The New Frontier: Economies on the Rise

IMF Blog, May 19, 2014

Source details

Author: Min Zhu
Date: May 19, 2014
Note: (Version in 中文, Français, Português, and Español)
Core message: A group of fast-growing low-income "frontier economies" are attracting international investor interest; they combine huge potential with significant risks and require tailored policy responses.

Broad working definition: fast-growing low-income countries that have been deepening their financial markets; some have moved to the lower-middle income group.
Examples of countries deepening financial markets: Bangladesh, Kenya, Nigeria, Mozambique, and Vietnam.
Examples of countries tapping international capital markets: Bolivia, Ghana, Honduras, Mongolia, Nigeria, Senegal, Tanzania, Vietnam, and Zambia.
Comparative characteristics:
- Markets are not as deep and liquid as emerging markets.
- Offer higher returns and portfolio diversification benefits relative to emerging markets.

Main drivers:
- Fast growth often supported by sustained efforts to achieve macroeconomic stability.
- Building business-friendly institutions.
Policy and structural reforms cited:
- Lowering inflation via prudent fiscal and monetary policy.
- Strengthening policymaking apparatus, reducing excessive red tape, lowering trade restrictions.
- Reforms shifting economic structures toward services (examples: Tanzania and Kenya).
Debt dynamics and investment:
- Alleviation of debt burden over the past decade freed resources for physical and human capital investment.
- Several countries received debt relief under the Highly Indebted Poor Country Initiative; others reduced debt outside this initiative (examples: Kenya, Mongolia, Nigeria, and Vietnam).
Financial market development:
- Rapid deepening of domestic financial markets—more domestic financial services and products than peers.
- Some countries have attracted international investor interest in domestic bond markets and issued sovereign bonds in international capital markets.
Infrastructure financing opportunity:
- Access to international capital markets can attract financing to address infrastructure gaps (roads and railways), providing further growth impetus.
- But market access also introduces new financial risks that require careful management.

Global financial environment:
- Low interest rates combined with advanced economies shedding debt pushed investors to seek higher returns, expanding interest in frontier economies.
Resource demand:
- Emerging economies' quest for resources improved terms of trade and spurred domestic and foreign investment in resource-rich countries (examples: Bolivia, Ghana, Nigeria, and Mongolia).
Public investment:
- Low debt burden, favorable external borrowing rates, and high commodity prices increased access to private financing sources abroad, raising domestic public investment.

Identified risks:
- Greater market scrutiny from external private capital exposes weaknesses in domestic macroeconomic policies (weakening fiscal and external positions).
- Potential slowdown in capital flows as U.S. interest rates rise and monetary policy normalizes.
- Countries with foreign investor participation in domestic bond markets and significant fiscal and current account imbalances have experienced volatile exchange rates and rising spreads in recent months.
- Limited size and liquidity of government bonds in international capital markets mitigates—but does not eliminate—the risk of capital flow reversals; new issuances may face higher spreads and maturing bonds may struggle to find buyers.
Policy recommendations and measures:
- Preserve macroeconomic stability and fiscal sustainability.
- Continue building adequate external reserves.
- Bolster economic and institutional fundamentals, including domestic savings.
- Further structural reforms (labor, trade, regulation) and higher investment to enhance productivity and help countries move up the value chain.
- Deepen domestic bond markets to allow more efficient intermediation of financial flows.
- Monitor build-up of risks and preserve fiscal and debt sustainability.
- Use proceeds of government bonds for high-yielding projects, whether issued domestically or internationally.
- Consider framework in the IMF’s recent paper on managing capital flows to help manage risks associated with these flows.

Frontier economies show great promise but face significant risks from increased capital flow exposure.
Continued commitment to macroeconomic stability, fiscal and external sustainability, and investor-friendly institutional improvements is central to continued success.
Policymakers should optimize benefits from capital flows while taking actions to address related risks.

Source: The New Frontier: Economies on the Rise, Min Zhu, May 19, 2014.

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