Emerging Markets Insights

The Egyptian pound is likely to devalue by up to 20% against the dollar in 2012. The currency’s slide in value represents the biggest threat to the Egyptian economy.

• Egypt’s government is running out of hard currency to prop up the pound, which will result in a devaluation
• Devaluation is likely to take place following the presidential election at the end of June 2012
  • Egyptian authorities want to avoid an economic crisis that could delay elections

The currency is supported by unsustainable conditions

• Capital flight: Egypt’s revolution drove a 60% contraction in FDI. The tourism sector, a key industry that drives foreign currency accumulation, reported a 30% reduction in revenue last year. Meanwhile, portfolio investors sold more than US$7.5 billion in Egyptian T-bills in 2011, comprising more than 25% of foreign holdings
• Import dependence: As the largest wheat importer in the world, Egypt has a US$23.6 billion trade deficit, adding pressure to the local currency
• Unsustainable monetary policy: The central bank spent US$18 billion, 50% of its total reserves, supporting the currency in 2011

Egypt is running out of funds to stabilize the local currency

• The US$23 billion budget deficit will expand because of  new subsidies and weak foreign investment
• The central bank required a US$1 billion loan from the military earlier this year, which is an unusual step that exposes a lack of funding for the institution
• Most of the US$10 billion pledged by the G8 and GCC countries has not yet reached Egypt. Donor countries want to see a greater level of economic stability before releasing funds
• Renewing discussions with the IMF over a US$3.2 billion loan will not make a significant difference in funding if an agreement is reached

Political and social factors undermine the currency’s outlook

• Political uncertainty is undermining the outlook for the currency as investors, both domestic and foreign, do not want to hold Egyptian pound-denominated assets
• To reduce uncertainty, Egypt must achieve several political milestones this year, including presidential elections and the writing of a new constitution
  • The constitution will define the military’s future role in Egypt
  • An unclear transition timetable from military to civilian rule could deepen local tensions
  • The same underlying factors that led to the revolution, such as high inflation and unemployment, are still serious concerns and may be drivers of continued instability

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The death of former Libyan ruler Muammar Gaddafi marks the symbolic beginning of a new era in North Africa and transitioning states are keen to attract foreign investment. Companies should avoid being paralyzed by uncertainty, and must begin planning to re-engage and expand in the region to capture medium to long-term opportunities.

Investment opportunities exist across sectors though key considerations differ by country

• Consumer Goods: Egypt’s market size and strong sector growth, especially in cities, make it an attractive investment, while relative stability in Morocco and Tunisia will support a healthier outlook (see MarketView screenshot above)
• Industrials: Ongoing public and private investment in oil and gas will support Algeria’s desirability as an investment destination in related sectors. Rebuilding opportunities and an effort to bring oil production back online will mean strong growth in Libya
• Technology/Telecommunications: Size and growth underpin the outlook in Egypt, where plans could be revisited to become an outsourcing hub, while ICT services make Algeria’s B2B market an attractive investment target
• Healthcare: Tunisia’s market does not offer robust size or growth, but it is a safe bet due to previous investment in the healthcare sector. Conversely, Libya’s healthcare infrastructure suffers from years of neglect, but the country is a wildcard for future growth due to high GDP per capita among a small population

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Explosive deterioration of its relationship with Israel. A trip of the post-Arab Spring Middle East. Turkey’s foreign policy is generating quite a lot of attention in the Middle East these days.

Beyond its political implications; however, the policy of courting key Middle Eastern countries like Egypt also has a serious domestic driver: Turkey’s economy is charting precarious waters.

Turkey has been struggling with a rising current account deficit driven by strong domestic demand. The rise in household consumption has been financed by capital from Europe, making Turkey increasingly vulnerable to an outflow of short-term capital as European economies continue to struggle.

The other pillar of Turkey’s economy – exports, is also threatened by the potential of a Eurozone recession. With over 50% of Turkish exports going to the EU, Turkey is particularly vulnerable to a drop in demand from such key countries as Germany, Italy, and Spain. FSG Monitor estimates that a US-EU recession would lead to a 2% drop in Turkey’s GDP in 2012. The projected decline may not be as dramatic as in other countries in the region, but compared to Turkey’s Q1 2011 11.6% GDP growth, followed by 8.8% for Q2 2011 (Turkey had the highest H1 2011 GDP growth in the world), it’s very significant.

