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Iran’s Offsetting Oil Anguish Salve

2019 May 19 by

The Tehran Stock Exchange local index hit the record 200,000 mark despite harsher US sanctions aiming to eliminate oil exports and branding in full the Revolutionary Guard (IRGC), which controls listed companies accounting for an estimated one-fifth of the economy, as a terrorist organization. Investors preferred equities over the battered currency and gold markets as they sought refuge from deepening stagflation, with gross domestic product down 4% on 30% inflation through the last fiscal year ending March, according to government figures. The International Monetary Fund predicts greater output contraction over the next year to 6% as consumer prices rise 40%. Oil earnings fund around half the budget, with last year’s deficit at an historic $15 billion. The central bank, which has just begun formal open market operations, is responsible for 20% money supply expansion to further embed inflation, as it tries to kick-start growth and ensure banking system liquidity.

 Economic and financial sector health is at its worst since 2012, when previous global as opposed to unilateral sanctions pushed Tehran into relief talks with outside powers in exchange for nuclear weapons development monitoring. While Washington has withdrawn from the deal, Europe and Asia are still in, as they look for cross-border payment structures to allow continued trade without drawing US Treasury Department ire. France and Germany championed a special-purpose vehicle for barter exchange in essential goods, but it not yet in effect and may be confined to highly-restricted humanitarian purposes with the Trump Administration’s intended ban on all oil exports and Revolutionary Guard-connected transactions. Iraq is the only country to get permission for a waiver on petroleum shipments, and China and Turkey criticized the decision and may phase them out over time, but their banks and companies are clearly in enforcement cross-hairs. The Bank of Kunlun, a well-known Chinese intermediary, has already faded from the scene, and policy banks leading the bilateral Belt and Road initiative are also on the alert. However domestic retail investors have factored in these outside worst-case scenarios and see local currency value only in shares, with the rial in parallel trading free fall toward 150,000, compared with the 42,000 official rate, after the IRGC’s terrorist designation.

Iranian oil sales through March plunged around 60% from the 1.5 million barrels/day projected in the budget, before the Trump Administration’s zero target was finalized. Non-oil exports slipped 6% to $45 billion, reversing the previous year’s 12% increase. The squeeze’s fiscal hole is exacerbated by widespread tax evasion, estimated at 30-40% of the eligible base according to a parliamentary commission. It also jeopardizes the traditionally positive current account balance and international reserve position, which analysts believe is now below $75 billion, with only a fraction held at home immediately accessible and liquid. Iranian officials claim the stash is ample and that their heavy crude is not readily replaceable by major Gulf producers, and secret transaction channels are in place for backup. However recession was reported across the board in the last September-December 2018 quarter, including agriculture, mining and industry, which plunged 9%. Flooding the past month added economic damage with losses put at $2.5 billion, and catapulted meat and vegetable prices 100% into the Persian New Year, government statistics showed.

The World Bank’s Middle East/ North Africa outlook released for the Spring Meetings forecasts another year of near 4% contraction, a 5% of GDP fiscal deficit, and slight current account surplus. It will be the only country in the region in recession, with unemployment also expected to worsen to 15% on youth joblessness double that figure. Multilateral agency observers cite promised banking sector reforms, including central bank monetary policy conduct through benchmark Islamic finance instruments, bond and interbank market deepening, and stricter independent regulatory oversight as pathways out of crisis. They have long advocated exchange-rate unification, shelved indefinitely a year ago when emergency import measures and an informal dealing crackdown were imposed when the US left the nuclear agreement. Iran’s Budget and Planning Organization head admitted in April that the “ approach is not working” with fraud and embezzlement and offshore flight allegedly pervasive. The multi-tier system may be simplified in an open electronic platform, as central bank governor Abdolnasser Hemmati also points to “psychological factors” in currency panic due to linger without broader economic policy sanity.

