CFA Magazine: Navigating North Africa’s diverse economies

CFA Magazine, June 2013

North Africa sounds like a term that should bind a homogenous group of nations. Egypt, Tunisia, Libya, Algeria and Morocco are all Arabic nations, predominantly Muslim, with similar language, culture, topography and climate. Among these nations can be found the heartbeat of the Arab Spring, within which ordinary people rose up to depose long-entrenched autocrats and dictators and so brought popular democracy to their countries.

But that’s what you might call the view from 30,000 feet. The reality is that North Africa includes a considerable diversity of political, social and economic circumstances. Two of the five didn’t have revolutions at all, one, Morocco, because it already had offered many freedoms, the other, Algeria, arguably because it repressed them more than its peers. Those that did have revolution emerged completely differently: Tunisia struggling valiantly and apparently successfully towards a workable model, Egypt which appears to have replaced one inflexible figurehead with another and might yet see another revolution to depose the new one, and Libya where revolution has left a vacuum of leadership so uncertain that the United Nations still won’t unfreeze its oil wealth. For the investor, in particular, it’s a region that requires a nuanced look before going anywhere near it – but there are opportunities here for the patient buyer.

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To start at the most positive end of the spectrum, CFA visited Morocco in late February. It is about as far removed from the popular image of North African revolution as can be. Any discussion with business leaders or bankers in Casablanca and Rabat might touch on Libya or Egypt as a matter of regional curiosity, but swiftly turns to Europe, which is where Morocco’s key trading partners are.

“There have been security issues across the region; it keeps people on their guard,” says Walter Siouffi, managing director for Morocco for Citibank Maghreb in Casablanca. “But in terms of how it affects us, Morocco’s trade is predominantly with Europe, with FDI coming from Asia and the west. So what’s happening across North Africa doesn’t have a big impact here.”

The central reason Morocco looks very unlike its regional peers is because there was no revolution here, because reform had already been underway for some time. Morocco is a monarchy, but one with a fair amount of power ceded to parliament, and a young democracy. The change in the king to Mohamed VI following the death of his father, Hassan II, in 1999 brought with it an era of slow and modest but tangible reform. In June 2011, as the Arab Spring gathered pace elsewhere in the region, Morocco had the sense to get ahead of any mood of unrest and the king announced a referendum on constitutional reform; it was held the following month and political reforms were enacted, strengthening democratic institutions and protecting individual rights, while leaving some powers with the King.

The clearest example of the international investment community drawing a distinction between Morocco and other North African states came when it tried to sell a debut international dollar bond issue in December. It raised $1.5 billion in 10 and 30-year dollar funding, and attracted $7.9 billion of orders from 475 accounts. For a first time issuer in a politically difficult region, the commitment of world investors to 30-year funding – very long term, even for a sovereign – sent its own message about how Morocco was viewed. Bookrunners were delighted, if perhaps surprised. “I have racked my brains and I can’t think of another issuer printing 30 years straight out of the gate,” says Nick Darrant, head of CEEMEA syndicate at BNP Paribas. “It’s hard to see how the deal could have gone better,” said Charlie Berman, head of public sector EMEA at Barclays.

In fact, investors in the deal had many questions, but they weren’t about Middle East politics or overspill. Instead, investors wanted to know what Morocco was going to do about its fiscal position. Morocco’s deficit stood at 7.2% of GDP in 2012; subsidies around fuel and agriculture are equivalent to 6% of GDP; and falling foreign exchange reserves and a widening current account deficit have pushed external funding needs to about 10% of GDP. All these numbers have been getting worse, and none are healthy.

CFA visited Minister of Economy and Finance Nizar Baraka in Rabat (for the full interview see the May edition of Euromoney magazine) and found him accepting of the problems and adamant that they can be fixed. Baraka admits 7.2% is “a huge deficit” and aims to reduce it to 4.8% in 2013, and 3% in 2016. He says the deficit was badly affected by matters out of its control – movements in exchange rates and commodity prices, both of which are undeniably true – and adds that a boost was necessary in investment in 2011, further pushing out deficits. On subsidies, he plans to reduce their level from 6% to 4.2% of GDP while improving the efficiency and management of the budget and subsidies.

