The Middle East and North Africa: A Region Gathering StrengthPublished in Knowledge@Wharton
The Middle East and North Africa (MENA) region is generally rebounding from the surprisingly sharp tailspin that rocked the oil-rich area during the global 2009 recession. Boosted by rising oil prices, improving capital markets and gradual growth in lending, governments across the region are pursuing aggressive spending plans and actively courting international investments to spur job creation.
These gains point the way to a continued economic comeback for many MENA countries, yet some wounds have been slow to heal. The overall region has been experiencing a "two-speed recovery," says Fadi Arbid, chief executive officer of Amwal AlKhaleej, a leading Middle East-focused private equity and alternative investment firm and the first to be headquartered in Saudi Arabia. "On one hand, the real economy is growing nicely," says Arbid. "Oil prices are at a comfortable level for most Gulf governments, and public sector spending is booming. On the other hand, the capital markets and investor confidence are still struggling, albeit slowly regaining strength. We still haven't fully recovered. Investors are still very nervous and rattled. Overall, people are more optimistic now than they were a year ago, and we're finally seeing some investment flows, but nowhere near what we should be seeing, given the strong economic fundamentals."
At the same time, the economic impact of the political turmoil that has swept across the region from Libya to Bahrain remains highly uncertain. "I don't think it is possible to think through the future of the economies" in the wake of the turmoil, says Howard Pack, professor of business and public policy at Wharton. "One still has no idea if the political system [in Egypt and elsewhere] will be authoritarian, democratic, or something in between, and the range of economic policies they will follow may not be predictable from the political system. Think of Eastern Europe after 1989 -- lots of things took a decade or more to settle down, and some still haven't."
In this article, experts from Wharton, Amwal AlKhaleej and other regional analysts assess the outlook for the area and to what extent it was vulnerable to the global financial crisis.
Only Some Shelter from the Storm
The region initially looked sheltered from the credit crunch that enveloped the developed world in mid-2007. MENA countries appeared to be inoculated against the crisis by soaring oil prices, heavy government spending, domestic economic reforms and financial systems that were for the most part relatively disconnected from the global economy.
But the financial storm that pounded the world after Lehman Brothers imploded in September 2008 dispelled any hope that the hydrocarbon-rich MENA region would prove fully immune. "People probably underestimated the challenges coming out of this crisis," says N. Bulent Gultekin, professor of finance at Wharton and a former central bank governor of Turkey. "This has been a worldwide recession, and it's not easy to recover from something like that. But the Middle East region is essentially still okay. The oil producing countries still have a constant source of income, and the other [Middle East] countries have still been less affected than many others."
However, the recession damage was heavy. Oil prices plunged below the budgeted break-even points of most hydrocarbon exporters, and non-performing loans started to proliferate in certain countries in the region, weakening the outlook for the banking sector and causing lending to freeze. Equity markets, particularly those in more "internationalized" countries such as Egypt and the United Arab Emirates (UAE), fell significantly farther than counterparts in emerging and developed markets. The Saudi market also fell as sharply as those in Egypt and the UAE.
Despite their abundant hydrocarbon wealth, the Arab Gulf states -- which along with Egypt remain the main economic drivers of the MENA region -- were among the poorer performers in the immediate aftermath of the global financial crisis. The six main Gulf countries -- Saudi Arabia, Bahrain, United Arab Emirates, Oman, Qatar and Kuwait -- known collectively as the Gulf Cooperation Council (GCC), a loose regional bloc, saw economic growth slow from 7% in 2008 to just 0.4% in 2009, according to the International Monetary Fund (IMF). As recently as October 2008, when the global financial system was engulfed in post-Lehman panic, the IMF had forecast that the Gulf's economy would expand a brisk 6.6 % in 2009.
The MENA region as a whole suffered a similar setback. The IMF reports that real Gross Domestic Product (GDP) growth for the region fell from 5.0% in 2008 to 2.0% in 2009, compared with an average annual growth rate of nearly 6% between 2003 and 2007.
The psychological impact of the unexpectedly painful downturn has perhaps been even more pronounced than the headlined economic growth figures indicate, Wharton and Amwal AlKhaleej experts say. "Initially many thought the region would be isolated, secluded and sheltered from the financial crisis, so it was a big shock to many when it became apparent that we weren't," says Arbid.
