Author: Nigel Dudley
There are positive signs for the investment community. Senior Arab Figures, such as Bahraini Finance minister Abdullah Saif, are calling for the creation of a ‘capital-markets culture’ in the region. All the stock exchanges are buying state-of-the-art computerized technology. Saudi Arabia has introduced changes in its investment laws designed to attract more foreign capital and the United Arab Emirates (UAE) is, after years of prevarication, edging toward a formal exchange which will replace the lottery of the over-the-counter market. Even the Palestinian Authority has an exchange and was the fastest growing market in the region last year.
Local fund managers are increasingly positive about opportunities, citing the combination of political and economic stability, the relaxation in foreign investment laws, the new-found readiness to privatize state industries, the waiving of taxes and currency stability against the dollar.
According to Maha Al-Ghunaim, managing director of the Kuwait-based investment bank Global Investment House (GIH), “the Gulf Co-operation Council [GCC] equity markets are the last frontier in emerging markets. We believe this area is undergoing a major restructuring.
Foreign investors’ laws are currently being approved and implemented in almost all GCC countries.”
However, bankers and politicians are well aware that it will take several years to make significant progress. Before the region’s exchanges achieve international credibility, they need to shake off their reputation for extreme volatility and insider dealing. They also have to broaden the types of companies quoted on the markets and improve the quality of research provided by local and international brokers.
Some progress has been made on broadening the market – there are now more quoted telecommunications companies as governments privatize and allow more competition in both mobile and land line services. But the markets are still dominated by Financial institutions, property companies and old-economy shares.
There is little sign of any e-commerce stocks, though in recent months that has proved to be a blessing in disguise.
Until these problems have been resolved, Middle East markets will be off the radar screen of most institutional investors.
Western investment banks advise putting only 2% of any global fund into Arab markets.
Serious Arab investors are continuing to put most of their money in equity and property investments in Europe and the United States.
Bankers estimate that Gulf nationals, an estimated 190,000 of whom are millionaires, hold $900 billion in assets overseas. In stark contrast, Arab markets have a capitalization of only $185 billion, equivalent to 6.5% of total capitalization of the 38 emerging markets and 0.6% of global capitalization at the end of 1999. Even the largest of these – Saudi Arabia with $61 billion, followed by Egypt with $32 billion and the UAE with $20 billion – are mere scratches on the body of global stock markets.
Another barrier is that only a small proportion of the shares in this already small market can be considered by international investors. According to Henry Azzam, chief economist and managing director of the Beirut-based Middle East Capital Group, governments are still the largest shareholder, holding about 40% of capitalization. “Some 30% of the remaining $110 billion is held by families and strategic investors, seeking control and board representation. They are unlikely to trade their holdings. If you remove those markets that do not allow foreign holdings, only a fraction can be considered by global investors.”
A further deterrent to international and serious local investors has been the poor performance of the markets in the last 18 months. A correction was clearly needed after the dramatic growth in the mid-to-late 1990s.
In 1997 alone, Kuwait produced a rise of 40%, Bahrain was up 49%, the UAE climbed by 32% and Oman recorded the best performance in the world by rising 141%.
It was too good to last. The fall in oil prices, combined with the Asian and Russian crashes in 1998 and action by regulators alarmed by the amount of money borrowed for investment in already overheated markets, plunged Arab markets into the red. And even though oil prices have doubled in the last year and Arab markets were virtually unaffected by Nasdaq’s problems, the First half of 2000 was also poor.
Egypt, in particular, has not matched up to the bullish expectations of many analysts, showing the worst performance among Arab stock markets this year. Even the announcement in July that Egypt would be included in the MSCI index from May 2001 failed to generate much excitement.
In the longer term, however, Cairo&Alexandria Stock Exchange (CASE) chairman Sameh El Torgoman says he believes that the country’s inclusion in the index will make “international investors look more closely at the Egyptian market”. However, even this prospect did not deter Flemings from recently downgrading Egypt from “neutral to underweight in a portfolio designed to outperform the IFC Investable Europe, Middle East and Africa (EMEA) index”.
This change in attitude has come after a year (1999) in which investment bankers somewhat naively were singing the praises of the Egyptian market – it is still the only Arab market to appear in most banks’ emerging- markets research documents. The combination of a chronically slow pace of privatization, indecisive foreign exchange policy and widening Fiscal deficits have damaged the country’s risk rating and meant a rough time for all but a few shares in the telecommunications sector.
Morocco is at a two-year low; Lebanon continues to trade Flatly despite the Israeli withdrawal and Jordan’s market has been deserted by foreign investors. “The market has had to contend with a Flight of capital to stock markets in the developed world,” says Azzam.
Only now are Arab markets showing any sign of bottoming out and, in the absence of more progress on the Middle East peace process and evidence of a return to growth, the recovery is likely to be slow. Azzam says that in the western Mediterranean, Tunisia and Morocco will perform well while the smallest market, the Palestine Stock Exchange, will benefit from interest in its telecommunications stocks. Lebanon and Jordan are expected to have another weak year.
