Winter 2012

ECONOMICS PANEL: Funding future growth

MapCould Lebanon be set for an oil and gas boom? What is the best way to invest in infrastructure? These questions and more are answered in our economics panel. Edited by Gerorge Mitton.

Where in the Mena region will have the fastest growth rates? The oil-rich countries of Saudi Arabia, Qatar and the United Arab Emirates, say our participants.

Less obvious was Lebanon, which Khaled Abdel Majeed at Mena Capital tips for a boom around 2018. There is likely to be oil and gas in its territorial waters, he says, and the impact of their discovery will have a significant effect on the nation’s small economy.

A potentially risky long-term bet is Egypt, which could develop fast if it achieves the political reforms promised by its revolution. Now, it is unstable, while protesters clash with supporters of the ruling Muslim Brotherhood over a controversial draft constitution.

With oil prices forecast to stay high, ambitious infrastructure plans in the Gulf are a promising trend. Investments in building materials, such as cement, are a safe way to take part in this growth. The banking sector will also benefit from increased lending, while fixed income investors should see more high-quality issues, says Anirban Kundu at Saudi Re.

However, Amer Khan of Shuaa Asset Management warns against investing in sectors such as construction and contracting, which display “intense competition” and “overhangs to profitability”.

Participants felt the rise in trade volumes between the Mena region and Asia, particularly China, offered opportunities. Investors should examine companies exporting to Asia or “local tourism and leisure sectors, which will see a growth in visitors”, says Sean Daykin of Emirates NBD Asset Management.

Meanwhile, participants had several ideas about youth unemployment, which is projected to remain above 25% in the Mena region in coming years. Historically, there has been a reliance on governments to provide jobs, says Fahad Alturki at Jadwa Investment. The private sector has been “hamstrung” by inflexible regulations and unable to create employment.

Participants agreed policy makers should invest in education and training to get more young people in the Mena region into work.


Where in the Mena region will see the fastest economic growth in the next five to ten years?

I expect fast growth in Lebanon and the UAE. Lebanon’s growth is owing to the likely presence of oil and gas in its territorial waters. Given the small size of the economy, the impact will be substantial and is likely to kick in around 2018. I pick the UAE because it has demonstrated an ability to attract human capital that is unsurpassed in the region. This applies mostly to Dubai.

Which markets will provide the best equity returns?

For a time frame of one to two years, the UAE and Egypt. The UAE is trading at around nine times 2012 earnings and eight times 2013 estimated earnings, with earnings growing 24% this year and 12% next year. The Abu Dhabi government is starting to spend again. Dubai’s economy is being driven by a rebound in tourism and trade as well as a recovery in the all-important real estate sector.

Egypt is suffering from political transition issues, but the revolution is positive overall in that it installs accountability in government and will improve efficiency over time. The market trades at nine times 2012 estimated earnings and about 7.5 times 2013 estimated earnings – a bit cheaper than the UAE but with higher earnings growth next year
of 24%, though Egypt is higher risk.

How can investors participate in the GCC infrastructure boom?

The obvious way to play that is to invest in contractors and building materials, but in both cases it is important to do your homework as some companies’ bottom lines do not match growth in revenues. The reason is overcapacity, particularly in the contracting business. Margin compression is exacerbated by measures to force the employment of nationals. It is best to stick to building materials.

How should investors respond to rising trade volumes between the Arab world and China?

From a Mena perspective, it does not really matter much in the short term whether Westerners buy the oil or Easterners. In the longer term it matters as Westerners are less likely to spend much on protecting Gulf oil producers. As for imports, again, it does not matter for Mena market investors whether Mena consumers are buying Chinese-made laptops or US-made laptops.

What should policy makers do about youth unemployment?

The main issue here is a lack of skills and a poor work ethic. The only way to solve this is to improve the quality of education. This has started but it will take years to sort out the problem.


Where in the Mena region will see the fastest economic growth in the next five to ten years?

