Emerging Markets Insights

More than two years of economic and political turmoil in North Africa has reoriented foreign investors toward the most stable market in the sub-region: Morocco. The country’s relative stability is mostly driven by two factors: steep increases in food and fuel subsidy spending and modest political reforms following street protests in February 2011. These two factors have allowed Morocco to avoid the same fate as its North African neighbors and emerge as a top investment destination.

Running out of money

Government spending on subsidies has promoted stability, but it has also contributed to Morocco’s precarious fiscal position. FX reserves are barely enough to cover four months of imports, which is a 10-year low, and the budget and current account deficits are straining the economy. This is forcing the government to consider cutting the same food and fuel subsidies that promoted stability. Such a move could come this year and impact all industries operating in the country, raising input and supply chain costs and reducing customer purchasing power. The government estimates that reducing or eliminating subsidies would lead to annual inflation rates jumping to 7% from 2% during the next few years.

Planning for subsidy rollbacks this year

Companies should prepare a flexible response to Moroccan subsidy rollbacks to mitigate risk and identify opportunities. The impact of subsidy rollbacks will depend on which areas of the economy are targeted and speed of implementation. Below are three subsidy rollback scenarios and recommended actions for foreign companies:

1. Full subsidy rollback (high impact/ least likely)

This scenario includes rolling back fuel subsidies, which comprise more than half of total subsidy spending. A change to heavily subsidized fuel would reverberate across Morocco’s economy and lead to a higher cost of distribution and inputs. Companies should plan to adjust tactics for core functions like finance, marketing, and sales in the context of a period of significant belt-tightening in 2013. All industries should look into forward contracts for local inputs given the likelihood of a spike in inflation. Technology companies should position their products as cost-saving solutions and emphasize their after-sales services.

2. Partial subsidy rollback (medium impact/ most likely)

This scenario includes electricity and sugar with an initial reduction of up to one-third of total subsidy spending. The plan would undermine private consumption, especially for the middle class which is not eligible for cash payments that could go to as many as 2 million poor Moroccan families.  Companies should consider supporting top partners and offering special prices to important customers, because higher electricity costs would hurt local businesses. Consumer goods companies should switch to smaller packaging and emphasize value items in their product portfolio.

3. Limited subsidy rollback (low impact / somewhat likely)

This scenario primarily focuses on sugar, which is an obvious target for the government. Artificially low prices created by subsidies led Moroccans to become among the highest per capita sugar consumers in the world. Not all companies will need to respond to limited subsidy rollbacks. FMCG and other consumer goods companies should consider offering short-term financing to top partners and engaging the overnment as a preemptive step to turn the potential crisis into an opportunity.

Do not run, Do not hide

Instead of investing time and energy in lobbying the government to spare your industry, leading companies should consider preempting the reform initiative. Assess the feasibility of waving your eligibility for subsidies, agree to replace government payments for top suppliers for a two- or three-year period, or adjust pricing downward as part of a corporate social responsibility effort. This effort could be a high-profile move and highlighted as an effort to support the Moroccan people during tough economic times.

Maintaining a foothold in Morocco is critical for foreign companies operating in North Africa, which has the greatest long-term investment potential in MENA. The region is not for the faint of heart, but companies are often rewarded for sticking out short-term instability for long-term opportunity. Other companies may leave in response to protests or uncertainty, opening up opportunities for gaining market share.

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Despite economic and political instability, the Middle East and North Africa (MENA)’s economies will continue to expand, offering both opportunities and risks. In the current business landscape, effective distributor management is a critical element to capitalizing on opportunities and mitigating risks in MENA.

Local partners can provide a buffer to operational risks in order to assuage the corporate center, which might be concerned about some of the more volatile markets. Local partners can also provide critical capabilities like market insight and value-added services, which help companies to capture growth opportunities that might otherwise be out of reach.

More than two-thirds of FSG clients that were polled said they rely on distributors to reach their customers in MENA. In addition, nearly 70% plan to expand their local presence during the next three years and distributors will play a critical role in this process.

Companies that are assessing new partners should vet the prospective distributors based on considerations that are unique to the MENA region:

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Saudi Arabia is identified by most of Frontier Strategy Group‘s clients as their number one market in the Middle East and North Africa (MENA). Foreign investment opportunities abound as the government aggressively diversifies its oil economy by executing on plans to spend more than US$300 billion on education, healthcare, IT infrastructure, and other non-oil sectors.

At the same time, doing business in Saudi Arabia can be difficult due to operational challenges. The introduction of new and stringent labor regulations, which could begin to affect MNCs as early as December 2011, is the latest example.  The new law, known as Nitaqat, seeks to bolster Saudi employment in the private sector by imposing limits on the number of foreign workers that companies can maintain.  In response, some companies are considering relocating operations or shifting strategic focus in MENA. FSG advises clients that such a shift would not be wise, as it would significantly weaken any regional investment strategy.