Israel’s Blunted Blue and White Whirl

2019 May 11 by

Israeli stocks and bonds now featuring in developed world indices maintained solid gains with Prime Minister Netanyahu’s surprise coalition re-election victory, after the opposition Blue and White alliance headed by former military chief Ganz first claimed triumph. He becomes the longest-serving in the post following bargaining with small right-wing parties that may shield him from prosecution on corruption charges while in office. The contest was largely run on the force of the two personalities, with US President Trump also throwing his weight behind the incumbent with recognition of Golan Heights control taken from Syria 40 years ago. The challenger’s economic policies were unclear, but income disparity and high housing costs regularly surfaced as issues despite 3.5% GDP growth and unemployment near that number. Consumption, investment and exports have been strong despite the shekel’s 5% rise to 3.5/dollar this year. Inflation is only 1% with the central bank’s benchmark rate barely positive, but the fiscal deficit has doubled to 3.5%, with public debt close to 65% of output. The Prime Minister signaled no major budget changes during the campaign, after previously backing big state enterprise privatizations through the stock exchange. The investment-grade sovereign rating could be further elevated with such steps, while stocks should continue to advance on good bank and technology listing earnings. Investors also await possible business incentives and capital infusions under a promised US proposal for a fresh Palestinian conflict approach. Netanyahu’s new arrangement has ruled out a formal two-state solution, so the search for creative constructs has become urgent especially with half the population in poverty in the West bank and Gaza, according to World Bank analysis.

Across the border Lebanon is at the other end of the ratings scale at a B minus/C with its MSCI component off 3% in the first quarter, and big Eurobonds maturing in April and May. A cabinet was formed finally, with heavy Hezbollah participation slammed by US Secretary of State Pompeo during a visit. The move will allow over $10 billion in international aid pledged at a conference in France to flow, as Iraq and Syria rebuilding plans are also contemplated. The cabinet cobbling may again be short-term on meager 1.5% growth and double-digit fiscal and current account deficits. A tax crackdown and partial privatizations are expected, but major budget reform like electricity price hikes are off the table. Saudi Arabia lifted its travel ban to help revive Gulf tourism, but oil is still not at the break-even level at home curbing discretionary spending. Both Saudi and Qatari sovereign funds have committed to buying Lebanese bonds, with $5 billion in foreign debt service this year. Both foreign reserves and non-resident bank deposits recently dipped $1 billion, as officials reaffirmed the exchange peg. The former pool covers over a year of imports, and the latter is a vital fixed-income investor base largely drawn from wealthy expatriates. Along with the Hezbollah presence, the government risks alienating donor agencies with a harder line against the estimated million Syrian refugees arriving since the civil war. They are barred from formal employment and receive limited education, as authorities have begun to urge a return home despite dire infrastructure and security embrace.

Egypt’s Punctuated Lavish Praise

2019 May 5 by

Egyptian bonds and stocks, the latter up 15% on the Morgan Stanley Capital International core emerging markets index in the first quarter, continued to draw strong foreign investor inflows around the spring International Monetary Fund-World Bank gathering. Government officials fanned out to promote an economic comeback and political stability narrative to public and private sector counterparts, with President Abdel Fattah El-Sisi showered by US President Donald Trump’s “great job” praise in a White House meeting. The former army chief won a landslide 97% election victory last year, and is on track to secure constitutional extensions that could keep him in the post another 15 years. He agreed to a $12 billion IMF program in 2016, due to expire later this year, which floated the currency and cut fuel subsidies to win sovereign ratings upgrades to “B” and “positive.”

 The stock exchange prepared for another wave of state bank and enterprise partial sales following burst decades ago, and with the pound finally settling at its market level, overseas portfolio managers snapped up local Treasury bills with double-digit yields. Foreign reserves have tripled to $45 billion from their precarious position before the Fund package, with offshore natural gas discovery joining tourism rebound to boost external accounts. However inflation is almost 15% and the fiscal deficit is stuck in high single digits in relation to gross domestic product. Improving indicators otherwise may have come at the cost of runaway public debt, over 90% of GDP, to invite a “great job” rethink on the President’s longer-term performance and reform path.

GDP growth in 2019 is set at 5.5% as a Middle East-North Africa region leader, aided by “megaprojects” such as Suez Canal widening and the $45 billion Cairo relocation to a new administrative capital. The government’s “Vision 2030” charts a diversification strategy for the coming decades that also slashes poverty to meet the United Nations’ Sustainable Development Goals. Banks have been directed to earmark one-fifth of loans over time to small and midsize business to support that sector. A foreign direct investment push is designed to increase the current $7 billion take, equal to 3% of GDP, after new bankruptcy, profit repatriation, and residency laws were passed. In their Washington rounds, officials noted that US company total commitments around $25 billion represented 40% of their Africa total, and that Suez Canal modernization will complement the continent’s nascent sweeping free trade zone.

