CEEMEA remains vulnerable despite joining recovery party

While some economies within the region are benefiting from higher oil prices, the continued exposure to European Union sovereign debt crises and new political risks in the Middle East and North Africa region combine to make emerging CEEMEA still a riskier and less profitable region than Latin America and Asia, writes Julian Evans.

  • 25 May 2011
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The region that takes in emerging Europe, the Middle and Africa (CEEMEA) was hit worst by the credit crunch out of all the emerging markets, and it has been the slowest to recover. The IMF is only predicting 3.7% economic growth for emerging Europe in 2011, compared to 4.75% for Latin America and 7% for Asia, and that is after both those two regions grew much faster than the emerging EMEA region in 2010.

The main risk for emerging EMEA in 2009 and 2010 was the region’s heavy reliance on foreign capital, and the risk of that capital drying up again, as it did in the first quarter of 2009, causing many banks and corporates in the region to go bankrupt.

Throughout 2010, there was continued risk of a European sovereign debt crisis causing another abrupt stop to capital inflows into the CEEMEA region. The IMF and EU did a good job at managing those risks and giving confidence to the jittery markets, but the possibility of a European sovereign debt and banking crisis hasn’t gone away.

The CEE region, hit so badly by the credit crunch, has got back into growth, in part thanks to strong exports to Germany and other EU economies. However, domestic demand is still a long way below pre-crisis levels. Consumers across the CEE region are saving more and spending less. Unemployment in the region remains around the 10% level.

In the meantime, a new risk for the region appeared in Q1 2011, in the form of the Arab Spring: a wave of revolutions that swept through the Arab world. The participants of the Arab Spring have been applauded by Western politicians and media for their courage in demanding more democratic regimes.

However, even bloodless revolutions, like Egypt’s, have their economic cost: Egypt’s economy is expected to contract this year, as are Tunisia’s, Morocco’s, Lebanon’s and Syria’s. Where the revolutions and the counter-revolutions have been bloody — as in Libya, Bahrain and Syria — the impact is likely to be lower foreign investment, and in the case of Libya, potentially many months or even years of civil war.

The Arab Spring has not, however, been entirely bad news for those EMEA countries which export oil and gas. The fear of a disruption in oil production in Egypt, Libya, and even perhaps Saudi Arabia, has led to oil prices rising to over $100 a barrel, peaking at around $125 in early April. This has given oil and gas exporting countries like Russia, Nigeria, Kazakhstan and UAE a tremendous economic boost.

The oil price hike has also, however, raised the spectre of inflation for the region once more, and food-related social unrest that hit the region in 2008. Because it has grown slower than other emerging market regions, emerging EMEA has been slower to begin raising rates. Some central banks in the region have begun raising rates this year, and others are likely to follow.

Russia and the CIS enjoy commodities boom

In 2008 and 2009, Russia received a rude awakening after several years of oil-induced complacency. The global banking crisis led to a rapid drop in capital inflows. The stock market crashed, the oil price plunged, several large banks and corporates had to be propped up by the state, the country’s $500bn in petrodollar reserves disappeared within 12 months, and the economy contracted by 8% in 2009.

President Dmitri Medvedev declared that the economy’s dependence on natural resources was "humiliating", the level of corruption was "chronic", and he seemed to declare a new direction for economic policy, towards greater liberalisation, reduced corruption, and lower state involvement in the economy.

However, Russia is always more liberal when the oil price is low and foreign investment is needed. And the oil price has now risen back to over $100 a barrel, bringing the government budget safely back into the black. "The swagger is back in Moscow", says Andrew Cornthwaite, deputy CEO of Renaissance Capital in Moscow. "The Kremlin needs foreign capital less than it did a year ago."

GDP in Russia is growing healthily, 4.5% in Q1, and is predicted to grow at around that amount in 2011, thanks mainly to the boom in commodities. But if the economy wants to catch up with developed markets, and to compete with the 6%-9% GDP growth of countries like China, India, Brazil and Turkey, then it needs to attract more investment.