In this unstable environment, the Turkish government has announced it will seek to promote export-oriented domestic production. But this strategy will only work if there is enough demand for Turkey’s increased exports. With the European economy in a shaky state, Middle Eastern markets will be increasingly instrumental to Turkey’s economic stability. Currently, the Middle East is the second biggest regional market for Turkish exports, accounting for 20% of the country’s exports, plus another 4.9% of exports going to North Africa.

Turkish businesses are clearly seeing the writing on the wall and are aggressively seeking expanded influence in the Middle East, as evidenced by Prime Minister Erdogan’s large business delegation on his recent trip to Egypt and his promise to increase trade between the two countries to US$5 billion.

In this context, MNCs should expect Turkish competitors to aggressively pursue opportunities in the post-Arab spring markets. As we already discussed, MNCs with overly risk-averse strategies in the region can fall behind regional competitors with a greater risk appetite. It also means, however, that MNCs with Turkish partners can use these relationships in support of strategic expansion in the MENA region, benefitting from the good will Turks are enjoying among the region’s populations and leadership.

In this context, the role of Turkey as a manufacturing hub for the Middle East and North Africa region is becoming increasingly attractive, not just to MNCs but also to the Turkish government itself. As a result, MNCs with local production facilities meant for export to the region are well-positioned to lobby the Turkish government for additional incentives and support.

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After months of turmoil and civil war, the precipitous fall of the government of Muammar Gaddafi has re-ignited the momentum behind the so-called “Arab Spring.” Escalating violence in Syria, transitions in Egypt and Tunisia, and tensions throughout much of the region will ensure political uncertainty for the remainder of 2011 and quite possibly well into 2012.

Amid all of the ambiguity, one fact remains certain:  more change is on the way and global companies need to prepare for it. Outcomes will vary from country to country, as will the groups impacted, and timelines for transition. Years of endemic corruption that benefitted small segments of the population have led to a pervasive sense of injustice and huge gaps in employment and education.  For many years, governments have been unwilling or unable to 1) control high food and fuel prices; 2) curb unemployment and underemployment especially among young people; and 3) establish viable and forward-leaning education systems. The governments must address these root causes of societal conflict while also trying to attract FDI— a tough balancing act. All of this will lead to an unpredictable manner in which citizens will interact with their government and in the way that governments interact with external actors, including foreign MNCs.

Given the shifting landscape, foreign MNCs see potential for new challenges in the region. In a poll that Frontier Strategy Group conducted at the end of July, nearly 80% of executives identified external factors as the biggest challenge facing their businesses in MENA. This new regional reality has raised pertinent questions for businesses that are unsure how to engage new and transitional governments: How can companies mitigate risks through government relations? Should companies take a wait-and-see approach in the region or build government relations networks that will assist them through these transitional years?

Mitigating risk through government relations

Foreign MNCs have a variety of tools that they can utilize to mitigate risks associated with ongoing changes in governments. Judith Barnett, principal for the Middle East-focused consultancy The Barnett Group, sees several concrete steps that companies can take to reduce risk:

“There will be more changes, but the core of the governments will stay. Executives should visit these markets and establish close relationships with career people who handle product registration, bans, taxation, and tariffs. Being aligned with some of the local business organizations and federations is very important during this transition.  MNCs also need to organize a strategy that allows them to invoke a range of relevant ministers who could play a substantial role in establishing new government processes by the time they leave office. Coordinating with a relevant embassy can be important because in most, but not all of these discussions with local government officials, the Ambassador and her staff can be very helpful in assisting companies to reach out to local governments and most importantly, to conduct follow through activities.”

While senior executives in Latin America are awash in funding and senior executives in Asia have high growth markets like China and India, EMEA executives must contend with an atmosphere in which they are expected to do more with fewer resources. This presents challenges for obtaining internal buy-in for a government relations unit in the region. However, failing to devote the appropriate resources to government relations in MENA can result in tens of millions of dollars in losses.  “An internal government relations program is actually inexpensive to establish. With a set of priority issues (trade barriers your Company is confronting), a strategic plan, focused meetings with government officials, and intense follow-through, you can resolve expensive problems and make 2011 and 2012 market-building years.  You need to build your brand’s name, but you also need to protect it. That is where government relations can be critical. All you need is one tariff increase, product ban, new tax, or problem with registration to throw off your entire year,” Ms. Barnett adds.

