Private Equity in Developing Countries - Morning Group 2

This topic will further be moderated and edited by either of the following members:

  1. Kim Sun-Kyung
  2. Esen Sagynov
  3. Kim Dae-Keun

Most of us, by now, know already the potentials of Private Equity business. We are already aware of the scope of its operations, which reaches the horizon far beyond our imagination. We witnessed already the few and the most powerful people in the business. But do we know about how everything starts? Do we know where everything starts? And why? How much is Private Equity business important for Developing Countries? Does it boost country's development? Or does it hamper the progress? We decided to investigate the origins of Private Equity business especially in developing countries. We also want to know the current hot issues related to PE in any developing countries and why they occur. Stay online and visit this page frequently to get more information about Private Equity in Developing Countries.

Posted by Esen Sagynov on July 7, 2009.

In the past few years, the developing world has been witness to a dramatic change in the private equity activities across the globe. The year of 2006 has been announced by International Finance Corporation (IFC), the private arm of the World Bank, as a year of emerging markets. Regions like Central and Eastern Europe, Africa and the Middle East have become the favored destinations not only for opportunistic investments but also for specific funds. India and China are expected to become one of the most powerful emerging markets by 2050. These emerging economies have been in the limelight primarily due to three facts as identified by The Economist magazine.

1. To begin with, the combined output of the emerging economies in 2006 constituted more than 50 per cent of global production in PPP (purchasing power parity) terms.
2. Emerging economies contributed half the growth in global GDP (gross domestic product) .
3. And the most noteworthy fact is that the top 32 nations among the emerging/developing economies maintained positive GDP growth consistently in the years 2005 and 2006.

Defining an emerging economy

An emerging, or developing, market economy (EME) is defined as an economy with low-to-middle per capita income. Developing countries constitute approximately five-sixths of the global population and half of the world’s output. They are found to be in a transitional stage, moving from a closed to open economy, having embarked on a reform path, irrespective of size. In other words, an emerging market is a country that makes an effort to improve its economic performance to catch up with the economies of more advanced nations.

The term “emerging market” is not simply restricted to nations that are small. Thus it is interesting to note that not only the big nations like Brazil, Russia, India and China, but also small nations like Tunisia are categorized as emerging markets. Among all the emerging markets, the economies of Brazil, Russia, India and China, commonly termed as the BRIC economies, find a special place. They are the key players among the emerging economies as classified by the IMF and the World Bank. These countries are among the largest emerging economies in demographic, economic and financial terms. A study by Goldman Sachs in 2003 identified the BRIC countries as the future economic power whose combined strength is expected to overpower the G-6 by 2050.

Since 1980, the BRIC countries have displayed consistent annual growth. China has grown at an average rate of 9.8 per cent, followed by India at around 5.8 per cent and Russia also at about the same level as India. Brazil grew at a relatively slower rate of 2.4 per cent. In contrast, the large industrialized nations (Group of Seven or G-7) have shown an average 2.7 per cent annual growth. This clearly indicates an overall increase in prosperity in BRICs. Accordingly, the living standards have gone up in the BRIC economies, thus narrowing the gap between the BRICs and advanced economies. Among the various parameters of economic growth, developments of capital markets have remained primary.

Role of capital market in fostering economic growth

A long-lasting debate in economics pertains to:

1. Whether financial development causes economic growth
2. Or whether it is a consequence of increased economic activity.

The issue of correlation between stock market growth and overall economic developments has always been a debatable issue. Recent research has begun to focus on the linkages between stock markets and economic growth. The positive aspect of these is that a well functioning stock market may help the development process in an economy through the following channels:

• Growth of savings
• Efficient allocation of investment resources
• Better utilization of the existing resources

The stock market is supposed to encourage savings by providing households with an additional instrument that may better meet their risk preferences and liquidity needs (Leigh, 1997). When the stock market goes up, people feel wealthier and hence spend more. However, when the stock market falls, they feel poorer, crunched by debt run-up during the ‘good times’ and they slash their spending (Ondrich and Ruggiero, 2001).

On the negative side, some analysts view stock markets as ‘casinos’ that have little positive impact and perhaps even a negative impact on economic growth. According to this view, by allowing investors to sell stocks quickly, liquid markets may reduce investors’ incentives to exert corporate control by monitoring the performance of managers and firms. In other words, dissatisfied owners sell their shares instead of working to make the firm operate well. According to this view, greater stock market liquidity may hurt economic growth (Demirguch-Kunt and Levine, 1993).

A number of eminent researchers and economists like King and Levine (1993), Demirguc-Kunt and Levine (1993), Levine and Zervos (1996), Hansson and Jonung (1997), Khan and Senhadji (2000), Blackburn et al. (2001), Arestis et al. (2001), Agarwal (2000), Wachtel (2003), and Rioja and Valev (2003) have shown empirically that the financial system has a significant role and provides an important contribution to economic growth.