"Russia has a pipeline of very capital-intensive infrastructure projects", says Yaroslav Lissovolik, chief economist at Deutsche Bank Russia in Moscow. "Those projects include hosting the World Cup and the Winter Olympics, not to mention the need to upgrade the country’s road, rail, and energy systems. This will require a major shift in economic policy, to attract more foreign capital."

The investment to GDP ratio in Russia is only 20%, compared to 30%-40% for Asian economies. Now that the government is receiving more capital from its commodities exports, it can afford to pay for some of the infrastructure upgrades. But it faces many other demands on its budget spending, including the pension system and a population growing more dependent on social benefit handouts. It needs foreign capital inflows, but they are still just 50% of pre-crisis levels.

For foreign companies, the main attractions of Russia’s economy are its natural resources, and its domestic consumer market. But deals in the former sector are rare, difficult, and highly politicised: look, for example, at BP’s struggles to extricate itself from one Russian merger, with TNK, to enter into another merger, with Rosneft.

Meanwhile, the retail sector may be beginning to pick up again, after a weak 2010.

"The retail sector underperformed in 2010 because of a decline in real income and slow retail lending growth", says Natalia Orlova, chief economist at Alfa Bank.

"Retail loan rates are still quite high compared to other economies, with an average interest rate of 18%. And the middle class was not in a confident mood to borrow and spend."

Retail confidence on the rise

There are some signs that retail confidence is beginning to return this year, and foreign consumer companies are once again making big investments, as PepsiCo’s $3.8bn acquisition of Russian juice company Wimm-Bill-Dann showed at the beginning of the year.

However, that acquisition by a foreign multinational remains a rare deal in a quiet M&A market, which analysts and economists put down to a lack of trust among foreign investors in Russia’s business climate. "The government says it wants to increase the level of foreign direct investment in Russia", says Sergey Alekashenko, director of macroeconomic research at the Higher School of Economics in Moscow.

"More FDI is definitely needed. But the government is failing to improve the country’s weak legal system, or the endemic state corruption, which is the reason foreign investment is so low."

President Medvedev has taken some steps to reduce the state’s role in the economy. He passed a decree removing state bureaucrats from the boards of state-owned companies like Rosneft. The government is also pressing ahead with its privatisation programme, although so far it has only sold a minority stake in VTB.

As the country approaches another presidential election in 2012, with no genuine opposition and the state maintaining a firm grip on the media, the government faces little call to make radical economic reforms.

As its economic position strengthens, analysts expect more money to be diverted into the country’s stabilisation fund, strengthening the sovereign’s fiscal position and improving the sovereign’s credit profile. Investors are hopeful that the government will take steps to improve the country’s investment climate — hopeful, but not entirely optimistic.

Kazakhstan has also been rescued by the rise in oil prices. The oil-rich central Asian economy is forecast by the IMF to grow 5.9% this year, having grown 7% last year. The banking sector, which took such a battering in 2008 and 2009, is still weak — around 25% of loans are non-performing, and there are no signs of buyers for any of the banks that were nationalised during the crisis. Like many other countries in the emerging EMEA region, Kazakhstan is facing inflationary problems. Inflation is predicted to hit 9% this year by the IMF, before falling to 6.5% in 2012.

Ukraine is also struggling with inflation of 9.5%, aggravated by a sudden rise in gas import prices, and by rising food prices. And while the economy is growing healthily, with GDP rising by 5% in Q1 2011, the country has an increasing current account deficit, which makes it heavily reliant on foreign capital inflows, whether from the IMF or international debt markets.

"Massive sovereign borrowings propped up Ukraine’s external balance in the first quarter of 2011," says Raiffeisen Bank Aval’s chief analyst, Dmitry Sologoub.

"Meanwhile the current account deficit has widened due to the hike in gas imports. This makes the economy quite vulnerable to any sudden changes in international market sentiment."

In neighbouring Georgia, the main concern is how to increase FDI. The Georgian government made itself a haven for FDI before its war with Russia, thanks to low taxes and a reputation for being less corrupt and more business-friendly than certain other CIS economies.

However, the war with Russia in 2008 dented the country’s reputation for stability, and FDI fell to just $500m in 2010. It’s set to rise to $1bn this year, and the government also successfully sold a $500m Eurobond in the first quarter. The IMF predicts the economy will grow by 5.5% this year.

