-2000 2001-05 2006
Argentina 182 288 145 6.1 5.7 7.8
Brazil 153 132 69 5.1 5.6 6.6
China 28 24 21 8.8 10.8 14.5
Colombia 105 99 90 5.7 6.3 5.4
India 76 46 33 5.6 9.8 9.1
Indonesia 140 63 45 4.7 5.4 4.1
Mexico 133 80 50 2.3 3.2 3.1
Nigeria N.A. N.A. N.A. 4.8 4.7 8.4
Russia 318 60 15 2.0 7.4 13.4
Turkey 225 196 149 4.2 4.6 4.8
(*) (Short-Term External Debt + currently maturing Long-Term External Debt + Total Nonresident
Deposits over one year) / Official Foreign Exchange Reserves.
Source: Moody’s and Institute of International Finance (IIF)
IFC Country Exposure and Relevant Risk Issues
1.16 Figure 1-6 presents the current top ten IFC country exposures measured on a committed portfolio
basis. Collectively, the top ten countries account for 52% of IFC total exposure in FY07 (51% in FY06
and 48% in FY05) and 65% of developing economies’ total GDP in the period 2001-2005. IFC largest
country exposures are Russia and India (about a 9% share each). In terms of portfolio growth, while IFC
total committed exposure increased by 17.5% in FY07 (compared to 12.2% in FY06); exposure in the top
10 countries increased by 19.9% (compared to 19.3% in FY06).
1.17 The most notable change in country exposure was India (68% increase), which passed from
fourth in FY06 to second position in FY07 with $2,117 million. Russia continues to be the top exposure
in FY07 (with $2,238 million and 13% increase with respect to FY06). Similar to the last fiscal year,
China passed ahead of Brazil in 3rd position with a 13% increase, compared to an 8% increase for Brazil.
While Turkey, Mexico and Argentina hold the same positions as last year, Colombia entered the top 10 in
the 8th position (with a 50% increase, the second largest after India). Ukraine stepped out of the top 10
(and is now in position 15).5 Argentina is the only country within this group with a 5% lower committed
exposure dollar value by the end of FY07 with respect to FY06.
Figure 1-6: IFC Committed Exposure ($ millions) Top ten countries as of end of FY07
FY 2005 FY 2006 FY 2007
Russia India China Brazil Turkey Mexico Argentina Colombia Indonesia Nigeria
Committed exposure in Ukraine decreased from $551 million by the end FY06 to $487 million by the end of FY07,
despite having $74.5 million in new commitments during FY07. This is mainly explained by a total of $135.6 million
in prepayments ($93.6 million), repayments ($20 million) and equity sales ($22 million).
1.18 The relevant country issues for the top ten countries are highlighted below. They represent the
views of the global investment community as expressed in various publications and as summarized by the
Corporate Portfolio Management Department.
Russian Federation: High oil and commodity prices have sustained GDP growth rates above 6% and a
current account surplus of around 10% of GDP. Capital inflows are expected to continue sustaining
investment and domestic demand expansion. However, exchange rate appreciation is expected to impact
the current account significantly, as well as competitiveness in non-commodity sectors. Political risk
dropped in the past fiscal year due to the renegotiations of oil and gas production contracts with foreign
India: As its integration with the global economy continued in FY07 through rising services exports and
continued capital inflows, the economy started showing signs of overheating (high capacity utilization
and rising inflation). Constraints to continued high economic growth in the coming years are
infrastructure and (urban and skilled) labor supply.
China: The impressive economic expansion of the past ten years continued in FY07, backed by a strong
and dynamic export sector, increasing capital inflows and continuing reform. The main concerns for
continued expansion in the coming years are the impact of tighter monetary policy to control increasing
wages and inflation associated with rapid economic expansion, and continued pressure for currency
appreciation to alleviate global imbalances.
Brazil: Economic growth continued accelerating in 2006 and is expected to increase toward the Latin
American average in coming years due to high commodity prices, investment and domestic demand
expansion. While inflation and interest rates showed a decreasing trend in the past years, the main
concern in regard to vulnerability is the accelerated appreciation of the real, and its impact on the current
account balance. External debt as a proportion of GDP continued decreasing to comfortable levels
supporting a sovereign risk rating upgrade.
Turkey: Although economic growth has maintained a level above 6% in the past years, and inflation and
interest rates are decreasing, external vulnerabilities as drivers of future macroeconomic instability
continue to be a concern. On the one hand, a current account deficit above 7% of GDP in 2006 is the
highest in the past 15 years (mainly due to high oil prices and increasing import growth associated with
expanding domestic demand). On the other hand, external debt is expected to remain around 50% of
GDP, with there still being many issues about fiscal policy implementation. EU accession talks continue,
but uncertainty remains on the final outcome.
Mexico: Concerns about the political turmoil surrounding the 2006 presidential election did not impact
macroeconomic stability. Low inflation, stable interest and exchange rates, and GDP growth dependency
on the U.S. economy are expected to continue in the coming years; thus, there will be uncertainty and
concern about the impact of a slowdown in the U.S. The main constraint to growth continues to be the
slow pace of structural reform. The recently elected government, with a minority in Congress faces a big
challenge in this sense due to its dependency on political coalitions with other parties.
Argentina: The expectation is for moderating economic growth rates, from the high 8-9% levels to 5-6%
in coming years. The current account surplus is also expected to ease gradually, while the exchange rate is
expected to remain stable at competitive levels. Despite the change of government next October, the
general expectation is for the continuation of the policies currently in place. The main concern is the
effectiveness of direct government intervention to control inflation.
Colombia: Above historical average growth is expected in coming years due to continuous improvements
in public security as well as political stability. Inflation is at comfortable levels, though recent economic
expansion (setting a 6.7% record-high growth rate in 2006) and overheating signs required monetary
policy tightening. Strong currency appreciation effects on exports and a widening current account deficit
are the main concerns in the short run. Although the free trade agreement with the U.S. may not be
ratified soon, preferential access to this market was extended for two years. Public security will remain
the main challenge for future economic growth and sustainability.
Indonesia: GDP is expected to grow at 6% in 2007-2008 thanks to domestic demand expansion and
investment growth. However, reforms and growth are still not driving enough job creation (a major focal
point of recent reforms). Inflation has recently eased, allowing the central bank to cut interest rates and
Nigeria: Past reforms, high oil prices coupled with increasing off-shore production activity to overcome
the output loss in the Delta due to political unrest, and strong growth in non-oil sectors are expected to
generate high growth rates above 7% and sizable (though decreasing) current account surpluses in coming
years. The main concern is the ability of the newly elected government to manage tensions with the
opposition parties, to provide political stability and to continue promoting economic reform.