The fiscal targets in the $12 billion Fund agreement have been met despite the steep headline deficit, with a 2% primary surplus expected this year on higher tax collection. Food prices, and electricity and fuel tariff hikes with subsidy reduction, are the main inflation drivers. The currency is firm at around 17.5/dollar, and the central bank recently cut interest rates 100 basis points. The inflation goal is 9% by year-end with additional 3% leeway, and foreign investment in local government paper may double to $20 billion should it be within reach, but the more likely scenario is position unwinding that in turn weakens the pound. The current account gap will come in around 2% of GDP despite Zohr gas field production and tourism revenue approaching its pre-Arab Spring peak, with slumping Gulf remittances and expanding import appetite. Egyptian representatives conceded these points during the Bretton Woods meetings week, but countered that the domestic consumption could draw on a large 85 million population as reported unemployment fell to a decade low 9%. Standard Chartered Bank echoed these views in a January review predicting Egypt’s ascent to a top 10 global economy in 2030, with $8 trillion in output as Africa’s giant.

Bank balance sheets revived the past five years with Moody’s Ratings assigning a positive outlook, with a 15% increase projected this year. Bad loans at 4.5% of portfolios are one-quarter the amount a decade ago, and capital adequacy is 15% of assets, according to 2018 figures. The loan/deposit ratio is low and local currency deposits are three-quarters of the total. Only 30% of citizens have formal accounts, and greater financial inclusion is to be achieved through digital and technological outreach under a joint industry-regulatory framework. Retail and Islamic lending are promising lines to match trends in neighboring countries, with the youth demographic inviting consumer credit. However one-third of bank assets remain concentrated in government securities, and default or restructuring as widely feared before the IMF program may again be contemplated with exit over the coming months.

Algeria’s Layered Liberation Lament

2019 April 14 by

Thirty years after a popular revolt against one-party military-guided rule that may have been an Arab spring precursor, Algerians took to the streets to demand the 80-year old stricken President not seek another term and that competitive elections be held against the backdrop of long-promised political and economic reform. The late 1980s uprising led to civil war, resulting in tens of thousands of deaths and a harsh army crackdown after an Islamic party election victory was annulled. A state of emergency lasted the next two decades, until the 2011 regional protests, when the authorities also boosted social spending to quell double-digit youth unemployment with vital oil export prices still high. The state hydrocarbons monopoly Sonatrach by then had diversified with Asian partners beyond traditional European ones, with almost all foreign direct investment at less than 1% of GDP in the sector with post-independence access and ownership restrictions in local banks and industries lingering. Foreign exchange in turn has always been strictly controlled despite an active parallel market, while domestic capital market plans dating from the 1990s stalled despite a legal stock exchange launched with World Bank technical advice. President Bouteflika’s brother is also a member of the ruling clique, and business cronies benefiting from import curbs and government contracts have resisted breakaway from the National Liberation Front’s mercantilist and protectionist policies. The regime has suggested a compromise with technocrats in place until a legitimate fresh poll can be organized, but this capability has often been on display at the central bank and finance ministry while influential generals and politicians pull the strings behind the scenes.

Since the 2014 oil price decline, the economy has grown only 2-3% annually and foreign reserves halved to $95 billion, as the IMF’s 2018 Article IV report cited urgent fiscal, monetary and structural overhauls still on the back burner. The current account and budget deficits approach 10% of GDP, and inflation is projected in the 7.5% range this year, aggravated by liquidity injection from central bank borrowing. State banks are sufficiently capitalized and profitable, but the bad loan ratio is in double digits and the government is in arrears to client suppliers. Originally it was to embark on fiscal consolidation through raising fuel and electricity taxes and introduce business climate and currency hedging changes in 2019, but the agenda is off the table with the popular unrest. With public debt at 40% of GDP and constrained domestic bond markets, the Fund proposes external issuance along with modest exchange rate depreciation to address overvaluation. Interest rate subsidies should be phased out, and bankruptcy and creditor rights modernization could aid small business financing.  Allowing overseas majority control in joint ventures, and more flexible and inclusive labor markets are other overdue steps. Increased Treasury bill issuance and maturity extension, and bid-ask spread introduction on the official currency market to shrink the estimated 50% parallel premium should be priorities following the central bank’s recent clarification of non-energy earnings surrender mandates. Bank supervisors are behind in beginning to implement the old Basel II rules, and lack crisis preparation and intervention blueprints. Adjustment strategy before the mass demonstrations predicted budget balance early in the next decade, but political accommodation is now the undefined feature of the larger liberation formula, the report intimates.

The Middle East’s Integrated Introspection

2019 March 10 by

Unlike most other emerging stock markets enjoying a bounce this year, as reflected in Bank of America’s latest asset allocation survey where they were a record overweight, Middle East components Jordan, Lebanon, Morocco and Tunisia have limped through February under international development agency criticism and investor ambivalence. An International Monetary Fund report underscored the lack of trade and financial integration among Maghreb countries Algeria, Libya and Mauritania alongside Morocco-Tunisia despite union proclamation three decades ago. Only the last two are not exclusively focused on commodity exports and are out of conflict and in democratic transition, with group average gross domestic product growth only 2.5% on 25% youth unemployment.

