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Last week’s Alterio report initiated Maghreb as well as SSA-focused analysis:
Our initial report on Mashrek Maghreb macro conditions comes at an increasingly sensitive time for the region’s economies as roughly one year following a seismic ‘Arab Spring’ lead shift within the culture’s broader civic paradigm the need for political and economic synergy remains as critical as ever to achieving lasting, viable stability and growth given a stark dichotomy between the need to address high unemployment, social inequality, tax reform and subsidies versus the need to maintain fiscal discipline as well as secure financing against a dim backdrop of ever-deteriorating EU demand (EU imports of Moroccan goods grew 7.8 percent in 2011, for instance, down from 19.8 percent growth in 2010), largely uncompetitive export baskets and food/fuel dominated (i.e. price taking) import ones. As we touch upon in this initial commentary, however, there exists within the region—and moreover the broader Middle East at large—a convoluted catch-22 whereby, as described in a recent research note (see citation) the “need for regional economic linkages across the Arab world” sits in direct contrast with “political incentives of Arab elites [that] are not fully aligned with opening regional markets” and by extension helps nurture a fragmented economic model which seems to particularly effect [in terms of total share of merchandise exports as % of GDP] resource-poor, labor abundant countries such as Morocco, Tunisia and Egypt.[i]
The resulting chill on private investment further exacerbates the aforementioned EU macro squeeze and places a greater premium on [and cost to] external financing. The latter element refers to an ongoing [region wide] balance of payments dilemma which will demand continued attention from investors in the coming year given trending declines since 2009 in respective capital accounts (admittedly most acute in Egypt where FDI fell by over 50 percent in 2011 to just over $USD2bn and portfolio flows saw a similarly marked collapse) and weakening trade balances intensified by subsidized, sticky domestic demand (most notably the oil import bill which at ~9 and 7 percent of GDP in Morocco and Tunisia, respectively, is uncomfortably high), a strong correlation to Eurozone growth (more than 88 and 80 percent of Moroccan and Tunisian exports, respectively, go to the EU) and in Egypt’s case a projected gradual depreciation of the EGP (though we do expect the CBE to exert a generally tightening monetary bias over the course of the year while also promoting repatriation of foreign assets and generally tightening liquidity in the domestic banking system to retain deposits) given a dangerously low import cover that has fallen from 6.2 months to 3.7 months since last summer and threatens to further chill capital flows given omnipresent domestic political uncertainty, highlighted most recently by the High Administrative Court’s declaration that the voting system used to elect a new parliament last winter was unconstitutional—a decision that in turn could derail not only a new constitution, but May’s planned elections and an ultimate transition from military-to-civilian rule by year’s end (not to mention potentially jeopardize roughly $4.2bn aggregate in aid requested from the IMF and World Bank)
To this end Egypt’s funding predicament gives us the most pause given the ramifications on the state’s cost of borrowing (evidenced by recent 3-year debt auction yield widening), even though [considering in part how important its export market is for a number of countries] the country scores comparatively higher per both our Contagion Score and Original Sin metrics and also saw a healthy rise in both remittances and Suez Canal receipts during the latest quarterly report which is reserve positive. In light of said ambiguity we plan to continue to monitor official donor’s medium-and long-term lending figures as a proxy to gauge any secular turnaround in creditor sentiment. We also remain cautious about equity valuations at current levels; despite a near 46 percent rebound in 2012, we fear the state’s crowding out of private sector borrowing and the ramifications on growth leave future cash flows vulnerable.
[i] “The economics of the Arab Spring”, OxCarre Research Paper 79, Department of Economics, Oxford University, December 2011.
With Europe’s woes undoubtedly solved (trifling quibbles aside) and sovereign integrity intact (R.I.P. CDS), Tunisia and Morocco–two frontier markets relatively and acutely tied to the EU’s ultimate fate (to wit, 75% of Tunisian exports are destined for the EU) in particular seem poised to benefit. For even if the realities of moribund or at least muted growth as well as an entrenched downwards trajectory in manufacturing PMI remain in Europe’s cards, the illusion of sovereign stability may now be adequately vivid such that external financing–namely remittances (per Barclays, the EU remains the main source of remittances to most non-oil exporters in MENA, specifically up to 85-90% in Tunisia and Morocco) and net FDI flows (deemed critical to boosting growth and exports)–won’t turn fickle. The situation looks especially precarious in Tunisia, where FDI fell more than 150% q/q following the spring uprising and is projected to fall from 1.4bn in 2010 to 0.3. That said, the country’s “so-far-smooth plan for its transition to full democracy” looks hitherto credible, while GCC flows (chiefly from both Saudi Arabia and Qatar) coupled with multilateral lending by international financial organizations such as the World Bank and the IMF (not to mention support from the Deauville Partnership which involves, in addition to the G8, the UAE, Saudi Arabia, Kuwait, Qatar, and Turkey) should, at least in the near-term, help support macro fundamentals by partially offsetting deepening current account balance deficits (5.2 and 5.6% of GDP in 2011 in Morocco and Tunisia, from 4.2 and 4.7 percent respectively last year) with fiscal balance support and thus provide an implied ceiling to both CDS and z-spread.