Thus, backed by empirical evidence one can say with a fair amount of confidence that capital markets play a crucial role in the overall economic development of a nation and recent evidence suggests that PE is playing a significant role in the development of global capital markets.

Posted by Kim Sun-Kyung on July 27, 2009.

PE in emerging countries

In simple terms, "private equity" encompasses a range of techniques used for financing commercial ventures in various ways that do not involve the use of publicly tradable assets such as corporate stock or bonds. The most typical forms of PE include venture capital, growth and mezzanine capital, angel investing and PE funds. PE can be defined as a financing mode for private companies in their early or later stage of lifecycle where investors are seeking higher rates of returns and near-term liquidity.

It has been observed that the risk profile of many companies prevents them from raising capital through conventional modes of financing. PE tries to bridge the gap between the conventional mode of external financing and self-financing. It is important to note that the shares of private equities are seldom listed in the exchanges and hence are subjected to rigorous diligence; however, they can be listed over a period of time through a public offering or through a potential buyer. Over the past few years, PE investments have grown significantly, which boosted the capital markets of various developing economies and in turn the economy as a whole (Table 1).

Table 1: Ten largest funds addressing emerging markets that had a closing in 2006

Region Focus Raised to date ($US M)
Asia China, India, Philippines, Thailand 3,100
Asia Pan-Asia 1,810
Asia Pan-Asia 1,560
Middle East Region 1,000
Africa South Africa 880
CEE/Russia Region 793
CEE/Russia Plan 776
Asia China, India, Philippines, Thailand 750
Africa South Aftica 748
Latin America/Caribbian Brazil 698
Total 12,115

Since 1980, professional PE managers have undertaken much of the investment on behalf of institutional investors. The means for organizing this activity has been a limited partnership, with the institutional investors acting as limited partners and the investment managers playing the role of general partners. The specific advantages of limited partnerships are ingrained in the ways in which they address these problems. The general partners specialize in finding, structuring and managing equity investments in closely held private companies.

Reasons for the growth of PE activity in the developing world

Some of the factors instrumental in the growth of PE activities in these regions are reflections of the strong fundamentals of the developing nations themselves.

Economic progress of the developing nations over the past decade has been a primary factor that resulted in the strong flow of PE investments in those regions. Some of the reforms that shaped the entry of PE investments in developing economies can be describes as follows.

One of the most significant macroeconomic shifts was the 1989 Brady Plan. The plan allowed several Latin American countries to restructure their external debt. This huge reduction in the debt service boosted the economic health of these markets in a substantial manner. The successful reform process further increased the confidence of investors. Since then, although periodic financial crises have disrupted the continent,9 their economies have remained relatively stable.

Developing nations initiated other macroeconomic reforms too. An area that saw many reforms pertained to the taxation system. Many developing nations realized that one way to fuel the economy was by lowering taxes on capital gains, thereby encouraging equity investment and stock market growth. Similarly, many nations, relaxed the restrictions on foreign investment, which had earlier often prohibited investments in particular industries, mandated that foreign investors need to hold a minority stake and even limited the repatriation of profits. One of the notable features of developing countries in the past decade pertains to the great progress made in improving their accounting and disclosure standards. All these changes have combinedly resulted in lowering the costs of investing in these nations, as well as reducing the information asymmetries that foreign investors generally face.

Successful PE investment

The PE cycle in any country is motivated by the ease of exit from the market within a predetermined time-frame. In the US and other developed economies, a well-controlled IPO market facilitates a gateway for the success of the entire PE market. As observed in the most empirical evidences, the exits that are achieved through IPOs tend to take full advantage of the value of the firms as compared to selling the shares to strategic investors or back to their original owners through the process of management buyouts (MBO). In stark contrast to the US market, emerging nations lack the equity markets that provide a feasible outlet for the sale of most of the companies to PE portfolios.

Primary markets play the role of a medium for raising capital except for a handful of the largest companies, and secondary markets cater to a smaller number of large-sized firms. Unfortunately, the problems do not end here; rather they become worse over a period of time. In many countries, companies have delisted their shares locally in favor of more established international exchanges that promise to generate better returns.

Posted by Esen Sagynov on July 29, 2009.

Future prospects in developing countries

The macroeconomic perspective

1. Generally, the pace of growth in emerging markets is expected to continue to be about double that of developed markets, according to IMF projections.
2. Emerging countries also have younger populations relative to developed countries.

These growing workforces will drive domestic consumption and, ultimately, fuel economic growth. The health of many emerging economies has improved significantly over recent years, helped by booming demand for commodities and rising export revenues. Recently, developing countries adopted prudent fiscal and monetary policies, which fostered stability and growth, boosting economic fundamentals. Many emerging nations now run positive current account balances. Emerging economies account for 80% of the world’s population, 66% of its foreign exchange reserves, and 50% of gross domestic product, but just 7% of world equity market capitalisation.

