Emerging Markets Heading for Banner Year in 2006: IFC Notes Progress, Development Challenges Ahead

This promises to be a banner year of performance for the emerging markets, but major challenges remain on macroeconomic stability, corporate governance, and environmental and social issues, according to the International Finance Corporation, the private sector arm of the World Bank Group, at its milestone 50th anniversary year.

“Emerging markets as a group have proved they can sustain high growth and attract capital. There is tremendous dynamism. But the growth is uneven, and there is a huge unfinished agenda,” said Lars Thunell, executive vice president of IFC.

Thunell noted that the flow of private capital into the developing countries – at roughly $350 billion – is now more than four times the amount of international aid. But, he noted, the development community needs to do a better job of using market-based solutions to reduce poverty, address social needs, and preserve the global environment.

“More and more development and aid organizations – multilateral banks, foundations, nonprofits – are looking at an entrepreneurial approach to development. They are asking how they can harness the power of private capital, free enterprise, and social entrepreneurship to bring about needed change,” Thunell said. “This is where IFC, with 50 years of experience in this area, can play an even larger role.”

“We need to broaden and deepen this economic growth to reach more of the poor, especially in countries where investment climate barriers are keeping small entrepreneurs and women trapped in the informal economy,” he added.

IFC, which was founded to promote private sector growth in the developing countries and coined the term “emerging markets” in the early 1980s, cited the convergence of a number of trends during this milestone year:

• Macroeconomic growth rates for developing nations continue to be roughly double those of developed nations.
• Cross-border capital flows into the emerging markets – foreign direct investment, equity flows, and commercial bank lending – are approaching the record levels last witnessed a decade ago.
• Emerging market equity funds have been reporting record inflows, and the growing interest of institutional investors is likely to lift the capitalization of emerging stock markets above $5 trillion for the first time in history.
• The scale of emerging market mutual funds, whether measured by assets or as a percentage of emerging markets GDP, is now more than double the levels seen in 1997.

“We need to bolster the stability of existing capital markets and flows in the developing world by strengthening domestic financial institutions and deepening local currency markets,” Thunell said. “We need to improve corporate governance, so that more of the up-and-coming companies that are creating jobs can tap into the capital in the global economy.”

IFC’s role in the emerging markets has evolved from pioneering foreign direct investment to creating the first equity funds for developing countries and introducing more advanced products and initiatives, such as local currency bond issues, securitizations, and carbon emissions credits. In December 2005, for example, IFC helped launch the first stock index of environmentally responsible companies in Latin America. Since 2003, leading commercial banks have adopted IFC’s environmental and social standards, known as the Equator Principles, as the benchmark for their project finance lending.

Today IFC is the largest multilateral provider of financing – loans, equity, risk management, and structured finance products – in the developing world. In addition, the Corporation serves as a catalyst and laboratory for innovative, market-based solutions for reducing poverty and addressing environmental and social challenges. From its founding in 1956 through FY05, IFC has committed more than $49 billion of its own funds and arranged $24 billion in syndications for 3,319 companies in 140 developing countries. IFC’s worldwide committed portfolio as of FY05 was $19.3 billion for its own account and $5.3 billion held for participants in loan syndications.

“When I was at IFC and coined the term ‘emerging markets’ in 1981, there was practically no foreign portfolio investment in the emerging markets,” said Antoine van Agtmael, founder and president of Emerging Markets Management. “The idea was to give a more uplifting name to what we had originally called the ‘Third World Fund.’ Today, there is enormous potential in the private sector of these countries, whether you are a market investor or a development institution looking to reduce poverty.”

Broadening Economic Participation
The economic growth rate for the developing nations is projected to be between 5.5 and 5.9 percent in 2006. Nonetheless, this encouraging growth figure masks significant untapped potential. Across the developing world, the amount of economic activity in the “informal” economy – unreported, unregulated, untaxed – ranges from 40 to 80 percent.

Ongoing research sponsored by IFC and the World Bank, the Doing Business report, shows that red tape and processing delays are a major drag on job creation and economic growth in the formal economy of many developing nations. In such countries as Brazil, Indonesia, and Mozambique, simply registering with the government to open a business can take more than 150 days – more than 10 times longer than it takes in advanced economies. Such barriers disproportionately affect women. IFC is supporting investment climate reform initiatives based on the Doing Business research in more than 20 developing countries. (Additional information can be found at: www.doingbusiness.org.)