Morocco and Tunisia’s CDS history to date continues to reiterate the market’s notion that Maghreb’s geopolitical backdrop and macro fundamentals are more or less indistinguishable even though hitherto (a) one underwent a full fledged revolution and the other’s demonstrations look tame in comparison (for now?) and should lead to certain reforms; (b) sharp declines in both industrial production and tourist arrivals (6% of total domestic output) underscore a likely -0.5 y/y 2011 real GDP contraction (and the associated decreased direct and indirect tax receipts) in Tunisia (versus +4.1% in Morocco, where growth indicators, rather, including credit growth have remained intact throughout the year) as well as a widening of the former’s CA deficit (6.2% forecast from 4.8% in 2010), an uptick in inflation (4.8% forecast versus 4.4% last year and 2.8% projected for Morocco) and a downturn in reserves (whereas thus far sticky FDI flows, at 2.5% of GDP, should allow Morocco to grow theirs to roughly 1/4 of nominal GDP, versus ~15.9% for Tunisia).
That said both countries remain vulnerable to both EU oriented trade and investment ties (54% of exports and 86% of remittances, per Morocco, and a similar relationship for Tunisia though a higher export percentage) as well as to other exogenous shocks; Barclays noted for instance that the external financing needs of the region’s oil importers (i.e. Egypt, Lebanon, Syria, Tunisia, Morocco and Jordan) “will exceed USD165bn for 2011-13, and, over the same period, their fiscal financing needs amount to another USD145bn, without taking into account the implications of their post-transition reform agendas. In a recent report prepared for the G8 meeting, the IMF states much of this financing gap will need to come from external financial support by the international community because it expects private debt and capital markets to remain cautious towards countries in the region, increasing their risk premium and their cost of borrowing.” At least one commentator bemoans the phenomenon, arguing that too much aid perversely “will hobble the Arab spring”, while debt sustainability measures (i.e. public debt to GDP ratios) aren’t trending down like they are in, say, Lebanon. Yet as economist John Sfakianakis duly noted last week in reference to the GCC’s recent outreach “the economic benefits of accession favour the two prospective entrants” such that it may be fair to say that at least one main driver of inflation in Morocco could be tempered going forward (and not a moment’s too soon per global wheat prices). With all of this in mind interestingly Moroccan z-spreads on euro denominated, 2020 paper have widened versus Tunisia comparable credit since late January and have failed to correct despite CDS convergence over that same period; in highlighting the discrepancy and in accordance with the above analysts note Morocco’s “comparatively stable political situation and solid economic performance and external position contrasts with the growing uncertainties in Tunisia.”
MENA CDS activity of late is eerily reminiscent of the risk “contagion” caused by investors questioning Dubai’s debt-servicing capabilities in late 2009 when [irrational] fear spilled-over to Abu Dhabi as well even though the latter’s fiscal integrity was never seriously in question, a fact later confirmed when it underwrote a bailout. But if such objective measures are largely ignored in the market of default probability perception, perhaps it should come as no surprise that more nuanced, subjective ones such as the differences between the historical, social and economic dynamics of say, Saudi Arabia versus Egypt, also fail to be carefully analyzed. Even The Economist’s latest stability rankings, for instance (see chart)–the result of ascribing a weighting of 35% to the share of the population that is under 25; 15% to the number of years the government has been in power; 15% to both corruption and lackofdemocracy indices; 10% for GDP per person; 5% for an index of censorship and 5% for the absolute number of people younger than 25–seem inadequate. An accompanying piece, for instance, notes that in Saudi Arabia (whose marginalized Shia population is, unlike in Bahrain, a relative blip) the unity of unrest seen elsewhere may be structurally unlikely: “Building an opposition movement is difficult in Saudi Arabia. [While] grievances are plenty: about living standards, poor schools, lack of jobs, the government is adept at using repression, propaganda, tribal networks and patronage to divide and weaken any opposition. Middle-class liberals are wary of democratising steps that might give more power to anti-Western Islamists. State-backed clerics have denounced the Egyptian and Tunisian protesters, and issued fatwas against anything similar in Saudi Arabia. Only in the [admittedly oil rich] eastern province—home to a large Shia population—is there much tradition of protest. But community leaders there are cautious, and desperate to avoid any accusations that they are a ‘fifth column’ for Iran.” Barclays too notes that addressing how immediate tensions in the region may unfold is at least partially dependent on a given military: “Bahrain’s military is almost entirely composed of Sunnis and there is a significant foreign element in the ranks as well. Hence, they may be more willing to brutally suppress dissent than their Egyptian counterparts and the regime may not be as concerned about possible splits within the officer corps,” it wrote to clients. That said, perhaps such “nuance” is just noise from the collective market’s point of view. The real concern for Saudi Arabia may not be the emotional state of its Shias but rather the physical soundness of the 18-mile-wide strait Bab el-Mandab.
