We have long believed that the antiquated terms “developed” and “developing”, which are so often used to distinguish between countries’ wealth and standard of living neither represent a country’s financial risk, nor their economic global impact. We were therefore pleased to hear this week that the World Bank has dropped the “developing country” classification from its World Development Indicators, as the term has become “less relevant”.
The categorisation is based on a country’s Gross National Income (GNI) per capita using the “Atlas conversion factor”, where 2/3rds of the world’s countries were classified as “developing”; having fallen into the “low- and middle-income economy” categories. This is not to say that the “developed/developing” classifications have not been useful proxies, however, considered more an art than a science, there is no clear-cut blanket definition, especially if we are looking at investment risk.
At Stratton Street we prefer to use the net foreign asset (NFA) position to analyse a country, and hence investment risk. The NFA uses a country’s current account, which measures the flow of assets for the country as a whole, and so captures the build-up of assets or liabilities not just of the government, but also the debt or asset accumulation of corporates, banks and individuals. Consequently, the concept of NFA measures the aggregate savings or borrowings of the entire country, not just government debt. Our model assigns a 1-7 star rating to a country using its NFA as a percentage of GDP; a 3 star country for example has net foreign LIABILITIES (NFL % of GDP) below 50%, whereas 7 stars are given to a nation with over 100% net foreign ASSETS (NFA % of GDP). Using this method, we can automatically reject a number of countries, i.e. those with high NFL.
If we take the examples of Portugal, Turkey and China, which have GNI per capita (PPP) of $21.3k, $10.8k and $7.4k; Portugal fell under “developed” while the latter were classed as “developing”. We could then look at their respective credit ratings; Ba1, Baa3 and Aa3, just from that the “developing” nations look less-risky, and China has several notches of protection. NB: We have never been holders of debt issued by Turkey or Portugal. Now if we look at our 2016 NFA star ratings, Portugal is 1 star, Turkey only has 2 stars while China has been assigned 5 stars. So to us the World Bank measures, although evolving and helpful in the correct application, do not truly depict the risk one faces if their investment is based on such categorisation; “developed/developing”, or “frontier” and “emerging” etc. for that matter.
Hopefully other institutions will move away from these definitions just as they have from describing nations as first, second or third world; categories which primarily describe a country's affiliation with capitalism or communism. Defining China as “developing” is just as unhelpful as thinking of South Korea as Third World, yet many still insist on doing so. Meanwhile we will continue to look for value in our 3-7 star nations and remain cautious of the many overlooked risks in “developed” markets.