 A separate World Bank analysis examines the economic and social dynamics of possible Syrian refugee return from Jordan, Lebanon and Turkey, which together host the greatest population of the 5.5 million registered outside the country. It dissects the so-called “mobility calculus’ to weigh factors beyond hostility end, such as job, land, and infrastructure access in deciding on repatriation. The study finds these considerations remain overwhelming deterrents along with basic security, and explain why only 100,000 have gone back from neighbors. Damascus’ $400 billion reconstruction price tag, with scant expected Western donor support, is another argument for extended displacement both externally and internally, with equal numbers at large.

In 1989 the five Maghreb members established a free trade area again agreed by representatives in 2010, but it was never ratified.  In contrast Morocco and Tunisia inked pacts with Europe, Turkey and the US and they also joined the World Trade Organization and China’s Belt and Road Initiative. Over one-tenth of imports were Chinese in 2016, although trade openness declined overall with limited progress on product quality and export diversification. Intra-Maghreb commerce is less than 5% of the total, and mostly gas and oil, iron and steel, and clothing. Bilateral direct investment statistics are sparse but flows are “insignificant,” the IMF comments. The main example is Moroccan banks’ cross-border expansion, in the North as well as Sub-Saharan Africa. Number one Attijariiwafa Bank is in Tunisia and Mauritania and a dozen other countries, as the region continues to struggle with weak state-owned lenders. Financial technology has spread, with digital and mobile money regulations now in place. A new Maghreb Bank for Investment and Foreign Trade was created in 2017 with $500 million in capital to promote institutional and payments network integration, but the founders warned the process will be slow amid a spike in global financial volatility.

Tariff, non-tariff and geopolitical barriers persist, with the average 15% duty a departure from the 5% -10% in advanced and developing economies. Cross-border trading rankings in the World Bank’s Doing Business publication are low, reflecting poor logistics performance. Capital movements are typically restricted, with only Morocco’s account relatively liberal, although it still controls currency conversion for profit repatriation. Its more flexible pegged regime against a dollar-euro basket is far from a competitive float, a goal envisioned over a 15-year time horizon. Further Maghreb steps to closer ties as originally promised could forge a single block of 100 million consumers with combined $350 billion GDP, and facilitate global value chain inclusion through positioning as a hub between Europe and Sub-Sahara Africa, the Fund suggests. Trade is complementary and capital markets would benefit from internal reforms and cross-listing arrangements with existing regional zones in West Africa and elsewhere. Morocco embarked on this path with an application to join the English-speaking ECOWAS, and invited banks and brokers to locate in the nascent Casablanca Financial Center for broad geographic reach.

In the eighth year of the Syrian refugee crisis Jordan remains under intense fiscal and social pressure, as the latest IMF program and the World Bank’s mobility reviews point out. Growth was just 2% last year on 4% inflation, as the budget deficit again exceeded the target ahead of the London donor conference at end-February. Tax evasion and state enterprise losses remain widespread, as subsidies stay intact to mitigate the pain of near 20% unemployment. At international community urging, the government issued more work permits to Syrians to allow them formal jobs. However extreme poverty still affects half that population there, the identical rate as at home with reduction urgent in both places, the World Bank concludes.

Lebanon’s Battered Bank Bulwark

2019 February 24 by

Following a year with Middle East stock markets down aside from tiny Tunisia, ratings agencies repeated a gloomy banking sector forecast for 2019, with Lebanon in particular now on a related sovereign debt restructuring precipice as the ratio to gross domestic product tops 150%. S&P Global Ratings in a January report predicts tighter liquidity, falling currencies and geopolitical unrest, while oil importers they should get balance of payments relief. For the region including Turkey annual loan growth will average 7-8%, with Jordan and Lebanon stagnant from a combination of Syrian war refugee and trade spillover and depressed consumption and tourism. Tunisia has upcoming elections and understates bad loans in the absence of international financial reporting standards, as it tries to keep another International Monetary Fund program on track. Banks in Egypt and Morocco depend on expatriate transfers, while Turkey’s must roll over volatile external funding as $40 billion comes due in the next twelve months. Return on assets will fall further to 1.2% despite higher government bond yields, with most countries implementing strict Basel III capital adequacy criteria.

