Last updated: December 21, 2010 12:26 pm

Frontier markets

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There’s a clue in the name: rugged, mostly unexplored, and potentially treacherous. Yet if the reasons to raise allocations to emerging markets are still intact in 2011 – low yields and low growth in developed economies, combined with plentiful liquidity – then “frontier markets” should benefit from trickle-down effects. As defined by MSCI, these markets outperformed emerging markets this year, gaining 16.5 per cent, against 12.3 per cent. But their overall recovery from the crisis has been far less spectacular, thanks to the lack of foreign capital.

Take Bangladesh, where foreign investors own just 5 per cent of the stock market, compared to about a third in South Korea or Thailand. If institutions needed justification for their decision to steer clear, Sunday’s 7 per cent plunge in the Dhaka market – the steepest one-day fall for five years – would have provided it. But once calm is restored, foreigners should aim for a more sophisticated take than “here be monsters.” Yes, Bangladesh has all the problems of a low-income country – poor infrastructure, bureaucracy and corruption – along with high inflation and a weak currency. But its vast pool of cheap, young labour means that it stands a good chance of replicating its success in clothing in other light manufacturing and service sectors: Bangladesh has built the world’s biggest ship-breaking business from scratch over the last 30 years, for example. Unlike Southeast Asia in the early 90s or India today, its transition to a middle-income country is entirely unreliant on foreign financing or portfolio flows.

Trying to catch a falling knife might be unwise: in the three years to December 5th, Dhaka’s recent peak, it was the best-performing equity index in the world, up 209 per cent. But Bangladesh’s inclusion in Goldman Sachs’ “next 11,” a grouping of the largest non-BRIC emerging markets by population, seems merited. On a fundamental, long-term view, frontier markets like this seem a lot like emerging markets a generation ago: under-owned, under-researched and generally under-appreciated.

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