The fastest economic growth will continue to come from the “haves”, in-terms of oil reserves, rather than the “have-nots”. The GCC countries, particularly Saudi Arabia, Qatar and UAE, are likely to grow fastest, with rising spending on infrastructure and housing supporting the dramatic growth in local population. Rising wealth in the region will boost the consumer economy, such  as hotels and leisure facilities, in economies such as the UAE.

Which markets will provide the best equity returns?

On a 12-month view, the most attractive returns will come from Saudi Arabia, Qatar and UAE. These are medium-risk bets since growth should be relatively secure as it is driven by government spending. A higher risk, longer-term bet might be Egypt, but political uncertainties make this a more difficult investment.

How can investors participate in the GCC infrastructure boom?

The direct beneficiaries would be construction companies and materials providers, which would all benefit from new contract awards and ongoing construction. These are mostly listed in Saudi Arabia and UAE, with examples including Arabtec, Drake & Skull and Saudi Cement. Financials would also benefit, as these projects create investment banking activities and higher lending. Beneficiaries would include Qatar National Bank, Al-Rajhi in Saudi Arabia and National Bank of Abu Dhabi in the UAE.

How should investors respond to rising trade volumes between the Arab world and China?

Historically, most oil from the Middle East was exported to the West, while imports into this region came from the developed world. With Asia and China growing, and US energy independence being talked-up, these trends will change. Consumer spending in Asia will grow dramatically, along with oil demand. Investors should allocate capital to companies and sectors which benefit from these trends, such as companies exporting to Asia or local tourism and leisure sectors, which will see a growth in visitors.

What should policy makers do about youth unemployment?

In the oil-rich countries of the Mena region, the vast majority of the national population work in the public sector. Unemployment will not fall unless there is greater participation in the private sector. This is a challenge on many levels. Education is critical for the youth to obtain the right skills to be able to add value to private companies. Policy makers should work to alter negative perceptions of the private sector by focusing on the positive aspects and promoting role models of success.


Where in the Mena region will see the fastest economic growth in the next five to ten years?

We expect Saudi Arabia and the UAE to post significant growth in the medium to long term. Saudi Arabia should continue to grow on the back of its burgeoning population, its commitment to diversify its economy away from hydrocarbons and its sound fiscal balances and revenues. The UAE should continue to attract foreign investment and tourism, as outlined in government plans, and will steadily grow into a world class transport, financial and tourism hub.

Which markets will provide the best equity returns?

UAE equities offer investors a heady mix of value and growth. From a valuation perspective they have lagged their regional peers through three difficult years and are playing catch-up, after which medium to long-term growth should get priced in. The dynamics of the Saudi economy are likely to drive growth and equity valuations across various sectors over the coming years. Investors may also find selectively superior returns in Qatar, on its way to hosting the World Cup 2022, through the execution of a robust planned development programme.

How can investors participate in the GCC infrastructure boom?

Investors should focus on sectors that are direct beneficiaries of this spending but also sport a durable competitive advantage versus foreign competition. Two examples are cement and banking. Cement is a direct beneficiary of construction activity with high transportation costs, which ensures supply must remain regional. The latter, notably in the UAE and Saudi Arabia, is well capitalised, conservative and poised to grow while remaining at a deep discount relative to historical levels. Sectors such as construction and contracting that display intense competition and consequent overhangs to profitability are less attractive.

How should investors respond to rising trade volumes between the Arab world and China?

It is definitely an indicative trend of future trade patterns – from resource rich economies to fast growing, resource hungry ones. As China continues to urbanise and focuses on satisfying rising demand for finished products, Middle Eastern energy exporters, makers of basic materials and speciality chemicals manufacturers with feed cost advantages will benefit. And vice versa, given Middle Eastern demographic trends and per capita incomes, import of Chinese goods should continue to surge, which bodes well for the domestic retail industry.

What should policy makers do about youth unemployment?

Youth unemployment has been a chronic global problem since the financial crisis and, regionally, is structural in nature. However, policy makers in the Middle East have a window of opportunity to tackle this given regional demographics and the stage of their economic development. Alongside growth and diversification of their economies, they should focus on developing youth skill-sets to match the demands of the economies they are shaping for future years. Not just developing skills, but the right skills, remains key.