Egypt was removed from the riskiest category on projected medium term 5% GDP growth with rising gas production and tourism. Loan expansion is set at 15%, but double-digit inflation will hurt borrower debt servicing ability. The loan-to-deposit ratio is a conservative 40%, and private sector credit is only 30% of output as banks prefer state company lines and Treasury bill holdings. In Jordan only leader Arab Bank has a cross-border presence for diversification, and amid steady profitability sovereign debt exposure at one-fifth of assets is steep. Morocco’s automotive and phosphate exports will pick up through end-decade, but high unemployment and income inequality stoke social tensions. Banks face increased commercial real estate developer losses to lift bad loans to 7% of the total, and they will turn to domestic capital markets for financing beyond customer deposits, S&P believes. The recent dirham band widening against the currency basket will have negligible balance sheet impact, with the free-float transition timetable extended to 15 years. Tunisia’s economy shows meager 2-3% growth on an uneven reform record to shrink fiscal and current account gaps, with the political cycle likely to again freeze progress. Banks must draw on central bank refinancing, with one-fifth of loans non-performing on glaring asset-liability mismatches, the rater notes.

Lebanon was demoted to the top risk “10” group mainly due to the central bank’s “distorting” stimulus and swap operations. Public debt will hit 155% of GDP at year-end and burdens the sector after an official spate of “financial engineering” deals swapping local for foreign currency obligations. Real estate and construction credit will sour without subsidies, but banks have a solid 70% US dollar and euro- denominated non-resident deposit base and a broader regional footprint. Despite parliamentary elections in 2018 for the first time in a decade, government formation remains in limbo, with billions of dollars in donor pledges suspended as a result. With double-digit budget and current account deficits, and the Finance Minister explicitly raising the restructuring option, Eurobond yields spiked to over 900 basis points over US Treasuries the past month. This year respective totals of $7.5 billion domestic and $3 billion foreign bonds must be rolled over, and the central bank and commercial banks hold 85% of that amount. Gulf allies Qatar and Saudi Arabia are in line to buy paper, as growth is estimated at a meager 2%. Almost $35 billion in reserves supports the 1500 exchange rate peg to the dollar, but the prospect of bond write-downs could unravel the delicate balance and spur severe capital outflows and balance sheet damage.

Debt service will absorb one-quarter of GDP this year, and the central bank will likely have to strike more arrangements such as the “soft leverage” one in place with commercial lenders since 2017, which generated short-term profits on favorable regulatory terms, to preserve buyer appetite. The $11 billion in bilateral and multilateral assistance pledged at last year’s CEDRE conference would almost equal the requirement, but even if accessed with a functioning coalition are soft loans demanding repayment and disbursed with delays. Foreign investors controlling over 10% of Lebanese debt are underweight since early 2018, and default scenarios with 25% haircuts would pare capital positions at leading banks like Blom and Audi to simultaneously tarnish their overseas appeal.

The Gulf’s Cracked Finance Facade

2019 January 14 by

Gulf stock markets were mixed, with Qatar, Saudi Arabia and Kuwait with 10-25% gains, Bahrain flat, and Oman and the United Arab Emirates with losses on the MSCI index. The OPEC meeting revealed further fractures as Qatar quit the group, and remaining members no longer in control of world oil price direction geared production toward the estimated $90/ barrel break even for budget balance. On the geopolitical front, Saudi and UAE support for the legacy Yemen government’s fight against Houthi rebels came under US and Europe diplomatic and military challenge, as the UN convened an initial round of peace talks in Sweden. As money managers consider their 2019 regional weighting beyond technical index changes, the International Monetary Fund also came out with dual studies on the financial sector and foreign investment climates. They highlighted gaps with emerging market peers that hamper growth, diversification and inclusion, and the findings reinforce near-term aversion that will persist after reallocations temporarily lift performance.

The IMF paper argues that outside Saudi Arabia financial system development lags economic fundamentals, with dominant banks and missing non-bank institutions like pension funds and insurers. Debt markets are nascent and equity activity is sizable but narrow, with large state companies the main participants. Small business and women’s credit access is minimal, in part due to limited knowledge. Overdue reforms include government bond yield curve creation, tighter corporate governance and investor protection rules, and wider international ownership scope.

 Total Gulf Cooperation Council bank assets are $3 trillion, about 200% of gross domestic product in line with other emerging economies, with the non-bank system share at 20%. The UAE sector is biggest and Oman the smallest, and only Bahrain has both wholesale and retail lending. Islamic finance has grown at a 10% clip the past decade, double the conventional rate, with large company funding the preferred business model. Saudi Arabia is an exception with a half dozen non-bank intermediaries, and aims to place sovereign wealth money in local hands now chiefly placed abroad. It is the leading stock market in terms of capitalization and turnover, but Qatar and Kuwait are ahead in relation to output. The GCC just started to issue government bonds to cover fiscal deficits the past five years, and private activity is negligible at 5% of GDP as corporates tap global markets instead.

