Investment Adventures in Emerging Markets

The Middle East: A Youthful Reawakening

Over the past few months, the world’s attention has focused on events in the Middle East and North Africa (MENA), as the uprising that began in Tunisia spread to Egypt and onward to a number of countries in the region. The widening conflicts were quickly reflected in CDS (credit default swaps) spreads widening in those countries and the decline or closure of regional stock markets. Although we do not have investments in Libya, when I see what is happening there, I worry about the safety of innocent citizens. I’m encouraged by the determination of many Libyans who are fighting for more freedom and an opportunity to more fully share in their country’s economic future.

The upheavals in Tunisia, Egypt and other countries can be attributed to a complex of variables, most important of which are rising food prices, unemployment, corruption and political stagnation. Unemployment has stayed high and, more crucially, waves of new young job seekers entering the labor market have not been absorbed. As in many emerging markets, the populations in MENA countries are young—approximately one-fifth are between the ages of 15 and 24.[1]

Most politically explosive is that an increasing number of the unemployed are high school and university graduates. Average unemployment in many MENA countries is estimated at more than 10%, but among the youth that percentage could be almost four times as much.[2] It is important to note that the recent protests have come not from the lowest income levels but from middle-class and educated Arabs seeking fair treatment.

Moreover, innovation and investment are stifled by bloated bureaucracies that smother small businesses with red tape, while corruption feeds the politically powerful. Of course, corruption is not exclusive to the MENA region, but it has become more exposed, most recently with increased information being shared online through cell phones and social media outlets. In Egypt, about 20% of the population uses the Internet, and in the Middle East that percentage is higher, at around 30%.[3]

Partly in response to the regional uprisings, almost all MENA governments are currently taking populist measures, such as increasing spending to boost economic activities and welfare levels, which are likely to put pressure on future budgets. Economic liberalization could also slow in the short term as the government focuses on socialist measures. Some of these measures will be positive in the long term, such as higher budget allocations to improve education, housing and healthcare. In addition, socialist measures could hopefully help decrease the economic inequalities and the disparity between the top and bottom sections of the population. Other measures, such as increased subsidies and handouts, are positive from an individual standpoint but not from the standpoint of government finances. Increased freedom, increased democracy and decreased corruption are other possible developments as a result of the political upheaval in the region, and these potential outcomes will be indeed positive. For these economies to truly thrive, the opportunities for small business growth and entrepreneurialism must be improved. One risk in the region is a tendency toward more fundamentalist Islamic movements, but so far we have seen few signs of this, which is also encouraging.

According to projections from the International Monetary Fund, the MENA region as a whole grew approximately 3.9% in 2010, but within the region, growth rates varied considerably: countries such as Tunisia and Egypt recorded growth of about 3.8% and 5.3%, respectively, while Qatar recorded growth of 16% for the year.[4] North African and Levant countries are likely to see increased pressures on their current accounts and budgets in the short term, and consequently slower economic growth. However, the picture could probably change in the medium to long term if governments implement the right policies. In addition, over the longer term, foreign direct investment from wealthy Gulf countries could potentially spill over into the North African countries, which offer several production and operational advantages as well as a wide consumer base and a cheaper labor force.

In the resource-rich Gulf countries, high oil prices have boosted GDP, current accounts and trade balances to record levels. Much of this wealth has been channeled toward spending on infrastructure and economic diversification, which is likely to continue. This is not new and has been a theme across the region ever since oil prices started climbing around 2004.

In the short term, we expect to see increased volatility and the eventual outcomes are uncertain. I think it is very unlikely that a Libyan-style uprising would take place in Saudi Arabia; however, I do see a high likelihood for smaller protests as well as an increased level of negative news streaming out of Saudi Arabia and the greater MENA region over the coming weeks and months.

Given the current turmoil, we are monitoring the situation closely but continue to cautiously look for potential opportunities to accumulate companies that are oversold and well-managed. We are interested in companies that are domestic, regional and/or international leaders, that focus on the core advantage of the countries in which they operate and/or those that are likely to benefit from increased budget spending and economic activity.

[1] Source: International Labour Organization, Global Employment Trends for Youth, August 2010.

[2] Source: International Labour Organization, Global Employment Trends 2011.

[3] Source: Internet World Stats, 2010.

[4] Source: International Monetary Fund, World Economic Outlook, October 2010, and World Economic Outlook Update, January 2011.

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