As the Middle East and North Africa looks to diversify
and grow sustainable economies, Raghu Mandagolathur from CFA Society Kuwait
discusses the need to broaden the scale and spread of finance in the region.
The financial
landscape of the Middle East and North Africa (MENA) region primarily comprises
three major asset classes: equities, bonds and bank assets. International
Monetary Fund (IMF) data indicates that MENA financial landscape suffers from
two structural problems: it is lacking in scale and skewed towards bank assets.
For successful efforts on economic
diversification, the MENA region should broaden its base asset classes like
equities and bonds, which are better suited to longer term financing, and
reduce its reliance on bank funding which can only provide short to medium-term
financing
First the scale
issue…
MENA GDP is estimated
at $2.9 trillion (2011) and is expected to reach $4 trillion by 2018 implying
an annual growth of 4.8%, far lower than 11.2% achieved between 2004 and 2011.
From a scale
perspective, the value of MENA asset classes is roughly equivalent to 95% of
its total annual GDP compared to the global average which is nearly 3.7 times
GDP, or 370%. This gap was noticed in all asset categories but especially that
of bonds where MENA’s share is equivalent to only 8% of GDP compared with 140% internationally.
Using the 2018
regional GDP forecast by IMF, there is
notmuch of a change in scale, with values only expected to improve in MENA from
95% to 105%.
From a
structural point of view, lack of change will mean continued dependence on
banks for funding resulting in muted growth in equity and bonds as asset classes.
In such a scenario, the implied compounded annual growth rate for MENA’s equity
asset class is only 7.4% for 2011-2018, compared to 17% achieved during
2002-2011. For bonds, the implied annual growth for 2001-2018 is 7% compared to
10% achieved during 2002-2011. Even bank assets growth is expected to drop from
7.5% to 5.1% for the same periods.
While the
global economy is coming out of a structural economic crisis and systems are
being introduced in the region to ensure transparency, investors should ideally
be more focused upon making investments in equity and debt over the longer term
since it yields higher returns. Instead confidence
on equity and debt is projected to wane in the region which is not a good sign.
And then the skew issue….
In terms of
distribution of asset class, bank assets in MENA are dominant, constituting 63%
of the total against 9% for bonds and 28% for equities. This is starkly
different from the global trend where the structure is less in favour of
equities and more in favour of bank assets and bonds. MENA’s continued position
in favour of bank assets again points to a system which is not in a position to
cater to long-term finance. This then has to be bridged by government finance
or private equity.
And finally, some suggestions…
Finance and
funding in the MENA region basically requires scale and spread as explored in
this article. In order to increase the scale all three main asset sources (bank
assets, equities, and debt) should be developed. The development of equity
market will depend on increasing the number of primary issuances, allowing
foreign investors in, and modernising the exchanges along with improved
regulations. The development of debt markets (both public and private) will again
require rapid issuances to create a vibrant secondary market as well as developing
a yield curve.
Bank funding continues
to be important but it should not crowd out other avenues. Ideally, it should pave
the way for other avenues of long-term capital like equity and debt.
Alternatively, development banks can be formed to fill the gap for long-term
finance. Such a structural change in favor of long-term sources like equity and
debt will also trigger a need for qualified professionals along with the need
to follow stronger ethical codes empowering regulators who will need to have
wider responsibilities.