Scaled by population, the number of equity listings is particularly meager in Oman, and in 2017 the region had just twenty initial public offerings worth $1 billion. Market concentration is high with banks and state-owned enterprises around half of capitalization, and buy and hold primary investors constrain share free float. Foreign ownership is around 5% overall, with Oman and Saudi Arabia still imposing minority company positions. Household borrowing relies on informal family and work channels outside banks, and 60% of youth have accounts compared with 80% of adults, and small firms get 5% of loans. This inclusion gap is identified as a policy priority, but officials must further expand credit bureaus, overhaul insolvency codes and introduce fintech innovations, the survey insists.

Stock market regulation improvement paved the way for the UAE, Qatar and Saudi Arabia to move from the MSCI frontier to core index, but implementation of governance and protection norms remains “weak.” Debt markets lack repos and competitive auctions, and robust disclosure and ratings systems. Currency instruments have been thwarted by the dollar exchange rate peg, and Bahrain has the only sizable mutual fund sector at one-quarter of GDP. Life insurance is “negligible” as a possible catalyst for long term fixed income allocation, and private pension plans are rare. A partial program to remedy these deficiencies would bring modernization benefits that raise per-capital income growth at least half a percent, the document concludes.

Broader trade and investment criticism was also pointed in a separate study, which noted “limited progress” in shifting from oil exports at two-thirds of the total and integrating into global supply chains. The intra-GCC amount was 10% of non-oil commerce and has further contracted with the Qatar embargo. FDI inflows have “stalled” despite rich natural resource endowments with lagging worker skills and productivity. Outside hydrocarbons they are skewed as a result toward real estate, where slowdown in the Dubai hub in particular may match the faltering financial market foundation.

The Middle East-Central Asia’s Wayward Aim

2018 December 24 by

Middle East and Central Asian financial markets are under immediate fire from souring emerging economy sentiment and the Turkey crisis in particular, and also lag on commodity diversification, fiscal discipline, and private business support, according to the International Monetary Fund’s November review. It pointed out that sovereign bond spreads increased 100 basis points through August to mirror the broad emerging market trend, with distinct Turkish banking and trade linkages. Parent banks in Qatar and Lebanon control over 5% of local assets, and Azerbaijan suffers from reduced import demand with lira depreciation. The US-Europe-China trade battle more generally hurts oil, mineral, auto and textile shipments from the area, and will aggravate gross domestic product growth and current account deficit worries already weighing on investor confidence, the IMF signals.

Gulf oil exporters will see 2.5-3% growth through 2019, but the medium term price forecast is for gradual decline to $60/barrel. Public infrastructure spending is the main driver, including Expo 2020 and 2022 World Cup preparations in the United Arab Emirates and Qatar respectively. Other petroleum powers Iran, Iraq and Libya are under international commercial sanctions or still experiencing internal conflict. The combined current account surplus is estimated at $120 billion, with the capital account also receiving inflows from $30 billion in sovereign debt issuance and Saudi Arabia’s MSCI stock market index upgrade. However state-owned companies face a large $135 billion maturity hump next year to warrant caution, the report stresses.

In Saudi Arabia, the UAE, Kuwait and Qatar the fiscal position is balanced or slightly expansionary, but sustainability will require public sector salary and subsidy cuts and tax collection such as recent VAT introduction. Bank liquidity is better but private credit is “tepid” with 5% range annual growth, on weak construction and real estate demand. Borrowing rates are higher in line with US Federal Reserve moves under the dollar exchange rate peg, and small business access is limited although fintech is opening new channels. Bankruptcy law, corporate governance, and credit bureau overhauls are overdue and local corporate bond market development should be a priority. More than one-quarter of employment is government-related, triple the emerging economy average, and domestic job creation is subject to numerous costs and distortions and poor professional education and training.

Arab world oil importers have double the growth at 4.5%, with Egypt and Pakistan leading the way as domestic consumption and remittances strengthen. Current account deficits still average 6.5% of GDP despite 15% export expansion, and Egyptian tourism has recovered with heightened security and resumed direct Russia flights. However reserves are under pressure in Jordan, Tunisia, Pakistan and elsewhere, with bilateral and multilateral financing needed for support. Banks are “stable and adequately capitalized,” but portfolios tilt toward government lending with public debt over 90% of GDP in half the group’s countries. More than 50% of the total is foreign currency-denominated, and interest payments take one-fifth of revenue. Energy subsidy reform is “critical,” but will worsen double-digit inflation that could spur further monetary tightening. Per-capita income growth has been lower than peers the past decade, and overriding challenges include reducing informality and raising productivity with “downside risks” to the outlook.

