Dollars and Dissent: What Regime Changes in MENA Countries Mean for Investors

Few would disagree that the uprisings that ousted the leaders of Tunisia and Egypt, and the effect they have had in spurring dissent in the rest of the Middle East/North Africa (MENA) region, have underscored the pressing desire of the people there for democracy, transparency and the right to a more equitable life. But everything that has transpired, and more importantly, the speed at which it has transpired, has also shown that the road to democracy is rough, rocky and unpredictable, and as these countries chart their course to get there, the global economy and the financial markets will be fraught with uncertainty.

As this issue of Investment Advisor goes to press, the Egyptian stock market—the oldest, largest and most diversified in the Middle East/North Africa (MENA) region—remains shut and some fear the country may even be disbarred from the MSCI Emerging Markets Index. While Egypt’s prime minister-designate has named a caretaker cabinet to guide the country in its path toward free elections, violence in Libya is escalating to the point of civil war; oil market uncertainties continue to dominate the headlines; and the recent protests in the Persian Gulf state of Bahrain include a sectarian aspect that threatens to involve other countries in the region, not least Saudi Arabia, where there is a cyber-movement toward inciting protests on March 11.

The ongoing geopolitical problems have repercussions both in the short term and in the long term. Oil, of course, is central to the story, particularly with Libya in chaos and Saudi Arabia on the brink. A disruption in oil production from Libya alone would not be detrimental, says Joseph Tanious, a market strategist for JP Morgan Asset Management, since the country is only ranked 18th in a list of world oil producers, but if the troubles were to spread to Saudi Arabia, the situation could take a turn for the worse.

“MENA produces 35% of the world’s oil and Saudi Arabia is the region’s biggest oil producer,” Tanious says. “Even as each MENA country is unique and complex, they have a lot of similarities, like high inflation and high unemployment among a young population, so the risk of contagion is strong.”

That risk and the way in which it plays itself out is coming to bear on the region’s political stability and fiscal flexibility.

“What’s important now is seeing how MENA sovereigns cope with changes once they have been set, and whether new governments have the wherewithal to carry on with reforms,” says Mike Noone, associate director covering the MENA region at Standard and Poor’s in London. “There is going to be pressure from the public on the governments because expectations are high and public demands for improvements in the standard of living, as well as increased demand for food subsidies will place fiscal pressure on these governments. There is going to be a new administration in Egypt later this year, so we’ll have to see how they deal with all this. Even though there may be experienced people from before, coping with all the changes will be a big challenge.”

How governments respond to the demands of protesters is also extremely important, Noone says. While the countries of the Gulf Cooperation Council (GCC) have low debt burdens and oil revenues, and can deliver on subsidies and social spending, things are not so clear-cut for oil importers, he says. Egypt, for instance, has a fiscal deficit officially forecast at between 8.2% of GDP and 8.4% of GDP for this fiscal year ending June 30, “so it could be very difficult for them to find the cash to meet demands unless they cut capital spending,” he says.

At a turbulent time, foreign investors are looking to the governments of the MENA countries to take the right course of action. Undoubtedly, the instability in the region has impacted foreign investment in the short term, but the need for fundamental changes that lead to greater stability in the long term is what the investors interviewed for this article are more focused on and are hopeful for.

The speed at which the MENA “revolution” has gained momentum was unprecedented and completely unexpected. But the paradigm shift it could result in would be invaluable for foreign investment going forward, and those governments that are able to effect those changes are the ones that will inspire investor confidence in the future.

Monem Salam, director and vice president of Islamic Investing and manager of the Amana Funds, Saturna Capital

There is an old Middle Eastern adage, says Monem Salam, director and vice president of Islamic Investing and manager of the Amana Funds for Bellingham, Wash.-based Saturna Capital, which states that every new leader ends up being worse than the first one. It has been proven right at different points in history in different parts of the world, but Salam is hopeful that this time, the countries of the MENA region will prove it wrong.

“In Ireland, there was a ballot, in Egypt, they took to the streets, but this is all about the feelings that have come to the fore in the aftermath of the 2008 financial crisis,” Salam, (left), says. “What’s important is that the average age of the person who protested in Egypt and across the rest of the region is the same as the generation of baby boomers was in America when they were out on the streets. Their protests led to great things for America, and in the same way, we think that this can happen for the MENA region, too. We are very optimistic that the younger generation can lead the way to a much-needed change.”

Change, Salam says, is inevitable, even in the GCC countries. Those governments may have money to spend, but appeasing their populations through food subsidies and other measures is only a quick fix to a longer-term problem that has to be resolved, he says.

Salam would expect to see a lot of volatility in the short term, but he hopes that macro level changes in the MENA region, when they happen, will give him a greater opportunity to invest in it. The Amana funds have only invested peripherally in MENA (“We preferred to buy companies in Turkey that have distribution in MENA, for instance, because Turkey is more liquid and less volatile,” he says.) and its emerging markets exposure is currently in Southeast Asia and Latin America. But looking ahead, “I do think there will be value [in MENA] and opportunities in the long term, once calmer heads prevail,” Salam says.

Larry Seruma, chief investment officer and managing principal, Nile Capital Management

Through the Nile Pan Africa Fund, Larry Seruma, chief investment officer and managing principal, Nile Capital Management, invests in all African stock markets from Cairo to Capetown, looking for growth businesses that are trading at value prices.

He believes he’ll be able to find what he wants in Egypt, a market that he is committed to as a long-term investor and one in which he thinks individual companies offer potential against a broader, more positive macro backdrop.

“When the Egyptian market opens, we expect to see selling pressure that will create more value opportunities for long-term investors,” Seruma, (left), says. “Before the crisis, Egypt’s market traded in line with other emerging markets, which are now trading at 11 times P/E. When Egypt’s market opens, it may trade between 7 times P/E.”

Seruma gives the example of Commercial International Bank (CIB), a stock that traded at 2.85 P/B before the uprising began in Egypt. Investors may have an opportunity to buy it at 1.5 times P/B or below when the market opens, he says. He also likes Orascom Construction, which gets half of its revenues from construction and the other half from fertilizers, an industry that is now experiencing high prices, a dynamic that is benefiting Orascom. “Over the last two years, Orascom has traded at an average multiple of 15 times P/E, but it may trade much lower when the market opens,” Seruma says.