Developing nations, also known as emerging markets, is one of those investing terms that even the least-informed investors have likely heard. It refers to nations that are in the process of rapid growth, on their way to becoming industrialized nations like the United States, France and Canada.
There is disagreement over which countries should be considered emerging markets. The International Monetary Fund (IMF) has a list, as do the FTSE, Standard and Poor's and Dow Jones. Although many nations are labeled, "emerging" or "developing," some are more economically and socially healthy than others.
Some believe that the term, emerging markets, is antiquated, because there is no guarantee that these countries will one day become developed markets, although many of the nations on the IMF list are growing.
Debt Is Deceiving
In recent months, Spain made headlines because of its skyrocketing bond yields. Some economists estimate that above a certain rate, often around 7%, countries like Spain will be unable to service that debt.
A yield of 7% is low, however, compared to one developing country, Vietnam, which currently has a bond yield of 9.6% on its five-year bonds.
Although the yield is higher, Vietnam's national debt is only 38% of its gross domestic product compared to the United States, which has a five-year bond yield of 0.8% (though its debt accounts for 70% of the country's GDP), and Spain, which has a debt-to-GDP ratio of nearly 69%.
Not the Whole Story
Some countries may divert funds from essential expenditures like infrastructure and other social needs in order to service debts, which are often left over from past rulers. These debt payments have a direct impact on the country's ability to increase its GDP. Vietnam may have a manageable debt level relative to its GDP and an unemployment rate below 3%, but the 18.7% rate of inflation and the fact that 40% of its GDP comes from state-owned industry has made its emergence into a developed nation more difficult.
Debt Relative to Risk
Although most emerging markets have a debt-to-GDP ratio much lower than developed nations, bond yields are higher because of factors like default risk.
InvestmentNews reports that countries that default have lower debt-to-GDP ratios than countries considered to be healthy, making the risk to the investor higher and just like corporate bonds, the higher the risk, the higher the yield. Some investors believe that investing in emerging markets becomes too much of a risk once debt to GDP is higher than 40%. If that's true, which countries should you avoid?
Hungary has a debt to GDP of 80.6. Although foreign investment in Hungary is widespread and 80% of its GDP comes from private firms, Hungary holds the distinction of having one of the highest debt to GDP ratios of any emerging market country.
Brazil's debt to GDP may be 54.2, but this South American country's economy outweighs every other economy on the continent. Its economy is largely based on agriculture, mining and manufacturing.
China's debt to GDP is currently at 43.5, but data coming from within the country isn't always seen as accurate due to the way it reports. Some argue that China shouldn't be considered an emerging market country since its total GDP is over $11 trillion.
Another emerging market, Argentina, has a debt to GDP of 41.4%. Much of its GDP comes from the exporting of crops. Argentina was once one of the world's richest countries but numerous financial events including a severe depression have left it crippled economically.
The Bottom Line
Most portfolio managers agree that emerging market exposure is still appropriate for most portfolios despite the challenges of the sector. For added security, consider investing using exchange traded or mutual funds instead of trying to gain individual stock or bond exposure. Although debt to GDP is an important metric, it is only one that should be considered when evaluating the health of countries from which information is difficult to obtain.