Frontier markets face gloomy prospects

Financial markets are driven by information flows. Global markets during the week ending June 21, 2013 traded in negative territory following the announcement by the US Federal Reserve Bank (FED) on its quantitative easing (QE) outlook.

Victor Makanda

Analysts labelled the trends on the markets a trifecta as both US and European equities tumbled, Treasury bond yields rose and gold shed more than 6% to a two-year low.

The Fed announced after its two-day meeting held on June 17 to 18 2013 that they would adopt a three-stage process which would begin with the slowing of asset purchases, starting possibly later this year.

This slowing or tapering off, of the stimulus package would be dependent on the continued improvement in the US economy. Ending of asset purchases would then follow, perhaps in 2014, when unemployment is anticipated to have fallen to 7%.

The return to normal monetary policy which requires unemployment to fall to 6,5% would follow thereafter. The interesting revelation was that while the Fed has yet to alter the pace of its QE efforts, global markets behaved as if monetary policy was already become much tighter.

While tapering and the ultimate end of the current ultra-loose monetary policy by the US Fed may not be imminent, frontier markets also felt the impact of the news. The South African market shed 3,24% while Nigeria and Kenya lost 2,11% and 2,07%, respectively.

On the local front, the Zimbabwe Stock Exchange (ZSE) Industrial Index eased 0,88%. Could this be the beginning of an end to the bull run enjoyed by frontier markets? Can these developments possibly herald the onset of a “frontier market crisis”?

Liquidity injected by major central banks, that is, the US Fed, the European Central Bank, the Bank of England and, recently, the Bank of Japan has been the major driver of equities. Frontier markets have logged impressive returns relative to developed markets ever since the financial crisis hit the globe in 2008.

Most investment funds’ flows have found their way into emerging and frontier markets searching for higher returns. Equities in Ghana, Nigeria, Kenya and Zambia have logged year-to-date gains between 21,74% and 57,83%.

However, the gradual recovery of the world’s largest economy which is now compelling the Fed to possibly reduce its QE actions may not be positive for frontier markets.

Hot money flows have fundamentally been the major drivers of most African economies and in turn has been supporting overall global economic growth. The recovery, though sluggish in the US economy, may possibly lead to a crisis in most frontier economies in the short-to-medium-term.

This is explained by the fact that growth in frontier economies has been largely supported by foreign inflows from developed economies. As a result, the anticipated recovery in the US and other developed economies may herald a corresponding contraction for frontier economies.

The South African economy is a classic example of this phenomenon as the rand of late has been finding support from the woes of developed economies. However, the slow recovery in the US has seen a weakening of the rand as foreign inflows are slowly dissipating, impacting negatively on the overall economy.

Foreign inflows into Zimbabwe may also be reduced. While the adage that: “When the US economy sneezes, the world catches a cold” remains true, its recovery may not necessarily be good for frontier economies. This is so as foreign inflows are expected to falter.

Reduced inflows may see a further thinning of the already low foreign direct investment into Zimbabwe. Low foreign investor participation on the local bourse may also signal the renaissance of a bearish market as domestic investors, including institutional players, are not liquid enough to drive the market on their own.

The weakening of commodity prices may also limit the growth of the mining sector considering that Zimbabwe is a commodity based economy. The Chamber of Mines recently announced that gold and platinum accounted for more than half of the revenues of the mining sector.

Revenues stood at US$584,7 million for the first four months of 2013. With the weakening of gold which is down by over 20% for 2013, the mining sector and overall economic growth prospects for Zimbabwe may have taken a knock.

Corporates engaged in mining activities are also feeling the heat with Falgold’s recent set of interim financial results providing testimony.

Falcon Gold Zimbabwe registered a loss of US$2,61 million compared to a previous profit of US$3,16 million weighed down by low production, rising operational costs and declining gold prices. What is worrying is that despite the current loss position, future prospects are not looking bright with management mulling various strategies including divestures and restructuring if gold prices weaken further.

Bindura Nickel Corporation also published a cautionary statement that they had failed to raise debt for the Trojan project due to the negative sentiment caused by falling nickel prices.

Although globalisation was inevitable, trends on the global front are slowly giving birth to significant downward risks for local corporates and the domestic economy at large.

Frontier markets are also likely to feel the heat as developed countries’ policy makers give a kiss of life to their own economies.

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