Frontier markets need to cease the moment

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Global recession has led to slow growth in most developed economies.

Column by Collins Rudzuna

Leading economies as the US, Japan and the Eurozone are still to recover fully from a meltdown that began with a financial sector crisis in 2008.

Developed economy central banks have responded with aggressive monetary policy tools. Central banks have been increasing money supply in the hope that cheaper, more abundant money will encourage increased employment and consumer spending.

They also hope that companies will have more money for capital spending to meet increasing demand, thereby spurring economic growth generally. With interest rates at ultra-low levels, investors in the developed world are being forced to look beyond their own markets to get decent returns.

So far, the search for better returns has led some investors to frontier market stock exchanges. In Africa Nigeria, Kenya and Zimbabwe have benefited immensely.

Stock indices in these three countries have all gained more than 25% since the beginning of the year. Typically, money managers will allocate only a small portion of their investable funds to African stock markets.

In the context of the recipient exchanges and their participants, however, the inflows are substantial. African stock exchanges are way smaller than the total funds that some of the offshore investors have to outlay.

Where investors place a few millions from their multi-billion dollar funds to place in Africa, the inflow in our context is a windfall.

On the Zimbabwe Stock Exchange (ZSE), for example, daily trades are usually worth less than US$2 million and a single investor from a developed country could easily dominate trading on the exchange for a few days. In April, for example, trading on the ZSE averaged US$1,3million daily.

The inflow of funds from developed country investors seeking higher returns has been beneficial to local stock exchanges at many levels. On the one hand it has created much-needed liquidity in markets that usually struggle to maintain a decent flow of funds.

For stockbrokers it has created a new stream of income to augment the limited deal flow from local participants. Unfortunately most of these benefits do not make for much long-term benefits for the wider economy. Portfolio investments are usually very quick to flow in and out of a country.

Once a target return is achieved, the typical frontier market investor will liquidate their position and realise their profits. There is little incentive in maintaining long-term exposure to what is usually viewed as a high-risk or even speculative investment.

The rampant money printing spree in the developed world could potentially reap even more benefits for Africa, and Zimbabwe in particular. Having captured the attention of developed world investors, frontier economies can use this opportunity to demonstrate that even longer-term investments are a viable option.

Most of the perceived risk of frontier markets is exaggerated by the media. Some investors have only been forced by circumstances to brave this perceived high-risk investment landscape. While attention is still on them, frontier markets can entice investors to put in money for the long haul.

One of the perennial impediments to growth for poorer economies is the lack of savings and resultant shortage of long term capital. If investors could be persuaded to widen their participation to include venture capital, infrastructure development and project finance, their money could go beyond making a quick buck and actually go into mutually beneficial longer-term investments. Africa has a long list of infrastructure projects that have long been on the cards but failed to kick off due to lack of funding.

Some of these projects, such as roads, telecoms infrastructure and dams could be developed in a profitable way if structured correctly.
Authorities and private sector players could do much to convince foreign investors to stay for the long haul. Providing accurate first-hand information to counter sensationalised media reports is one such effort.

Investors often have just a surface appreciation of the real potential of frontier economies. Governments and companies can take advantage of their presence to give them a first-hand appreciation of the real situation on the ground.

Zimbabwe’s extensive coal and gas fields, for example, lie idle in the midst of a regional power shortage. Their exploitation could probably be done profitably. Instead of just trading Hwange shares, investors could fund these projects and make money while they are at it.

Another effort that can be made to convince investors to stay would be to adopt investor-friendly policies. African countries have been accused of prioritising politically- motivated policies to the detriment of economically beneficial ones.

Although poorer countries like Zimbabwe are in dire need of investment, there is still much to be done to implement policies which give comfort to investors. Unstable political environments, inadequate investor protection measures and overly-stringent processes for investing are some of the features that have been fingered as impeding investment inflows. In Zimbabwe, some potential investors have expressed concern over property rights and indigenisation laws.

Aligning these policies to the ultimate goal of attracting investment could help in converting short-term portfolio investments into longer term direct investments.

The sudden increase in interest in frontier markets is largely the result of a sea of liquidity emanating from developed country currency expansion.

It is highly likely that once the global economy stabilises the inflows will tail off. A window of opportunity has thus been created. If frontier economies do not use this window to attract longer term investment, they may be passing up on a once-in-a-lifetime opportunity.

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