OREANDA-NEWS. July 08, 2007. Companies considering direct investment in emerging economies should look at a broad range of possible destinations and weigh up the balance of both risk and reward when making their final decision, according to a new report from the emerging markets group at PricewaterhouseCoopers LLP, reported the press-centre of  PricewaterhouseCoopers.

The best known emerging markets – in particular the BRIC (Brazil, Russia, India and China) countries – have definite attractions, but they may not always be the optimum choice for foreign direct investment in either the manufacturing or services sector, the report The PricewaterhouseCoopers EM20 Index – Balancing Risk & Reward points out.

The inaugural PricewaterhouseCoopers EM20 Index is an innovative ranking of 20 key emerging markets according to their relative attractiveness for overseas investment. Separate rankings have been generated for stylised manufacturing and services businesses, reflecting their differing investment criteria. For manufacturing companies seeking to invest in businesses overseas, low production costs are a key requirement; for services companies seeking to sell to domestic markets, emerging economies with relatively high per capita income are generally the most attractive.

Vietnam takes the top spot as the most profitable emerging market for manufacturing companies followed closely by China, Poland, Chile and Malaysia. On the services side, the United Arab Emirates leads, followed by Saudi Arabia, South Korea, the Czech Republic and Hungary.

The PricewaterhouseCoopers EM20 Index is based on a model, developed by PricewaterhouseCoopers economists, which closely mimics the methods used by companies in the real world when deciding where to invest. Unlike other indices, the PricewaterhouseCoopers EM20 incorporates both reward factors (economic fundamentals such as GDP per capita, projected economic growth rates, taxes, transport costs and tariffs) and risk aspects (country risk premia derived from bond market data, which act as a proxy for the market’s view of country risk).

Ian Coleman, head of emerging markets, PricewaterhouseCoopers LLP, said:

“In the UK there is a widely recognised need for companies to embrace emerging market opportunities more rapidly in order to avoid falling further behind competing developed countries. The Index can act as a valuable framework or filter to help companies with their initial screening of investment location opportunities, but, of course, a good investment appraisal is bespoke and considers all factors relevant to a business. That means including factors over and above economically-derived risk and reward such as the need for certain types of labour skills or language capabilities. The regulatory environment and business culture may also be relevant for many companies.”

Ian Coleman added:

“India and China are undoubtedly important markets and the latter’s high ranking in manufacturing is no surprise. At the same time, Vietnam and Malaysia are now serious rival destinations in South East Asia, while Poland may rank high for companies seeking a relatively low cost location in close proximity to the major European markets.”

Top three rankings

A notable feature of results for the manufacturing sector was the close clustering of many of the countries’ rankings. This suggests that management of manufacturing businesses currently have considerable choice when it comes to selecting an emerging market destination - many of the EM20 countries will be worthy of serious consideration.

Vietnam’s success – topping the rankings with an index score of 95 (on a scale of 0-100) – illustrates the interplay between risk and reward in the EM20 Index. Vietnam is highly cost-competitive and offers investors the potentially highest returns. On the other hand, it is also the fourth riskiest investment location within the EM20. Nevertheless, so great are the potential returns that they offset Vietnam’s relatively high country risk premium.

As with Vietnam, low costs lie behind China’s second placed ranking for manufacturing (also with an index value of 95, but slightly lower on an unrounded basis). Offering relatively high rewards and benefiting from a low risk rating, China is a highly attractive manufacturing location – as indicated by the interest in the country already shown by many international businesses.

Poland emerges as the highest-placed European country for manufacturing investment, with a score of 94. Its ranking success largely reflects its low-cost labour relative to Hungary and the Czech Republic. Poland also benefits from its proximity to the export markets of the European Union.

On the services side of the Index, the wealthiest of the EM20, the United Arab Emirates (UAE), gains the top ranking at 95. This is a dramatic change from its position in the Manufacturing Index, where it occupies last place due to relatively high cost levels. However, the UAE’s very high GDP per head means it enjoys a significant lead over its nearest EM20 services rival, Saudi Arabia. The UAE also benefits from a statutory corporate tax rate of 0% and a low risk premium. In the Index ‘services’ does not refer to offshoring activities such as call-centres where the service being provided is geographically remote from the end-user, but rather to services sold to the domestic market.

High per capita income combined with a very low statutory tax rate (2,5%) places Saudi Arabia in second place in the EM20 Services Index (with a value of 70). Saudi Arabia, with its 25 million citizens, is the largest of the Gulf Cooperation Council countries; its financial services sector has considerable potential and many international organisations have secured banking licences in recent years.

Though again a high income country, South Korea, in third place in the index, has a statutory corporate tax rate of 25%, which places it at a disadvantage compared to the top two locations. Putting all factors together, the EM20 Services Index value for South Korea is 61.

John Hawksworth, head of macroeconomics at PricewaterhouseCoopers LLP, commented that:

“Our services rankings were dominated by higher income countries, with the UAE and Saudi Arabia showing up particularly well, which also reflected their low corporate tax rates. Corporate tax rates vary significantly across emerging markets and are therefore a key driver of our rankings, both for services and for manufacturing. This emphasises the importance of good tax planning when considering emerging market investments.”