ESADEgeo POSITION PAPER 30 MARCH 2013
Frontier Markets:
A World of Opportunities
Toms Guerrero Blanco
Research Assistant
ESADEgeo Center for Global Economy and Geopolitics
Frontier Markets: A World of Opportunities
1
Frontier Markets:
A World of Opportunities
Toms Guerrero Blanco
Research Assistant
ESADEgeo Center for Global Economy and Geopolitics
March 2013
Abstract
The emergence of frontier markets is speeding up the global economic rebalance.
No longer do the highest economic growth rates belong exclusively to the BRICS
countries. Lesser known economies, such as Nigeria and Vietnam, are key players
in global economic growth and are expected to continue to be so for several
decades
1
.
The economic growth that frontier markets are undergoing is still due to the
combination of low labour costs and abundant natural resources.
To avoid excessive commodity dependence and guarantee sustainable growth over
time, the governments of these countries have opted for creating sovereign wealth
funds and tech hubs.
Spain could take advantage of the opportunity that frontier markets represent, just
as it once did with the Latin American market.
Introduction
When Farida Khambata, an Indian economist at the International Finance Corporation (IFC),
coined the term frontier markets (FM) to describe countries at an earlier stage of economic
development than emerging markets (but holding the same potential), the vast majority of
states belonging to this set of countries were characterised by their instability, restricted
market accessibility and low liquidity. At best, they represented a future opportunity.
Nowadays, after a marked improvement in their fundamentals, the 37 frontier markets
included in the main financial indices (see Table 1) are synonymous with economic growth
(see Figure 1) and low debt levels (see Figure 2).
1
Forecasts taken from World in 2050: The BRICs and beyond: prospects, challenges and opportunities, PwC,
2013.
Frontier Markets: A World of Opportunities
2
TABLE 1. LIST OF FRONTIER MARKETS BY INDEX AND WEIGHTING
Country
S&P
BMI
MSCI
FMI
FTSE
F50
Country
S&P
BMI
MSCI
FMI
FTSE
F50
Argentina 5.4% 2.9% 7.8% Mauritius 1.7% 0.9% 3.7%
Bahrain 2 0.6 0.4 Namibia 0.2 - -
Bangladesh 1.3 2.5 5.1 Nigeria 9.8 12.8 21.1
Botswana 0.6 - - Oman 2.3 3.4 6.6
Bulgaria 0.2 0.1 - Pakistan 3.8 4.2 -
Ivory Coast 0.5 - - Panama 3.3 - -
Croatia 1.4 2.1 2.4 Qatar 13.4 14.2 24.6
Cyprus 0.6 - - Romania 1 1.1 4.3
Ecuador 0.6 - - Serbia - 0.2 -
Estonia 0.4 0.4 0.9 Slovakia 0.4 - -
Ghana 0.3 - - Slovenia 1.5 1.9 3.6
Jamaica 0.7 - - Sri Lanka 1.9 2 3.7
Jordan 3.7 0.9 1.7 T and T * 1.2 - -
Kazakhstan 5.2 3.6 - Tunisia 1 0.8 2
Kenya 1.8 2.9 8.4 Ukraine 1.5 0.3 -
Kuwait 19.5 27 - UAE 6.8 10.2 -
Latvia 0.1 - - Vietnam 3 2.4 3.4
Lebanon 2.5 2.4 - Zambia 0.3 - -
Lithuania 0.3 0.5 0.6 Total: 37
* Trinidad and Tobago.
Note: The initials of the indices in Table 1 are: S&P Frontier Broad Markets Index, MSCI Frontier Markets Index
and FTSE Frontier 50 Index.
Source: Standard & Poors, FTSE and Thomson Reuters Datastream.
Nowadays, the economic and financial development of the frontier markets is monitored
chiefly by financial entities which maintain a series of specialised indices in this sector.
However, there is clearly room for improvement for these indices, which are tremendously
popular among todays investors
2
. The two most significant deficiencies they have are the
following:
2
Index weightings assigned to each country and sector are not properly justified and do not correspond with the
actual performance of their economies.
*GDP at constant prices.
Source: FMI.
