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MENA REPORT

Politics not economics to dictate play


GCC-linked fixed income securities warrant a closer examination
By Imran Ahmed ven by its own historical standards, the last 18 months have been tumultuous for the Middle East and North Africa (MENA) region. Short of an Arab-Israeli war, the MENA region saw many seemingly unpredictable events occur. After the January 2011 downfall of former President Zine El Abidine Ben Ali in the small, liberal state of Tunisia, an apparently irreversible momentum towards change permeated the entire MENA region. The Arab worlds largest and possibly most influential state, Egypt, lost long-time strongman and ex-President Hosni Mubarak in February 2011. The following month, Saudi Arabian troops entered Bahrain to help quell protesters demanding that Bahrains long standing Sunni monarchy be overthrown. In April last year, Syrias Baath party leader, President Bashar Assad, sent tanks into the Syrian city of Daraa to quash a revolt against his party rule. Although a weakened Mr. Assad remains in power, his regimes longevity is in serious doubt. Many expect him to ultimately go the way of Libyan autocrat, Muammar Gaddafi, who was brutally killed by Libyan rebels last October. Other than Bahrain, the remaining five members of the Gulf Cooperation Council (GCC) nations, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates (UAE), appear to have so far successfully managed the Arab reform movement. Certainly, there were smatterings of protest in Oman and Saudi Arabia. There were even some democratic noises among certain segments of UAEs civil society. Nonetheless, the ruling regimes of these relatively wealthy GCC nations never faced any real threat to their rule. For global asset managers, the impact of social unrest in MENA is more relevant in its effect on global capital flows out of the region - not for money flowing into MENA stocks. Oil Price (WTI, January 2011- March 2012)
$120.00

Not surprising really, given the various legal and practical obstacles faced by international investors wishing to purchase MENA stocks. Saudi Arabia is by far the largest stock exchange in the region, with a current market capitalisation of just over US$400 billion. For perspective, note that Brazils BOVESPA is capitalised at $1.4 trillion or the Philippine Stock Exchange at just under $200 billion.1 While non-Saudi MENA stock exchanges may be easier to access for international investors, other MENA exchanges pale in comparison to the size of Saudi Arabia. The United Arab Emirates, Qatar and the Cairo Stock Exchanges have a combined market capitalisation of $285 billion.2 Despite some deregulation since the countrys accession to the World Trade Organisation, Saudi Arabia still retains certain restrictive rules that impede foreigners from purchasing Saudi equities. Where the formal rules do not hinder international investors,

$100.00

February 11 - Egypt's President Mubarik resigns

April 25 - Syria deploys tanks in city of Daraa

October 20 - Libyan leader Muammar Gaddafi killed

$80.00

March 15 - Bahrain King declares state of emergency, Saudi troops enter country

$60.00

January 14 - Tunisian President Ben Ali flees to Saudi Arabia

$40.00

$20.00

$Jan Jan Jan Feb Feb Mar Mar Apr Apr May May Jun Jun Jul 04, Jul 18, Aug Aug Aug Sep Sep Oct Oct Nov Nov Dec Dec Jan Jan Jan Feb Feb Mar Mar 03, 17, 31, 14, 28, 14, 28, 11, 25, 09, 23, 06, 20, 2011 2011 01, 15, 29, 12, 26, 10, 24, 07, 21, 05, 19, 02, 16, 30, 13, 27, 12, 26, 2011 2011 2011 2011 2011 2011 2011 2011 2011 2011 2011 2011 2011 2011 2011 2011 2011 2011 2011 2011 2011 2011 2011 2011 2012 2012 2012 2012 2012 2012 2012

Source: US Department of Energy

30 Asia Asset Management June 2012

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MENA REPORT
MENA Stock Market Capitalisations
Market Capitalisation (USD billion) Saudi Arabia Kuwait Qatar Abu Dhabi Morocco Egypt Dubai Jordan Bahrain Oman Lebanon Tunisia 400 108 97 76 61 60 52 24 17 14 13 10 Year to Date Return 19.6% 4.0% -1.4% 7.1% -0.2% 33.5% 23.0% 1.2% 0.4% 4.5% 3.0% 6.8% 2011 Return -3.0% -16.0% 1.0% -12.0% -13.0% -42.0% -17.0% -13.0% -20.0% -16.0% -20.0% 23.14%*

Source: World Federation of Exchanges, Markaz research and Zawya Return data from Markaz as at March 22, 2012 and in local currency. * Tunisia data from Bloomberg as at April 17, 2012. 2011 data represents last 12 months data.

