Emerging Markets Insights

The Middle East and North Africa’s shifting environment is making it more difficult for companies to justify investment. Several events are fueling the perception of MENA’s instability. Economic and political transitions in Egypt, Libya, and Tunisia are giving pause to foreign investors who are taking a wait-and-see approach to their entry and expansion strategies. There are serious concerns that Syria’s devastating civil war will increasingly undermine stability in neighboring markets, including Iraq, Jordan, and Lebanon. Other threats to stability, such as the fallout from a deepening eurozone crisis and the specter of a conflict involving Iran, keep corporate offices jittery about regional investment.

Despite a challenging environment, huge opportunities exist for companies operating in MENA. The MENA region’s resilient economy is expected to continue expanding steadily through 2013 and beyond. The region’s youth population has reached 200 million and it will grow significantly during the next two decades when MENA’s total population approaches 500 million. An estimated US$100 billion per year is needed for infrastructure investment to sustain growth rates and boost economic competitiveness. 

EMEA executives have a difficult time making the case for MENA, even though other regions in EMEA also have challenges. Economic growth in Central and Eastern Europe is slowing rapidly. Sub-Saharan Africa remains very risky operationally. Spending power in wealthy GCC countries is nearly 50% higher than in Central and Eastern Europe. MENA’s GDP will surpass US$4 trillion by 2015, which will be 2.5 times larger than Sub-Saharan Africa.

Even if your corporate office is not thinking about MENA investment, others are focusing on the high-reward markets. Companies will be fighting for a smaller piece of the pie due to rising competition. In a recent FSG survey of leading companies, more than 65% plan to increase their current presence in MENA markets during the next 1 to 3 years. Nearly one-third of surveyed companies expect to enter at least one new MENA market within the next 3 years.

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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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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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(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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