Growth Picks Up Again
Now trends that battered the region during the downturn are reversing themselves. A resurgent Asia and worries over the region's political stability helped the price of oil recover to more than US$100 a barrel by February 2011, bolstering government budgets in the Gulf in particular. The price of benchmark Brent crude spiked above US$120 in April. Stock markets continue to recover but still face jitters over the political turmoil, while bank loans are becoming more available.
The long-term picture still is bright. The region's population remains exceptionally young, which could lead to a significant "demographic dividend" in the form of a rapidly growing and highly productive labor force if enough private sector jobs are created. And foreign investor confidence in the region picked up following a marked dip in foreign direct investments over the past two years. More generally, the latest GDP projections by the International Monetary Fund (IMF) released in April 2011 show annual economic growth rising from 3.8% in 2010 to 4.1% in 2012. While the recent wave of unrest will depress investments this year, the level is expected to resume rising once the political outlook becomes clearer.
Here is a look at key countries in the region:
Saudi Arabia Shows the Way
Saudi Arabia has led the way. It is the largest Arab economy -- and, with some 28 million residents it has the largest population in the GCC (80% of which is indigenous). It is also the world's largest oil exporter. The government started to implement a five-year US$400 billion investment program in 2010, bringing public spending to a historic high of 39% of GDP, according to research by Barclays Capital. This boosted economic growth from a meager 0.6% in 2009 to 3.4% in 2010, according to the IMF. More recently, Saudi Arabia has announced an extra US$130 billion of spending to ward off any hints of unrest.
Saudi banks have largely shrugged off the financial crisis after having been shaken by the default of two major family-owned conglomerates and a rise in non-performing loans. Lending remains cautious but is recovering faster than in many other parts of the region and is buttressing economic growth
The country's Tadawul bourse is one of the better performing stock markets in the Middle East and has added almost a third to its total market capitalization over the past two years. The growing wealth has helped make Saudi consumers more confident about the future than are many of their neighbors.
Government programs further fuel this confidence. "The government is spending a lot of money on health care, housing, and education, -- not the least of which are the expenditures announced by the King in March 2011-- and we can see the emergence of a nascent middle class in Saudi Arabia, which creates a lot of opportunities," says Arbid. "Both health care and education are winning sectors in addition to many sectors that are consumer based."
Runaway Growth in Qatar
Next door to the east of Saudi Arabia, the small peninsula of Qatar (population of about a million) is benefiting from a long-standing investment drive in its liquefied natural gas industry and related infrastructure. This helped Qatar's economy grow at an estimated breakneck pace of 16% in 2010, up from 8.6% in 2009, according to the IMF. The country is now the wealthiest in the world per capita, and the government plans to continue to invest billions of dollars in domestic and international developments and assets. In particular, hosting the football World Cup in 2022 could mean between US$50 billion and US$100 billion of investments in infrastructure over the next decade, and will underpin economic growth for years to come. Any concerns over its domestic banks were swiftly obviated by a series of large government capital injections.
The UAE Strives to Restore Trust
The UAE, which borders Saudi Arabia and Qatar, was arguably the country hit hardest by the crisis, largely due to a severe property crash and debt restructurings in the commercial hub of Dubai. Abu Dhabi, the UAE capital, has kept spending on many of its ambitious economic diversification projects -- incurring a projected US$57.5 billion budget deficit over the 2009-2010 period, according to government estimates--but many developments have slowed down.
While Dubai has managed to restructure the debts of Dubai World, a major state-owned conglomerate, several other government-linked entities are struggling to repay their loans and bonds, and talks with creditors are ongoing. Wharton and Amwal AlKhaleej experts say the government's handling of the debt restructuring has become more sure-footed -- after some initial miscues regarding the emirate's debt crisis -- but the reputational damage and the economic fall-out will take time to resolve.
"Trust takes years to build up, but can be quickly destroyed," says Raphael (Raffi) Amit, a Wharton professor of management and entrepreneurship. "The downturn has revealed a lot of problems in the Middle East, and the credibility of companies and institutions has been questioned across the region. The wounds are still open, which is apparent from the lack of investment flows into the region."