“In the Gulf, the rise in Saudi stocks is likely to continue this year, with lacklustre performances in Bahrain, Qatar, Oman and Kuwait. The newly established market in the UAE should also show a more positive return,” says Azzam.
This cycle of boom and bust has been a periodic occurrence in the Middle East and senior local politicians and bankers have been talking about the need to create a deeper and wider market for at least two decades.
Attitudes are changing in the Gulf because governments realize that membership of the World Trade Organization, which most are joining, means opening up markets to international competition. The more dynamic ministers, such as Qatari Finance minister Yousef Hussain Kamal, now accept the argument that governments must act as regulators of, rather than participants in, industry.
The low oil prices during most of the late 1990s made governments look at such policies as privatization and BOT (build-operate- transfer) as ways of reducing their budget deficits. Projects today, say bankers, must stand up to Financial scrutiny and even that does not guarantee that the public funds will be available.
“Policy-makers are starting to see the benefits of diversifying,” says Nabeel Waheed, head of Mashreq Bank’s treasury and investment-banking division. “They realize you need the private sector to make a major contribution and, for the First time, private companies are considering projects of between $20 million and $100 million. This cannot be Financed by banks alone, which means a debt-and-equity market has to be established.”
Privatization and introducing competition in essential services will also provide a stimulus to markets. The telecommunications market is likely to provide some of the most lucrative investment opportunities – with the region needing to invest $7 billion a year in telecommunications, much of the Financing will come from the private sector.
This year 40% of Jordan Telecom was sold to a group led by France Telecom – the First privatization of a telephone company in the Arab world. Kuwait’s two mobile phone companies, Mobile Telecommunications Company and National Mobile Telecommunications Company, are quoted. Mobinil in Egypt and Paltel (the Palestinian Authority’s land and mobile phone company) are some of the best performing shares in the region.
In other sectors, Abu Dhabi is starting to privatize electricity generation and there are changes even in Kuwait. “On the privatization side, we are seeing lots of opportunities – faster in some places than others. Kuwait has just concluded its First BOT transaction in wastewater treatment,” says Al-Ghunaim of Global Investment House.
An important bonus from this process is that it will help to diversify the region’s markets which are dominated either by banks or by a very few shares. More than 60% of the capitalization of Arab markets is accounted for by banking, investment, insurance and real estate, compared with the 24% average for emerging markets. Only 15% is in manufacturing compared with 36% in other emerging markets.
Even where banking is not dominant, some markets are dominated by a very few shares. In Lebanon, Solidere, the company established to redevelop the centre of Beirut, accounts for 80% of the market while in Palestine, the Palestine Development and Investment Company (Padico) and Paltel, account for 28% and 47% respectively of market capitalization.
Despite the increasing interest in equity markets, some bankers with many years of experience of the Middle East remain sceptical about the long-term prospects. According to one: “Most of the countries in the region have done very well without a stock exchange. Abu Dhabi, for example, has earned a fortune from oil in the last 25 years and succeeded without markets. They will not gain a particular advantage from opening one now.”
Sceptics say that the geopolitical risk in the region will deter foreign investors from making anything but the smallest investments.
They also argue that there is a complete lack of economic cohesion in the region; that there is not enough desire to reform archaic ownership regulations; and that the way ahead is through direct rather than portfolio equity investment.
Some of that cynicism is justified. In recent years there has been no faster way of transforming newly arrived investment bankers into cynics than asking them to prepare for the opening of the UAE stock exchange. The arguments between Abu Dhabi and Dubai, which have delayed the creation of a UAE exchange for the past Fiwve years, demonstrate how difficult it is to set up cross-border institutions.
It will be many years before a Gulf stock exchange becomes a reality. The region has a long history of failing to work together, opting for competitive rather than complementary products. Even though there is some cross- listing and cross-trading – Bahrain has already established these with Muscat and Kuwait – there has been little serious attempt to co-ordinate automated systems, listing procedures and trading rules.
However, there is now strong support at the highest level in the region for a change in attitude. Ministers say that a single regional market is the minimum requirement for attracting funds in a global market.
Bahraini Finance minister Saif, arguing that there should be much closer co-operation between the region’s exchanges, says: “It is very important that at a time when major international stock exchanges have seen the need to forge links among themselves, that there should be an Arab or Gulf regional market – though this does not mean there can be only one regional exchange.”
He believes that capital-market funding, which would complement rather than replace bank lending, would enable companies, including the Gulf’s traditional family-owned businesses, “to fulfil their true potential”.
At present many of the leading Gulf companies, such as Kanoo, Al Zamil, Almoayed and Algosaibi, are family-owned.
Potential investors, whether foreign or local, and companies deciding whether to Float need to be satisfied that they are participating in markets that are well regulated. Most exchanges are separating the market function from the regulatory function, though some bankers say privately that the distinction is more cosmetic than real.
The Amman Stock Exchange is one market where there is determination to separate the responsibilities. According to chief executive Jalil Tarif, reforms are “intended to bring the market up to international standards and to apply G30 recommendations on trading, clearance and settlement systems. Having a single body as a market operator and regulator served market needs well for the last 20 years but it no longer complies with best international practice.”
