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Global policymakers continue to perform a balancing act between containing the global COVID-19 pandemic and managing the economic fallout. Many countries in the MENA region implemented containment measures on top of monetary and fiscal stimulus. In most cases, it has become apparent that the risk of prolonged, lower economic activity has outweighed the risk of further mobility restrictions to try and contain the virus contagion.
We are still of the view that we will continue to see further easing of restrictions, which could be interrupted by occasional preventive policy measures. Even with relaxing restrictions, it is difficult not to expect a lingering impact on consumer behavior from the pandemic or no permanent economic damage from the measures put in place to contain it. The effects will likely be far-reaching and weigh on global economic growth beyond 2020.
Higher unemployment and rising debt levels are pressing challenges that policymakers—both central banks and governments—will have to continue to monitor and address. In the meantime, financial markets will likely continue to be volatile as participants grapple with the ever-changing information coming out.
We believe that economic activity will continue to improve in the months to come as governments further ease restrictions on mobility. We are less confident about the employment outlook as local economies continue to shed jobs and reduce wages amidst weaker demand.
Recovery May Take Time
MENA stock markets have rallied from the lows hit during the height of the pandemic-driven selloff this spring, but the realities of the pandemic and lower oil prices have rendered a weaker outlook for the remainder of 2020. Earnings estimates have been revised downwards and are currently reflecting a gradual recovery by the end of the year. The market continues to believe that recovery should come in 2021, yet at levels below those of 2019.
That said, a severe decrease in near-term corporate profitability should not alter the long-term prospects for larger corporations that can absorb the current shock.
Since our last post, we still believe that times of exceptional stress can provide good opportunities to reallocate capital and establish new entry points into quality names. Resilient sectors such as consumer staples, health care and technology appear well-positioned to benefit from the COVID-19 outbreak—we’ve seen evidence that quarantine measures have accelerated the use and need of the services they provide. Online retailing is seeing a boom in sales as conventional “brick-and-mortar” retailers rush to move their offerings onto digital channels.
We continue to favor resilient businesses that have the balance sheets and the flexibility to adapt to the new world post COVID-19. We strongly believe companies that pursue big strategic moves through every phase of the economic cycle can increase their odds of outperforming their peers over the longer term.
It is worth noting that the Gulf Cooperation Council’s (GCC’s) banking system was positioned significantly better going into the current crisis than it was ahead of the global financial crisis of 2008-2009.
We believe the region’s banks are well-capitalized and have ample buffers in place to withstand the volatility. Though non-performing loans are likely to increase and profitability may come under pressure, we expect government policies to be put in place to mitigate some of the effects. Banks’ share prices have also declined significantly, to levels last seen during the global financial crisis. This signals large impairments to their balances which, as of this moment, we believe are premature.
Individual Country Outlooks
United Arab Emirates: There is no doubt that the UAE’s economy is a victim of its own success. Years of steering the economy towards other non-oil sectors has immensely benefited the country. However, its economy has been hit hard by the global pandemic, given its sizable exposure to directly impacted sectors such as real estate, hospitality, transportation and retail. The UAE’s equity market has been hit hard and is among the world’s worst-performing this year. The scale of the disruption caused by the collapse in oil prices and the COVID-19 pandemic is unprecedented and difficult to quantify. That said, we believe the country’s recent policies to relax long-term residency requirements and foreign ownership limits could help mitigate some of the risks. Furthermore, we believe that the country’s world class infrastructure, strong connectivity and tax-haven status should continue to support the emirates’ position as a desirable international hub. We expect any health breakthrough or a general normalization in travel restrictions to have a more material impact on the UAE economy and overall market. We believe the challenges facing the economy will persist; however, the UAE market scores high on value metrics and could attract long-term bargain hunters.
Saudi Arabia: The government has taken bold, yet drastic measures to reduce spending and increase revenues. Hiring freezes, suspension of capital expenditure (capex) spending and a 10% increase in the value-added tax (VAT), which was the largest ever in the country, will aim to restore government finances but will simultaneously put a heavy toll on the country’s growth outlook. Coupled with the pandemic-led restrictions and a pressured demand outlook, the International Monetary Fund (IMF) expects the country’s gross domestic product (GDP) to contract by 6.8% in 2020 but recover by 3.1% in 2021.1 We do expect the economy to recover in 2021 as oil production increases and the economy normalizes.
Looking forward, we continue to see challenges facing the private sector as companies grapple with mobility restrictions, lower demand and higher VAT. Longer term, and given the lower growth environment, corporations will have to revisit their business models and manage their costs. Weaker participants could be forced out, and stronger franchises with liquid balance sheets will likely gain market share. Despite the current macro environment uncertainty, the initial public offering pipeline continues to increase, expanding the equity opportunity universe.
Egypt: The pandemic has highlighted the country’s external account vulnerabilities. Despite the meaningful reforms and policies the country has implemented over the past three years, Egypt still remains heavily reliant on tourism receipts, Suez Canal revenues and remittances to fund its large trade deficit. However, the current crisis has underlined the strong support Egypt enjoys from multilateral agencies, with the IMF pledging an additional US$8 billion in funding. Moreover, the country was successful in raising an additional US$5 billion from the Eurobond market—an additional hard currency inflow that will help the country bridge the funding gap.
Kuwait: The country’s Council of Ministers approved a set of economic reforms and recommended speeding up the debt law approval. The propositions also stipulate that the country’s annual 10% transfer of revenues to the Future Generations Fund will be a function of the government budget being in surplus. Parliament’s approval of the debt law is a needed prerequisite to allow the government to plug its financing gap resulting from lower oil prices and restore a portion of its capex spending without depleting its state funds. We view the likelihood of the debt law passing as high.
Limiting the Human and Economic Impact of the COVID-19 Pandemic
We had held the belief that central banks across the globe would not hold back from implementing further monetary or fiscal measures to pump liquidity into banking systems and support consumption. The table below outlines the policy response in MENA countries, which has varied across the different countries. We believe that additional measures should be implemented to mitigate any further risks to economic activity.
We have argued before that as with any crisis, there will be winners and losers. Some sectors such as education, health care and retail have innovated quickly during lockdown, and some areas of tech-related spending will no doubt buck the weakness trend of other sectors, many of which had not even seen investment spending recover fully from the 2008 global financial crisis. As active investors, we don’t think we are done with COVID-19 challenges just yet—however, this could also be an opportunity to attract long-term bargain hunters to the MENA region.
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What Are the Risks?
All investments involve risks, including the possible loss of principal. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Investments in foreign securities involve special risks including currency fluctuations, economic instability and political developments. Investments in emerging markets, of which frontier markets are a subset, involve heightened risks related to the same factors, in addition to those associated with these markets’ smaller size, lesser liquidity and lack of established legal, political, business and social frameworks to support securities markets. Because these frameworks are typically even less developed in frontier markets, as well as various factors including the increased potential for extreme price volatility, illiquidity, trade barriers and exchange controls, the risks associated with emerging markets are magnified in frontier markets. To the extent a strategy focuses on particular countries, regions, industries, sectors or types of investment from time to time, it may be subject to greater risks of adverse developments in such areas of focus than a strategy that invests in a wider variety of countries, regions, industries, sectors or investments.
1. Source: International Monetary Fund, World Economic Outlook, June 2020. There is no assurance that any estimate, forecast or projection will be realized.