The company perspective

Companies of developing countries have restructured over the last few years, allowing them to pay down corporate debt and improve business conditions. Management discipline has led to stronger cashflow and expanding profit margins. Transparency and corporate governance of developing countries has improved, with management becoming more attuned to minorities' rights. While dividend payout used to be an extremely low priority for most emerging market companies, many are now returning excess cash. The expanding range of high quality companies with improving credit-worthiness provides opportunities for skilled fixed income managers. Developing countries have M&A and investment potential. If the growing number of high quality companies is given and huge private equity "war chests", the potential for mergers and acquisitions is considerable.

The investment perspective

Because the markets of developing countries are often inefficient, assets are under-researched. The resulting mis-pricing of assets provides opportunities for managers who carry out their own in-depth research. To the more, the JP Morgan EMBIGD index of emerging market debt returned 300% between 1994 and the end of 2006, while the MSCI Emerging Markets equity index outperformed the MSCI World Index in 13 out of the 19 years since inception, to the end of 2006.

Emerging Markets have broadened and developed, particularly over the last 10 years. There are over 40 countries in the investment universe, covering three regions: Latin America, Asia, and emerging Europe, the Middle East and Africa (EMEA).

Emerging markets have also many opportunities in various sectors as well as corporate finance. In particular, Emerging markets need to expand infrastructure such highway, airport, and seaport and so on. These sectors can be wonderful products in private equity investing of emerging markets.

Emerging market resources: property, debt and equity property

1. Property
Strong domestic and export-led growth, along with growing working populations, are set to boost development in manufacturing, office and residential property markets. At the same time, populations are likely to become increasingly urban, thanks to industrialization and the emergence of the middle class. In countries such as China and India, metropolitan areas are already growing strongly. These conditions should translate into a good level of growth in capital values and income from property in the long run.

2. Emerging market debt
The emerging market debt asset class includes a range of investments, from sovereign hard and local currency debt, to foreign exchange instruments and corporate credit. Although emerging markets can be volatile, improving country fundamentals are likely to lead to further positive returns as risk factors simultaneously moderate.

3. Global emerging market equities
The global emerging market equities universe is a large and diverse one. It is made up of countries that may be part of regional blocs but are often at very different stages of development. This miscellany includes everything from supermarkets in Asia to generic drug-makers in central Europe; IT in India to mining giants in Latin America.

Posted by Kim Dae-Keun on July 30, 2009.


To develop a healthy PE market in an emerging economy, one of the most significant aspects that need to be addressed is the protection of shareholders’ rights. Primary reforms may include strengthening investors’ confidence. Such reforms may include increased voting rights to the minority shareholders, well-timed enforcement of shareholder disputes and better access to the necessary information relating to the company. Some of the emerging economies have taken a lead in liberalizing the investment restrictions. The Korean government allows pension funds to invest along with the venture capital funds. Brazil and Chile follow a similar pattern. Another area that needs attention is improving the right of entry to public equity markets. It is usually observed that when the securities markets function well, institutional investors become a primary source of investment capital for private firms. Constant changes in regulations, volatility of the market and demand for greater disclosure norms are some of the factors that render the future of PE in the developing world highly uncertain.

However, increasing involvement of leading PE firms in investments in the developing nations should increase the quality of the deal selection and management. In short, one can expect the PE industry in developing nations to mature over a period of time, with the investment cycle becoming increasingly similar to that of developed nations. In the short run, China and India are clearly positioned to exert a major influence on the performance of PE funds in the developed world.

The successful PE investors in emerging markets need to cultivate an armory of personal characteristics, like the US venture capital pioneers in the 1960s. The early US venture capitalists were hard-pressed to convince skeptical investors to invest capital in high-risk companies with no track records; they even complained about inexperienced and secretive entrepreneurs and had difficulty effecting profitable exit opportunities long before the NASDAQ emerged as an IPO outlet for small companies. Failures outnumbered successes and serial complainers had more reliability than the innovators and risk takers. Fortunately, the US venture capitalists rapidly ascended the learning curve; it demonstrated an uncommon capacity to make creative adjustments along the way.
The new generation of emerging market PE managers must follow a similar course, and not permit early failures and disappointments to dampen a good number of factors that augur well for the future. Certain governments are already responding by passing legislation to better protect the rights of minority shareholders and by liberalizing burdensome tax regulations that depress foreign investors. Hence, despite some early setbacks, there are heartening signs that a PE rebound in emerging markets is not only desirable but also likely. However, the main players must make innovative adjustments that reflect the realities surrounding this type of investing pattern. With a different approach, the promise of PE will begin to be realized.


Banerjee A. (2008). Private equity in developing nations. Journal of Asset Management (9, pp. 158–170).

Posted by Esen Sagynov on July 31, 2009.

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