Welcome to the final 2020 edition of WSJ Pro Emerging & Growth Markets, our weekly review of key news affecting frontier and small emerging markets.

In this week’s newsletter we take a look at the prospects for emerging and growth markets in 2021. After a difficult year, many regions are poised for a strong recovery over the coming months. Profound challenges remain, however, including growing inequality and the rising risk of social unrest as countries struggle to satisfy short-term spending demands while ensuring long-term economic stability.

Stage is set for powerful recovery. After a year that saw a mass exodus of investors from emerging markets during the early days of the pandemic, growth markets appear poised for a historic comeback. The intense rush of investors for the exits in the first quarter of 2020 pushed down already depressed valuations of emerging- and frontier-market assets, creating a broad range of buying opportunities, while the continuing search for yield by investors is drawing fresh capital into the market.

Jacob Grapengiesser, a partner at frontier-focused fund manager East Capital, said global economic conditions have set the stage for a powerful rally in emerging-markets assets. “Roaring economic growth, trillions of dollars of monetary stimulus and attractive valuations are providing the best conditions for emerging and frontier markets that we’ve seen in at least a decade, setting the stage for a multi-year bull run,” he said.

Research firm Oxford Economics says investors should be optimistic. The firm is forecasting that 2021 will see the fastest rate of global economic expansion for over 40 years. “[We] anticipate not just one but two years of steady recovery and positive growth,” the firm said.

According to Mathilde Lemoine, chief economist at fund manager Edmond de Rothschild, global GDP growth will hit 5% in 2021 and 4% in 2022 after contracting by almost 4% this year. Growth in emerging markets will be even swifter: Dr. Lemoine forecasts emerging economies will follow this year’s 2% economic contraction with a 5.6% expansion in 2021 and 4.3% GDP growth in 2022. Citi is even more bullish, forecasting 6.1% growth in 2021 for emerging markets.

Patrick Esteruelas, head of research at emerging-market-debt-focused fund manager Emso, agrees emerging markets will benefit from a “coordinated” global economic recovery in 2021. “We think that a resurgent global economy and continued low core real yields will create a strong backdrop for emerging markets,” he said. Emso expects stimulus measures, including ultra-loose monetary policies, rolled out worldwide in 2020 to continue, providing powerful support for bonds in emerging markets, which are likely to continue offering meaningfully higher yields than those from developed markets. A “more predictable and inclusive government in Washington DC” should also help improve confidence in emerging-market economies, Mr. Esteruelas said.

While investors see growing opportunity in emerging and growth markets next year, the countries’ citizens face a much more uncertain future.

Inequality, which in many countries has been heightened by the pandemic, threatens to trigger more unrest in 2021, according to DJ Peterson, president of advisory firm Longview. “While the tide of COVID may ebb in 2021, despair and slow and uneven recoveries are likely to result in spikes in social and political risks throughout the year and beyond,” he said. Particularly vulnerable are smaller emerging markets whose governments haven’t had the economic firepower available to offset the impact of the pandemic on their populations.

Edmond de Rothschild’s Dr. Lemoine is also concerned about the long-term negative impacts of the pandemic—particularly “the risk of fewer employment opportunities and widening inequality following the closure of schools and universities.”

Asian frontier markets present valuation gap. Asian emerging and growth markets are already seeing an increase in investor interest and 2021 will witness a stronger surge of investment, according to fund manager Asia Frontier Capital. “With global economic growth recovering, we expect Asian frontier markets to benefit in 2021 as investors rotate into markets and stocks which are under-owned and in the value category, both categories that Asian frontier markets fit into,” Thomas Hugger, AFC’s CEO said.

Manufacturers are also continuing to shift production away from China and into other emerging Asian markets, lured partly by much lower wages and by a need to diversify their supply chains. Although the pandemic hit overall activity levels, demand has been recovering and is expected to grow throughout the coming year.

Exports from Bangladesh, Pakistan and Sri Lanka, for example, plunged early this year, but have since recovered close to pre-pandemic levels, Mr. Hugger said. Exports from Vietnam barely declined and are now significantly higher than they were at the start of the year.

Earnings growth in Asian frontier markets has also recovered strongly, particularly in Pakistan and Sri Lanka, Mr. Hugger said. “Many companies [are] surpassing their pre-pandemic levels of net profits.” 

India’s recovery to lag rivals’. India’s economy has been hit particularly hard by the pandemic-prompted restrictions imposed and its recovery is likely to trail that of other major economies, London-based Capital Economics said. “The severe downturn will leave lasting wounds in the form of firm closures and unemployment, which will inflict further damage on the beleaguered banking sector,” Shilan Shah, senior India economist at Capital Economics said.

Debt load dims Sri Lanka’s economic prospects. Although its economy has been bouncing back strongly in the wake of the pandemic, Sri Lanka’s heavy debt load presents a potential hurdle and could force the country to again ask for assistance from the IMF, according to Johanna Chua, an Asia-focused analyst at Citi.

If Sri Lanka can manage its debt obligations without restructuring, though, it could prove to be a highly attractive investment destination, AFC’s Mr. Hugger said. “We believe Sri Lanka can be the dark horse of 2021 as valuations remain very attractive and earnings will recover very strongly from two years of sub-par growth due to the impact of the 2019 Easter Sunday attacks and COVID-19, while the political situation has improved significantly as a majority led government is now in power,” he said. If tourism were to recover, it could further enhance Sri Lanka’s attractiveness, Mr. Hugger added.

Tight policies to hinder recoveries. Most African economies suffered a smaller hit than those in other regions in 2020. But with vaccines likely to be distributed later in Africa than elsewhere in the world, and with the consequent delay in lifting pandemic-related restrictions in African nations, Capital Economics expects their economies to bounce back more slowly next year.

