The Rise of Africa's "Frontier" Markets
| Author | David C. L. Nellor |
| Position | Senior Advisor in the IMF's African Department |
| Pages | 30-33 |
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A number of sub-Saharan countries are beginning to attract investors to their financial markets
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Several african countries, with developing financial markets that are likely to attract institutional financial investors, are promising candidates to become part of a second generation of "emerging market" countries.
The same crucial developments that presaged the arrival of institutional financial investors in emerging markets in the 1980s are taking place in parts of sub-Saharan africa today- growth is taking off, the private sector is the key driver of that growth, and financial markets are opening up (see box).
The global environment has played a key role. The search for yield, triggered by significant global financial market liquidity, has encouraged investors to expand their horizons.
But the new generation faces a more complex, more integrated global environment than did emerging markets of a quarter century ago. Then, institutional investors accessed emerging economies largely through equity markets and, in some cases, foreign currency debt issues. Today, these investments are but a part of the picture. Investors are immersed in a wide range of financial activities, including domestic bond and foreign exchange market instruments. Financial technology is more complex too.
The International Finance Corporation coined the term "emerging market" in 1980 to refer to developing countries with stock markets that were beginning to demonstrate the features of the mature stock markets in industrial countries.
Emerging markets-which afford the opportunity to participate in economies through financial investments-have been identified in all regions of the world. In africa, only South africa so far has been seen as an emerging market (see "emerging Markets emerge" on p. 54 of this issue).
Financial markets gradually became more sophisticated and complex over the past 25 years. Today, however, financial technology is transferred to african emerging markets more or less simultaneously as it is developed in sophisticated markets-although lack of market depth and infrastructure does inhibit its application.
That means that the second-generation emerging markets in africa face significant immediate challenges to which their predecessors could adapt over a quarter century. For one, maintaining financial sector stability will be challenging.
With most of the financial flows intermediated through domestic banking systems, africa's central banks have to strengthen considerably their supervisory capacity to manage the sophisticated financial activity that has emerged almost overnight. at the same time, policymakers have less scope to manage these activities. For instance, prudentialbased approaches to manage capital flows, such as taxes on short-term flows, can be bypassed more easily because of the availability of derivative transactions that were not used in emerging markets a generation ago.
This article identifies sub-Saharan african countries, beyond South africa, that offer institutional investors the prospect of good returns and a means to diversify risk through investments in financial markets. It recognizes how the changed global environment affects policy and raises issues investors are thinking about as they move into these markets.
The compilers of emerging market indices decide whether a country is an emerging market by assessing the nature and sophistication of the stock market in relation to the degree of development of the economy. recently, Standard & Poor's- which in 2000 took over the emerging market financial indices from the International Finance Corporation (IFC)-has used the term "frontier markets" to describe countries with markets that are smaller and less liquid than those in the more advanced emerging markets. Many of the emerging markets in the 1980s might have been called frontier markets under today's classification.
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The term emerging markets is used here to identify countries in sub-Saharan africa that have financial markets and attract investor...
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