CEE region struggling
back despite weak domestic demand

Central and Eastern Europe can be divided into three regions according to economic performance and outlook. First are the weaker economies, who were particularly hit by the credit crunch and who have struggled to get back to growth. These include Hungary, the Baltics and southeast Europe.

Second, there are the stronger central European economies — Poland and the Czech Republic — which weren’t so badly affected by the credit crunch and which are benefiting from strong exports to Germany. Finally there is Turkey, which is enjoying stronger growth than the rest of emerging EMEA, and is uniquely facing over-heating issues.

Those countries that required IMF support during the credit crunch — Hungary, Latvia and several southeast European countries — are gradually returning to an export-driven growth, but are hampered by weak domestic demand and high unemployment.

"Some CEE countries went into crisis in 2007 after very large domestic credit booms, which were mainly financed by FX borrowing", says Robert Burgess, emerging markets economist at Deutsche Bank. "Last year was a very difficult year for them. They went through a classic L-shaped recovery. Exports recovered well, but domestic demand has been very slow."

"Consumers and businesses throughout the CEE region are not spending a lot, because they felt they had over-extended themselves before," says Daniel Hewitt, senior emerging EMEA economist at Barclays Capital.

"Unemployment is high in many countries, which is further hampering domestic demand." In Serbia, for example, unemployment is at 18.8%, which is the highest for the CEE region. But Latvia, Bulgaria, Slovakia and Poland are all near or above 10%.

Consumers don’t want to borrow, and neither do banks want to lend. The CEE region is heavily dependent on Western banks, which maintained their lending to the region throughout the crisis, partly because of agreements with the IMF. But those agreements are coming to an end, and it is possible that Western banks will delever further. "Some banks aren’t rolling over their loans", says Gillian Edgeworth, head of EEMEA economics at UniCredit in London. "The region is still quite dependent on external capital flows."

The SEE region is particularly weak. Both Croatia’s and Romania’s economies shrank in 2009 and 2010, and growth in these countries remains sclerotic, at around 1.6% estimated in 2011. Rising food prices could be a problem for the region, says Edgeworth. "Real wage growth and purchasing power have eroded significantly, while food prices are rising fast," she says.

Baltics impress

The Baltics were also badly hit by the credit crunch, particularly Latvia, where the economy shrank three years in a row and is only expected to return to growth this year. But all the Baltic governments have won admiration from economists thanks to their ability to reduce budget deficits quickly — Latvia, for example, is on course to reduce its budget deficit from 11% in 2010 to just 2% in 2012.

"The Baltics have come through the crisis very impressively", says Edgeworth of UniCredit. "The economies have returned to growth, the banking system has stablilised, and the governments have pushed through spending cuts that no one thought were possible to get passed."

At the stronger end of the economic scale, Poland and the Czech Republic continue to post strong GDP growth, in large part thanks to strong exports to Germany. However, unemployment in Poland remains high, at 12%-13%. "In May, Germany and Austria opened up their labour markets to EU migrants," says Hewitt of Barclays Capital. "This could take some of the strain off Poland’s labour markets."

The Czech government has impressed the market with its willingness to reduce its budget deficit, which is on course to fall from 5.8% in 2009 to 3.5% in 2012. Poland is still struggling to reduce its deficit, which hit 7.9% last year. "The budget deficit is considered an area of weakness for Poland," says Hewitt of Barclays Capital. "The government is trying to reduce it through a series of small measures, like increasing VAT. It seems to be moving slowly in the right direction."

Finally, Turkey is in a unique position in emerging EMEA, in that it’s in danger of over-heating. "Turkey’s economy is perhaps growing too fast," says Burgess of Deutsche Bank. "Inflation looks OK, but everything else is flashing red. The banking sector came through the crisis in better shape than other countries, and as a result, credit is growing at 35% a year. The economy grew at an annualised rate of 10% in H2 2010. The current account deficit is 7%, so the country is very dependent on short-term capital inflows."

The Turkish central bank is facing the classic emerging market dilemma, of wanting to raise interest rates to slow credit growth, but at the same time not wanting to attract more hot money. Burgess says: "The central bank is attempting to slow credit growth with macro-prudential measures like raising bank reserve requirements. But we expect it will have to raise rates further."