Wait-and-See approach is the wrong one

In markets plagued by political and economic turmoil, conventional wisdom for many Western firms is to take a wait-and-see strategy before unfreezing projects, increasing investment, or expanding operations. This type of risk-averse policy leaves an opening for Chinese, Gulf, Turkish, and other international companies to gain significant market share in a very short period of time. Judith Barnett comments that there are long-term ramifications for this approach:

“Wait-and-see is the wrong strategy. When I visited Egypt over the summer, companies were talking about US$150 million investments, US$1 billion investments. These are smart companies that are moving forward at this time of opportunity. The more you continue to support these countries, the more that people will remember it. There is a great deal of brand, and inter-personal loyalty in the region.”

There is no doubt that MENA markets will present challenges to businesses in the short to medium term. Democratic transitions are not usually a smooth process. For example, unemployment historically increases as the economy is transformed. This will exacerbate political stability. Still, the investment opportunity is undeniable in the region. Right now 200 million people in MENA are under 29 and that figure will rise significantly over the next 10-15 years when the population surpasses 500 million. Regional GDP will surpass US$3 trillion next year, which is 30% higher than the rapidly growing African continent is forecast to reach by 2020. The MENA figure is expected to more than triple to US$10 trillion by 2030. A robust government relations strategy is critical for capturing this growth opportunity.

“Candidly said,” states Ms. Barnett, “If you don’t take care of your customer, someone else will!”

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In my last post Weeding out corruption critical to African growth prospects we looked at the current state of corruption in Africa and its impact on conducting business on the continent. Below are four tips for an anti-corruption strategy in Africa:

#1 Recognize nuance: corruption varies by country, sector and type of interaction (both public and private sector) – risk assessments and due diligence to highlight ‘red flags’ associated with important transactions are always worthwhile investments and should be built into the deal cycle accordingly

#2 Training and messaging is invaluable: consistently repeat the mantra to staff in-country, to management at HQ, to suppliers and other service-providers, and to government and wider stakeholders that the organization is not prepared to involve itself in illegal or unethical practices

#3 Uncover wrong-doing proactively: prevention is cheaper than cure, but self-diagnosis is also preferable to external investigation; publicizing whistle-blowing channels and regular self-auditing are invaluable tools in this process

#4 Prepare for the worst: even with the best intentions, and policies, wrong-doing will still be a realistic possibility somewhere in your business footprint in Africa; the worst time to be crafting a coping strategy is on the fly so proactively prepare a corrupt incident crisis management and business continuity strategy to cover for that eventuality

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(A sign promoting the fight against corruption in Zambia - author's photograph)

From examinations of malpractice in South Africa’s police service, via investigations into grand larceny perpetrated by the recently toppled Gadhafi and Mubarak regimes in North Africa, to debates about new anti-graft bodies in Kenya and Zimbabwe, a cursory glance at media stories from the past seven days illustrate that corruption is rarely far from Africa’s headlines. Nor is it often absent from lists of investors’ most common complaints about, or reasons to delay, committing funds to the continent. With the business opportunity in the region proving increasingly difficult to ignore, and legislation governing Western companies’ ethical conduct tightening, developing holistic and effective corporate strategies to avoid entanglement in illegal activity has arguably never been more important.

Shifting sands, but still quicksand

Africa’s changing demographic and governance profile – generally younger and more democratic – is gradually changing its transparency outlook. Observing events in Tunisia and Egypt from close quarters and fearful of similar mass protests mobilized within their own increasingly connected societies and maturing civil society institutions, fewer governments south of the Sahara feel they can be seen to be tolerant of corrupt activity. However, as powerfully illustrated in a compelling recent book about the root causes and impacts of corruption in Kenya, the incentives that drive malfeasance including inter-ethnic competition and poor bureaucratic pay remain strong across most of the continent. The recent experiences of Nigeria, Senegal and Kenya amongst other countries highlight that all too often political movements that surf an anti-corruption and good governance wave to power all too often themselves succumb to temptation once entrenched in government.

