The financial landscape of the Middle East and North Africa (Mena) region primarily comprises three major asset classes: equities, bonds and bank assets. International Monetary Fund (IMF) data indicates that MENA financial landscape suffers from two structural problems: it is lacking in scale and skewed towards bank assets. For successful efforts on economic diversification, the MENA region should broaden its base asset classes like equities and bonds, which are better suited to longer term financing, and reduce its reliance on bank funding which can only provide short to medium-term financing.
First the scale issue…
MENA GDP is estimated at $2.9 trillion (2011) and is expected to reach $4 trillion by 2018 implying an annual growth of 4.8%, far lower than 11.2 per cent achieved between 2004 and 2011.
From a scale perspective, the value of Mena asset classes is roughly equivalent to 95 per cent of its total annual GDP compared to the global average which is nearly 3.7 times GDP, or 370 per cent. This gap was noticed in all asset categories but especially that of bonds where Mena’s share is equivalent to only 8 per cent of GDP compared with 140 per cent internationally.
Using the 2018 regional GDP forecast by IMF, there is not much of a change in scale, with values only expected to improve in Mena from 95 per cent to 105 per cent.
From a structural point of view, lack of change will mean continued dependence on banks for funding resulting in muted growth in equity and bonds as asset classes. In such a scenario, the implied compounded annual growth rate for Mena’s equity asset class is only 7.4% for 2011-2018, compared to 17 per cent achieved during 2002-2011. For bonds, the implied annual growth for 2001-2018 is 7 per cent compared to 10% achieved during 2002-2011. Even bank assets growth is expected to drop from 7.5 per cent to 5.1 per cent for the same periods.
While the global economy is coming out of a structural economic crisis and systems are being introduced in the region to ensure transparency, investors should ideally be more focused upon making investments in equity and debt over the longer term since it yields higher returns. Instead confidence on equity and debt is projected to wane in the region which is not a good sign.
And then the skew issue….
In terms of distribution of asset class, bank assets in Mena are dominant, constituting 63 per cent of the total against 9% for bonds and 28% for equities. This is starkly different from the global trend where the structure is less in favour of equities and more in favour of bank assets and bonds. Mena’s continued position in favour of bank assets again points to a system which is not in a position to cater to long-term finance. This then has to be bridged by government finance or private equity.
And finally, some suggestions…
Finance and funding in the Mena region basically requires scale and spread as explored in this article. In order to increase the scale all three main asset sources (bank assets, equities, and debt) should be developed. The development of equity market will depend on increasing the number of primary issuances, allowing foreign investors in, and modernising the exchanges along with improved regulations. The development of debt markets (both public and private) will again require rapid issuances to create a vibrant secondary market as well as developing a yield curve.
Bank funding continues to be important but it should not crowd out other avenues. Ideally, it should pave the way for other avenues of long-term capital like equity and debt. Alternatively, development banks can be formed to fill the gap for long-term finance. Such a structural change in favour of long-term sources like equity and debt will also trigger a need for qualified professionals along with the need to follow stronger ethical codes empowering regulators who will need to have wider responsibilities.
— Raghu Mandagolathur is a CFA charter holder and a founding Member of CFA Bahrain and CFA Kuwait. He works as a Senior Vice President & Head of Research for Kuwait Financial Centre S.A.K (Markaz).