Jerry Parwada

While the big equity markets of Europe, the US and even Australia have struggled since the global financial crisis, investors have increasingly found that there are profits to be made in emerging and also the new frontier markets.

The story of Brazil is now well known, but new mutual funds and also hedge funds have been investing in countries as diverse as Romania, Kenya, Kazakhstan and Nigeria.

The economic forecasts for some of these markets are certainly bullish. By 2015 the BRICS group of Brazil, Russia, India and South Africa is expected to account for almost one quarter of global GDP, up from 8 percent in 2000.

Sub-Saharan Africa has not featured strongly on many investment radars but over the next five years seven of the region’s economies are expected to be among the top ten economies measured by growth.

This year the Zambian and Nigerian economies are both expected to grow by 6.8 percent, Mozambique by 7.5 percent, Ethiopia by 8.5 percent, and Ghana by 13.7 percent.

These are encouraging forecasts, but if the emerging and frontier markets are to remain a beacon of light for global markets some structural issues need to be addressed if the phenomena is to be sustainable.

The boom in many of these markets is being accompanied by strong inflationary pressures which, if left unchecked, will undermine the markets and create havoc in the individual domestic economies.

Already, we are seeing very high food price inflation in many of these countries, driven in part by the substitution of staple food for the production of biofuels. The moment food production is substituted for fuel production food will rise in price and inflation is the result.

These are the kinds of investments which deliver returns to investors while creating difficulties for the local population. These are transient money flows which may be damaging to the very growth potential that make the emerging markets so attractive.

If the inflows are too unbalanced, the phenomena will become more speculative than sustainable and beyond that will also foment political instability. More prudent Governments might deliberately slow down growth to curtail inflationary pressures.

The hedge funds, mutual funds and private equity groups investing in these markets and also local industries such as biofuels are stateless entities driven entirely by profits and are difficult to regulate in terms of how they invest. If a nation tries to protect itself from speculative investment through regulation, the funds will simply go elsewhere.

There is, however, a solution and it is in the hands of multi-lateral agencies such as the World Bank and its finance arm, the International Finance Corporation, and regional development banks such as the Asian Development Bank and the African Development Bank. These agencies have the ability to balance the growth story with intelligent investing and counter-balance the more speculative inflows from the likes of the hedge funds.

Portfolio and inflows of Foreign Direct Investment are much better directed to projects that genuinely improve productivity. This is the only kind of money flow which is permanent in any way.

Zimbabwe, for example, has a crying need for import substitution after the political turmoil of the last decade has decimated its agricultural sector. Zimbabwe, once the farm of southern Africa, is now importing food from neighbouring countries.

The IFC could increase its partnerships with local organizations in such an economy and successfully contribute to the production of food. Partly due to the flow of hard currency remittances from expatriates, many of these countries are dollarized in one way or another so food can be sold at competitive prices, removing the need for massive subsidisation.

Such initiatives would not only help feed the local population, but they would also lessen the pressure for inflation which is the biggest economic danger.

The boom in emerging and frontier markets will only be a positive for the countries themselves if it is balanced and sustainable. And if it is sustainable it will be a positive for the global economy over a long period and prove to be more than an investment fad.

Associate Professor Jerry Parwada is Head of the School of Banking & Finance at the Australian School of Business.