Recognizing that transforming a vicious circle – where citizens, bureaucrats and businessmen all feel it is in their immediate personal interest to prolong corrupt practices – into a virtuous one is far from an overnight project, Western governments are increasingly seeking to rupture that co-dependency through extra-territorial legislation in their home countries. Until recently, the US Foreign and Corrupt Practices Act has been the trailblazer in this regard, ensnaring a who’s who of major corporations in its investigations – many of them with a footprint in Africa. A newer kid on the block, the UK Bribery Act, was only enacted on 1 July this year – it has raised eyebrows by outlawing smaller so-called ‘facilitation payments’ or small bribes made by UK entities – the grinding, every day variant of the corruption blight – as well as the large payments intended to skew business outcomes that usually attract the main focus of investigators.

(Percentage of users who report paying a bribe to at least one of nine service providers in the past year; source: Transparency International Global Corruption Barometer, 2010)

Short term pain, long term gain

The howls of protest that greeted the UK legislation – that it’s impossible to do business in places like Africa without paying bribes, that zealous enforcement of its provisions will render UK businesses uncompetitive against less scrupulous competitors – underline the sort of short-term thinking that continues to define the intractability of the problem in the region. In fact, growing numbers of corporations are finding out that taking a zero-tolerance approach even in the most murky and problematic jurisdictions does eventually pay dividends. A short-term opportunity cost – of tenders lost or delays to processes previously greased by bribes – is rapidly replaced by a reduction in demands and enhanced status as an employer and partner of choice. The contribution to overall societal transformation may be more modest, but the benefits in terms of litigation and compromising commercial entanglements avoided are generally a more than sufficient ROI.

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To gain a better understanding of the impact of recent events in Libya, I spoke with Arezki Daoud who is editor of The North Africa Journal.

In a post-Gaddafi Libya, what issues will the government need to focus on through next year for a successful transition?

This weekend’s events were predicted. We forecasted a protracted conflict, one that would end with the slow extinguishing of the regime in the manner that we have been witnessing. In essence, despite the bloody outcome, the terrible loss of life and wholesale destruction of the country, what’s coming could potentially be a more difficult period for the Libyans. Their fight against Gaddafi was a unifying factor. Now that that factor is gone, differences are likely to emerge on a host of issues, starting with drafting a constitution, establishing institutions, empowering political leaders to take proper action within a new framework of a proper rule of law, etc. But more importantly, the challenge for the Libyans would be to avoid falling into the trap of tribalism. In this conflict, many won, a few have lost and those who have lost could pay dearly if the spirit of revenge takes over.

In addition, we are assuming in the short term that rogue elements will operate under the radar to undermine any progress on the political front. They will work hard to pit tribes against other tribes. The use of shadowy agents is common practice in the Arab world. We have seen it in Tunisia, Egypt, Syria, etc and we believe Muammar Gaddafi has developed some of the strongest underground destabilization networks in the Arab world.

So in terms of what to do, it is critical that security be under the control of a single authority and that a process starts quickly to establish a constitution.

Do you expect the transition timeframe to last longer than in Egypt or Tunisia due to Libya’s lack of government institutions?

The likely scenario is one that looks at a much longer transition period for all the reasons mentioned above. But in a virgin territory where there has been no supreme law, there is also a slim likelihood of a faster political transition. We should assume that political stabilization could take more than one year.

What does this mean for regional stability? Do you think this will lead to a significant decrease in global oil prices?

The market may respond positively purely on the news of the end of Gaddafi, but the impact of Libyan oil in the world’s supply system will be limited given the economic crises affecting consuming markets. Even without Libya, oil prices have been dropping with the weakening global economy, therefore we expect the end of this crisis will have limited impact on the oil sector.

What types of challenges do you see for foreign businesses in a post-Gaddafi Libya?

Corporate executives hate uncertainty and so the lack of clarity around the existence of central authority could be a major inhibitor to foreign investments at this stage. Executives we talk to often say they will take a wait-and-see approach and will move into the country as soon as a strong authority is in place, which would create the right conditions for operating in the country. Libya has many experts that could help shape up future business legislation, but this is too premature to speak of such business environment as the political environment remains volatile.