FIGURE 1. ECONOMIC GROWTH* FIGURE 2. PUBLIC DEBT TO GDP
RATIO
Frontier Markets: A World of Opportunities
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a) The omission of macroeconomic and institutional variables, which prevents the economic
and financial performance of frontier markets from being recorded objectively. The
Argentinean governments recent nationalisation of Repsols subsidiary YPF highlights the
need to start incorporating institutional and macroeconomic variables when putting
together these indices. Only then will they be able to project returns in keeping with the
true risks these countries present.
b) The lack of relationship between the real economic growth of these economies and the
returns forecast by these indices (see Figure 3).
FIGURE 3. ECONOMIC GROWTH VS FINANCIAL RETURNS
Although what has been described above continues to paint a picture of frontier markets that
is closer to that of a future challenge than a present opportunity, I now aim to explain some of
the most important phenomena taking place in these markets, and show the opportunities
these countries currently represent for Spain.
Frontier market sovereign wealth funds
Not only did the 2007 financial implosion, which came into focus with the fall of Lehman
Brothers in 2008, provoke the collapse of the global banking system and the start of the
financial crisis we continue to suffer from today, it also contributed to the arrival on the world
scene of the giants of state capitalism: sovereign wealth funds
3
.
3
Term coined in 2005 by Andrew Rozanov in Who Holds the Wealth of the Nations?
Note: Data for the period January 2000 to September 2012.
Source: Thomson Reuters Datastream.
Frontier Markets: A World of Opportunities
4
In the first few years of the crisis, the emergence of these new stakeholders caused a certain
amount of confusion among the main governments of the OECD economies, the strongest
sufferers in the global recession. However, this perception, which led the main media to
classify sovereign funds as barbaric and invasive, gradually changed over the course of
time.
4
The providential intervention of these new actors in the US bank bailout was a decisive
factor in the change of perception, upgrading sovereign wealth funds to the category of white
knights of capitalism (see Table 2).
TABLE 2. SOVEREIGN WEALTH FUND INVESTMENT IN US BANKS*
Sovereign Fund Bank Value ($M) Date
Abu Dhabi Investment Authority CitiGroup 7,500 November 2007
China Investment Corporation Morgan Stanley 5,600 December 2007
Temasek Holdings Merrill Lynch 4,400 December 2007
Government of Singapore
Investment Corporation (GIC)
CitiGroup 6,880 January 2008
Kuwait Investment Authority Merrill Lynch 3,000 January 2008
Korea Investment Corporation CitiGroup 2,000 January 2008
Temasek Holdings Merrill Lynch 2,000 January 2008
Government of Singapore
Investment Corporation (GIC)
Merrill Lynch 600 February 2008
* Period 2007-2008.
Source: 2012 Sovereign Wealth Funds Report, Invest in Spain/ICEX, KPMG and ESADE Business School, 2012
In the vast majority of cases, these state investment vehicles, whose risk tolerance is higher
than that of traditional Central Banks, have originated in countries with abundant natural
resources as a tool to achieve five main objectives:
a) To obtain long-term profits from current account surpluses arising from the exploitation
of natural resources.
b) To reduce inflationary pressure stemming from the budget surplus.
c) To avoid the effects of the so-called Dutch disease, the loss of competitiveness of
other sectors in the economy (with respect to the extractive export industries) as a result
of the appreciation of the national currency.
d) To diversify and restructure the countrys economy, investing in high-tech industry and
knowledge-intensive services
5
.
4
Rolando Avendao y Javier Santiso, "Are sovereign wealth funds political biased? A comparison with mutual
funds" in Karl Sauvant, dir., Sovereign investment: Concerns and policy reactions, Oxford, Oxford University
Press, 2012, pp. 221-257.
5
In this respect, Javier Santiso advocates the creation of strategic sovereign wealth funds that develop cutting-
edge sectors in new technologies Fondos Soberanos Latinos
Frontier Markets: A World of Opportunities
5
e) To develop a model of inter-generational solidarity that allows the generations to come
to enjoy the wealth that finite natural resources are bringing to present-day generations.
At present, there are over 70 sovereign wealth funds worldwide, and the current trend
suggests this number will continue to grow in the next few years
6
. In 2012, sovereign wealth
funds in frontier markets gained special relevance, for two main reasons described below.
