The Unexpected Early Winners of the Arab SpringPublished January 09, 2012 in Arabic Knowledge@Wharton
After toppling long-standing regimes, destabilizing others and grabbing the world's attention, the Arab Spring's protestors most likely remain amazed at the far-reaching effects of their actions in early 2011. Although their demands in Tunisia and Egypt were focused squarely on long-term economic and political betterment, they also had an immediate impact on investment prospects in two countries that are geographic bookends of the Middle East -- Morocco and Iraq.
Indeed, the near-term beneficiaries of the Arab Spring may be those farthest from the intense protests. Both Morocco and Iraq are attracting fresh foreign investment as countries such as Egypt and Tunisia - the current champions for long-term economic opportunity - see investors flee to countries that formerly took a back seat to their relative dominance.
Already positioned with established, aggressive programs to attract investors, Morocco and Iraq are among the early winners of the Arab Spring. Morocco, whose popular king has reigned for the last 12 years with a record of dramatic reforms targeted at modernizing the economy, seized the opportunity of turmoil elsewhere by embracing a new, stability-inducing constitution that is already paying dividends. In the case of Iraq, which continues to find its political footing and secure rising oil revenues, foreign investors are giving the country a fresh look since the unrest began in January 2011.
While each country's long-term economic appeal remains to be seen as the region's political battles are fought, Morocco and Iraq -- each distinctly affected by its pre-Arab Spring circumstances -- have emerged as early economic winners.
Morocco: A Long Wait in the Corridors
Morocco's ability to seize the changing tides of the investment landscape in the wake of the Arab Spring is not surprising in light of its track record over the past 10 to 15 years. Under the leadership of the current king, Mohammed VI, the country has aggressively pursued economic liberalization with clear positive outcomes, including a competitive telecom market with three licensed operators following the privatization of the industry in the 1990s, and a thriving Tangier Free Zone that has brought 475 international companies to the country's main Mediterranean port.
In 2008, automobile manufacturer Renault-Nissan inked a deal to begin construction of a vast industrial complex in the Tangier Free Zone at an estimated cost of nearly €700 million (US$1 billion), one of its largest investments in the African continent. According to Jacques Chauvet, Renault's head of Europe, Middle East and Africa operations, Morocco's growing domestic consumer market, its strategic proximity to various European and African countries and its reliable infrastructure with strong labor-cost advantages are what tipped the investment case in its favor. Thus, even prior to the events of the Arab Spring, Morocco was emerging as an attractive destination for foreign direct investment (FDI).
Some observers suggest that revolutionary sentiment in Tunisia and Egypt caused Morocco to redouble its focus on attracting investment. As the early months of the Arab Spring unfolded and despots around the region responded to protests with underwhelming concessions, Morocco stayed ahead of the curve by quickly initiating constitutional reforms and other efforts aimed at quelling revolutionary sentiments. These reforms clearly aided the investment atmosphere by reducing the perception of political instability and attracting new FDI projects during the first quarter of 2011 - a time when countries such as Egypt, Tunisia, Libya and Syria suffered significant investment outflows.
Perhaps anticipating the opportunity to affirm his country as a beacon of stability in the region, King Mohammed VI pushed constitutional reforms that further strengthened Morocco's attractiveness for investing. On the heels of the peaceful protests of February 20, 2011, the king announced the beginning of a dialogue that would change the country's constitution. His speech, unprecedented in the region for its clear and significant concessions, had messages for protesting Moroccans and others. Investors received a strong signal from his statement that "we shall continue to press ahead with thorough reforms ... in development-related sectors. We shall see to it all institutions and agencies fulfill their mission in an optimal manner, [and] observe good governance standards...." Investors observed the fulfillment of other concessions and were confident that this was definitely not an empty promise.
This and subsequent speeches were well-received by investors monitoring the shifting sands of the Arab Spring. A July 2011 survey by the Economist Intelligence Unit found that an astounding 46% of respondents cited political instability as a top obstacle to doing business in Egypt, compared to just 14% in Morocco. Moreover, the International Monetary Fund, in its July 2011 mission to Morocco, praised the ongoing governmental reforms, saying they "will enhance efforts to strengthen structural reforms and foster medium-term growth." Indeed, it seems that Morocco has been successful in using political reform as a catalyst for improving investors' perceptions of the country's political stability.
These political calculations and years of work positioning Morocco as an appealing investment destination have paid off in terms of economic prospects during the Arab Spring. In one example of a win for the country, Guy Hachey, president and CEO of Bombardier Aerospace, the world's third-largest airplane manufacturer, announced in May 2011 that Morocco was very likely to win a major industrial investment in competition with other regional players. His pronouncement praised the Moroccan government's stability and efforts at reform, noting that they allowed Bombardier to invest "with confidence."
