Between sustaining investor confidence, meeting demand for financing, competition from bank lending, and liberalisation to allow in more foreign investors, Middle East capital markets are not short of challenges as they look forwards to 2013.
Economic fundamentals are resilient, although the Washington-based IMF expects real gross domestic product (GDP) growth in Middle East and North Africa (Mena) oil-exporting countries to soften from the average 5.5 per cent seen this year to a still-healthy 3.7 per cent in 2013.
The fund forecasts that oil-importing nations – a category that now includes the region’s most populous country, Egypt – will see growth jump from this year’s modest 1.2 per cent to an impressive 3.3 per cent for 2013.
So the economic setting for a further expansion of the capital markets is mostly positive, outside those countries affected by major instability or political crisis.
There are reasons why Gulf capital markets could attract growing interest in the months to come.
“We are seeing decent levels of risk appetite among international investors who already dip into GCC debt capital markets,” says Chavan Bhogaita, head of markets strategy development in the financial markets division of National Bank of Abu Dhabi (NBAD). “The hunger for yield means that institutional investors need to look at markets such as the Middle East as part of their portfolios. While overriding concerns about the global macro scene remain, these fund managers have to put their money to work somewhere. Whether they are simply seeking a safe place to park cash or an attractive risk return on fixed-income investment opportunities, the GCC market ticks a lot of boxes.”
The potential for growth is driven not only by investors’ search for safe and rewarding opportunities, but also by the region’s greater expertise in stirring that interest.
“From a debt capital markets’ perspective, Gulf issuers have come a long way in terms of engaging international investors and we expect this to continue,” says Bhogaita. “Indeed, allocations on recent bond issues have been heavily skewed towards the international investor base rather than regional money managers. The aim is to get fixed-income investors from outside this region more comfortable with the issuers here; this should open up greater pools of liquidity to be tapped in future, to diversify and increase the sources of funding.”
Allocations on recent bond issues have been heavily skewed towards the international investor base
Chavan Bhogaita, NBAD
Demand was strong for a recent NBAD $750m bond issue, says Bhogaita. “Despite the deal coming during Ramadan, the order book was over $4.5bn in less than four hours. Our view at NBAD is that for the high-quality issuers from this region, there remains very solid demand from both regional and international investors.”
However, some industry insiders believe certain growing Mena economies will not see much capital markets growth.
The trend in activity and market development is patchy. The more obvious contextual factors, such as economic performance, consumer spending and saving capacity, and the health of the financial sector are not always reflected in a 2013 outlook that varies from country to country.
Among the retail investors who play such an important role in the Gulf stock markets, levels of confidence do not necessarily reflect the local business conditions that actually shape the performance of those companies that are listed.
At the level of corporate and wholesale financing, Mena capital markets – both equity and fixed income – face competition from bank funding, which has not suffered the dramatic conservative retreat from risk seen in the West.
Bond and sukuk (Islamic bond) activity has been fairly resilient, to the point where the UK’s HSBC set up a new service to facilitate fixed-income investment by its more affluent clients in Qatar.
But stock markets across the Mena region have seen relatively few initial public offerings (IPOs). Further technical development and transparency measures may be required before they can attract more international interest. So far, only Egypt and Morocco are categorised by US index provider MSCI as ‘emerging markets’, while Gulf exchanges have failed to secure upgrades from the ‘frontier’ category.
A major question for GCC bourses in 2013 will be their readiness to implement the further reforms required to appeal to foreign investors on a larger scale.
The stock markets also need to see a revival in confidence among those international investors, as Faisal Sarkhou, acting chief executive at Kipco Asset Management Company (Kamco), points out. “Equity markets have become very volatile in the region on the back of heightened political tensions and global market instability, resulting in fewer IPOs, with Saudi Arabia witnessing the majority of IPOs in 2012,” he says.
For the moment, the levels of activity on most Mena bourses are a poor reflection of the strength of the economies in which they are based.
Through gradual reform, Morocco and Saudi Arabia have shrewdly navigated the region’s political upheavals and maintained a positive business and financial climate. Yet their capital markets are dull and show little prospect of becoming much more lively in the near future.
Morocco enjoyed 2.9 per cent GDP growth this year and major corporations in the country have performed steadily, sustaining major programmes of capital investment; there is also a growing middle class.
Yet the Casablanca bourse continues to shrink. In 2011, the volume of transactions declined by 56.7 per cent to MD103.4bn ($12.15bn), and market capitalisation fell by 10.8 per cent to just MD516.2bn. The trend continued this year, with trading activity down by 24 per cent over the first nine months. During the third quarter, the rate of decline was more than 50 per cent. Indices of investor confidence are depressed.
A major question for GCC bourses in 2013 will be their readiness to implement further reforms
Looking ahead to 2013, it seems likely that even if economic activity picks up further, structural factors will hold the bourse back, partly because much of the country’s economic growth takes place outside the publicly listed business world. Entities that are owned largely by state or royal interests, such as the giant Societe Nationale d’Investissement (SNI)/Omnium Nord-Africain (ONA) conglomerate, continue to play a big role in Moroccan industry and commerce.
They have relatively little need to rely on open market capital and in some cases seem determined to reduce this reliance even further. The 2010 merger and delisting of SNI/ONA withdrew a substantial segment of business activity from the publicly listed arena.