What types of opportunities do you see for foreign businesses in a post-Gaddafi Libya?

Business opportunities are likely to arise within 6 months after the official end of the hostilities. Given the Western support to the insurgents, Western companies are likely to be the first to take advantage of the reconstruction, modernization that the country will undergo. This would positively impact the obvious sectors, namely infrastructure, oil and gas but also services as tens of thousands of foreign workers left the country and now a foreign workforce will be required to bring services back. Other industries, from consumer goods to pharmaceuticals will have to wait yet the country will likely resort to import, providing opportunities as well.

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Muammar Gaddafi’s 42-year grip on power is slipping away as rebel forces fight to gain control of Libya’s capital Tripoli. This bloody conflict has taken a heavy toll on Libya’s economy and its people, but more challenges lie ahead as the country will soon focus on rebuilding and a political transition.

While it is too early for most foreign companies to return to Libya, firms should start to assess major players in the National Transitional Council (NTC) for a future government relations strategy. A transitional leadership already exists and new political players will emerge as prospective candidates start to jockey for position ahead of elections that will take place within the next year.

The NTC is speaking in a conciliatory tone regarding how former regime associates will be treated during the transition. This is not surprising considering the number of officials that have defected in recent months. However, foreign MNCs should still evaluate local partner ties to the past regime, especially if there are tribal connections to Gaddafi. As we are seeing in Egypt, Tunisia, and around the region, companies can experience a significant slowdown in business if the government targets their local partners for corruption investigations. There are serious reputational issues to consider as well.

Because many government institutions will need to be built from scratch, companies should keep a close eye on efforts to write a new constitution. This will likely mean significant changes to a post-Gaddafi business environment, which could lead to much greater transparency in the long term.

The hydrocarbon sector is still critical to Libya’s development, but there is already talk that it will take 18 to 24 months to return oil production to pre-February 2011 levels. Libya will continue plans to diversify its economy away from hydrocarbons and there will be a need to (re)build infrastructure- both physical and institutional- which will provide long-term opportunities to B2B companies in the construction, IT, cement, and transportation sectors.

GDP per capita is among the highest in Africa due to Libya’s oil and gas resources and a small population though little of this money has flowed to the majority of the population in the past. If the government implements new policies to address this critical flaw, then it could lead to a plethora of new opportunities for B2C companies.

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Consumers are struggling with higher food and fuel prices across the emerging markets of  Middle East and Africa as external factors such as high commodity prices and regional unrest combine with internal factors including strong domestic demand. Next month, Ramadan will heighten the upward pressure on prices in countries with large Muslim populations, which may lead governments to consider interest rate hikes to bring inflation under control

■     Algeria: A desire for stability will trump any motivation for political change in the short term

■     Angola: Moody’s and Fitch signaled that Angola’s investment climate is improving, but several threats could derail recent progress

■     Egypt: The new budget plan fails to address how Egypt will emerge from its post-revolution struggles, but cautious optimism remains for 2012

■     Ghana: Politically stable Ghana has made huge strides recently in local enterprise stimulation and resource manufacturing potential

■     Iran: The rollback of subsidies is sustaining inflation at high levels, which is hurting Iran’s economy more than sanctions

■     Iraq: Investment opportunities in Iraq are growing rapidly, but the security situation remains precarious in the medium term

■     Kenya: Economic potential is restricted by high commodity prices, which are contributing to inflation growth and a weakening currency

■     Morocco: Relative stability should hold for the short term, but fallout from the constitutional referendum should be monitored closely

■     Nigeria: The development of the healthcare sector may be a slow process, but its untapped potential is huge

■     Saudi Arabia: Pace of government transactions slows, but private consumption spike will provide opportunities for consumer-oriented companies

■     South Africa: The investment climate received a boost with the approval of Wal-Mart’s entry, but familiar challenges still threaten the economy

■     Tanzania: Massive infrastructure plan hinges on willingness of private investors to take a risk on Tanzania

■     UAE: The government is getting ready to launch a key industrial zone just as companies revisit the UAE as a long-term export base

Each month Frontier Strategy Group releases monthly market reports to its clients. These concise, executive-friendly reports highlight key developments and market trends in a particular region.

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