Typical street scene in Santa Ana, El Salvador. (Photo: iStock)

Typical street scene in Santa Ana, El Salvador. (Photo: iStock)

IMF Survey: Africa's Aspiring Second-Generation Emerging Markets

August 18, 2008

  • Search for yield has encouraged investors to expand their horizons
  • Some African countries compare favorably with Asian countries in 1980
  • African central banks must give enough weight to financial sector stability

Several African countries, with developing financial markets that are likely to attract institutional financial investors, are promising candidates to become part of a second generation of "emerging market" countries, IMF analysis shows.

Africa's Aspiring Second-Generation Emerging Markets

Highrises in downtown Dar es Salaam, Tanzania: Sub-Saharan African countries offer investors means to diversify risk (photo: Stephen Jaffe/IMF)

SUB-SAHARAN AFRICA

The same crucial developments that presaged the arrival of institutional financial investors in emerging markets in the 1980s are taking place in parts of sub-Saharan Africa today—growth is taking off, the private sector is the key driver of that growth, and financial markets are opening up.

The global environment has played a key role. The search for yield, triggered by significant global financial market liquidity, has encouraged investors to expand their horizons.

Complex environment

But the new generation faces a more complex, more integrated global environment than did emerging markets of a quarter century ago. Then, institutional investors accessed emerging economies largely through equity markets and, in some cases, foreign currency debt issues.

Today, these investments are but a part of the picture. Investors are immersed in a wide range of financial activities, including domestic bond and foreign exchange market instruments. Financial technology is more complex too.

Financial markets gradually became more sophisticated and complex over the past 25 years. Today, however, financial technology is transferred to African emerging markets more or less simultaneously as it is developed in sophisticated markets—although lack of market depth and infrastructure does inhibit its application.

Sophisticated financial activity

That means that the second-generation emerging markets in Africa face significant immediate challenges to which their predecessors could adapt over a quarter century. For one, maintaining financial sector stability will be challenging. With most of the financial flows intermediated through domestic banking systems, Africa's central banks have to strengthen considerably their supervisory capacity to manage the sophisticated financial activity that has emerged almost overnight.

At the same time, policymakers have less scope to manage these activities. For instance, prudential-based approaches to manage capital flows, such as taxes on short-term flows, can be bypassed more easily because of the availability of derivative transactions that were not used in emerging markets a generation ago.

An article in the September 2008 issue of Finance and Development magazine identifies sub-Saharan African countries, beyond South Africa, that offer institutional investors the prospect of good returns and a means to diversify risk through investments in financial markets. It recognizes how the changed global environment affects policy and raises issues investors are thinking about as they move into these markets.

■ Read the full Finance and Development article.

Comments on this article should be sent to imfsurvey@imf.org