MENA region hit by political risks — and opportunities

In the first quarter of 2011, the MENA region became the main centre of risk for the emerging EMEA region, and for the entire global economy. Revolutions in Egypt, Tunisia, Morocco, Libya, Bahrain, and Syria shook the region, hit economic growth in the affected countries, dried up foreign investment, and sent the price of oil spiralling.

The higher oil price was good news, of course, for GCC oil exporters like Saudi Arabia, UAE, Iraq, Kuwait and Qatar. The Institute of International Finance estimates that GCC oil exporters’ economies will grow by 6.5% this year, thanks to the rise in the oil price. The picture is particularly rosy for Qatar, whose economy is predicted to grow by 18%, the highest rate in emerging EMEA. Iraq is also predicted to grow by 11%. The majority of GCC states will also see their combined current account surplus double to $292bn this year, up from $128bn last year.

But despite this boost to their budget surpluses, the authoritarian monarchies of the GCC are hardly celebrating the Arab Spring. Instead, they are nervously eyeing their own populations — as is the rest of the world. If a revolution disrupted oil production in Saudi Arabia, or the UAE, the impact on the oil price, and the global economy, would be enormous. And the revolutions of the Arab Spring have moved dangerously close to Saudi Arabia, with the government in neighbouring Bahrain opening fire on protestors.

"The region is divided into two groups," says Emad Mostaque, Middle East and North Africa strategist at Religare Capital Markets. "Firstly, those countries with high levels of natural resources and lower populations, such as the UAE, Kuwait, Saudi Arabia, Qatar and Libya; and secondly, those countries with low levels of natural resources and high populations, which include most of the countries in North Africa." Both these groups are facing the same challenging fact: 50% of their population is under 25. But their means of coping with this challenge are necessarily different.

Social contract

In oil-rich countries like Saudi Arabia and Kuwait, governments have mainly created jobs in the public sector. "It’s a social contract," says Mostaque. "The royal families give the people well paid and secure jobs in the public sector, and in return they get to keep power." The governments’ largesse to their populations has only increased this year, as concerns have grown about social unrest or revolution.

"At the moment, there’s not much incentive for young Saudis or Kuwaitis to work in the private sector," says Mostaque. "You can get a well paid job in the public sector, with 65 days holiday a year, working a four-day week, with very good job security and benefits. Why bother working for a private company where they’ll actually expect you to work hard?’

But this situation can’t last forever, because the oil and gas reserves of the Gulf won’t last forever. Governments will need another source of revenues, which will have to come from a more efficient and productive private sector, and from taxes. When young Saudis or Kuwaitis are working hard in the private sector, and supporting their governments through taxes, they will expect a lot more freedom, and better government, argues Mostaque.

In countries like Egypt, Tunisia, Morocco and Lebanon, which don’t have the luxury of high hydrocarbon reserves, the situation is tougher, because higher oil prices mean higher-costing fuel imports. The IIF predicts the economies of Egypt, Lebanon, Morocco, Syria and Tunisia will contract in 2011. Growth is expected to rebound in 2012, but these countries face considerable downside risks to growth, according George T Abed, an IIF senior counsellor: "Not only is the political reform process unlikely to be smooth and could drag on beyond 2011, further delaying and slowing any economic recovery, but investigations into political corruption are adding to business uncertainties," he says.

Crucial 12 months for Egypt

Jobs in these oil-importing countries will need to come from liberalisation, cutting red tape, and from small and medium-sized businesses. For Egypt in particular, the next 12 months are going to be crucial. Economic growth more or less flat this year. The question is how quickly the economy rebounds next year. "If the economy doesn’t rebound, then the Muslim Brotherhood is likely to do very well in elections in November, and Egypt could start to go down a very different path," warns Mostaque. "If it rebounds, the Muslim Brotherhood is likely to do less well. The Egyptian economy is quite small, so there’s a big incentive for Western governments to do what they can to help the economy grow. It will be a lot cheaper way to protect democracy in the Arab world than, say, spending several billion dollars on the war in Afghanistan."