Central Asia and the Caucuses growth is also in the 4% range, but the rate will ebb over time from economic partner spillover and soft private investment. Exchange rates appreciated against the Russian ruble to help contain inflation, and allow easing in Azerbaijan, Georgia, Kazakhstan and Tajikistan. The negative fiscal balance improved to 4%, as stimulus programs like Kazakhstan’s Nurly Zhol housing plan end. Positive terms of trade and increased foreign direct investment help oil exporters, but current account gaps will widen in the Kyrgyz Republic, Tajikistan and Uzbekistan. Highly dollarized banking systems in Azerbaijan and Georgia are vulnerable to capital outflows and currency swings, and the region will not reach middle-income status for at least two decades. Officials pledge to slash government control and ownership but advance slowly, such as with the Kazakhstan stock exchange’s partial strategic company sales to maintain a positive MSCI return through October. Armenia and Georgia are among featured reformers on the World Bank’s Doing Business list and stiffer bank regulation has been promoted, but securities market infrastructure and oversight languish to investor chagrin, the survey warns in foreshadowing likely 2019 and beyond performance.

Yemen’s Bank Catastrophe Call

2018 December 17 by

As the US and UK call for a ceasefire and reconsider military support for the Saudi-backed Yemeni government’s campaign against Houti rebels, with fierce fighting now around the strategic Hudaydah port, the UN’s special envoy Martin Griffiths  underscored the scope of “economic warfare” accompanying hunger  for an estimated half the 30 million population. He cited “income famine” with years of unpaid civil servant salaries as split officials and central banks in charge in Aden and Sana’a clash over spending and banking and currency policies. The former, headed by President Abdo Rabbu Mansour Hadi operating from Riyadh, authorized fuel access to only licensed importers in September, while the latter spurned the decree and threatened retaliation against complying businesses, banks and money changers. The actions further reinforced fuel and exchange rate squeezes, as the rial slumped 50% against the dollar between July-September on the parallel market. In the view of experts on the ground such as the Sana’a Center for Strategic Studies, the established financial system and currency are at risk of outright collapse to add to the humanitarian catastrophe, without practical steps and policy reforms coordinated by international development institutions and private partners.

Yemen’s is the region’s poorest economy, and the latest International Monetary Fund projections are stark. Once a promising oil exporter, gross domestic product will contract 3% with the civil war, on 40% inflation from staple scarcity and rial depreciation. The fiscal and current account deficits are each estimated around 10% of GDP, and turnarounds next year are predicated on ebbing conflict. Output collapse since the outbreak of hostilities has been worse than in Libya and Syria, and the Fund notes “urgent needs” for food supply and public sector salary assistance. In the Gulf banking sector broadly private credit is “tepid” with state borrowing demand and commodity-related retrenchment in the construction industry, which was the mainstay in Yemen alongside hydrocarbons and agriculture. Saudi Arabia has provided fuel grants and deposited $2 billion to strengthen the currency, but transaction details are sketchy and confidence and substantive effects are so far minimal. In an October visit, special envoy Griffiths called for a collaborative emergency economic plan between local, foreign and regional parties, concentrated on exchange rate and central bank strengthening.

 The UN humanitarian chief, Mark Lowcock, in turn, emphasized that half the population was in pre-famine condition, and two-thirds were “food insecure,” for a once in a century disaster. The international community has a $3 billion appeal underway, with 70% of pledges met according to the latest tally. The Rethinking Yemen’s Economy project, a network of analysts and business and government leaders funded by the European Union, points out that 90% of products were imported commercially before the war, through conglomerates like the Hayel Saeed Anam Group, which now operates out of the United Arab Emirates. Food is still available, but with destroyed distribution channels and consumer purchasing power costs have skyrocketed. Children suffer the most, with over 2 million “acutely malnourished” and also prone to cholera and other preventable diseases. The World Bank has announced a trade finance facility for food shipments and a war risk insurance mechanism is under donor consideration for other cross-border commercial engagement.

