Emerging Markets Finance Spring 2002 Wei Li Darden School of Business Acknowledgement: Some of the materials are drawn from IMF reports and from Professor Walter Molano’s emerging market course.

Emerging Markets Defined  Income. Lower and middle income economies with per capita income < $9,656 in  Financial market depth. Investable market capitalization/GDP < 20% (Note: Investable market capitalization is a market's capitalization after removing holdings not truly "in the market" for foreign portfolio investors. Non-investable holdings include, but are not limited to, large block holdings and parts of companies that are inaccessible due to foreign investment limits.)

Global mix of natural resources

Global mix of capital

Opportunities for exchange  The mismatch between resources and population provides an excellent opportunity for trade (exchange of goods and services).  The mismatch between capital and population provides an excellent opportunity for investment (exchange of assets).  Emerging Markets Finance is the vehicles that facilitate the interchange of resources and capital.

Financial vehicles  Trade finance Usually short term facilities  Foreign direct investment Usually cross-border project and corporate finance performed by multinationals in setting up new productive capacity. Usually long-term in nature – years time horizon Recently FDI flows have included services, such as electricity and telecommunications  Portfolio investments—equity and debt investments in corporate or sovereign entities Very volatile Highly dependent on short-term liquidity conditions, such as interest rates and US monetary policy

Global exchange of factors

Net Private Capital Flows to and Gross Private Issuance in Emerging Markets (Source: IMF)

Net private capital flow to emerging markets

Summary  Comparative advantage is a power tool for understanding capital flows.  Emerging markets financial activity focuses mainly on Asia, Latin America, and the Emerging Europe.  The main areas of investment are in foreign direct investment, trade finance, and portfolio investment.  The areas of activity are largely dependent on the region. For example, fixed income trading is largely focused on Latin America. Equity investment concentrates in Asia. Foreign direct investment activity is strong in both regions and in emerging Europe.

Emerging markets finance  Focuses on direct investment  Has two central themes Risk management Valuation  Country risk approach  Downside risk approach  Real options

Gerber: What happened?  Gerber purchased 60% of Alima on February 13, Promised to keep all current employees for at least 18 months and increased all salaries by 40%  In fiscal year 1993 (ended March 30), Gerber reported profits in “the seven- figure category”.

GerberSummary  Two strategic considerations: Alima as a “Euro facility”—access to both east and west Europe. An expansion option (a call option). At the minimum, it will cost less to ship baby food to France from Poland than from the US.  A good deal: $25 million is far less than that a greenfield plant ($ million)  Mitigating political risk: Leave a large portion of its $11 million investment in an escrow account in London. Gerber agreed to release the monies as the Poles met the negotiated terms—mainly the tax credit.  Gerber bears most of the macroeconomic and project risks. Should the cost of capital be higher than 15%?

EMDB Coverage