Where in the Mena region will see the fastest economic growth in the next five to ten years?

The GCC will exhibit continued strong growth, driven by accommodative government policies and supportive demographics. Possible succession issues are unlikely to change the current focus on economic expansion and the will to play a larger global role.

Other major Mena economies, Egypt and Turkey being the most significant, could exhibit strong economic performance in the latter half of the decade, but I expect political restructuring to be a hurdle in the near term.

Which markets will provide the best equity returns?

Saudi Arabia, Turkey and Qatar provide the best potential for equity returns, though it might not always be achieved through the public markets, since their composition is not always representative of actual growth drivers in the economy. Investors might have to look for more direct avenues, such as private equity and private equity-like structures. Egypt could be a surprise if the political turbulences are sorted out quickly, though it seems unlikely.

How can investors participate in the GCC infrastructure boom?

Infrastructure spending is intended to facilitate follow-on growth in other segments of the economy. Equity investors should be positioned to benefit from the broader economic impacts of infrastructure spending and focus on logistics, education and consumer discretionary sectors in the equity universe. Fixed income investors stand to benefit due to the increased supply of high quality issues leading to an expansion of the overall market resulting in pricing more in line with larger global markets.

How should investors respond to rising trade volumes between the Arab world and China?

Allocation of investor capital is based on a variety of factors and emerging Asia is already one of the largest recipients of foreign direct investment in the world. Emerging economies are likely to stay robust in comparison to the developed world. These economies, including China, are a preferred destination for the energy exports of the Arab world. GCC and Mena investors should concentrate on investments that focus on the domestic consumption theme in the emerging economies, including China.

What should policy makers do about youth unemployment?

Young Mena economies are evolving and so is the young population of the region. Successful application and implementation of skills imparted by a globalised education system should be a focus. Policy makers should continue supporting economic development and ensure that educational institutions equip their graduates with relevant tools to succeed on a global platform. The Mena region provides lucrative opportunities for public-private partnerships in the field of education and that should be the focus for investors looking to partake in this evolution.


Where in the Mena region will see the fastest economic growth in the next five to ten years?

The economic outlook for countries in the Mena region is mixed. The oil producing economies are expected to sustain solid growth supported by elevated hydrocarbon revenues and reserves that would withstand external shocks. The non-oil producing countries, and particularly those in transition are facing weak initial conditions generating an ambiguous implication on legal frameworks, procedures and legislation, in addition to an anti-private sector wave in some countries.

All these factors are likely to weigh on medium-term growth. The challenge for both groups of Mena countries is to sustain an efficient economic performance that generates jobs and reduce poverty.

How can investors participate in the GCC infrastructure boom?

The shortage of infrastructure in the GCC region in the face of a rapidly growing population makes this a key investment sector for both local and foreign investors. Investment is likely to be concentrated in infrastructure services sectors such as power, water, transport, education and healthcare. There is also a potential scope for investment in residential real estate particularly in affordable housing.

How should investors respond to rising trade volumes between the Arab world and China?

China and more generally Asia would be increasingly important trading partners for the Arab countries. Robust economic growth rates for main Asian countries compared with other developed countries means that trade links between the Arab world and Asia are likely to strengthen over the coming decade even if there are no policy moves to promote such trade relations. In fact, the share of Mena exports to Asia increased from 12.6% in 2000 to 26% of total Mena exports last year. There will be in particular high Asian demand for fuel, industrial chemicals and plastics products.

What should policy makers do about youth unemployment?

Historically, there was a reliance on Mena governments to provide jobs, but over time this has become unaffordable. However, in many countries the private sector has been hamstrung by regulation and unable to take over the role of creating jobs.

These problems are worsened by fast growing populations, inflexible labour market regulations and weak education systems with little emphasis on vocational training.

Over the long term, the key to creating employment is having a liberal investment environment that allows the private sector to develop unhindered while ensuring that entrants to the labour force have sufficient skills to be attractive to the private sector.

©2012 funds global mena

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