In the short-term, then, the Arab Spring is clearly going to hit the economies of North Africa, and the situation is still alive and uncertain in many Arab countries. Longer-term, however, analysts suggest the overthrow of aging dictatorships by vibrant civil societies could be positive for the region’s economies.

"The changes taking place in the region could provide a boost for its economies over time," the IMF said in its April regional report. "A more inclusive reform agenda that meets the population’s demands by providing greater access to opportunities and more competition would make the region’s economies more dynamic."

Sub-Saharan Africa doing well, although South Africa disappoints

In Sub-Saharan Africa, the picture is also mixed. Oil exporting countries like Angola and Nigeria are obviously reaping the benefits of higher commodity prices and are posting the highest GDP growth in the region. Nigeria, for example, posted GDP growth of 8.4% in 2010, and is expected to post growth of over 6% in 2011 and 2012. Angola, meanwhile, is expected by the IMF to grow by 7.8% this year and by 10.5% in 2012.

The oil-importing middle income economies of the region — South Africa, Botswana, Namibia and Swaziland among others — are expected to grow by 3.7% in 2011 and by 4% in 2012, which is more than some other parts of emerging EMEA, but the slowest rate of growth in Sub-Saharan Africa.

"South Africa in particular has been a disappointment," says Burgess of Deutsche Bank. "There was a lot of optimism about it in 2007 and 2008, but it’s shown a fairly lacklustre recovery since the credit crunch, and growth has struggled to get above 3%."

The biggest problem facing South Africa is unemployment, which at 25% is one of the highest in emerging markets. In some provinces, the unemployment rate is as high as 40%. The main driver of job creation is the public sector, but this is unsustainable in the medium term.

Another challenge for the region is inflation, which will probably average 7.8% in sub-Saharan Africa this year, up from 7.5% in 2010, according to the IMF. In oil-exporting nations, the Fund expects inflation to average 10.3% in 2011, while in less stable countries, such as Zimbabwe, consumer prices will probably increase on average 9.1%. The difficulty for African central banks is how to raise rates and cut fiscal spending, while protecting lower income populations from rising food prices and unemployment.

More upside than down?

The countries that make up the emerging EMEA region clearly share some similar problems, in particular the question of how the end of quantitative easing in the US will affect emerging markets. The region as a whole is also exposed to the continued weakness of the European sovereign debt and banking markets. Inflation and rising food prices is also a growing concern for the region as a whole, though some central banks have more monetary options than others.

But within the region, clearly the fortunes of different economies are mixed. Oil exporters like Russia, Nigeria and Saudi Arabia have pro-democracy demonstrators in North Africa to thank for a sudden swing back into budget surpluses.

The rest of the region is having to cope with higher fuel import prices. Oil exporters also have less dependence on external capital inflows, which could be crucial if global market sentiment turns bad in the next two years.

The recovery in the EMEA region looks vulnerable. However, perhaps there are more opportunities on the upside, as domestic demand slowly picks up and consumer confidence returns.

Since the credit crunch, the region has lagged behind Asia and Latin America, but there are signs that it is beginning to join the emerging market party.
  • 25 May 2011

All International Bonds

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 JPMorgan 222,090.35 998 8.23%
2 Citi 207,802.09 868 7.70%
3 Bank of America Merrill Lynch 172,151.11 725 6.38%
4 Barclays 162,393.55 662 6.01%
5 HSBC 133,323.28 724 4.94%

Bookrunners of All Syndicated Loans EMEA

Rank Lead Manager Amount $m No of issues Share %
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1 BNP Paribas 27,275.91 109 7.92%
2 Credit Agricole CIB 25,517.00 104 7.41%
3 JPMorgan 21,834.93 53 6.34%
4 Bank of America Merrill Lynch 21,222.68 53 6.16%
5 SG Corporate & Investment Banking 16,639.52 78 4.83%

Bookrunners of all EMEA ECM Issuance

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
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1 JPMorgan 7,363.27 46 9.58%
2 Morgan Stanley 7,283.40 35 9.48%
3 Goldman Sachs 6,842.44 35 8.90%
4 Citi 5,763.97 41 7.50%
5 UBS 4,691.07 23 6.11%