In this note, we survey how Middle Eastern markets fared in the recent turmoil in global financial markets triggered by the response to the bankruptcy of Lehman Brothers, the demise of the other independent broker dealers and the U.S. bailout of AIG and of the broader financial system. The events of last week, illustrate clearly that the Middle East is not, if it ever was, immune from global trends. However, it is the real economy linkages and various home grown liquidity vulnerabilities that provide the most pause going forward. However, this isn’t a time to be drastic, with oil still over $100 a barrel, there are a lot of oil revenues going to the GCC and the broader region but the Middle East may be as prone to capital misallocation as anywhere.
Until recently, many in the Middle East asserted that the region was immune to the spreading financial crisis emanating from the U.S.- events of recent weeks seem to put paid to that assessment. In fact the MENA region is home to the three best performing members of the MSCI EM equity universe (Tunisia, Morocco and Lebanon), the only ones in positive territory as of September 19 (via Odd Numbers). Middle Eastern banks had rather low exposure to impaired assets and those that did, quickly raised new capital. Regional liquidity was ample (and in fact too much of a good thing for some).
Yet in the last quarter, most of the year to date gains have been erased –the Arab Monetary Fund’s index of Arab equity markets shows a decline of almost 12% over the first 19 days of September, with Oman and Saudi Arabia the worst performers. Most regional markets have been falling much of this summer, amidst lower volume trading. While Arab exchanges are still doing better than many EM and Frontier equity markets, their role as a safe haven seems unlikely – particularly given clear economic and financial linkages through capital markets, financing costs for local banks and corporates, the price of oil and trade and investment flows.
Regional markets did not escape the Sep 16-17 global selloff – all fell, though some ended neutral for the week. Similarly on Saturday (for Saudi Arabia) and on Sunday and Monday for the other markets, Arab markets rebounded along with global markets.As foreign investment increases so do correlations with global equities – on the upside and downside. Property and financial sector stocks suffered most as they will be hardest hit if credit costs remain elevated and they are most reliant on foreign capital raising. However regional markets are also suffering from home-grown issues (elevated inflation, liquidity squeezes) that are exacerbated by global trends.
Furthermore, the oil price outlook adds to uncertainty. While some countries stand to gain from a reduction in prices (oil-importing countries) a weakening oil price would reduce flows of funds in the GCC and the region. Yet the dominance of regional investors and in some cases the willingness of government actors to backstop the institutions and even buy shares, may provide a floor.
Recent events, including this summer’s spike in the GCC interbank rates expose vulnerabilities in the region’s institutions. The removal of fx appreciation expectations in the GCC, persistence of elevated inflation (double digit in most countries) and a falling oil price may have deterred foreign portfolio investment, which coupled with money supply controls have reduced domestic liquidity. Meanwhile overseas borrowing has dried up including in the debt markets. Both conventional and islamic security issuance are down. And many of the recently announced loan syndications may find capital raising a little more difficult. Especially since as a whole regional banks remain undercapitalized (a frequent symptom of scaling up quickly) In the coming months it will be important to watch central banks and finance ministries many of whom are still struggling to fight double-digit inflation even as they ensure liquidity.
Some suggest though, that the credit crunch could a blessing in disguise. Indeed, tighter credit could assist in placing the UAE, and the rest of the Gulf economies, on a better growth path, reducing recent overheating. While money supply growth is cooling, Credit tightening could alleviate inflationary pressures, potentially decreasing the cost of raw materials – though it could be a painful way to do so.
We survey the country-by-country results:
UAE: The country’s property stocks declined on global credit fears as the cost of borrowing money is rising. For much of this year, project financing costs have been on the rise and now fears are emerging of an potential over supply in the Dubai property markets that might leave developers exposed and questioning how “recession-proof” the banks are. Overall, Dubai’s net debts have been increasing and many projects are highly leveraged and reliant on foreign capital. The overliquidity in the domestic market has now reversed – not only have foreign investors decreased exposure to Emerging Markets, but in recent months, UAE has lost almost 90% of the country’s hot money which stemmed from bets on revaluation of the dinar in 2007 and earlier this year.