A first factor is the significant number of sovereign wealth funds recently being launched in
frontier markets, and specifically in Africa
7
. On the basis of the Monitor Company Group
(2008) definition of sovereign wealth funds
8
(which would exclude funds controlled by the
Central Bank, such as the Botswana Pula Fund, funds that restrict their investments to
national markets, such as the Investment Corporation of Dubai, funds used as stabilisation
funds, such as the Ghana Stabilization Fund, and public companies with large investment
portfolios, such as Sonangol), frontier markets are home to 14 sovereign wealth funds, the
vast majority in the United Arab Emirates.
Secondly, the frontier markets sovereign wealth funds have gained in significance due to the
sheer volume of managed assets, which already exceeds $1 trillion (see Table 3), and the
size of operations being carried out, such as the arrangement the Abu Dhabi Investment
Authority is set to conclude with the Royal Bank of Scotland to acquire 42 Marriott hotels for
almost $992 million
9
.
6
The ESADEgeo Sovereign Wealth Fund Report suggested that a total of 21 countries were considering the
possibility of setting up a sovereign wealth fund in 2012.
7
Capap (2012) forecast 12 new SWFs in Africa in the next few years. A new SWF has recently been launched
in Angola: the Fundo Soberano de Angola (FSDEA).
8
The five criteria needed for a sovereign wealth fund to be considered as such are: a) to be owned exclusively by
a sovereign government; b) to comply with the characteristics of an investment fund, not to those of a state-
owned company; c) to invest nationally and internationally in risk assets; d) for the investment to seek commercial
returns; e) it is not a pension fund with obligations in this respect.
9
Abu Dhabi Fund Said Close to Buying RBSs 42 Marriott Hotels
Frontier Markets: A World of Opportunities
6
TABLE 3. FRONTIER MARKET SOVEREIGN WEALTH FUNDS
Sovereign Fund
Managed assets
($b)
Country
Year
founded
Abu Dhabi Investment Authority 450 UAE 1976
Kuwait Investment Authority 290 Kuwait 1953
Qatar Investment Authority 135 Qatar 2005
Mubadala Development Company 65.3 UAE 2002
International Petroleum
Investment Company
49 UAE 2000
Kazakhstan National Fund 41.6 Kazakhstan 2000
Bahrain Mumtalakat Holding 11.1 Bahrain 2006
Emirates Investment Authority 10 UAE 2007
Abu Dhabi Investment Council 10 UAE 1999
Heritage and Stabilization Fund 4.3
Trinidad and
Tobago
2000
Mauritius Sovereign Wealth Fund 3 Mauritius 2010
Ras Al Khaimah Investment
Authority
2 UAE 2005
State Capital Investment
Corporation
0.6 Vietnam 2006
Oman Investment Fund N/A Oman 2006
Note: Data February 2013
Source: Compiled by author based on the SWFs annual reports.
Frontier markets as tech hubs?
On the one hand, frontier markets have used sovereign wealth funds to develop an inter-
generational model that enables future generations to enjoy the benefits that the currently
abundant raw materials are producing for people today. Yet, at the same time, a series of
investments have been initiated which aim to promote and stimulate the development of
technology sectors and innovation-intensive industries.
By implementing these economic policies, reinforced in recent years in the face of what
appears to be the end of the sustained increase in the price of raw materials, the frontier
market governments are pursuing two seemingly fundamental goals in order to guarantee
long-term economic growth. Firstly, they aim to reduce the dependence of their economies
on the exploitation of raw materials. Secondly, they are attempting to lay the foundations for
the transition from an extractive economy, based on the export of commodities and
manufactured goods, to an innovation economy, based on the intensive use of knowledge in
the production and development of the transformational industry and services sector.
Frontier Markets: A World of Opportunities
7
FIGURE 4. REVENUE FROM NATURAL
RESOURCES*
This transition is still at an embryonic stage,
far from actually becoming a reality. Proof of
this is that the variables that ought to record
the change in the production model continue
to project an image of frontier markets more
in keeping with that of extractive economies
than that of the innovation economies which
characterize the OECD countries. The most
recent data provided by the World Bank
leave no room for doubt: in 2009
10
, the
average total revenue derived from the
exploitation of natural resources as a
percentage of GDP was 9.5% in frontier
markets, as opposed to 6.8% in the BRICS,
3.9% in the world and 1.2% in OECD
economies (see Figure 4). Similarly, in the
same year, the average volume of
manufactured goods exports was 5.20% in the
frontier markets, as opposed to 12.88% in the
BRICS, 17.12% in the OECD economies, and
18.29% in the world (see Figure 5).
