The Next Goalpost for Frontier Markets: Privatization

Efforts by frontier-markets governments to sell off state-owned enterprises mean opportunity for market-beating returns for foreign investors.


Maika Elan

Societal anxieties and state ideologies about the free rein of private companies have long delayed market reforms in many frontier markets. Yet today the outlook is changing, as bulging national deficits and lower oil revenues have led states to embrace privatization as official policy. New views on trade agreements and International Monetary Fund programs are also encouraging states to make privatization an official policy.

Countries once considered rigid in their state-controlled ways are now inviting investors to revive inefficient companies and other noncore assets within the sectors of utilities, consumer goods, food and beverage, and transport. New policies from top decision makers have opened doors for investors looking for yield in markets that are typically difficult to enter and exit. Vietnam, Pakistan and Saudi Arabia are three countries leading this trend.

In 2000 Vietnam had more than 10,000 state-owned companies. Today the government controls fewer than 1,000. Change continues to occur as Vietnam searches for new methods to put its fiscal house in order, with a budget deficit at about 5.5 percent of gross domestic product and a debt-to-GDP ratio approaching 65 percent. Expedited privatization, along with the introduction of transparent business practices, has enabled Vietnam to be more competitive, especially relative to neighboring China. Free-trade agreements Vietnam has signed on its own and via its membership in the Association of Southeast Asian Nations are acting as a catalyst for further reforms. The country has free-trade deals with China, the European Union and South Korea and is a signatory to the Trans-Pacific Partnership.

In 2015 Vietnam amended its Securities Law to remove the limit on foreign ownership of Vietnamese companies. This move enabled the State Capital Investment Corp., Vietnam’s sovereign wealth fund, to draft plans to divest its holdings in ten large companies — including a 45 percent stake in Vinamilk, the nation’s leading dairy producer, worth around $3.3 billion, and a $1 billion stake sale in mobile operator MobiFone — and to partially privatize Binh Son Refining and Petrochemical Co.

Vietnam is also opening its electricity sector in a bid to attract independent power producers. The country’s regulator is drafting a competitive power wholesale market law, with implementation expected in 2019, that will end the monopoly of state-owned Electricity Vietnam and allow private players to purchase power at market-determined prices.

In Pakistan, political stability is driving the momentum toward privatization. Prime Minister Nawaz Sharif began to move state-owned companies into private ownership during his first stint as prime minister, in 1991, but that initiative got derailed by security concerns. When he returned to power for the third time, in 2013, he quickly engaged the IMF to secure a $6.6 billion extended fund facility conditioned on fiscal consolidation and energy sector reforms through privatizing state holdings. To date, Pakistan has conducted four capital market transactions to divest its entire holdings in three commercial banks and a partial stake in an oil and gas company. The transactions raised $1.8 billion and helped strengthen the country’s foreign exchange reserves and its fiscal position. The transactions also added $1.65 billion of additional liquidity to the stock market by boosting the free float of equity.

Even Saudi Arabia’s relatively closed economy is embracing liberalization. Interviews with Deputy Crown Prince Mohammed bin Salman about the kingdom’s Vision 2030, which aims to develop the country’s nonoil sectors, hint at energy sector privatization and the sale of minority stakes in Saudi Arabian Oil Co., or Saudi Aramco, the world’s largest oil company. Riyadh also seeks to open other noncommodity avenues to investors by raising the private sector’s contribution to GDP from 40 to 65 percent, cementing tourism as an official component of the economy and helping small and medium-size enterprises raise their share of GDP from 20 to 35 percent.

Over the past year Saudi Arabia adopted other business-friendly policies, such as permitting qualified foreign investors to invest directly in its equity market, lowering the minimum assets under management requirement for such investors from $5 billion to $1 billion and lifting foreign ownership limits for a single foreign investor from 5 to 10 percent. In addition, Saudi Arabia is moving toward a T+2 settlement cycle from a prefunded model, bringing it into line with global norms.

Privatization and other liquidity events are the best way for frontier markets to attract greater international allocations. Many investors ignore ongoing privatization moves because of sparse company information and inadequate checks and balances in capital markets. When companies are relieved of government ownership, information sharing stands to improve. In addition, if policymakers embrace widespread privatization, the productivity of their public sectors should improve. Ultimately, governments of frontier-markets economies should focus on fostering a safe business environment anchored on policy continuity and transparency, instead of managing individual companies. Prudent investors should take advantage of game-changing events in these markets, which can generate more alpha than can developed economies.

Hedi Ben Mlouka is CEO and CIO of Duet MENA, part of alternative-asset management firm Duet Group , in Dubai.

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