Is the CDS spread between Tunisia and Morocco justified? Against the backdrop of debt downgrades from both S&P and Fitch, the cost of insuring five-year Tunisian sovereign paper against default rose to 190 bps earlier this week, some 30 bp clear of Morocco with whom it largely trades in step. While the country’s political situation admittedly looks precarious–analysts note that although the constitution decrees that a temporary president must work towards presidential elections within a period not exceeding 60 days, opposition leaders view said timeframe as inadequate and prefer a transitional government that would draft a new constitution in anticipation of democratic elections–Barclays notes, for instance, that although “a prolonged transition could negatively affect economic growth” given a weakening of the country’s current account (FDI down) and fiscal deficits (outlays to repair infrastructure, appease social and inflation-related tensions), the latter compares quite favorably to those of other MENA countries and to that of Morocco in particular (2.6 versus 4.5% of GDP in 2010), while public debt–at 47% of GDP–remains “one of the lowest levels in the region” and roughly in line with Morocco. Additionally, food inflation is much more rampant in Morocco than in Tunisia, having accelerated 6.7pp in the past three months; moreover, this trend will likely persist and should put further pressure on subsidy costs going forward, which increased more than 140% in the first nine months of 2010, per analysts.
A recently published IMF working paper (“Spillovers from Europe into Morocco and Tunisia”) examines “the effect of growth shocks in European countries on economic activity in Morocco and Tunisia” and concludes that while the recent credit crisis did not cause a recession in these two countries (the authors point to their “relatively insulated financial systems, exceptional agricultural production and strong domestic demand”), going forward both nevertheless “rely on Europe for a large share of their external receipts (exports, tourism receipts, workers’ remittances and FDI), and growth is likely to be significantly influenced by events in their main European partners.” Against the backdrop of a decline in real output across Europe of 4 percent in 2009, per headlines of late said events have revolved almost exclusively around various austerity measures.
Besides documenting the strong correlation over the previous decade between growth rates in Morocco and Tunisia and those of their key European partners, the paper shows specifically that:
“Transmission channels appear to be different between the two countries. In the case of Tunisia, growth shocks are mainly transmitted through exports and, to a much lesser extent, tourism. Exports, tourism receipts and remittances play equally important roles in Morocco. These results are confirmed by the evolution of export, tourism, and remittances in the wake of the recent slowdown in Europe. A similar exercise at the sectoral level indicates that the sectors related to services are the most responsive to EU’s GDP in Morocco, while in Tunisia the most responsive sectors are more export-oriented.”
The piece concludes that given that European imports–which represent the main source of external demand for Morocco and Tunisia—are projected to be “less than half compared to the pre-crisis period in 2010 and 2011,” the key to future robustness will hinge on “increasing competitiveness and [the] further diversification of trade flows.” That said, there is a question in regards to Tunisia at least as to how much domestic demand can grow given that, per one of the piece’s authors Mr. De Bock, “the government seems very committed to further consolidate [spending]” while on the private front non-performing loans remain stubbornly high, indicating that credit expansion may not be the answer. Yet per the IMF Article IV consultation piece with Tunisia from September, “the public debt ratio has fallen significantly over the past decade and is now slightly below the average for comparable emerging markets. In the event that downside risks materialize and cause a deterioration in economic activity and budget revenue, the staff saw scope for a small additional widening of the fiscal deficit of up to ½ percent of GDP in 2010.” Public debt levels in Morocco, on the other hand, look much higher.