With that done, can Morocco meet its targets? “Yes. We have to,” he says. “We know what we have to do and we are doing it.”

Clearly the bond investors believe that, but not everyone is convinced. It’s interesting, for example, just how widely Morocco diverges the opinions of the rating agencies. Standard & Poor’s puts it at investment grade, BBB-; Moody’s has it sub-investment grade at Ba1 and put this rating down to negative from stable in February, because of “the deterioration in the government’s fiscal metrics. Timely implementation of these measures [on subsidies and the deficit] will be needed if the country’s public finances are to get back on a sustainable path and avoid a further rise in the public debt ratio.”

Morocco must achieve a balancing act: reduce subsidies to improve the national finances, without causing social upheaval by doing so. But if it can manage it, there is a lot to recommend investment in Morocco, as a growing number of FDI partners – Bombardier, Kraft Food, Danone and numerous Gulf institutions being recent examples – demonstrate. “With a public debt-to-GDP ratio below 55%, compared with European economies, as well as the IMF’s optimistic forecasts for 2013, Morocco offers promising prospects for development,” says Brahim Benjelloun-Touimi, economist and banker at BMCE Bank in Casablanca. “Relative to GDP, investments represented an average of 35% over the past six years, a figure encountered only in East Asian economies.”

For investors, it’s a market that has captured more attention on the debt side than equity, partly because it is a relatively small and illiquid stock market. David McIlroy, chief investment officer and portfolio manager at Alquity Investment Management, which runs an African equity fund, says his fund holds only some selective positions in Attijariwafa Bank and Maroc Telecom. On the plus side, it’s not volatile. “I’ve been dealing with emerging markets for 20 years, and in that time Morocco has been one of the lowest-beta markets,” he says. On the negative, though, it may well soon lose its place in the MSCI Emerging Markets index, within which it occupies barely 0.2% anyway.

Still, Morocco’s stability is something its neighbours can only dream of. They have other things to worry about.

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When Hosni Mubarak was deposed as Egypt’s leader, it was with an enormous sense of hope and possibility among ordinary Egyptians about how their country might now be governed. It’s fair to say a lot of that optimism has dissipated. Some go further. As one fund manager puts it: “I think they’re going to need another revolution.”

One can argue that things are improving in Egypt, but off a low base. According to Bank Audi, real GDP grew by 2% in 2012, which was better than 2011; and inflation dropped to 8.7%, after five years of double-digit growth in the country’s consumer price index. But, even if both of those numbers are improvements, they’re not particularly healthy. “The economy [has] remained pressured by a multitude of economic and social challenges in addition to an acute political divide across the country on key national issues,” Audi says.

There are some promising signs – tourism, the lifeblood of the Egyptian economy, was up 17% in terms of number of arrivals in 2012 and 13% by revenues, but again off a low base – but there are far more that are dire. Unemployment was 12.6% by the end of fiscal 2012, compared to 9% pre-revolution; foreign currency reserves have plunged to $13.5 billion by the end of February, equivalent to just three months of imports (and imports are absolutely vital in a country that buys most of its food and fuel from overseas), down from $36 billion pre-revolution; and the budget deficit is 11.1% in FY2011-12, with debt to GDP now over 80%. Investment has gone with it: Audi estimates that implemented investments in crude oil projects declined nearly 45% in financial 2012, and by a further 25.1% year on year in the first three months of fiscal 2013.

And around all this is the nagging sense that the new government, which is led by Muhammed Morsi and dominated by the Muslim Brotherhood party, is suppressing dissent and opposition in much the same way as the old one.

Is there a positive case? The sense is that Egypt is still falling, and that there needs to be some sense of an inflexion point before investors will consider coming back in in earnest. Is there any sign of that moment? “Not yet – technically,” says Angus Blair, president of Signet Institute, a regional think tank. “There is still too much current, and expected, political noise for non-hydrocarbon FDI to rise sharply.”

