Emerging Markets

Keep an eye on these emerging market cities

Elizabeth MacBride, Special to CNBC

Investors are pulling out of emerging markets, and plunging commodities prices are hitting growth in much of the developing world. But largely unnoticed by many U.S. investors, a group of medium-to-large cities in those markets is emerging as possible future powerhouses.

Vehicle light trails pass the Kingdom Tower on King Fahad Road in Riyadh, Saudi Arabia.
Kevin Winter | Getty Images

They are places like Luanda, a fast-growing Angolan metropolis of 10 million that many Americans have never heard of, or Suzhou, a city of 5 million near Shanghai whose population is growing at a rate of 6.5 percent a year, according to a recent United Nations report. And those midtier cities are seeing consumer spending that's sometimes growing even faster than their populations.

"The cities that are growing are an unexpected bunch. These are the unknown cities," said Saskia Sassen, a sociologist at Columbia University.

Megacities like Tokyo and Sao Paolo grab headlines, but the fastest population growth is happening in a group of global second-tier cities, which are easier for rural populations to reach and are safer and less intimidating than the megacities, many of which are surrounded by vast slums, Sassen said.

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Three of the world's fastest-growing cities with populations over 5 million are in Africa. Four are in China, two are in India and one in the Middle East. (One megacity, Beijing, is growing at a rate of 4.6 percent a year).

They are places like Suzhou, China, Surat, India and Kinshasha, capital of the Democratic Republic of Congo. Or, take Luanda. If Americans have heard of it, it's probably from images of a nearly 30-year-long civil war that overtook the southwest African country after independence from Portugal. After 10 years of peace, Angola's oil, gas, diamonds and other mineral resources are fueling a building boom.

Inner cities worldwide have become a major destination as investors put up high-rise apartments and office buildings, Sassen said.

Middle class aspirations, disposable incomes

To be sure, investments in poorer countries generally carry greater risks, such as weaker rule of law. But their proponents focus on newer trends. Fast-growing, midtier cities also are riding a demographic shift, one that investors who have been able to capitalize on their growth realize: There is an explosion in number of young people with middle class aspirations and disposable income, said Arif Naqvi, founder and group chief executive of the Abraaj Group. With $7.5 billion, it is a leading private equity firm investing in non-BRIC (Brazil, Russia, India and China) growth markets.

Naqvi looks below the top-line trends that spook the public markets. For instance, slowing growth in Indonesia doesn't faze him. The largest economy in Southeast Asia was a standout in terms of gross domestic product growth in the past decade. Now, with growth expected to fall to under 5 percent, public investors are yanking money out.

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But "GDP is no longer an indicator," he said. "I look at scooter sales. Everybody is getting excited about Indonesia. ... Billions are flowing out. GDP is growing by 6 percent. Motorcycle sales grew by 18 percent. That gives us a good yardstick and how much disposable income young people have."

Naqvi's firm has more than 25 offices in cities around the globe. Between 2013 and 2014, it deployed $750 million in 12 companies and realized $480 million through 17 full exits, according to the 12-year-old firm's annual report.

Among the markets on Naqvi's horizon—"interesting opportunities," as he calls them—are:

  • Pharmaceutical sales in Vietnam, where the 7.1-million population of Ho Chi Minh City is growing at a rate of 3.3 percent a year.
  • Automotive sales in Nigeria, where Lagos, a city of more than 12 million, has a population growing at a rate of almost 4 percent a year.
  • Companies in the Pacific Alliance, a free-trade area that includes Chile, Colombia, Mexico and Peru. Population growth rates in some of the cities there, such as Bogota and Lima, have slowed to a less than 3 percent a year (still substantial), but the Pacific Allliance zone itself is "at least the size of Brazil, without any of the attending risks of Brazil. And they have more and more trade links with the United States," he said.

"Investors in the U.S. today have not (awakened) to these opportunities," he said. He puts the Middle East, including Egypt and Morocco, on the list as places of stability in an ocean of "serious turmoil."

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Many of the fastest-growing cities are capitals of emerging markets countries or large cities in the biggest growth markets, like China. Cities in general are increasingly driving the world's economic growth: 423 cities are expected to account for about 45 percent of global GDP growth from 2008-2025.

Top Emerging Cities

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The fastest-growing cities are adding hundreds of thousands to their populations each year. Luanda, for instance, is expected to grow again next year by 4 percent, according to a United Nations report. That's more than 400,000 people, or about the same number who live in Miami.

While most of the top investors in the markets are local or based in Europe, a small but growing number of U.S. investors is looking for a way in while minimizing the risk of doing business there.

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Silicon Valley venture capitalist Alex Mendez is one of a group of investors who set up Puente Labs in San Francisco to serve as a host site for promising firms in Latin America that seek funding.

Puente will have six to 12 start-ups in residence at any given time, he said, with investors in the United States taking small equity stakes in them. He's looking in cities like Lima, Bogota and Sao Paolo, and says it's easier for entrepreneurs and investors to work with a mayor and municipal bureaucracy than a national government.

He points out that the trend toward urbanization is happening in the United States, too. "Look at Silicon Valley," he said. "We talk here about how its center is shifting to San Francisco."