Morgan Stanley

Hidden Gems for Investors as Frontier Economies Move Past Crises

Sep 18, 2024

Small emerging and frontier economies have gone through unusual turmoil in recent years and may present compelling investing opportunities as they recover.

Author
Steven Quattry

Key Takeaways

  • Investors may find hidden gems among frontier economies that are enacting policy reforms and normalizing after recent economic turmoil sparked by pandemic disruptions and higher interest rates. 

  • Nations that experienced significant currency depreciation have outperformed broader indices by an average 64% over the subsequent two years, according to our analysis of MSCI emerging and frontier markets. 

  • Countries including Argentina, Egypt, Nigeria, Pakistan and Turkey may offer compelling equity valuations across asset classes. 

Some of the world’s emerging markets and frontier markets that have experienced the most turmoil may now be best positioned for investment opportunities. In countries where inflation has soared and currencies have plummeted, a return to economic normalcy and more stringent policy has led to attractive equity valuations and earnings growth.  

 

The convergence of multiple shocks—including the COVID-19 pandemic, the conflict in Ukraine and high interest rates across the globe—hit vulnerable economies hard. A number of countries faced their most severe economic crises in decades, as these shocks were accompanied by unorthodox government policies that resulted in high fiscal or current account deficits, unwise monetary approaches and overvalued currencies. 

 

Now, in some of these markets, there are signs of economic healing. External creditors and voters are pushing countries back toward sound policies. Local companies are adapting to economic stressors. The result is historically low valuations for equity markets that may present attractive entry points for investors.  

 

Here are some of the most compelling situations.  

 

Argentina 

For years, Argentina’s government printed money to finance unrestrained spending. The country has faced 300% inflation and a stunning 87% depreciation in its currency, and it has suffered a painful recession this year.  

 

Javier Milei, elected president in November, has slashed inflationary public spending and for the first time in 70 years, the country is set to run a fiscal surplus without the aid of a commodity windfall or one-off privatization of government assets. Progress on reforms has helped Argentina negotiate with the International Monetary Fund (IMF) and gain access to more than $4 billion in funding.  

 

The administration’s efforts to liberalize domestic oil prices and export permits in the medium term could add to earnings upside for Argentine oil and gas companies. Assess opportunities in companies that have rights to develop reserves in Vaca Muerta, the most promising shale oil and gas reserves in the world, especially companies focused on production growth, cost efficiency, and improved profitability. 

 

Egypt

With an economy that relied on large fiscal deficits, loose monetary policy and a managed currency, Egypt ran into trouble following a decline in tourism during the pandemic and a loss of Suez Canal revenue due to the pandemic and geopolitical unrest. These events exacerbated the country’s shortage of U.S. dollars. 

 

To address these pressures, Egypt secured a $35 billion land deal with the United Arab Emirates, providing a much-needed cash infusion. Subsequently, the country abandoned its currency peg, resulting in a 60% currency depreciation and record inflation of almost 40% in 2023. Egypt’s adjustments unlocked an additional $15 billion in funds from the IMF, World Bank and European Union after agreeing to a series of policy reforms. 

 

Investors may find opportunity in large corporate banks, which are earning strong investment income due to high interest rates. Given the improving macroeconomic backdrop, an interest rate easing cycle is set to begin, allowing loan growth to return to high double digits. 

 

Nigeria 

The nation’s currency plunged more than 70% and inflation spiked to 33% in 2024, while the central bank has hiked interest rates to a record 26.25%. The economic pain has come in part from President Bola Tinubu’s ambitious reform program, which included increasing fuel prices and transitioning to a market exchange rate.  

 

These necessary reforms have caused hardship for consumers, and there is a risk that recent protests could escalate and unwind the progress Nigeria has made so far. However, the president’s bold actions may have laid the groundwork for increased private investment—a key pillar of his economic plan. A recent $2.25 billion World Bank package aims to promote economic stability and fiscal sustainability.  

 

In terms of investing opportunities, we see promise in telecommunications companies with a presence in Nigeria, which could benefit from growing data demand—as more smartphones are leading to increased data consumption—and mobile money businesses are growing at 30% or more. Key players have built distribution networks which are hard to replicate, creating a relatively high barrier to entry for other telecom operators. 

 

Pakistan

Here, the challenges have included political uncertainty, dwindling foreign exchange reserves, and unsustainable debt levels, contributing to a 46% depreciation of the currency and inflation that peaked at 38% in 2023.  

 

The successful formation of a political coalition, despite a tainted election, has brought a measure of stability. The government, under Prime Minister Shehbaz Sharif, has embraced more orthodox policies including fiscal adjustments, energy sector reforms and a free-floating currency. The country has secured more than $1 billion from the IMF and more is possible.  

 

Only one-third of Pakistan’s 248 million population has a bank account, so investors should monitor opportunities in large digital banks, should the number of new bank accounts climb. Additionally, the IT services sector is emerging as a standout, fueled by rising exports that reached an all-time high of $3.2 billion in the 12 months ending June.  

 

Turkey

President Recep Tayyip Erdogan had kept to the unconventional belief that lowering interest rates could combat inflation, leading to loose monetary policy for years. Inflation soared as high as 85%, and the currency fell by 69%.  

 

Erdogan made a dramatic turn toward monetary orthodoxy, however, after being reelected last year. He has appointed more credible officials to the central bank and finance ministry, a shift that led to a sharp increase in interest rates to 50% and an increase in foreign reserves, both of which are restoring economic stability.  

 

There are compelling opportunities in exporters and other companies that earn revenues in dollars but incur costs in local currency.  One such opportunity exists in enterprise software development, especially those that target small and medium-sized business enterprises (SMEs). In Turkey, software penetration for SMEs is only 16%, below the 30% EU average, and the Turkish government is driving to digitize government fiscal accounts including tax collection and permits. 

 

What to Watch 

Our analysis of MSCI emerging and frontier equity markets, going back to the 1980s, indicates nations that experience significant currency depreciation typically outperform the broader index afterwards. We found an average 64% outperformance in U.S. dollar terms over the subsequent two years.  

 

Investors may be wary of investing in these markets. But as foreign investors tend to exit when they see signs of trouble, local companies usually have to adapt to stay in business and will often be quite surprisingly resilient and resourceful. Many companies in these markets have delivered stronger earnings per share growth—in dollar terms—than even the S&P 500 or India stock market benchmarks, despite their volatile political and economic cycles. These earnings streams can be bought at near record low valuations, of anywhere between 4x and 8x earnings vs. many global benchmarks trading at more than 20x.

 

Emerging and frontier markets have clearly been through a turbulent period. Though they may not be out of the woods, we see significant potential for a rebound. Every economic crisis carries the potential to seed reforms and set the stage for improved economic performance. There are positive developments—and the potential opportunity for investor returns. 

See the Full Report

Learn more about the frontier markets outlook in "Hidden Gems: Unearthing the Potential of Overlooked Markets."

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