The lack of transparency in the UAE is a concern, and the reluctance of local banks to lend because of the overleverage in the system is hindering the prospects of a swift recovery, says Samer Sarraf, senior vice president at Amwal AlKhaleej. "Some progress has been made, but there is still a lot of uncertainty and volatility,' Sarraf says. "Banks have cut a lot of credit lines, which has caused a local credit crunch. There is still a lot of real estate supply coming onto an already oversupplied market which is holding back the recovery. Dubai is still going to be on a downwards trend for a couple of years, before it has got rid of all its excesses and can start a modest recovery." The recent events in Bahrain may accelerate this recovery with a new flow of population and capital finding its way to the UAE.
Still, Amwal and Wharton experts say that the positive long-term UAE story remains intact. The country's financial system remains one of the largest in the MENA region. Sectors such as trade, logistics, and tourism have held up relatively well and are on a full path to recovery, and Abu Dhabi's drive to diversify its economy into more value-added sectors such as petrochemicals, aluminum and other manufacturing industries makes good business sense. Key infrastructure projects such as nuclear power plants and a UAE-wide national railway system appear to be going ahead.
After falling by a negative 3.2% in 2009, real GDP growth in the UAE recovered to a positive 3.2% in 2010, according to the IMF, which in April 2011 projected growth for the year at 3.3%, rising to 3.8% in 2012. "Overall, the economic fundamentals of the UAE are still solid, once we've purged out all the excesses. Abu Dhabi still has plenty of oil reserves, and Dubai will remain the region's dominant business hub," says Sarraf.
Kuwait Plays Catch Up
Kuwait, near the northern tip of the Gulf, has long lagged its neighbors in developing and diversifying its statist economy, due to a political standoff between the country's fractious parliament and its royal family-dominated government. But Kuwait finally appears to be implementing an ambitious but long-delayed government investment program.
Thawing relations between the legislative and executive powers of Kuwait have allowed the passing of two key bills in the past year: a US$107 billion five-year development plan and a controversial privatization law, which could lead to more private-sector involvement in Kuwait's infamously state-dominated and bureaucratic economy. Kuwait's economy contracted 4.8 % in 2009, mostly due to the lower price of oil, which remains its dominant industry, but expanded an estimated 2.3 % in 2010 and is projected to grow 4.4 % in 2011, according to the IMF.
Egypt's Financial Clout
Egypt, whose Sinai Peninsula links North Africa and Asia, is the third-largest economy in the region after Saudi Arabia and the UAE, and the most populous Arab state. It enjoys a financial sector that is generally healthier than its Gulf counterparts. "The [financial] crisis has hurt everyone, but Egypt has suffered a lot less than most other countries," says Karim Saada, executive vice president and Egypt country head at Amwal AlKhaleej. "The banks are very conservative, the foreign exposure is minimal, and the average leverage ratios of Egyptian companies and individuals are very low--largely because interest rates are so high, so without subsidies and incentives it is very hard to take on a lot of debt."
While Egypt may have weathered the financial crisis better than most of its neighbors, the unprecedented wave of protests that toppled former President Hosni Mubarak in February brought the economy shuddering to a halt. The full financial and economic impact of Egypt's revolution remains difficult to gauge, but it is likely to be severe. The country's political future is uncertain and protests and strikes have continued. Foreign companies, which had poured billions of dollars into Egypt, have largely shelved investment plans until the outlook becomes clearer.
However, economists stress that Egypt's economic advantages -- a large and youthful population, educated middle class, skilled labor and strategic location --will ensure that its long-term economic prospects remain relatively undimmed. They could even be enhanced if a democratic, transparent government free of the former regime's graft emerges.
Mixed Outlook for Full Recovery
The overall picture of the region thus remains mixed. Saudi Arabia is likely to experience one of the region's most robust recoveries, thanks to its large population, comprehensive reform program, and soaring oil revenue. Moreover, the ability of the region's governments to address traditional challenges -- including underdeveloped regulatory architecture, poor corporate governance, perceived weak and arbitrary legal systems, and a dearth of highly skilled and educated workers -- could translate into significant economic gains and potentially lucrative investment opportunities.
But across the region key challenges such as still-weak lending growth and political uncertainty remain. "It took three years for the U.S. to recover from the IT bubble bursting in 2000, and that's in the U.S., where there's a strong regulatory and institutional framework," Wharton's Amit says. "In most of the Middle East the regulations that control capital markets are weak, and that hinders investment. I think it will take at least two years for the region to [fully] recover from the crisis, notwithstanding any geopolitical developments, such as heightened tensions with Iran, which will really concern investors."