Democratisation and the investment consequences for frontier markets

March 28 this year was a date for the history books. It marked the first time the Nigerian presidential election had been contested peacefully between two political parties, rather than between personalities in the same party. It was also the first time that the opposition had come to power in a presidential contest in the history of Africa’s most populous country.

The result might have been better news for Muhammadu Buhari, elected as president, than for his rival, Goodluck Jonathan, whose People’s Democratic Party had been in power since 1999, but in so far as it was peaceful and accepted by the defeated party, it marked the maturing of Nigeria’s democracy.

It was also one in a long list of so called “frontier” countries where we have seen the process of democratisation at work, including peaceful transfers of power in Pakistan in 2013 and in Sri Lanka in early 2015.

Frontier markets have become one of the most discussed asset classes of the past few years. Often referred to as the “emerging” emerging markets, frontier economies include the likes of Nigeria, Kenya, Saudi Arabia, Vietnam and Romania.

One of the biggest challenges for many investors has been the perception – whether apocryphal or real – that governance is lacking in many frontier markets.

While it may be too early to say whether we are embarking on a “fourth wave” of democracy, following on from the changes we saw in eastern Europe after the collapse of the Soviet Union, the current redrawing of the characteristics of frontier markets could have profound consequences for the asset class.

One of the major elements of this change is technology. This process of democratisation supported by developments such as biometric identification is in full swing across frontier markets – bringing accountability, oversight and greater stability in its wake.

Biometric ID cards have increased transparency and credibility of elections in frontier markets, reducing the risk of election fraud and helping to create the conditions for democratisation.

These have been introduced in Pakistan, Sri Lanka, Kenya and Nigeria. Biometric ID also makes it possible for governments to target social transfers with greater precision, reducing waste and boosting spending.

In the case of Nigeria and Pakistan, the government has also entered into a partnership to allow individuals to access prepaid financial services, attractive when individuals may not have had a bank account before.

For financial services firms, and particularly banks, this is a welcome development as it reduces the risk of fraudulent lending. The Nigerian authorities expect to have issued cards to 34m customers by June 2015. It is also enabling a technological leap to mobile banking.

One example of a company we particularly like in this context is Guaranty Trust Bank, which operates in Nigeria. Widely regarded as Nigeria’s highest quality bank, it has a highly regarded management team, excellent financial reporting and solid long-term prospects in a market which has considerable growth potential.

The annual Ease of Doing Business ranking from the World Bank found that 74 per cent of sub-Saharan African countries had passed at least one reform aimed at making it easier to do business in 2014. The figure was even higher at 85 per cent for countries in Europe and central Asia, fully 20 percentage points more than for high-income OECD members.

Even in countries where a different form of government is in place, we have still seen positive steps to reduce uncertainty and create a stable environment for businesses.

Saudi Arabia, for example, is certainly not a democracy, but one of the first acts of King Salman on coming to the throne was still to clarify the line of succession, which was well received by the investment community. This stands in contrast to Oman, where Sultan Qaboos has not publicly designated an heir.

In other cases, such as the Socialist Republic of Vietnam, we have seen the government take steps to create a more business-friendly environment, including an ambitious list of state-owned enterprises it wishes to privatise.

We might not be there in all cases and in all countries, but we believe investors should be encouraged by the extent to which the environment in frontier economies is generally getting more business friendly.

 

Michael Levy

Levy is investment manager for EMEA and global frontier markets at Baring Asset Management.