IFC has placed a strong emphasis on increasing its investment activity in Sub-Saharan African countries, whose economies have some of the largest informal sectors. IFC’s annual investments in Africa have risen 77 percent over the past three years, to $445 million for the most recent fiscal year.

In addition, to reach entrepreneurs in the informal economy and the small and medium enterprise sector, IFC has dramatically increased its microfinance portfolio in recent years to more than $320 million, representing 69 projects across 43 countries. IFC microfinance investee companies reach some 1.2 million borrowers in poor nations. Earlier this month, IFC’s Gender Entrepreneurship Markets unit announced a new research initiative to identify barriers that women face in obtaining finance.

Capital Markets, the Financial Sector, and Corporate Governance
To encourage growth and foster greater stability in the emerging markets, IFC has taken a leadership role in deepening and diversifying capital markets in developing nations by introducing local currency bonds, securitizations, and the provision of derivatives such as partial credit guarantees. Long-term local currency financing allows companies in the emerging markets to finance their growth without incurring the currency risk associated with dollar-denominated financing.

Last year, for example, IFC was the first multilateral to issue a so-called “panda” bond in China, a 1.13 billion renminbi-denominated bond ($140 million dollar) issue in the Chinese non-government domestic market. The issuance marked the first opening of the Chinese renminbi bond market to international financial institutions. IFC also recently completed the first securitization of student tuition payments in Chile, a $23 million transaction for Universidad Diego Portales, and provided the university with a partial credit guarantee of $6.9 million.

More than a third of IFC’s investment portfolio is devoted to strengthening and diversifying the financial sector – banks, leasing companies, mortgage companies – in developing companies. Last year, IFC helped expand affordable low-income housing in Mexico by providing more than $110 million in finance to support the mortgage operations of GMAC Financiera. IFC is also providing technical assistance for more than 125 financial markets projects in more than 60 developing countries.

To improve corporate governance, IFC works directly with client companies from more than 80 developing countries on their board practices, shareholder rights, internal control environment, and transparency and disclosure. Such reforms increase shareholder value, reduce the cost of capital, and improve long-term performance.

IFC has invested equity directly in about 670 companies in emerging markets, and has helped many successful companies grow to become excellent regional or global players today. As a minority shareholder IFC also emphasizes corporate governance and has been active on many corporate boards to improve governance standards.

“IFC's experience has shown that companies that can grow into attractive regional or global players, and that operate with outstanding corporate governance standards are excellent candidates for an equity investment, bringing both profitability and strong development impact,” said Haydee Celaya, Director for Private Equity and Investment Funds.

Addressing Environmental and Social Issues through Policies and Project Investments
IFC’s environmental and social standards for project finance lending have been adopted as the global benchmark by leading commercial banks around the world through a process known as the Equator Principles. IFC plans to bring a new, stronger set of environmental and social performance standards to its Board for approval later this year.

IFC, with its sister institution the World Bank, has pledged to increase its renewable energy and energy efficiency investment portfolio in the developing countries by an average of 20 percent per year from 2005 to 2010. Earlier this month, for example, IFC announced an equity investment of $5.5 million in Energias Renováveis do Brasil Ltda (Enerbrasil), to support construction, operation, and maintenance of a 49.3 megawatt wind power park in the municipality of Rio do Fogo.

Similarly, in December IFC awarded a $3 million grant to IST Holdings and Plug Power, which will install 400 fuel cells in cities and remote locations of South Africa over the next three years. The fuel cells will provide a reliable source of electricity and will replace polluting technologies such as diesel generators.

In addition, IFC has sponsored innovative public-private partnerships to preserve biodiversity and transactions that allow emerging market companies to tap into the carbon emission reduction credits market.

Please feel free to contact Corrie Shanahan of IFC at + (202) 473-2258 to discuss how IFC’s events, case studies, policy research, standards, and experts on the emerging markets can inform your coverage of this milestone year in the global economy. Web site: www.ifc.org