Despite Market Fears Regional Investors See Opportunities Beyond the Turmoil
Viewed from the ongoing pace of televised news, the tumult on Egypt's streets seems ready to engulf the entire Middle East. Indeed, only days after thousands of protestors filled downtown Cairo's main thoroughfare to demand an end to Hosni Mubarak's rule, Yemen's President Ali Abdullah Saleh announced he would be stepping down at the end of his term, and his son would not run for office, while Jordan's King Abdullah II fired his cabinet, appointed a new Prime Minister, and vowed political reform. Rumblings of protest also echoed in Algeria, Oman and Morocco.
Undoubtedly, the popular uprisings in Tunisia and Egypt have brought extraordinary change to Arab politics, challenging regimes to alter the way they govern, and providing new political freedoms for the people. But while many foreign investors have deemed the Middle East North Africa (MENA) region's new political uncertainty as a risk -- Moody's downgraded Egypt's credit ratings to Ba2 with a negative outlook, and other credit ratings agencies followed suit -- regional businesses and investors have taken a different approach. They believe that political changes that usher in more democratic governments in the region will pave the way for long-term stability and growth.
Mustafa Abdel Wadud, an expatriate Egyptian in Dubai, where he is a managing director at investment firm Abraaj Capital, says he and his firm are taking a long-term approach to Egypt, one that sees the current crisis as a momentary "blip," because the country's fundamental economics are strong. Though opinion is divided on the point of politics, he says, many analysts feel the region is moving in a positive direction. "In the long-term, there will be more stability in these investment destinations, which all have high growth but are considered high risk because of their current political structures," he says.
Erwann Michel-Kerjan, managing director of Wharton's Risk Management and Decision Processes Center, says the decline in regional markets reflect the fluid nature of events in the Arab world's largest and politically most important country, which is unsettling outside investors. "Businesses don't like uncertainty," he says. "When you have insurgencies somewhere, the markets go crazy. Take a look at the price of oil. It rose 10% to 20% in two days. It's not so much because we're afraid. We are afraid of not knowing."
Bellwether for Arab world
The global reaction to Egypt's civil unrest is more widespread than what followed the ouster of Tunisia's President Zine el-Abidine Ben Ali because of Egypt's status as a bellwether for the Arab world. Historically, the country has been a focal point of power in the region, from the Pharaohs through successive Islamic dynasties. Cairo was the Arab headquarters for the Ottomans and colonialist France and Britain. In modern times, it has been at the center of Arab political thought, spawning the pan-Arabist ideals of Nasserism, and the antagonistic worldview underpinning al-Qaeda's philosophy. Egypt's 1979 peace treaty with Israel cemented its standing as America's staunchest ally in the region, assuring itself of U.S.$2 billion in annual aid from the U.S., second only to Israel's annual U.S. aid package.
With a population of roughly 88 million, the country also represents the region's largest market. Its annual gross domestic product (GDP) in 2010 was estimated at U.S.$500 billion (adjusted for purchasing power parity), ranking it as the 27th largest economy in the world. Because of its market size, Egypt is usually the most prominent Middle Eastern country in Western equity portfolios, says Abdul Kadir Hussain, chief executive officer of Dubai-based Mashreq Capital. And though the country is not a major petroleum exporter, producing 680,500 barrels per day in 2009 (ranking it 29th in the world) with proven reserves of 4.3 billion barrels (27th largest), it is a key point for oil delivery, home to the Suez Canal and the Sumed Pipeline that runs from the Gulf of Suez to the Mediterranean and provides an alternative to the Suez Canal for transportation of oil. As a result, petroleum multinationals have located their central offices for the MENA region in Egypt.
Not unexpectedly, the unrest registered immediate market shocks. After a week of protests, global oil prices rose beyond U.S.$100 a barrel, while Arab stock markets saw U.S.$50 billion in losses, according to Kuwait asset manager Kamco. The majority of losses occurred among Gulf bourses, dropping U.S.$32 billion in value to U.S.$750 billion, partly because of the large exposure many Gulf firms and banks have in Egypt. Saudi Arabia's stock exchange, for example, fell by U.S.$21 billion.
