Turkey and the MENA region are experiencing heightened political and economic volatility in Q2 2018, as FSG expected late last year. Headlines regarding Turkey’s tensions with Western countries and its economic vulnerability, Trump’s withdrawal from the Iran deal and the large number of deaths during the Gaza protests have raised risk perceptions towards the region. In the rest of 2018, political and economic instability will remain elevated, challenging MNCs’ operations in Turkey, Israel and Lebanon, while increasing the pressure on GCC teams to boost commercial performance.
Q2 developments will have ripple effects into H2 2018
Numerous developments across the MENA & Turkey portfolio have increased the level of external volatility executives must manage in the rest of 2018.
Turkey announced early elections for June 24: High government spending ahead of elections, President Erdogan’s emphasis on low interest rates in his campaign rhetoric, high oil prices and a globally strengthening US dollar created the perfect storm for Turkey. The lira’s depreciation and the rise in oil prices in May will keep inflationary pressures high in H2 2018. This will be accompanied by rapid restructuring of state institutions and most likely a slowdown in the economy as fiscal and monetary policy tightens after the elections. Executives should be concerned if growth continues into 2019 due to low real interest rates and strong government spending, as this will increase the risk of hard landing in the economy. Moreover, the deteriorating US – Turkey relations resulted in Turkey’s inconclusive bid for exemption from US’ recent steel tariffs, causing Turkey to prepare counter tariffs on various imported products from the US, creating potential disruptions for US MNCs. Meanwhile, the US is preparing to suspend weapons exports to Turkey as part of its latest sanctions bill, until a more detailed report on Turkey is finalized by the Department of Defense and Department of State. If confirmed, such a decision is likely to exacerbate lira volatility.
Trump withdrawal from the Iran deal: The US will gradually re-impose sanctions on Iran, with the first wave starting on August 6 targeting Iran’s financial and automotive sectors. Although Iran, Europe, Russia, and China are trying to salvage the existing deal, their efforts are likely to be undermined by the Trump administration’s heightened pressure on Iran, especially with US Secretary of State Mike Pompeo threatening the “strongest sanctions in history” if Iran does not meet certain conditions related to its nuclear and missile programs and regional activities. In H2 2018, executives can expect further pressure on the rial because of capital outflows and new sanctions, lower consumer and business confidence in Iran, and severe difficulty with financial transactions in the short-term.
Iraq’s surprise election results create uncertainty for businesses: The new government under the leadership of Muqtada al-Sadr will aim to form a technocratic administration and tackle corruption. Opportunities for MNCs in 2019 will depend on whether in H2 2018 al-Sadr can use cross sectarian political alliances to reduce corruption, improve relations with the Kurdistan Regional Government, maintain security and attract investments into infrastructure rebuilding and manage pressures from both Iran and Saudi Arabia.
Hezbollah is consolidating its power in Lebanon with the latest elections: Hezbollah and its allies won more than 50% of the seats in Lebanon’s first parliamentary election in nine years, reflecting Iran’s growing influence across the region. While the elections results raise tensions with Israel and could put a strain on Lebanon’s relations with Saudi Arabia, FSG expects Hezbollah and the Lebanese government to prioritize domestic stability. However, even if Hezbollah restrains itself from engaging in direct conflict with Israel, amid regional tensions, a newly emboldened Israel could threaten Lebanon’s stability. Executives should expect consumer and business confidence in Lebanon to be vulnerable to rising tensions.
Trump’s Middle East policy is emboldening Israel’s regional strategy: With Trump limiting direct US intervention in Syria, withdrawing from the Iran deal, and opening the US embassy in Jerusalem, Israel’s latest actions such as firing live ammunition on demonstrators in Gaza, attacking Iranian targets in Syria, and maintaining military alertness along its border with Lebanon, will ensure regional tensions and defense spending will remain high in H2 2018.
Implications for businesses:
- Oil prices will remain high in Q3 2018 as markets react to new details on Trump’s sanctions and which countries will be reducing their purchases of Iranian oil. However, as US supply continues to increase and export infrastructure to expand, and the outlook for Iran’s exports becomes clearer, markets are likely to catch up with supply/demand dynamics and put downward pressure on oil prices into Q4 2018
- Currencies – such as the Turkish lira and the Iranian rial in the free market – will be volatile, while the strengthening US dollar will require more reserves from GCC countries to protect their pegs
- Heightened risk sentiment will increase the cost of borrowing for governments in the region, complicate executives’ demands within their organizations for additional resources to invest in MENA and Turkey, attract government resources to the defense sector and keep business confidence muted
Actions to take:
- Prepare contingency plans for the ripple effects of various levels of US sanctions against Iran, for heightened insecurity limiting economic activity in Israel and for disputed election results in Turkey
- Segment competitors according to their risk appetite, and look for competitive advantages in this high-risk period in Turkey
- Re-evaluate portfolio assumptions for 2019, considering the new outlook for Iran, Iraq and potentially Turkey
- Ensure external risks are evaluated based on how they’ll impact demand for your business and your operations on the ground and communicated effectively within the organization
- Prepare GCC teams for a potential decline in oil prices in late 2018 and into 2019. This includes increasing aggressiveness of short term sales efforts to capitalize on the high oil price environment now, as well as preparing team skillsets and the product/portfolio mix for lower oil price environment next year