In light of these figures, we can safely assert that frontier markets continue to be eminently
extractive economies. Nevertheless, recent events suggest this trend is shifting. Since
approximately 2010, some frontier market governments have been adopting measures which
give grounds for optimism and lead us to believe that an innovation economy, which can
prevent mid- and long-term economic stagnation, is drawing progressively closer. In this
process, two frontier markets (one from Africa and the other from the Middle East) appear to
have taken the lead.
1. Kenya: From iHub to Silicon Savannah
A little over two years ago, and thanks to funding by Hivos and Omidyar Network, we saw the
rise in Nairobi of what would be the first tech hub in Kenya: iHub. Since then, iHub, which
started out offering free internet access and specialist forums for entrepreneurs, has been
expanding continuously, becoming a benchmark for tech hubs in Africa; it has over 10,000
members, over 150 incubated companies, and the backing of multinationals such as Intel,
Google and Samsung.
10
The last year with data for all the frontier markets currently included in the indices covered in this report.
* Total revenue derived from the exploitation of natural
resources as a percentage of the GDP.
Source: World Development Indicators, World Bank.
FIGURE 5. HIGH-TECH EXPORTS^
^ Exports of high-tech goods as a percentage of the
total of manufactured goods exports.
Source: World Development Indicators, World Bank.
Frontier Markets: A World of Opportunities
8
iHub turned out to be only the beginning of things to come, since as a result of its creation, a
series of publicly and privately funded areas were set up with the aim of deepening Kenyas
commitment to upgrade its production sector. As a result of this public-private cooperation,
several successful projects saw the light, such as the startup incubator, NaiLab, and the
research and entrepreneurship institute, @ilabAfrica, inaugurated in 2011, followed by the
startup accelerator, 88mph, in 2012, and the proposal to build a technology city which has
been dubbed Africas Silicon Valley: Silicon Savannah.
This technology city project, planned to be carried out in four phases, the last of which is
expected to be completed in 2030, will be built on a 2,000-hectare site in the city of Konza (a
settlement 160 km from Nairobi). To do so, almost $14,500 million will be mobilised, of which
only 5% will be provided by the government led by President Mwai Kibaki
11
. The Kenyan
government hopes this ambitious project will convert the country into a benchmark for the
production and distribution of technological components in Africa, creating two hundred
thousand jobs in the ICT sector, and positioning Kenya as a tech hub of world renown.
2. Jordan: Making a virtue out of necessity
Not only was the Arab Spring, which brought about the downfall of the vast majority of
Maghrebs dictators
12
, the result of the citizens revolution, but it was also the triumph of a
revolution begun years before, which silently paved the way for the wave of protests to
spread at breakneck speed: the technological revolution.
If it is basically private initiatives that have promoted and provided funding for the
construction of the centres in Kenya; in Jordan it was the institutions of the Hashemite
Kingdom that decided to transform their capital, Amman, into a benchmark tech hub for the
Arab world and, therefore, into the main Pan-Arab competitor of Israels tech hub, Silicon
Wadi.
Contrary to what one might think, the technology epicentre of the Arab world originate from
the development and globalisation of cities such as Doha, Riyadh or Abu Dhabi catalysts
for progress in the Middle East and the main magnets for FDI but from decisions made by
Jordans King Abdullah II to re-launch his countrys economy, which is characterized by its
lack of natural resources and strong energy dependence.
It would appear these decisions are succeeding: the latest International Telecommunication
Union data indicate that Jordan currently hosts three quarters of all Arabic content online.
Moreover, the Queen Rania Center for Entrepreneurship (QRCE), launched in 2004, and the
11
Private funding will make up the remainder of the financing.
12
In Jordan, the wave of protests did not topple the monarchy. It only managed to have modest political reforms
introduced.
