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How Afghanistan’s Humanitarian Crisis Could Be Felt in Emerging & Frontier Markets

What could Afghanistan’s humanitarian crisis mean for frontier and emerging markets? Our Chief Market Strategist Stephen Dover discusses the situation with Bassel Khatoun, Director of Research, Franklin Templeton Emerging Markets Equity. 

This post is also available in: Spanish

Transcript

Stephen Dover: Bassel, there haven’t really been big investments in Afghanistan, but I’m wondering if you could talk a little bit about how the situation in Afghanistan might roll out to those countries around Afghanistan or other countries around the world, particularly since you look at both frontier markets and emerging.

Bassel Khatoun: First and foremost, the fall of Afghanistan has triggered a very tragic humanitarian crisis, and with thousands of people still trying to flee the country, our deepest thoughts and sympathies are with all of those that have been heavily impacted. And whilst the situation remains fluid, I think the investment implications for global emerging markets investors are certainly more contained and much more nuanced. So just for context, the main foreign-traded assets at risk from these events are the bonds and equities in Pakistan, a country which in its entirety represents an almost negligible two basis points in the MSCI Emerging Markets Index, and less than 1% of the Frontier and Small Emerging Markets Index.1 So I think that context is important to bear in mind as we think through the investment ramifications of these events.

Stephen Dover: Can you just talk a little bit about the market of Pakistan and how you look at it?

Bassel Khatoun: We think there are a couple of ways that Pakistan might be impacted. First of all, from the “Belt and Road” initiative partnership with China, which has already invested US$60 billion into that economic corridor, China may be keen to preserve those interests. The second impact may come from the spread of refugees into Pakistan across the border. And so, whilst there are some risks to the Pakistan story, under Prime Minister Imran Khan, the security situation in Pakistan has seen drastic improvement over the last four years.

Secondly, this has coincided with economic and fiscal reform within the country, including a very successfully negotiated package from the IMF (International Monetary Fund). And as such, we see asset risks have receded in the country.

Stephen Dover: The other country that’s had significant investment in Afghanistan is of course India. What do you see, if any, the impact on India with the changes happening In Afghanistan?

Bassel Khatoun: Well, you’re right, Stephen. Partly in response to China and partly with the ambition of competing with Pakistan, India has supported and financially invested in success of Afghan governments. So today, it will keep a very watchful eye over the security situation, primarily as it seeks to limit the threats of spillover, particularly into the Kashmir region. Overall, however, we don’t see the fall of the government, for now, having a drastic impact on the Indian equity story. And for us, the Indian equity story continues to be supported by the long-term fundamentals. The investment case is built upon under penetration, formalization of the private sector, domestic reform, a stable government. We do, however, feel that some of these positives and the post-pandemic recovery are somewhat neutralized by near peak valuations in the market.

Stephen Dover: Bassel, how might this impact China’s overall ambitions in the region?

Bassel Khatoun: Well Stephen, a couple of points really. First off, it is clear that China regards the Taliban as a governing force. It has already received senior delegation and unequivocally called them a key part of the future. Secondly, the capabilities and interests of China are now critically very different compared to when the US led forces into Afghanistan in 2001. And then, finally, and most importantly, I would say that Chinese interest and motivation in the region is high. Not so much directly in Afghanistan, but it has certainly become more vested in the security of Pakistan and the stability of Iran. And so, in particular, these interests are closely aligned with Pakistan because of the investments it’s made. It is very keen to avoid seeing a reversal of the security gains made in Pakistan over the last decade. And, as such, an inclusion of Taliban forces into the government of Afghanistan, at the very least, reduces this risk. So, I would expect increased support coming from China, but that likely to come in the form of humanitarian and financial support.

Stephen Dover: Bassel, we know that Afghanistan is rich in minerals, particularly those minerals that are important for the electrical vehicle market. What kind of impact do you see around that?

Bassel Khatoun: Great question Stephen, and you’re absolutely right. Afghanistan has access to vast mineral deposits, and they’re estimated to be worth over US$1 trillion. This includes rich reserves in iron ore, in copper, in gold and another rare-earth materials. And so, the Taliban’s control over Afghanistan now comes at a time when there is a supply crunch for these materials. So, we’ve seen skyrocketing demand for copper, lithium and cobalt in particular, which is being driven in large measure by the transition towards green energy. However, these valuable resources remain largely untapped in Afghanistan due to decades of conflict and corruption. And as a result, its mineral resources have been largely untouched for 40 years. So, whilst we think that it’s unlikely to change soon under the Taliban control, given that the focus of the government will likely be on a wide range of security and humanitarian issues, what we’re really talking about here is an opportunity cost or a foregone opportunity to extract resources which are in high demand.

And so, if at some point in the future, Afghanistan is indeed able to unlock this great wealth, this might lift and hopefully will lift many people out of poverty, create jobs and forge new opportunities for the country.

What Are the Risks?

All investments involve risks, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Special risks are associated with investing in foreign securities, including risks associated with political and economic developments, trading practices, availability of information, limited markets and currency exchange rate fluctuations and policies; investments in emerging markets involve heightened risks related to the same factors. To the extent a strategy focuses on particular countries, regions, industries, sectors or types of investment from time to time, it may be subject to greater risks of adverse developments in such areas of focus than a strategy that invests in a wider variety of countries, regions, industries, sectors or investments. China may be subject to considerable degrees of economic, political and social instability. Investments in securities of Chinese issuers involve risks that are specific to China, including certain legal, regulatory, political and economic risks.

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1. One basis point is equal to 0.01%. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges.

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