Egypt's economy has also suffered due to the unrest. The Egyptian stock market, according to Kamco, lost U.S.$12 billion in the first two days of protests before it was closed. The economy has lost at least U.S.$3.1 billion as a result of the political crisis, according to a report by investment bank Credit Agricole. The shutdown of its connection to the Internet cost Egypt about U.S.$90 million, according to the Organization for Economic Cooperation and Development. Losses in the Egyptian tourism industry, which accounts for 11% of its GDP (U.S.$10.8 billion in 2009, according to Egyptian Tourism Ministry), is expected to reach U.S.$1 billion, said Ahmed al Naggar, an Egyptian economy expert at the Ahram Center for Political and Strategic Studies in Cairo, in an interview with The National newspaper.
In spite of such losses, a number of regional investors are being patient, Wadud says, in part because they were expecting political and economic disruption. Unlike Tunisia's revolt, which started following a desperate 26-year-old's self-immolation, Egyptians carried a list of grievances as they took to the streets.
Egypt observers knew that 82-year-old Mubarak had been grooming his son Gamal for a handover of power, a move quietly opposed by the country's powerful military establishment. Other tensions included outrage in December over alleged widespread fraud in the Parliamentary elections, which produced a landslide victory for Mubarak's National Democratic Party, and then in January, attacks against Egyptian's Coptic Christian community nearly boiled into countrywide communal violence.
"You have to be prepared, but this is not an everyday risk," Wadud explains. "I don't want to dismiss what is happening. But every emerging market has these risks, and you just have to price that in. The reality is that this was expected. No one knew protests in Egypt would be this extensive. But [Mubarak's] succession was coming. It's just been accelerated."
Riding out market volatility
Mashreq Capital's Hussain says in the coming weeks, anyone observing the MENA region should differentiate between equity and debt markets. In terms of equity, he notes, most international investors see the MENA region as a frontier market, off-index bet. He expects them to sell because the country was already over weighted among their equity investments. "We're likely to have volatility for a few weeks," Hussain adds, "as we don't have enough regional buyers to take up international sellers." Debt, however, represents a much broader market, with many more international investors. "As long as investors are comfortable with default risk, they will ride out the volatility," he says.
Stating emerging markets were already weak before the civil unrest -- foreign direct investment inflows to the MENA region had fallen 12% in 2010, according to the World Bank, partly due to lingering concerns raised by Dubai's real estate crash and sovereign debt woes -- Hussain doesn't expect further disruptions affecting the MENA region. He believes many regional investors are taking a similar stance. "You won't see any panic selling," he says. "I don't think anybody is going to cut and run, though if you're in the region, there's nothing to run to. You just follow the situation and hope for a resolution."
Key to reassuring investors is explaining the limited impact of the civil unrest in MENA, says Moheiddine Kronfol, managing director of Dubai-based Algebra Capital. For now, similar large-scale riots and demonstrations are not expected to spread to the Gulf countries.
Investors are worried because the region is still recovering from Dubai's sovereign debt concerns, which were resolved only last year, he adds. "That definitely affected people's psyches. The situation in Egypt brings into focus political instability, and disparities between the rich and poor. Obviously, there is short-term anxiety, but you try to put this into perspective, that these countries represent just 20% of the region's market capitalization."
Crisis also presents opportunity, and Kronfol expects savvy investors to find good buys if succession in Egypt can happen in an orderly fashion. But there are challenges for firms like his in the aftermath, he adds. "After Egypt, investors are definitely asking about the other countries in this region. It's a new risk to educate people about."
Different perception of risk
The most nervous investors, Wharton's Michel-Kerjan says, are those that had regular dealings with the Mubarak and Ben Ali regimes. They are now wondering if their interests will be protected. "If you had been doing business with Egypt and Tunisia for, let's say, 10 years, and you had a good relationship with them, and now your counterpart in Egypt or in Tunisia is being thrown away from the country or is not in power anymore, you know that that could happen to your business too," he says.
Companies and investors with local stakes in Tunisia and Egypt are better suited to deal with the crisis, says the head of a multibillion-dollar Gulf conglomerate with interests in every Arab country. "Investors, multinationals and companies that hang on during the crisis will be in a better position to reap benefits," he says. "Obviously, the more regionally diversified company can absorb short-term pain. But the best position to ride out the crisis [belongs to] those companies acting in a local manner. Many companies have local teams, local operations and local people. They are going to stick it out. The perception of risk is different for insiders than outsiders."
This executive agrees that political change in Egypt would likely benefit rather than hurt businesses and investors there. "The fundamentals of the economy -- its population size and growth, pent-up demand, comparative advantages and costs -- are not going to change. But if there is popular political change, Egypt's highest risk, according to analysts, will come down. There is a difference between the sustained increase in the risk profile of a country, versus a one-off event. Once there is stability, the [risk] premium will come down. It's a view you have to take if you believe in a market."