Renewed focus on some of the vulnerabilities, has contributed to swift policy maker response. In fact, yesterday the central bank of the UAE pledged to provide $14 billion in term deposits for the banking sector, an unprecedented move, and perhaps linked to worries about its exposure to the property sector and vice versa. It may be trying to avoid more high profile foreclosures. Meanwhile the government has re-iterated its bans on short-selling. While it is illegal in the UAE, some institutions were doing so offshore with borrowed shares. Criminal proceedings and corruption allegations against some Dubai companies have contributed to selloffs of some property stocks – and may be a sign that the government is stepping in to establish some new rules of business.
Egypt: A summer of free-fall in its equity markets may have bottomed out with a week of intense selling by foreign investors especially hedge funds, causing Egypt’s benchmark index to lose almost 10% in two days, plunging to its lowest since March 2007 on Sept. 16. The market had a short-lived recovery on Sept. 17th only to take a further plunge as the market closed at the end of the week on Sept. 18th.
Adding to the current woes, the Egyptian pound, which tends to be heavily influenced by shifts in foreign equity interest in Egypt, has been taking a plunge since mid-August to reach its lowest levels in five months. Furthermore, with inflation well over 20% the pound is depreciating rapidly in real terms.
Morocco: Morocco may be immune from the subprime crisis directly as the financial sector does not hold the types of securities or loans in financial institutions or investment funds that are involved in the turmoil. However, Moroccan re
al estate shares fell as much as 6% on September 17th due to worries that the global credit crisis could reduce international interest in the country’s booming property sector, much of which is geared towards holiday homes for Europeans.
Lebanon: Limited investments in the US market, ample liquidity and prudent regulations placed by the Central Bank left Lebanese banks and financial institutions unaffected by the global financial crisis. Furthermore, political uncertainty has led many non-regional investors to avoid Lebanon in recent years – aside from the Lebanese diaspora who provide consistent and stabilizing inflows.
Kuwait: Last minute buying at the end of the week reversed the losing trend of the Kuwait Stock Market causing it make profits for the third successive day on September 18th. Early last week, the Kuwait Investment Authority announced plans to increase its holdings in the domestic equity market, including in some of Kuwait’s banks. This prospect likely contributed to the boost, however, the government has avoided direct intervention, which tends not to be successful.
Saudi Arabia: The TASI has already been losing for some time – and was one of the lowest performing in the region in recent months. The dominance of local retail investors makes this one of the most speculative in the region, with domestic inflation perhaps detering share sales. The removal of restrictions on foreign investment did provide a bounce last month, but this has been shortlived. Futhermore the emergcnce of many IPOs which tend to be brought to the market at discounted prices as a possible wealth transfer may also detract attention from other shares and withdraw liquidity from the market. New regulations on share prices announced earlier this month (Sep 11) may have contributed to the weakened sentiment. Last week, all sectors lost ground with all but the financial and cement sectors marking a decrease in traded volume.
Jordan: Corruption allegations against Jordanian companies added to global woes, taking Jordan’s key index down 5.6% from Sunday to Tuesday, before rebounding on Wednesday, but closing out the week at a loss – meaning that the general index has fallen to levels last seen in March. Unlike some of its neigbours it was the industrial materials sector (especially potash) that saw the biggest declines, though the Arab Bank did drag financials down.
Relative limited trading in Bahrain, Qatar and Oman and dominance of the financial sector in trading volume contributed to woes. Oman in particular is among the most vulnerable to oil price decline as its spending rates are higher
Tunisia, one of the smallest markets in the region by market capitalization, has been one of the best performing markets this year and the only to mark double digit returns in the AMF data. The improvement in the oil price as well as its attraction of manufacturing sector for European outsourcing, may be a factor. It and the market of Palestine were on of the few to mark gains in market capitalization over the course of September.