The international law firm Allen & Overy had a similar assessment. After several months of evaluating the best expansion route into Africa, the firm decided to establish an office in Morocco in July 2011. Wim Dejonghe, the managing partner, cited the country's "exemplary stability" relative to others in the region as a motivator for the decision. Bombardier and Allen & Overy are part of a trend as investors view Morocco with renewed interest compared to its protesting neighbors. The 2011 Global Venture Capital and Private Equity Country Attractiveness Index saw Morocco's overall attractiveness ranking rise over the first and second quarters of 2011, whereas Egypt's fell over the same time period.
Most importantly, this upward trend in attractiveness is reflected in the amount of FDI projects entering Morocco, compared to its North African and Middle Eastern counterparts. According to the 2011 first quarter report by the Mediterranean Investment and Partnership Observatory, Morocco was the only country in the Middle East and North Africa regions (excluding Iraq and the Gulf nations) to record a substantial year-over-year increase (61%) in FDI project announcements during the first half of 2011. This compares with devastating decreases of 35% and 43% in Egypt and Tunisia, respectively.
Overall, Morocco has deployed a careful strategy to attract investment over the past decade and has affirmed its ability to capture opportunity during the Arab Spring. Well-designed political reforms have established the country as a center of political stability. Initial reports on FDI note that the country has recorded substantial investment growth in the first quarter of 2011. Of course, the challenge for Morocco will be maintaining this momentum as larger economies, such as Egypt's, come back refreshed.
Iraq: A Well-timed Re-entrance
Morocco is not alone in its potential for attracting new investors, thanks to shifting political instabilities and years of work liberalizing its economy. While the people of Tunisia and Egypt were revolting in early 2011, Iraq was indicating that it had, after years of struggle, turned the page toward stability and progress. Indeed, increased oil production and high oil prices are projected to result in a 76% yearly growth in oil receipts in 2011, providing significant resources to invest in the country. Even against the backdrop of an uptick in violence and concerns over endemic corruption, the Arab Spring's repainting of political risk presents an opportunity for international investors to participate in the Iraqi reconstruction project.
Iraq is hardly a new player in the region's investment scene, although the country is now likely to attract renewed attention. Iraq's fundamentals are unbeatable, with oil reserves believed to be larger than Saudi Arabia's, an educated and enterprising populace accustomed to a leadership position in its region, and high economic growth coupled with low inflation. However, despite these advantages, investors typically have been unable to commit fully to Iraq because of corruption, political risks and obstacles to FDI.
The country's governance is keenly aware of these disadvantages relative to its neighbors, even those that were formerly beacons of political stability. Iraq now employs the international accounting firm PricewaterhouseCoopers to support its transparency initiatives. More substantially, investment laws were recently changed to allow foreign investors to own land for housing projects and to exempt foreign companies from tax levies for up to 10 years. Sami al-Araji, chairman of the National Investment Commission, describes these measures as "help(ing) foreign companies and investors become involved in this massive reconstruction opportunity."
As countries such as Tunisia and Egypt go back to the drawing board to move their economies forward, Iraq is leveraging established businesses - namely those initially created to serve coalition forces - as a driver of growth. Such companies are already deeply familiar with Iraq and are poised to use their presence to sell similar services to the emerging oil and gas industry and to Iraqi consumers. The Almco Group of Companies in Iraq, for example, has shifted successfully from providing wide-ranging services to the U.S. military to providing catering and construction to the oil and gas industry. Similarly, Al Morrell Development is marketing its Oasis bottled water brand to Iraqi consumers after years of being the primary bottled water vendor for the U.S. military.
Independent of protests throughout the Arab world, the changing landscape of Iraq has already reaped benefits. Growing foreign investment and years of spending by the U.S. government have created a new wave of Iraqi wealth. These factors and surging demand from Iraqi consumers for imported products are leading international companies, aware of such shifts, to invest in brand-building and distribution in the country. Ghassan Obaid, manager of the Iraqi media company Sadaa Media, has observed this directly: "We've seen a pronounced shift in our business breakdown in the past year. International brands like Nokia, Peugeot and Pepsi now make up the majority of our advertising clients."
Iraq also has demand for housing. While housing projects are being halted in Egypt and Tunisia, international investors and construction firms are flocking to Iraq. According to Dunia Frontier Consultants, foreign commercial activity doubled in the first half of 2011, compared to 2010, with real estate being the single largest sector.