Frontier Markets: A World of Opportunities
9
FIGURE 7. SPANISH INVESTMENT
ABROAD
startup accelerator Oasis500, launched in 2010 and located on a site that was built to be the
headquarters of the Jordanian Army, indicate that Yahoos acquisition of the Jordan-based
startup, Maktoob, for $80 million will likely not be the last.
Frontier markets: An opportunity for Spain?
The latest figures offered by the Ministry of Economy and Competitiveness on foreign
investment in Spain and Spanish investment abroad paint an uncertain picture of Spain; a
picture that does not bode well: Spain remains mired in recession
13
.
The breakdown of these disheartening figures,
which record a drop of over 50% in foreign
investment in Spain in 2012, and over 63% in
Spanish investment abroad compared to the
same period in 2011
14
, clearly show the delicate
situation of the country, as well as the
opportunity that frontier markets represent.
Foreign investment flows in Spain in the last
twelve years are a clear example of this
opportunity, revealing that the frontier markets
investment in Spain is long-standing. Since
2000, there have been numerous years in which frontier market investment in Spain has
been greater than investment from the all-powerful BRICS. In fact, in 2009, when OECD
investment in Spain plummeted and BRICS investment suffered, frontier market investment
reached an all-time high of 3 billion gross
(See Figure 6). In 2012, frontier market
investment was lower than BRICS
investment, but still extremely close; this is
hardly insignificant if the size of these
markets is taken into account.
The statistics on Spanish investment abroad
reveal two trends. Firstly, Spanish investment
in OECD economies has fallen sharply due to
the crisis. Secondly, these figures reveal that,
13
ESADEs 2013 Economic Report predicts a one-percentage-point contraction of the Spanish economy and an
increase in unemployment, which will reach rates over 25%.
14
All the data related to investment in 2012 in this section only cover up to the third quarter of said year.
* Up to September 2012.
Source: Compiled by author based on data from
DataInvex.
* Up to September 2012.
Source: Compiled by author based on data from
DataInvex.
FIGURE 6. FOREIGN INVESTMENT
IN SPAIN
Frontier Markets: A World of Opportunities
10
FIGURE 8. SPANISH INVESTMENT IN
FRONTIER MARKETS
FIGURE 9. SPANISH INVESTMENT IN
FM, INCLUDING COLOMBIA AND
SAUDI ARABIA
on the one hand, Spanish investment in BRICS and frontier market economies has been
practically unaffected by the crisis; on the other hand, Spanish investment in frontier markets
has remained at similar levels to those for BRICS since 2001 (see Figure 7).
The 2012 figures, which did not cover Spanish investment in Colombia
15
and Saudi Arabia
16
as both countries had been reclassified as emerging economies, confirmed this trend.
Frontier markets were established as an attractive destination for Spanish investment; to the
point that, if we add Spanish investment in Colombia and Saudi Arabia in 2012 to
investments made in the frontier markets recognised by the different financial indices (see
Figure 8) for that same period, the total investment is greater than the investment in the
BRICS (see Figure 9).
Against a backdrop of uncertainty, investing in frontier markets, which entail greater levels of
risk as opposed to the traditionally safe OECD economies, may seem a priori
counterintuitive. But the fact is that beyond the underlying explanation of the risk-return
trade-off, figures reveal that these high levels of risk the sole preserve of the frontier
markets until the outbreak of the financial crisis have become globalised.
In this context, frontier markets represent an excellent opportunity for Spain, which
unavoidably obliges us to rethink our commercial strategy and look beyond the BRICS.
15
Colombia to be Reclassified as an Emerging Market
16
The upgrading of Saudi Arabia to the category of emerging markets is just a matter of months. MSCI
Reintroduces Coverage of Saudi Arabian Stock Market
Note: Data for 2012 (January-September).
Source: Compiled by author based on data from DataInvex.
China-Europe-Spain:
The awakening of investment by Chinese companies in Spain and Europe
2
For further information on ESADEgeos Position
Papers, please feel free to contact:
Marie Vandendriessche
ESADEgeo Center for Global Economy and Geopolitics
Av. Pedralbes 60-62, 08034 Barcelona, Spain
+34 934 95 21 46
[email protected]
www.esadegeo.com
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