Yemen’s banking system was cut off globally over money laundering and terror funding concerns, before the 2011 version of its Arab Spring precipitated the then-President’s ouster and the chain of events to renewed war. European and American correspondents severed all contact from 2015 and refused to accept physical cash common in business dealings, forcing traders into informal currency houses escaping central bank regulation. International reserves quickly depleted as oil revenue was also diverted through these channels, and the monetary authority became completely dysfunctional when the respective Houti- and recognized government rivals were set up in late 2016. Unified supervisory, liquidity management, and payment capabilities no longer exist, as state-owned and private banks must increasingly rely on the two with their own capital crunch. The UN has convened meetings between the sides outside the country in Jordan and Kenya, but beyond informal contact progress is scant. With the currency literally under the gun, the system may be unsustainable and abolition of the two-tier system, which breeds corruption under the official rate, and a shift to a pegged regime as in the rest of Gulf, is likely another unplanned war legacy.

Iran’s Premium Pressure Valve Valuation

2018 December 10 by

The Tehran stock exchange was up 40% in local currency terms in September, although its annual decline was the same magnitude in dollar terms with the rial’s 75% depreciation, as investors rushed into commodity-linked companies able to raise prices ahead of the US’ final round of resumed energy and banking sanctions. The State and Treasury Departments vowed “maximum pressure” to curb Iranian Revolutionary Guard regional adventurism, and trigger negotiations on a new anti-nuclear and terrorism pact to replace the unilaterally shelved 2015 JCPOA joint agreement. They allowed European and Asian signatories still honoring it to provisionally continue oil imports, with the eventual goal of full cutoff. In a “single biggest action” 50 Iranian financial institutions and their domestic and foreign subsidiaries were designated off-limits, including the central bank and well-known state-controlled commercial lenders Melli, Sepah, Saderat and Tejarat.

 The Brussels-based SWIFT cross-border payments network in turn disconnected the group without naming the specific list, as European backers of a “special purpose vehicle” led by France and Germany scramble to finalize a euro-denominated channel to maintain credit and trade links from the original deal. President Hassan Rouhani hailed this potential opening and continued oil shipments at least in the 1 million barrels/day range, as his government with a new technocrat Economy Minister reportedly organized a dedicated sanctions-busting unit. Rial devaluation leveled off before President Trump’s November order, and stock exchange price earnings ratios hit double digits as retail investors tried to preserve savings and access hefty dividend yields. Outside the blacklisted firms across an industry swathe including construction, insurance, mining and shipping they may still find decent prospects, as the country again girds for self-defined external economic onslaught as a regular Islamic Revolution feature.

This fiscal year first quarter from March to June registered over 1.5% gross domestic product growth, according to official statistics, but the International Monetary Fund now predicts contraction at the same level and an even greater 4% drop next year. Inflation is back in double digits with the rial crash and agriculture bad weather, and is projected to leap from 15% currently to 30% in the IMF’s view, with benchmark Islamic Treasury bill yields already near 20%. The government has set aside $4 billion from the sovereign wealth fund and granted foreign exchange preferences to pay for basic food and medicine, which the US pledges also to exempt from trade prohibition on humanitarian grounds. Reprising a program from previous sanctions and war episodes, citizens will receive baskets of staples that could help tip the budget into serious deficit.  Public debt will reach 40% of GDP, as the current account surplus shrinks with slashed oil exports. The President and his team claim ample international reserves to withstand the crisis, estimated at around $100 billion, and previously shifted to euro holdings, but the exact figure is unknown and access and liquidity could be constrained under the repeated US clampdown.

The bilateral confrontation may further delay compliance with the multilateral Financial Action Task Force’s anti-money laundering and terror funding standards, a gap which keeps big Asian and European banks away regardless of sanctions status. Iran has been on the Paris-based body’s “grey list” pending passage of enabling laws, and the deadline was recently extended again to February 2019. In October, lawmakers over hardliner objections approved drafts by a slight margin, which the clerical Guardian Council headed by Supreme Leader Ayatollah Khamenei then rejected as a Western-imposed regulatory and foreign policy threat. Rumors abounded that agreement could compromise incipient crypto-currency arrangements with Russian and Turkish counterparts to circumvent all forms of monitoring, as private foreign exchange traders facing arrest also dabble in that alternative.  However the odds are brighter for other bank reforms, such as a corporate governance bill to boost supervisory disclosure and reporting. After appointing Economy Minister Farhad Dejpasand when his predecessor lost parliamentary confidence, President Rouhani reiterated that financial sector modernization, including deep and diverse capital markets, was a priority. The stock exchange has an over-the-counter market to aid small and midsize companies which will suffer badly in recession, and he pressed also for more large state enterprise divestitures already at $150 million this fiscal year.  These moves may be incremental, but can serve as a partial sanctions antidote while shifting the domestic narrative to overdue structural fixes that seal investor interest.