Even so, the London-based research firm forecasts a robust increase of almost 5% in sub-Saharan Africa’s GDP in 2021, boosted in part by a resurgence of global demand for commodities. Continuing high levels of debt could cause a drag on key economies in the region, though, according to Virág Fórizs, an economist at CapEc. “Many governments will probably end up living with higher debt burdens, which will come at the cost of tight fiscal policy that acts as a headwind to recoveries,” she said. “Ethiopia, Kenya and Ghana face perhaps the greatest debt risks,” she added.

The IMF is a little more circumspect. In its October report on sub-Saharan Africa, the multilateral forecast the region’s economy would grow by 3.1% after shrinking by 3% this year. “This is a smaller expansion than expected in much of the rest of the world, partly reflecting sub-Saharan Africa’s relatively limited policy space within which to sustain a fiscal expansion,” the IMF said. Perhaps more worryingly, the IMF said the slide in GDP would trigger a 4.6% decline in real per-capita incomes across sub-Saharan Africa.

Oil slump to drag on Middle East recovery. Persistently low oil prices have added to the pressure that the pandemic put on the Middle East’s economies, but as the global economy recovers in 2021, Fitch Ratings foresees more pain for the region. A sharp rise in debt levels over the course of this year will exacerbate the challenges countries in the region face, the firm said.

“The Middle East and North Africa region will see a return to growth in 2021, but the recovery will be dampened by fiscal consolidation efforts after a sharp rise in debt in 2020,” Jan Friederich, senior director at Fitch said.

For heavily indebted countries in the Middle East, gaining access to more funding will be dependent on pushing through economic and fiscal reforms, Fitch said, but the region’s populations are unlikely to welcome such moves. “Painful fiscal adjustments and the economic dislocation from coronavirus-containment measures risk a social and political backlash in 2021 in the absence of economic opportunities and improved living standards to satisfy still rapidly growing, young and under-employed populations,” the firm said.

Emerging Europe set to bounce back from second-wave slump. Emerging Europe appears to be heading for a second recession in the final quarter of 2020 after a strong resurgence of Covid-19 cases prompted many governments across the region to reimpose lockdowns and other restrictions. While the new virus containment measures are more targeted and selective than during the first wave, they are still likely to cause a more-than-4% dip in the region’s GDP over the fourth quarter, according to a November report by Manfred Stamer, senior economist for emerging Europe and the Middle East at fund manager Euler Hermes.

Mr. Stamer also highlighted a sharp drop in inward investment to the region since the start of the year. The decline “will not only affect growth in 2020 but also medium-term perspectives,” he said.

Ratings firm Standard & Poor’s believes the impact on both economies and investment prospects in emerging Europe will be short-lived, though. “Our near-term outlook for emerging European economies has weakened following the resurgence of the virus in the fourth quarter.

“After a temporary setback, we expect the recovery to gain speed in the second and third quarter of 2021, and for key economies in the region to reach the fourth-quarter 2019 GDP levels over the course of next year,” S&P said.

Latin markets present short-term opportunity. After being hit particularly hard by the pandemic, Latin America is in worse shape than many emerging-market regions, according to Citi. After seeing GDP collapse by more than 7% this year the region can expect growth of just 4.1% in 2021, the firm predicts. And while some regional stock markets have seen strong recent rises Citi expects the MSCI Latin America index to gain precisely 0% in dollar terms over the course of 2021.

In the short term, though, the firm is upbeat on Latin American equities, noting that they are surging as investors, encouraged by the recent news on coronavirus vaccines, look for value stocks in emerging markets. “We think this pro-value/LatAm rotation can continue into the new year as investors look through the bad short-term news towards the positive impact of vaccines on economies,” the firm said.

Christopher White, co-manager of UK-based fund manager Somerset’s emerging markets fund, is also optimistic. “As economic recovery takes hold, we expect the most beaten up areas of EMs, namely smaller companies, Latin America and EMEA, and the more cyclical and discretionary sectors, to perform particularly strongly,” he said. “Good quality small and mid-cap companies in emerging markets, particularly in these unloved areas, are currently trading at historically attractive valuations.”

Demand for emerging-market debt rises as investors seek extra yield. (WSJ)

Netflix aims for a hit in Africa. (WSJ)

Kidnapped Nigerian schoolboys say ransom was paid. (WSJ) 

Ghana’s hung parliament complicates task ahead for Nana Akufo-Addo. (BusinessDay) 

Ghana, Kenya and Nigeria to tap markets in 2021 as frontier debt springs back to life. (Reuters) 

Russia and Rwanda send military support to Central Africa Republic to quell election violence. (Reuters) 

EU Parliament calls for ‘restrictive measures’ against Egypt over human rights. (Anadolu Agency) 

More than 100 killed in latest ethnic massacre in Ethiopia. (AP)  

Vietnam and UK see positives in free-trade deal. (VoA) 

U.S. gives Cambodia choice between aid and China. (Nikkei) 

Sri Lanka to enlarge southern airport as freight import, export center. (MENAFN) 

Nepal elections could set back China’s goals. (WSJ)  

Battered by U.S. sanctions, Iran finds a lifeline in domestic economy. (WSJ)

Trump administration pushes ahead with arms sale to Saudis. (The Hill) 

Israel faces fourth election in two years after parliament is dissolved. (WSJ) 

Rocket attack on U.S. embassy in Baghdad ‘largest in a decade.’ (WSJ) 

Romania’s president designates former finance minister to form center-right cabinet. (Romania Insider)

Argentina seeking $5 billion from multilateral banks for 2021. (Bloomberg)

Chinese distant-water firm to build fishing base in Ecuador. (Seafood Source)