Frontier markets: Is risk vs. reward still attractive in 2025?

A look at why we believe frontier markets may offer more reward than risk in 2025.

AUTHOR Kevin Daly Investment Director, Emerging Market Debt

Following a strong 2024, we remain cautiously optimistic about the outlook for frontier market bonds.

Fundamentals have generally improved, and there’s still ample upside on the yield front. Duration risk is low, which could help mitigate the impact of rising US Treasury yields. Default risk, by all measures, has also declined over the past year, helped by debt restructurings and improved maturity profiles. Risks related to the new Trump administration are valid, but here, too, we think the picture is more nuanced than widely portrayed.

Declining default risk

After several external shocks in recent years, we’ve seen tangible evidence of declining default risk in frontier markets. Following restructurings, default risk in Zambia, Ghana, Ukraine and Sri Lanka has lessened considerably. Liability management has been equally important, with several countries reducing default risk by pushing out maturity periods (Chart 1). A good example is Cote D’Ivoire, which in early 2024 issued new nine- and 12-year bonds and later tendered its (shorter-dated) 2025 and 2032 bonds.
 

Chart 1. Frontier market bond maturity profile

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Source: IMF, Word Bank, October 2024

The reopening of the primary market in 2024 was also a welcome surprise, further easing concerns about financing pressures and default risks. Aside from Cote D’Ivoire, Benin, Kenya, Cameroon, Senegal, El Salvador and Nigeria all saw healthy demand for their new issues. The return to the primary market provides governments with a useful alternative source of financing, rather than relying on multilateral lending, which became more common in the post-pandemic period.

Improving fundamentals

There’s also reason for optimism on fundamentals. In 2025, frontier country growth is expected to bounce back with a broader differential versus developed market countries. Fiscal consolidation had remained elusive for an extended period, but we’re now seeing better progress, with frontier countries (in aggregate) expected to swing to a primary surplus by 2026. International Monetary Fund support programs have helped, as they typically make debt disbursements conditional to meet fiscal and debt consolidation targets.

Countries are achieving fiscal consolidation through a mix of revenue-generating and expenditure-cutting measures. For example, policies on the expenditure side include removing energy subsidies. In contrast, on the revenues side, policies frequently include reduced VAT exemptions and increased digitalization aimed at broadening the tax base.

While the pace of consolidation varies from country to country, the overall direction of travel for both fundamentals and default risks is now positive. Global credit ratings agencies have recognized this progress, with rating upgrades in 2024 exceeding rating downgrades for the first time in five years.

Yields remain attractive

Following a strong 2024, frontier bond yields have fallen, with 11 countries now offering double-digit yields, down from 25 one year ago. However, we think the yield of 8.56% on the JP Morgan NEXGEM Index remains attractive relative to the risks, its long-term history, and other EM and global bond assets (Chart 2).1,2
 

Chart 2. Selected global bond yield comparison at end-2024 (%)

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Source: JP Morgan, Emerging Markets Bond Index (EMBI® ) Monitor, 2 January 2025
 

The scope for significant spread compression could be more limited now that many countries are trading close to the tight end of their post-pandemic ranges. That said, spreads could still grind higher on an idiosyncratic basis.

Another source of yield is likely to come from changes to the JP Morgan NEXGEM Index composition, given the expected inclusion of higher-yielding countries such as Argentina, Ecuador, Egypt, and Ukraine.2

Potential Trump 2.0 risks

Risks associated with the incoming new Trump US administration are understandably the focus of much attention. There are concerns that higher US tariffs on imports and a crackdown on illegal immigrants might stoke US inflation. This, together with Trump seeking to boost growth through (potentially) unfunded tax cuts, has been pushing up US Treasury yields since the presidential election result.

Rising US Treasury yields tend to be negative for higher-risk assets, including emerging market assets. However, the impact on frontier bonds has been quite limited, with idiosyncratic factors driving performance. This may reflect that frontier bonds have historically had a relatively low correlation to US Treasury yields compared to other assets. While this provides some comfort, a significant rise in the US 10-year yield beyond 5.0% could become more problematic.

A positive for global growth?

However, it’s worth noting that Trump-related risks are not all negative. A Trump-inspired boost to US growth would be positive for global growth and, therefore, for frontier markets, too. Improvements in US government efficiency and a stronger fiscal position might lessen the risk to Treasury yields. Additionally, investor sentiment would likely improve if Trump succeeded in ending the Russia-Ukraine war. So, for now, we believe the potential Trump 2.0 risks are more balanced than widely portrayed and should be manageable for frontier markets.

Final thoughts

We believe 2025 can be another good year for frontier bond markets. Fundamentals are improving, default risk has been reduced, and yields provide investors with ample compensation for the risks. That said, careful credit selection and adaptability to unfolding global and local developments will be more critical than ever.
 

1 JP Morgan, Emerging Markets Bond Index (EMBI® ) Monitor, January 2025.
2 The JP Morgan NEXGEM Index is a fixed-income index that tracks frontier markets in emerging economies. It includes countries that issue government and corporate bonds in local and hard currencies.
 

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