The consensus among investors is that Covid-19 will overwhelm frontier emerging markets, causing immense economic fallout from a collapse in both domestic and external demand. However I, without meaning to sound too Pollyannaish I think another scenario is more likely: that such markets will outperform.
MSCI’s Frontier Emerging Markets index spans large companies across 34 nations — from Argentina, Bahrain and Bangladesh to Togo, Tunisia and Vietnam. Typically, such markets suffer from domestic economic weakness rather than external factors. Clearly, a number of these countries will have local frailties exposed by the unprecedented shock to external financing from tourism and remittances.
Sri Lanka, for example, will probably see a sharp drop in tourism, delivering a nasty economic shock for an economy already struggling. It is also true that some countries in this category, notably Nigeria and Egypt, will be hardest hit by external factors such as falling exports due to lower global demand and weaker remittance inflows from nationals employed overseas.
In some cases, disruptions to the real economy from lockdowns may further accentuate vulnerabilities in financial systems. This is particularly true in Bangladesh, for example, where bad loans at state banks amount to about 30 percent of gross domestic product and where the sector has suffered for years from poor liquidity.
However, this is not the whole picture. My more bullish view – based on data and intelligence gathered from an on-the-ground network spanning such markets around the world- is that there are in fact numerous countries where strong growth and recovery is possible once the impact of Covid-19 begins to diminish.
For example the Philippines, Peru and Vietnam are well positioned to recover. In these countries, the recovery will be aided by the relative resilience of their banking sectors and strong foreign exchange reserves. The Philippines, for example, has huge FX buffers, a low deficit and a banking system with ample liquidity. Moreover, the country’s ratio of external debt to GDP is only 24 per cent, less than half the EM average, while FX reserves cover nearly 12 months of imports, much higher than Asean peers Thailand or Indonesia. Expansionary fiscal and monetary policies have also been substantial without threatening macroeconomic stability.
Peru, like the Philippines, is similarly enacting strong initiatives to address the Covid-19 public health challenge. In economic terms, the country also enjoys additional freedom in fiscal and monetary policy because of years of sound policy management.
Both the deficit and cumulative debt are low. Even with a stimulus package of 8 percent of GDP — at the upper end of EM spending — Peru has surplus funding from a variety of domestic and external sources, including abundant Treasury assets and an IMF contingent credit line.
Vietnam’s handling of Covid-19 has been short and sharp. Whilst previous experience in dealing with earlier pandemics kept infections and deaths extremely low. As a result, the economy has resumed close-to-normal activity quickly.
Even Egypt and Pakistan, both highly indebted and seemingly vulnerable, may outperform. Both have reaffirmed their commitments to tax and civil service reforms and have maintained access to IMF programme funding. In Pakistan, the outlook has improved markedly since the 2018 general election victory of Imran Khan. In a short period, the country has seen notable improvements in business sentiment and macroeconomic policymaking.
Meanwhile, Egypt has greatly reduced uncertainty about its commitment to reform by not only obtaining the IMF’s easy money through the Rapid Financing Instrument but also committing to a newly funded Standby Arrangement, which alleviates market concerns on the stability of the government’s domestic borrowing programme. It, as in Peru, has already been rewarded with access to the eurobond market. This, along with large reserve buffers, should help Egypt cope with the decline in FX receipts from weaker tourism and remittances, and retain foreign portfolio investment in the local debt markets.
Even though these countries offer investors the best opportunities, it is important to note that frontier markets across the board will probably outperform developed markets in the short to medium term. The IMF also shares this view: its most recent World Economic Outlook forecast strong rebounds to pre-Covid-19 growth rates in frontier emerging markets and longer-lasting weakness in developed markets.
Investors should therefore not overlook the considerable post-Covid potential of frontier emerging markets. The reasons are straightforward: resilient government balance sheets, improving governance and promising growth and trade trajectories abound.