Despite this notable drive, the energy sector is still the most substantial benefactor of Iraq's relatively appealing and improving investment prospects. Forty-five international oil companies participated in Iraq's third oil-licensing auction round in the first half of 2011, and 41 have been approved to participate in the fourth round. This substantial increase over the first two rounds in 2009 is driven by the dramatic improvement in the security and political situations, and the competition should help Iraq sign favorable contracts.
These contracts promise to be major drivers of growth in the country, with the first round alone committing the winning bidders to more than US$200 billion in investment. The burgeoning oil and gas industry is also beginning to attract the interest of financial players. Northern Gulf Partners (NGP), an Iraq-focused financial advisory firm, recently helped raise private equity capital for an Iraqi-owned oil-field services firm. Zaab Sethna, co-founder of NGP, points to this and other deals in the pipeline as not only a vote of confidence for the oil sector, but also an indication that investors believe the country is "emerging as an enthusiastic democracy with liberal investment laws."
As investment risk increases in Egypt and simultaneously decreases in Iraq, the latter is still not without substantial obstacles. The World Bank ranks Iraq 166 out of 183 for ease of doing business (compared to rankings of 114, 94 and 55 for Morocco, Egypt and Tunisia, respectively) and 175 out of 178 for levels of corruption (compared to rankings of 85, 98 and 59 for Morocco, Egypt and Tunisia, respectively). Moreover, an early 2011 effort to attract foreign investors to privatize state-owned factories failed to attract any takers. Although Iraq's stock market fared impressively through the Arab Spring - recording a 40% increase year-to-date in August 2011, compared to a 34% drop in Egypt's main index over the same period - it is clear that more challenges await Iraq to attract foreign investment.
Despite these obstacles, investors such as Sethna remain optimistic about Iraq. While new leaders in Egypt and Tunisia will struggle to meet the people's demands for economic growth, Sethna predicts that per capita GDP in Iraq will probably double in the next four years. Fast-rising incomes, coupled with increasing political stability and FDI, will allow Iraq to "regain its place as a regional leader and economic engine."
A Long Road Ahead
Even though the Arab Spring has created fresh investment opportunities for Morocco and Iraq, both countries face growing challenges to consolidate the relative advantage they earned in the first half of 2011. As stability emerges in neighboring countries, it will become even more critical for each country to confront its challenges head on.
In the case of Morocco, public equity investors remain wary of the country's stock exchange, given the thinly traded float and significant concentration of the king's investment holding company, which until recently indirectly controlled nearly 50% of the Casablanca stock exchange. Furthermore, restrictions on the free flow of funds make it difficult for multinationals to operate freely and to transfer funds outside the country. Finally, Morocco, like many of its peers across the Arab world, is hobbled by persistently high unemployment and underdeveloped human capital.
Meanwhile, Iraq faces far more acute challenges. Despite signs of renewed investor interest and stability, the country continues to be a shadow of its former self. Most multinational corporations and international investors remain fixated on headline risks of insecurity and political instability, preferring to sit on the sidelines until the dust fully settles. Moreover, even institutional investors who recognize the country's enormous potential are holding back because of the reputational risks of entering prematurely.
Although both Morocco and Iraq have gained relative credibility in light of the region's spreading tumult, they continue to suffer from the associative bias against investing in the Middle East and North Africa. International investors often assess risk in broad strokes and fall short in understanding the unique economic drivers of a region's constituent countries. For instance, on the heels of the protests in Tunisia, the Casablanca stock exchange declined nearly 10% from its mid-January 2011 highs. Moreover, Iraq - often the driver of blunt perceptions of instability in the Middle East -- for many years has been marching to the beat of its own economic drum and refurbishing its investment environment, with only limited notice from international investors.
While both Morocco and Iraq certainly face significant challenges in the future, they are the unexpected short-term beneficiaries of the Arab Spring, a movement that turned from the one act of self-immolation by a single Tunisian into regime-challenging protests by millions across the Arab world. Indeed, these brave protestors have made a significant down payment on brighter prospects for economic opportunity in their countries. Even so, the biggest short-term winners of the Arab Spring are found at the bookends of the Middle East and North Africa.
As unrest in the region evolves, investors who recognize the changing pockets of opportunity stand to benefit the most. According to Mustafa Abdel-Wadood, of Abraj Capital, a Dubai-based private equity house, "You start to differentiate in a post-Arab Spring world, and you look at the different markets that were affected."
It is this level of nuance that countries like Morocco and Iraq are counting on. Whatever the future holds for the region's shifting opportunities, however, investors are wisely taking the long view. As Abdel-Wadood notes, "I think the main theme when considering whether to enter these markets is the potential for long-term growth that will ultimately lead to a more positive outcome."
This article was written by Christopher Hogg, Amir Memon and Taylor Valore, members of the Lauder Class of 2013.