The marginalisation of the bourse is likely to extend into next year, because business can turn to the bond market and banks for funding. In 2011, the stock of local bond market debt rose by 7 per cent, while bank lending grew by 10 per cent.
Banks are able to play a particularly important role in financial intermediation because they have been little affected by the global financial crisis and feel in a position of strength. The non-performing loan rate sank to just 4.9 per cent by December last year.
Banks have enjoyed a rising stream of deposits and also mobilised funds on the financial market. Their subordinated debt rose by 8 per cent in 2011, while certificates of deposit were up by 28 per cent. This has given them the resources and the confidence to lend to business and consumers.
For different reasons, prospects for the Saudi capital market also fall short of what one might expect, given the kingdom’s economic and financial fundamentals.
“The domestic fixed-income market is not well developed because the government has not issued any sukuk that could provide a benchmark for a yield curve,” says Fahad al-Turki, senior economist at Riyadh-headquartered Jadwa Investment. “The aviation authority, a state entity, did issue a sukuk in early 2012, and there are signs a second could follow, but this is not sufficient to form the basis for a market benchmark.”
Al-Turki says the government issues treasury bills of up to one-year’s maturity to control the money supply. But the treasury-bill market is too short term to provide a benchmark for longer-term fixed-income instruments.
“Anyway, the government is cash rich and does not need to issue new debt to finance its public spending commitments,” says Al-Turki. “The finance minister has said that the government will maintain its current debt, but has no plans to issue any more.”
The existing government debt of about SR130bn ($34.7bn) was issued in the 1990s and is not traded in the market.
“Saudi companies do not need to borrow on the fixed-income market,” says Al-Turki. “They will continue to rely mainly on bank loans or finance from the specialised credit institutions, which have stepped up their activities since 2008, to compensate for any possible slowdown in bank lending after the global financial crisis.”
The [Saudi] government is cash rich and does not need to issue new debt to finance public spending
Fahad al-Turki, Jadwa Investment
The outlook for the Saudi stock market, the Tadawul, is also uncertain. “We are very positive about the domestic economic fundamentals,” says Al-Turki. “The petrochemicals sector relies on exports and is therefore exposed to economic problems in other parts of the world. But banks and other businesses focused on the Saudi market, in sectors such as telecoms, construction, and food and agriculture, benefit from the strength of local demand.”
Most Tadawul investors are retail investors, though, he says. “They get worried about international economic news, leading to a higher correlation between the Tadawul and international markets.”
The Capital Market Authority has completed the technical IT and infrastructure preparations for a further opening of the Tadawul to foreign investors, but no date has been set for this, and when the move does come it is likely to be gradual.
Saudi Arabia is not the only country where the potential timetable for opening up the market to international investors remains uncertain. The UAE has approved the draft of a companies law that would relax constraints on foreign ownership. But the draft has been ready for months and it is unclear when the final steps will be taken to put it into effect, opening the door to the international capital that could inject new volume and vigour into the market for listed stocks.
The fixed-income market in the UAE and Qatar is more developed and appears set to continue growing, because there are sufficient issues by major public entities to provide a benchmark for the private sector to follow suit.
“International investors are now participating much more in GCC fixed-income markets,” says NBAD’s Bhogaita. “Regional issuers of fixed-income products are now much more savvy about how they present themselves, and many Middle Eastern entities have become more transparent, although further progress is still needed on this.
“For the GCC bond and sukuk markets, priorities for 2013 would include: greater volumes of issuance, and hence better liquidity in the secondary markets; progress in tackling ‘systemic’ issues such as transparency and corporate governance and legal frameworks for creditor protection; increasing the liquidity of the local currency debt market; the development of more comprehensive and liquid sovereign yield curves for US dollar-denominated bonds and sukuk; and the introduction of a Central Bank of the UAE discount window.”
By contrast, stock markets across the GCC economies are hampered by their heavy reliance on domestic retail investors, who are heavily influenced by short-term economic news and international headlines. These personal investors are looking for either an unadventurous long-term home for their cash or quick profits from under-priced initial listings. But they rarely take a strategic or analytical view of their investments, at least not on a scale to offer funding security to major companies.
So in many countries, big corporates seem likely to continue relying on bank finance or, occasionally, fixed-income issues as their main source of funds, because banks and bond market investors will make a strategic commitment to lend or invest.
However, in Kuwait, which has a more established stock market, the oldest bourse in the GCC could benefit from the wave of major reforms being introduced by the new Capital Market Authority.
Egypt, too, with a long-standing tradition of stock market and bond investment, may be poised for a gradual resurgence in confidence over the coming year, as it moves on from the upheaval of the 2011 revolution.
In mid-September, President Mohamed Mursi’s government successfully marketed £E4.3bn ($702m) in floating-rate, 273-day treasury bonds at an average 14.4 per cent. The country also saw a decline in the yield on benchmark 5.75 per cent dollar bonds maturing in 2020, a useful measure of confidence about the medium term.
With bank funding and bonds offering competing funding, on top of global uncertainty, the region’s capital markets are unlikely to over-perform in 2013. However, with confidence gradually picking up, and reforms on the cards to open them to international capital, they are far from a lost cause, and should see much more improvement in their performances in the future.