the practical challenges associated with maintaining and operating custody, brokerage and administrative accounts in Saudi Arabia are often enough to discourage foreigners from entering this market. In a world of easy money and low interest rates, the accumulation of capital by oil exporting MENA countries was a significant factor for global capital flows. The top 15 international sovereign wealth funds include six names from MENA, with assets aggregating to $1.7 trillion.3 Much of this surplus capital was (and is) recycled back into international capital markets through direct and indirect purchases of global debt and equity securities. In the past, limited amounts were invested in MENA domestic capital markets. However, following the Arabian Spring, GCC nations ramped up domestic public sector spending as a means to placate discontented populations and try to forestall future political unrest. Two outcomes of the higher government spending are reduced capital flows from wealthy GCC nations into international capital markets a trend that will most likely remain in place for some years to come and a much higher breakeven price of oil

for GCC nations. The breakeven price of oil is the price per barrel of oil required to maintain a balanced budget. Other than Kuwait, the breakeven oil price for GCC budgets has risen dramatically from the typical $30-55 per barrel level of just a few years ago. By reducing the fiscal flexibility of the Gulf Arab regimes to spend their way out of possible future problems, the higher breakeven price has also raised political risks associated with countries of the region. It is inevitable that increased government spending will filter through into corporate earnings via project

and consumer spending. Nevertheless, the positive impact from increased public sector spending may not be sufficient to compensate for continuing pressures on the banking and real estate sectors. If Dubai is assumed to be a lead indicator for the region, evidence suggests that the excesses of the last few years still affect regional economies. According to official figures from the Dubai Municipality, over 3,000 cars were abandoned by fleeing expats during the first three months of 2012, a rise on the approximately 2,700 cars abandoned in the same period in 2011. 4 Another sign of financial stress was the UAEs largest lender, Emirates NBD Bank, takeover of Dubai Bank, a struggling smaller bank in October 2011.5 The implications of reduced capital flows from the GCC will be felt in the less affluent MENA countries. In all likelihood, investment flows to these nations from cash-rich GCC corporations will not return to precrisis levels for some time. Companies with global ambitions, like Dubais real estate developer Emaar, should have already pulled in their horns as they nurse balance sheets back to better health. At its heart, the MENA region remains primarily a story of oil and demographics. One set of nations are endowed with bountiful resources of oil. Another group has limited oil but lots of human capital, i.e. large and young populations. Throw in a common language and long-term synergies between oil-rich versus population-

Break-even Oil Price


Country UAE Saudi Arabia Qatar Kuwait Oman Bahrain USD* 107 80 60 55 90 - 100 90 - 100

Source: Emirates NBD research and Reuters analyst polls accessed on April 16, 2012. http://www.arabianbusiness.com/uae-break-even-oil-price-rises-us-107-453437.html http://en-maktoob.news.yahoo.com/poll-table-gulf-arab-budget-break-even-oil-130659023.html * per barrel

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MENA REPORT
rich countries should become more apparent. Ideally, capital should move from the rich to the not-so-rich nations, while people should migrate from the populous group towards the oil exporters. However, long-term synergies are constantly marred by shorter-term political uncertainties. In the aftermath of the Arabian Spring, MENA nations have increasingly shifted their socio-political focus inwards. Economic and political integration within MENA has naturally fallen lower down the agenda of Arab businesses. Persisting political crises, including regime change, insurgencies and simmering civil unrest, has changed the MENA regions economic complexion for institutional money managers. High oil prices buttress the fiscal positions of oil exporting nations, but, moreover, these high oil prices may be around for the foreseeable future, especially if the international communitys troubles with Iran continue. However, the uncertainties attached to ongoing political deregulation may adversely affect economic development. For global money managers, the decision to invest in MENA equities may be more about assessing mediumterm political risk with earnings growth a secondary factor. Undoubtedly, earnings growth is a key variable. But profit numbers subordinate themselves to politics quickly when unrest hits the streets. Instead of equities, astute investors within the MENA region are better advised to focus on fixed income securities issued by the wealthier GCC states. In the search for yield, GCC-linked fixed income securities warrant a I closer examination.

International Oil Reserves (billion barrels)

Saudi Arabia, 265

Other, 636

Iran, 151

Iraq, 143

Kuwait, 102 Qatar, 25

Libya, 47
United Arab Emirates, 98
Data as at end 2010 Source: Organization of the Petroleum Exporting Countries, accessed April 3, 2012 http://www.opec.org/opec_web/en/data_graphs/330.htm

1 2 3 4

Source: World Federation of Exchanges (data as at end March 2012). Source: World Federation of Exchanges and Markaz (March 2012). Source: Sovereign Wealth Fund Institute (accessed April 16, 2012). Source: The National, Put Abandoned Cars to Good Use, April 8, 2012. Accessed on April 16, 2012. http://www.thenational.ae/thenationalconversation/editorial/put-abandoned-cars-to-good-use Source: Gulf News, Emirates NBD Takes Over Dubai Bank, October 11, 2011. Accessed on April 17, 2012. http://gulfnews.com/business/banking/emirates-nbd-takes-over-dubai-bank-1.889634

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