A recent Reuters piece on the imminent dual listing of Tunisie Telecom on the Tunis bourse and a European bourse mentioned that “financial analysts say Tunisia could unleash a surge in investment, especially into its stock market, if it eases or removes currency controls.” Foreign companies have long considered such controls, which make it difficult to repatriate capital, as a major obstacle to investment. Yet two ongoing and impending events–one being Tunisia’s application to the European Union for “advanced status”, which would give it preferential trade terms; the other being a planned switch to a fully convertible currency in 2014–have all but cemented the continual easing of restrictions on capital movement. But as the herein linked piece on political succession points out, Tunisia’s political future is all but certain–always a cause for concern regardless of how solid present and near-term macro fundamentals look.
Only six markets worldwide are trading above their 2007 highs, and all of them can be classified as “frontier,” per a recent piece from the Wall Street Journal:
Tunisia, the tiny African nation south of Italy, has been the best performing stock market since 2007. The Tunindex, a 12-year-old index of 45 stocks, is trading 81% above its high for that year, and is up 15% for 2010. Sri Lanka is up 53% since 2007 and 36% this year. The other four comprise Venezuela, Colombia and Chile— Latin American countries benefiting from a rush to commodity-rich emerging markets—and Indonesia.
The tally of performances demonstrates just how much investors have been favoring emerging markets, and the extent to which they have been willing to delve into frontier markets.
Emerging market mutual and hedge funds saw inflows of $17.3 billion in the first half of 2010, while frontier markets saw $780 million incoming. Fund managers, the theory goes, are increasingly turning their attention to such markets if for no other reason that growth rates there are expected to vastly outperform those in developed countries.
The true test, of course, will be the viability of any long-term paradigm shift. Are money managers merely opportunistically seeking short term alpha, or are these shifts the beginning stages of a more concerted, long-term effort at mirroring what many observers predict will be a fundamental change and rebalancing in global finance whereby the relative fiscal strength of developing markets is reflected in higher exchange rates and greater consumption and foreign investment, fueling in turn a virtuous cycle and greater liquidity in their risky assets?
Good news continues to emanate from Tunisia, a frontier economy that from an economic convergence standpoint (i.e., the tendency of a variety of contrasting per capita income growth rates to ultimately normalize) has benefited as much, if not more so, from the 1995 Euro-Mediterranean partnership than any other member state. Silk Invest noted to investors last week, for instance, that according to the annual report of the World Economic Forum on Global Competitiveness (2009-2010), Tunisia ranked at the top of the African countries and 40th in the world (out of a total of 133 surveyed countries). Moreover, on Wednesday Tunisia and European Union (EU) officials signed a protocol establishing a mechanism for resolving commercial disputes–“aims to offer more guarantees to foreign investors and economic operators in Tunisia, which is likely to strengthen the competitiveness of the Tunisian economy and bolster confidence in its investment environment,” per news reports. Finally, FDI increased by 9.5% in 2009–helping underpin the expected 3.5% growth rate the country is expected to announce for the year. IMF Deputy Managing-Director Murilo Portugal has praised the country for managing to bring down its public and doubtful debts, and increase its currency reserves FDI volume in the face of credit contraction worldwide. Tunisia, Portugal said, is “reaping the fruits” of its ongoing economic liberalization and reform policy that he said has full IMF support.
One Tunisian company in particular to keep tabs on is Société Tunisienne d’Assurances et de Réassurances (Tunis Re), a publicly-traded insurance and reinsurance firm that markets a range of life and non-life policies for individual and corporate clients. Per A.M. Best, a credit-rating agency:
“Overall earnings are expected to remain consistently stable and positively impacted by likely stable investment returns, while the investment portfolio gradually increases exposure to shareholdings in 2010 and 2011 to take advantage of the anticipated markets recovery, translating into an expected return on equity in the range of 10 per cent over the next three years.”
From a technical standpoint the stock may be in the closing stages of a cup and handle at the moment–it trades at 145TND–though a break below 140-142 would breach a resistance line dating back to June. Volume has really tapered off, however, on a stock whose YTD chart has been quite exuberant.
According to Joel Toujas-Bernat, the International Monetary Fund’s (IMF) Tunisian mission chief, Tunisia maintains a “relatively favorable position” to address the financial crisis. In addition to the government’s historically “cautious” monetary policy, which created a buffer zone for public finances, Toujas-Bernat cited an anticipated “good performance” in agriculture and energy as the underpinning for the country’s projected 3% growth rate this year. Though the country’s export markets in particular have been affected by the crisis, he continued, “the political openness of the economy”, which has realized improvements in both productivity and competitiveness, has helped made Tunisian companies “more robust” and thus better equipped to withstand the economic shock.
JGW
Frontier Markets 