The liberalization of emerging market countries offers new opportunities for investors to increase their diversification and profit. Economic liberalization refers to a country that is “opening up” to the rest of the world regarding trade, regulation, taxation, and other areas that generally affect business in the country.
Generally, you can determine how economically liberalized a country is by how easy it is to invest and do business in that country. All the developed countries (of the first world) have already gone through this process of liberalization, whereas emerging countries must undergo a series of changes. Here are five effects of the liberalization of countries.
Key points to remember
- Economic liberalization is generally seen as a beneficial and desirable process for developing countries.
- The underlying objective of economic liberalization is to have unrestricted capital flowing in and out of the country, stimulating economic growth and efficiency.
- After liberalisation, a country will benefit politically from the stability induced by foreign investments, which almost function like a board of directors for the emerging country.
- These countries are considered high risk in their early stages, but this does not discourage large investments from institutional investors who want to get in first.
1. Removal of barriers to international investment
Investing in emerging countries can sometimes be an impossible task if the country you are investing in has several barriers to entry. These barriers can include tax lawsrestrictions on foreign investment, legal problems and accounting regulations, which make it difficult or impossible to enter the country.
The process of economic liberalization begins with the relaxation of these barriers and the relinquishment of some control over the orientation of the economy towards the private sector. This often involves some form of corporate deregulation and privatization.
2. Unlimited capital flow
The main objectives of economic liberalization are the free movement of capital between nations and the efficient allocation of resources and competitive advantages. This is usually done by reducing protectionist policies, such as tariffs, trade laws, and other trade barriers.
One of the main effects of this increased inflow of capital into the country is that it is cheaper for companies to access capital from investors. A lower capital cost enables companies to undertake profitable projects that they might not have been able to achieve with a higher cost of capital before liberalisation, resulting in higher growth rates.
3. Stock market appreciation
In general, when a country liberalizes, stock Exchange the values also go up.Fund managers and investors are always on the lookout for new profit opportunities. The situation is similar in nature to the anticipation and flow of money in a initial public offering (IPO).
When an entire country becomes available for investment, it tends to experience a windfall of foreign investment.
A private company previously inaccessible to investors that suddenly becomes available usually causes a similar situation. Evaluation and the cash flow model. However, like an IPO, the initial enthusiasm also eventually wanes and returns become more normal and more in line with fundamentals.
4. Political risk reduction
Liberalization reduces Political risk to investors. For the government to continue to attract more foreign investment, areas other than those mentioned above also need to be strengthened. These are areas that support and promote the willingness to do business in the country, such as a strong legal basis for resolving disputes, fair and enforceable contract laws, property laws and others that enable businesses and investors to operate with confidence.
As such, government bureaucracy is a common target to be streamlined and improved as part of the liberalization process. All of these changes combined reduce political risk for investors, and this lower level of risk is also part of the reason why the liberalized country’s stock market rises once the barriers are lifted.
5. Diversification for investors
Investors can benefit from the possibility of investing part of their portfolio in a asset class. In general, the correlation between developed countries like the United States and underdeveloped or emerging countries is relatively low. Although the overall emerging country risk itself may be above average, adding a low-correlation asset to your portfolio can reduce your portfolio’s overall risk profile.
However, it should be distinguished that even if the correlation may be low as a country liberalizes, the correlation may actually increase over time. A high degree of integration can also lead to an increase contagion risk, ie the risk that crises occurring in different countries will cause crises in the country of origin.
This is exactly what happened in the financial crisis which began in 2007-2008. Weaker EU countries (like Greece) began to develop serious financial problems which quickly spread to other EU members.In this case, investing in several different EU member countries would not have brought much diversification benefit, as the high level of economic integration among EU members have increased correlations and contagion risks for the investor.
The essential
Economic liberalization is generally seen as a beneficial and desirable process for emerging and developing countries. The underlying objective is to have unrestricted capital flowing in and out of the country to drive growth and efficiency in the home country. It is the post-liberalization effects that should be of interest to investors as they may offer new opportunities for diversification and profit.