Iran is Not a Frontier Market, it is an Emerging Market in Waiting
Iran is a big economy that has been largely overlooked by foreign investors. That combination of facts is exactly what makes it difficult to determine whether Iran should be considered a frontier or emerging market.
While there is no fixed definition of “frontier market” or “emerging market,” investors will often point to the categorizations used by MSCI, an American financial company that produces two influential indexes tracking the capital markets in frontier and emerging economies. The MSCI Frontier Markets Index covers 31 countries including Bangladesh, Croatia, Ivory Coast, and Nigeria. MSCI’s Emerging Markets Index today covers 26 countries including Brazil, China, Egypt, Pakistan, and Thailand.
Looking across these two indexes, Iran appears to fit somewhere in between. In 2011, prior to the imposition of financial sanctions, GDP per capita in Iran was just over $18,000 in purchasing power parity (PPP) terms. Today, following a decade of economic difficulties, that total is just over $13,000. Even with the steep decline in GDP per capita, the average Iranian continues to enjoy higher incomes than citizens in most frontier economies. For example, GDP per capita is just over $5,000 in Bangladesh and over $7,000 in Morocco. Of course, there are frontier markets with significantly higher per capita incomes than Iran, such as Kazakhstan ($27,000) and Estonia ($38,000). One way to think about the inclusion of these countries among frontier markets is that they are relatively small economies with high levels of per capita GDP.
But Iran is not a small economy. It is much more like Egypt, Indonesia, Brazil, or Mexico—countries considered emerging markets. The GDP per capita of these countries ranges between $12,000 and $18,000. Like these economies, Iran’s lower levels of per capita GDP are partly a function of the country’s large economy—distributing the benefits of economic development is more difficult in countries with large geographies and large populations. But what is notable is that GDP per capita in Iran exceeded the median among MSCI Emerging Markets Countries until 2011. Iran’s position in the top half of the distribution is even clearer when data for Saudi Arabia, the United Arab Emirates, Kuwait, and Qatar is stripped out. By this measure, Iran fits nicely in MSCI’s categorization of emerging markets.
Still, Iran differs from these emerging markets in one big way—while Iran may have a developed capital market, the country has received dramatically less foreign investment than the countries included in the MSCI Emerging Markets Index. For example, looking to data for 2017, the last year in which Iran was not under U.S. secondary sanctions, net inflows of foreign direct investment in Iran totalled just over $5 billion. That same year, net inflows in Brazil were $68 billion.
Here, the role of investors becomes clear. “Frontier market” and “emerging market” are labels applied by investors to explain their investment strategies and risk appetites. By most objective measures of its economic composition and performance, Iran should be considered an emerging market. But until the composition of investment inflows match those in other countries deemed to be emerging markets by investors, Iran will be considered a frontier market—a place where institutional capital has yet to flow in significant volumes.
Photo: Fabien Khan