“With no clear, creative or brave economic plan from the government, which has a fear of rising prices, the economic and political risk has risen,” he says. “We still like Egypt longer term very much, but we are recommending that investors wait until some tough decisions are made first and the legal environment clearer before entering the market.”

McIlroy at Alquity Investment Management says his fund has reduced its holding in Egypt from 12% at the beginning of 2012, when it was the fund’s third biggest country in terms of holdings, to 9% today; by contrast Kenya has gone from 9% to 17% over the same period. “The inflexion point needs to come when the Egyptian government makes the structural reforms that are required,” he says. A key point here is a planned $4.8 billion loan from the IMF, which McIlroy says will then unlock as much as $10 billion from other sources such as the African Development Bank and the European Union; before granting the loan, the IMF wants to see reform such as subsidy reduction, revised tax policy and a more business-friendly environment.

If that happens, and the loan is granted, things could start to improve. “Geopolitically in the international community, Egypt is seen as a market that’s too big to fail: it’s the largest Arab democracy, and the US don’t want to see it fall over,” McIlroy says. “As long as it makes moves towards the structural reforms the IMF are looking for, the chances are it will get the money.” But he doesn’t expect to see this before the fourth quarter, and he agrees with Blair: “At the moment the government is not speaking with one voice.”

That said, there are signs of investors prepared to take the long-term view already. Characteristically, they are chiefly from the Gulf, which sees not only a business case but something of a sense of obligation to help stabilize other parts of the MENA (Middle East and North Africa) region. Qatar National Bank is buying SG’s Egyptian operations; Emirates NDB is buying the Egyptian unit of BNP Paribas. Even Bill Gates has become involved, joining with other US investors to put $1 billion into the fertilizer and construction group OCI (which is moving from Cairo to Amsterdam, with rather negative consequences for Egypt’s stock exchange, since OCI accounts for about 20% of the index). When confidence does return, Cairo’s stock market will be a good place to express it: it is one of the oldest and deepest markets in the whole MENA region. And some regional brokers are already selectively recommending particular stocks in Egypt, with EFD Hermes suggesting Talaat Moustafa Group, Egypt’s biggest listed real estate developer, offers a “good play” on expectations of inflation and currency devaluation.

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In Libya, the challenges are different again, for this country was somewhat frozen in time from an economic perspective during the long years during which Gaddafi held power. “In 42 years of Gaddafi, the worst thing he destroyed was integrity,” says one Libyan banker. “Corruption was a way of life, but it wasn’t corruption: it was survival.”

Perhaps the challenge facing Libya is best illustrated by the situation around its key asset, its crown jewel: the Libyan Investment Authority. This is where the oil surpluses have been invested since 2007, with the idea – like other sovereign wealth funds in the region such as the Abu Dhabi Investment Authority or the Kuwait Investment Authority – that it would help to diversify hydrocarbon wealth and to make sure that funds are available for the country’s future when the oil eventually runs out. It has about $60 billion in assets.

In February 2011, Libyans in Benghazi took to the streets in protest against Gaddafi, and over the bloody months that followed, eventually removed him. Having wrested control of the government, an early priority was to work out exactly where all the LIA’s assets had gone, and to manage them prudently for the national good.

The man who was appointed to do this was Mohsen Derregia, a Libyan who had been in academia in the UK for the previous 11 years, but who was persuaded to return to Libya to become chairman of the LIA in April 2012, and CEO the following month. “I remember the Prime Minister calling me,” he says. “He said: It’s down to you. We can’t all walk away. Somebody has got to do this in the new Libya.”

It was no surprise to find that the LIA had in many respects been mismanaged; although some highly skilled people had worked at the LIA through the years, and some renowned international consultants including Mercer, Ernst & Young and KPMG had been involved in recommending investments, it was also common knowledge that Seif al-Islam, Muammar Gaddafi’s second son and the man most closely linked to the setting up of the LIA in the first place, was involving himself in investment decisions. Many of the LIA’s assets found their way into opaque subsidiaries, such as the Libya African Investment Portfolio, among the most obscure and little understood of all sovereign entities. “It was a big, big problem,” says Derregia. “And fixing the problem is not something you are going to do in one or two years.”

