JP Morgan is working on revising how it defines emerging markets, in a move that would affect how its widely used EM bond indices are calculated, say sources.
The GBI-EM Global Diversified index tracks $883 billion in face value of local-currency sovereign debt, and the EMBI Global Diversified Index $274 billion of US dollar-denominated sovereign debt.
The planned revision is unlikely to mean significant changes to the index series. Rather, it is thought the bank's motivation is to prevent the composition of the benchmarks changing, by keeping countries in the EM category that would otherwise soon be upgraded to developed status.
The US bank aims to make the benchmarks better reflect the development of EM bond markets and is expected to announce the new definition early next year, having launched the original EMBI in 1992.
JP Morgan has been using the World Bank's definition of emerging markets as those with gross national income (GNI) per capita of less than $12,475. The supranational organisation reviews this figure annually to take into account developed-market inflation.
The problem is that a simple income measure is inadequate for categorising a country as an emerging market, notes one source, hence the need for JP Morgan to adapt its approach. For example, there are countries in the Middle East with very high GNI per capita, but EM-like development.
Moreover, many countries are likely soon to graduate from the EM category but wouldn't necessarily qualify as developed markets, which have also matured and grown richer, says the unnamed executive.
As a result, JP Morgan is likely to adopt a measure that allows the threshold to adjust not only for inflation, but also for average growth in global income. It may do so by adjusting the current World Bank threshold by the per-capita world GNI growth rate, based on the Atlas method in current dollars.
JP Morgan is also considering incorporating sovereign credit ratings as another new component of the EM definition, in order to reflect the level of market development.
But some argue that ratings do not properly reflect the state of a country's market development – in the sense that many nations with very poor economies today have strong economic management, and vice versa.
Still, the anonymous source says it would make sense to have a 'two-dimensional approach' that captures not only the rate of a market's growth, but also its depth. JP Morgan's new threshold is likely to be more suitable than the old one, they add, given that it may incorporate both ratings and income.
“You need to move away from a static to a dynamic threshold,” says the executive, noting that emerging markets have to grow faster than rich countries to justify their catching up to achieve developed-market status.
According to the World Bank, countries over or close to the GNI per capita threshold in 2011 included Chile ($12,280), Croatia ($13,850), Equatorial Guinea ($14,540), Hungary ($12,730), Poland ($12,480), Uruguay ($11,860) and Venezuela ($11,920).
Most Asian countries that have not hit the threshold are still well below it, but are approaching it faster than many elsewhere. China's per capita GNI was $4,940 in 2011, up from $2,480 in 2007. Over the same period, the figure for India rose from $950 to $1,410 and for Indonesia from $1,600 to $2,940.
Any change in definition will not have an effect on how countries are classified – and therefore no market-impact – right away, says the source. Under the current and likely future rules a country must be over the threshold for three consecutive years.
JP Morgan declined to comment for this article.