Bahrain’s exchange has gained a reputation as one of the best regulated and it has ambitions to become the region’s stock exchange. As a First step it wants to become the regional listing centre for international and regional stocks and funds. Bahrain has already attracted several regional Firms, the latest of which was The International Investor, the Kuwait-based Islamic investment bank.
But the most significant change in the last year has been the creation of a properly regulated market in the UAE. “This development is very important because it will create new avenues for investors to place their money,” says Central Bank of the UAE governor Sultan Bin Nasser Al Suwaidi. “Viable projects will now be able to Find the right medium to get funding and add value to the economy. It will also help the process of moving a lot of businesses to the private sector.”
Getting agreement between Dubai and Abu Dhabi on the structure and regulations has taken several years. But this past February a law was approved providing for trading Floors in all the emirates while leaving control with the Abu Dhabi-based Emirates Securities&Commodities Market Authority. Its nine directors are responsible for market structure and regulations as well as licensing and monitoring the market. Dubai opened its trading Floor in the World Trade Centre in March and Abu Dhabi is expected to start in September.
Mohammed Al-Alabbar, director general of the Dubai Department of Economic Development, says that the formal market will help protect investor interests, increase confidence and end the negative practices seen in the UAE’s over-the-counter market. These included insider trading and the creation of an artificially priced market in which shares were ramped.
Kuwait also is starting to introduce reforms to improve regulation of the market. According to one banker: “We need to end the system of self-regulation. There must be an SEC with legal power which gives it the power to regulate any market transactions.” Some reforms have been introduced, including the obligations on companies and funds to disclose each quarter details of their Financial dealings on the exchange. These measures, designed to make the market more transparent, are being rigorously enforced.
These steps are essential. Kuwait’s Financial markets had gained a reputation for insider dealing and for allowing a limited number of shareholders to manipulate the market. There have also been rapid swings between boom and bust, resulting in substantial losses. Only prompt action by Central Bank governor Sheikh Salem Abdul Aziz Al-Sabah to restrain margin lending stopped the market overheating again in 1998.
It was symptomatic of the attitude of many Kuwaiti investors that the governor’s action was not popular – even two years later some Kuwaiti investors are still seething with resentment.
There is, though, little doubt that the measures were necessary. At one stage in the mid-1990s commercial companies, who had few projects to invest in, were putting their money into other quoted companies. These cross-holdings created an artificial earnings growth – at one stage, companies were making more than half their profits from investments and their operating assets were as low as 25% of total assets.
It remains to be seen if these reforms are enough to attract the foreign investors who will soon be allowed to invest directly. At present non-Gulf Co-operation Council nationals can hold shares only indirectly through a Bahrain unit trust. An Amiri decree, approved by the National Assembly, will allow foreigners to hold up to 100% of quoted companies – a decision has yet to be taken on exactly what the ceiling will be. Bankers in Kuwait expect it will be a significant proportion, reflecting the trend through the region towards allowing international ownership.
The most significant change in the region could be if Saudi Arabia decides to allow direct investment in its share market. The government has been very reluctant to lose control of its Financial sector and fears that this will happen if it allows too much foreign investment.
However, the government’s Finances mean that it has little choice in the long term but to develop a capital market large enough to Finance its private sector and that, say bankers, requires foreign investment.
The government has relaxed its investment laws to allow more foreign holdings. But the most dramatic change occurred last November when the government allowed non-Saudis to own shares in the local market through mutual funds, a decision which pushed up shares by 18% in the last two months of 1999 and stimulated a further rise this year.
The trend to allow greater foreign access is now gathering momentum though some countries such as Qatar exclude most of their market by preventing foreign ownership of bank shares.
But Oman, Jordan and Palestine have no restrictions while Bahrain is allowing non-GCC foreigners to own 49% compared with the present Figure of 24% and GCC ownership of listed companies can be 100% compared with 49%.
The UAE has also taken the First steps in this direction – until now the law allowed foreign ownership of up to 49% but quoted companies were allowed to restrict holdings by overseas investors. In July, Emaar Properties, which is developing much of the land alongside the road between Dubai and Abu Dhabi and has broken new ground by selling foreigners 99-year leases on their properties, voted to allow 20% of its shares to be bought by non-nationals.
Perhaps the clearest sign that regional bankers believe the Arab markets are capable of longer-term sustainable growth is that they have started to dust down their regional investment funds.
At the Abu Dhabi Investment Company, general manager Humaid Al Katbi says that “with the imminent opening of the local stock exchange and improving economic outlook we envisage significant potential for growth in capital-market activities. We are well prepared for this as we have formed a local brokerage subsidiary to develop the opportunities in this area.”
And Al-Ghunaim says that Global Investment House is launching a GCC equity fund directed at foreign investors. “We believe that there are fabulous arbitrage opportunities within the different industries within the GCC,” she says. “We advise the GCC equity investor to consider the GCC equity markets now before the Final and complete opening of these markets.”