The kingdom’s economy makes up nearly 40% of regional GDP and high public spending on the local population and government projects ensures opportunities across sectors. Any company eschewing this opportunity will not be able to make up for the losses incurred.

The Saudis are unlikely to back down

The latest iteration of the Saudization program introduces the most comprehensive measures to achieve higher employment yet.  The numbers explain why: more than 60% of Saudi Arabia’s population is under the age of 24, and youth unemployment rates are upwards of 25%.  In order to keep up with demographics, the economy must create 400,000 new jobs every year.  Increasing private sector employment would ease pressure on the public sector, which cannot carry the full burden of job creation in the long-term.  Currently, 90% of the private sector’s workforce is composed of expatriates. The government is likely willing to take a hit to FDI to accomplish its goal, which it believes could play a large role in staving off domestic unrest and supporting its young population in a sustainable way.

Christopher Johnson, who is managing attorney at Sharif law office in Riyadh, comments that, “Saudi Arabia sees the labor issue as an existential one, and crucial to flowing with rather than against the ‘Arab Spring‘.  There are also strong pressures from the Majlis al-Shura, the king’s advisory body, to limit foreign investment, on the theory that many of the services currently provided by foreign companies should be reserved for Saudis.”

What MNCs need to know about Nitaqat

Nitaqat updates quotas for the percentage of a company’s workforce that must be composed of locals. It designates non-compliant companies as red or yellow, and compliant and exceptional companies as green or blue.  Companies finding themselves in the yellow or red categories could face a host of restrictions, such as limitations on issuing or renewing visas for expatriate workers. On the other hand, compliant companies will benefit from an expedited hiring process. For example, there will be fewer restrictions on hiring away stand-out workers from other major players. Nitaqat replaces the blanket 30% quota across industries that failed to shift the composition of the workforce significantly.

The new labor plan varies in application by company size and industry. For example, while a manufacturing company only needs to employ 15% Saudis to avoid penalties, oil and gas sector players must employ at least 45% to meet the same threshold. Zahid Hussain, head of OD for an Al-Rajhi Group Company based in Jeddah, says that some industries will be impacted less than others. “Medicine and pharmaceutical, aviation, education, fashion, media, advertising, marketing, will be less affected compared to automobile, telecom, IT, and HR as the former already have a large chunk of locals on the job.”

MNCs must adapt to the new labor regulations

While Nitaqat will pose new challenges, an informed executive can take the right steps to successfully navigate the shifting labor landscape and capitalize on new opportunities as a result. Even though private sector salaries will rise to compete with public sector wages, Zahid Hussain points out that the new regulations will save companies money in other areas such as visas, travel, and relocation.

Matthew Lewis, Director of the Middle East at executive search firm Boyden advises foreign companies to, “hire locals and concentrate on training. It is easier than in other Gulf countries when you consider the size of the population and deeper talent pool as a result.” Christopher Johnson is finding success in hiring Saudi expatriates, who are returning in increasing numbers to the kingdom. “There are 100,000 Saudi students abroad that are beginning to return. They are more flexible and adaptable than their brothers who stayed home,” says Mr. Johnson. This ‘re-pat’ strategy is one that other companies have found success in implementing in Sub-Saharan Africa.

Small to medium size businesses may be the most affected by the new regulations.  As a result, companies should make sure that local partners are not impacted and offer help if so. The Saudi government admits that up to 20% of companies could find themselves in the red zone with punitive action beginning in December 2011. Leveraging resources to assist a local partner now is a much more palatable option than the disruptions to business operations over an extended period of time.

No escape from the new Middle East

MNCs must adapt to the new environment due to Saudi Arabia’s market opportunity, but also because more stringent labor regulations are becoming a wider regional trend. In October, Gulf Cooperation Council labor ministers agreed to provide greater employment opportunities to their citizens through new policies. This year’s regional unrest has acted as a catalyst to accelerate the implementation of rigorous nationalization standards. The new regulations are not anti-globalization, but they are nationalistic in character and protectionist in some instances. While this is the new reality of the Middle East, the fundamentals of investment remain as strong as ever: high government spending, oil revenue, economic diversification programs, and attractive demographics.

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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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(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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• Regional Spending – There are two key trends driving outlook in MENA:
  • MENA’s oil exporters are increasing spending of public funds to expand infrastructure and social stablility
  • Oil importers are not so lucky, and struggle with their fewer resources to keep unrest at bay
• Business Strategy – Takeaways:
  • Instability will continue to dominate the regional narrative
  • Slow government transition should not scare away investors
  • MENA’s volatility necessitates an external strategic focus for foreign MNCs

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