This was not really a surprise – but the challenges Derregia then faced in trying to do anything about it are illustrative of problems for post-revolutionary countries. His first priority was identifying assets and establishing their worth (Deloitte was brought in to help), starting with bonds and shares, then major assets, and then on to smaller positions. He also tried to set up a board, and this is where problems began. “There were several delays, but these were due to internal politics rather than anything else,” he says. “Unfortunately the idea of conflict of interest, and selecting a board that was conflict-free, was not really well understood. People in conflicted positions would try to delay decisions. Some of the decisions we have to take involve liquidating or merging some investments, and invariably some people as an individual will lose because of that, but the Libyan people will gain. These people would resist very hard, in unimaginable ways.”

Further challenges arose with getting assets unfrozen, and Derregia spent much of his first year on the job in various Italian courts trying to get assets back in the stewardship of the people who rightfully owned them. On top of that, the UN had frozen almost all LIA assets (though it missed out some of the subsidiaries). Initially, Derregia welcomed this, and even asked for an extension on the freeze. “I initially asked the government to keep the sanctions until I took stock of at least the fairly liquid assets so make sure we knew where they were,” he says. He then asked for the sanctions to be removed in July 2012 – but they’re still there.

And perhaps it’s not such a bad thing that they are. Earlier this year, Derregia noticed a distinct frostiness in his relationship with Prime Minister Ali Zeidan, and began to hear whispers of his own demise at the LIA. A letter was sent to Derregia on February 10, informing him of his removal, to be replaced by Ali Mohamed Salem Hibri, deputy governor of the Central Bank of Libya. He is challenging his removal in court. “I want the government to understand that in the new Libya, even if you have the power, you must act within the boundary of law, of rules and regulations,” he says. “I don’t understand what basis there is for wanting to change what happened in the last year. This is going to be lost effort: not to me, but to LIA and to Libya.”

So what’s left? The LIA’s headcount today is about 90, Derregia says, but the institutional knowledge is enormously reduced in previous years. It is back to square one. And that is what a lot of post-revolutionary North Africa is going through.

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Less is written about investment opportunity in Algeria than anywhere else, because it’s the least accessible; the militant attack on the BP and Statoil-linked Tigantourine gas facility in the desert at In Amenas, with the death of at least 39 foreign hostages, underlines the challenges of doing business there.

But what of Tunisia, where the Arab Spring all began? Times are hard here too. Unemployment stands at 17%, higher than in Egypt. And in the first two months of 2013, foreign direct investment and portfolio investment declined 9.6% year on year, according to Tunisia’s Foreign Investment Promotion Board.

It all sounds bleak and turbulent. But there are funds that do find opportunity in the North Africa part of MENA. The Franklin Templeton MENA fund, for example, had 12.4% of its assets in Egypt and 1.95% in Morocco when last disclosed on March 31. The Schroders ISF MENA fund, in its last published update at the end of February, held a neutral position in Egypt – saying “valuations are cheap but political uncertainty has increased” – though it had no exposure to Tunisia or Morocco, for different reasons. “Tunisia’s market is illiquid and the growth outlook is poor while Morocco remains expensively valued relative to its peers.”

Analysts believe that in the longer term, Egypt will provide attractive investment opportunities in consumer goods, Algeria and Libya in oil and gas, Egypt and Algeria in technology and telecommunications, and Tunisia for healthcare.

So for potential investors in North Africa, the biggest challenge is going to be all about timing: getting the moment at which confidence returns to Egypt, or finding the moment of best value in Morocco. For fund managers, it will be about understanding the politics in Libya’s sovereign fund, and positioning themselves when the time comes for assets to be unfrozen and allocated afresh. As always at a time of great change, somebody will make a fortune out of it, and plenty more will lose just as much.