Wadud says his firm's interests in Egypt are in industries that will not suffer long-term effects from the unrest, including construction, medical supplies and food retail. The firm's grocery stores in Cairo re-opened soon after protests began, and a medical lab never closed, he says, choices that have been well-received by the community there. The decision to keep shops open was influenced by experiences in Lebanon during its 2006 war with Israel, he says. Then too, grocery stores owned by his firm in Beirut remained open. "It built us a lot of goodwill," Wadud says. "People do remember these things."
Astute investors will remember that though economic disparities prompted the protests -- Egypt's poverty rate stood at roughly 24% in 2010, according to the government -- it still is a wealth-producing country, with natural resources and a well-educated population. Egyptian literacy rates in the 1980s hovered under 50%, and now are roughly 80%, according to the United Nations. Unlike its neighbors in the Gulf, it managed the global financial crisis well because it was not over-leveraged. Its tourism industry has endured past terrorist attacks and still rebounded -- 15 million visitors came to Egypt last year, according to the Tourism Ministry. The Suez Canal, which earned Egypt revenues of U.S.$4.77 billion in 2010, has not been affected by the current turmoil. According to the Egyptian Central Bank, the country has U.S.$36 billion in foreign reserves, and Citigroup estimates Egypt has another U.S.$21 billion in so-called unofficial reserves in commercial banks.
Early economic indicators suggest Egypt should recover quickly once protests end. At the end of the first week of protests, the price of insuring Egyptian debt fell 100 basis points, once it became clear the government would be able to honor debt. Before the unrest, the International Monetary Fund estimated Egypt's economy would expand 5.5% in 2011. It refused to readjust its estimates, stating the country's situation was still unclear. Even some Western investment analysts sought to look past Egypt's present crisis to focus instead on its long-term potential. According to a Bloomberg report, Mark Mobius, executive chairman of Templeton Emerging Markets Group, noted in a report about Egypt's "compelling" economics that he had a "strong" outlook for his investments.
Right outcome needed
As the immediate market shocks subside, analysts will be observing how both North African countries handle the broader challenges facing them. "For all the euphoria about people power facing down dictatorial regimes, Egypt and Tunisia face even tougher challenges now, because their populations had raised expectations and believe they now deserve changes that will bring tangible improvements in their lives," says Robin Wright, distinguished scholar at The Woodrow Wilson International Center for Scholars in Washington, D.C. "Any regime -- old or new -- will find it almost impossible to deliver benefits soon enough."
Paul Dyer, a fellow at the Dubai School of Government and an expert on Middle East labor and demographics, says his biggest concern is the renewed spending on food subsidies and other populist measures that new governments in both countries may undertake. "If there is a successful change in Egypt, to a democratic, freely elected government, what are they going to do to solve the problems? Giving more subsidies and creating more government jobs is not sustainable."
Dyer, who has studied the region for more than a decade, says the youth protesting against Mubarak's regime need a new economic model. "You have young people socialized into thinking public sector jobs are the only good jobs," he says. "But the ideals largely behind the state can no longer be met -- job provision, subsidization, free healthcare and education."
The first step, Dyer says, is to give more support to entrepreneurs and small-to-medium sized businesses, rather than creating more state-supported jobs. He sees a success story in Bahrain, because of its economic, education and labor reforms. For instance, he notes, unlike its Gulf neighbors, Bahrain abolished the visa sponsorship system, enabling freer employment mobility, and allows for unions. "Countries in the region will only solve problems in the long run by being bold, and initiating true reform," he says.
Dyer welcomes the fact that the protests in Tunisia and Egypt seemed to arise from the grassroots. "They rallied on a community level to create innovative solutions. That's inspiring for a group of people that have depended on the government to solve their problems. Maybe that will spill over into the business world."
Wadud believes that liberalization and open, freely elected government would be the best political outcome for Egyptians and business interests, but a continued military-led government wouldn't derail the country's economic prospects either. Only an Islamic extremist regime would be seen as a negative, and Wadud sees little possibility of that outcome. Echoing concerns raised by other analysts, he says not knowing for sure where Egypt's next government will come from is his biggest concern.
"The protests against the regime were organized through social media, not traditional opposition parties, and were largely leaderless, so it is difficult to determine who will come forward," he says. "I believe there will be strong growth going forward, but it will depend on getting the right political outcome."