In terms of an overview – let me first touch base on the macro a little bit. Broadly speaking, the simplest way of looking at MEA on the macro front is by divvying up the countries in terms of hydrocarbon exporters and hydrocarbon importers. In recent years, both exogenous and endogenous shocks have hit the region hard. For the oil exporters, the global financial crisis was more significant given the impact on global oil prices, which led them to underperform oil importers in 2008-2009.
2010 onwards, oil recovered but the Arab Spring hit at the end of the year. The impact was disproportionately more on the importers given larger populations, worse social indicators, and the lack of fiscal space to address grievances quickly. In contrast, with a plethora of sovereign assets, low levels of public sector debt and higher commodity prices, the oil exporters were well positioned to increase or sustain higher countercyclical spending. Resultantly, oil exporters have been outperforming importers since the Arab Spring as well.
The story now is changing somewhat. This year and next will see the gap between these two groups narrow in terms of headline macro performance, but this is driven almost exclusively by weaker outcomes in the hydrocarbon exporters, given lower international oil prices and lower production in some cases; MENA hydrocarbon exporters will thus see lower surpluses on both fiscal and external accounts, and contribution to headline growth from the oil sector will decline. Still though, they will outperform importing countries, which are reeling from the impact of the Arab Spring, other geopolitical risks and (in North Africa) their links to continental Europe.
At a regional level, three key issues are central to the macro outlook for the MEA region/credit performance:
•    First, for many of the most prolific borrowers in the GCC and Sub Saharan Africa (SSA), the outlook for commodity prices is key. So far –and we are already past half the year, oil has averaged pretty well: WTI is sitting around USD95/bbl and Brent at about USD108/bbl. Production at the issuers is mixed – Saudi Arabia/Nigeria is down, but production remains near peak levels in the UAE, Iraq and flat over last year in Angola. Where production is higher, any impact on lower prices will be mitigated.
•    Secondly, there is politics particularly for the importers where geopolitical and domestic political challenges have sustained. Highlighting some of these, in Jordan and Lebanon, the key challenge is the Syrian situation; in Egypt, the post Mubarak transition continues to chart its own path moving from one type of authoritarian regime to another; and in Morocco, the Islamist led ruling coalition in the post Arab Spring elections in end 2011 is facing pressure with the exit of a major parliamentary ally.
•    Third, global markets. MENA generally performed better than other regions in the recent sell-off, but has consequently also lagged in the rally back. Personally, I am somewhat sceptical about the rally, but in recent client meetings the view seems to be – the summer will be fine. Yes, there are outflows, but redemptions and coupon payments are significant, which is supporting bids in the market. If this is to hold for the summer, then yield is good. In my region, there is Lebanon, Jordan, Egypt, Iraq and Bahrain. Fundamentally though, the picture in all these countries is weak.
There are other more medium term challenges as well, including the Iranian nuclear program, the ageing monarchy in Saudi Arabia, the lack of diversification in the oil exporters and changing geopolitics that may ultimately pit an empowered political Islam against the wealthier monarchies.
In terms of our views on some of the more significant credits:
In Morocco, the picture is mixed. Agriculture is expected to swing back into action which means headline growth will be around the 4.5-5% mark, higher than most regional non-oil peers. The USD6.2 billion contingency IMF program is still in place, in addition to continued FDI inflows (USD2.5 billion or so), continued international capital market access, support from GCC donors and multilateral lending institutions such as the World Bank and the African Development Bank, which makes financing external and fiscal deficits less challenging than in peers.
But political challenges have mounted. News of the departure of the Istiqlal party (one of three coalition partners for the Islamist PJD) has meant that either the Islamists led government will have to find a new partner or call early elections. But not many would want elections as the PJD (and Prime Minister Benkirane) remain popular. Plus, plenty of options in the existing 395 seat parliament (media reports suggest National Rally of Independents-RNI), but key remains monarchy approval; the RNI holds 50+ seats in the 395 seat parliament, Istiqlal ~60 seats; PJD 100+ seats; 198 is required for sustaining government.
In any case, whether a new coalition emerges or fresh elections are called, it can be argued that the prospects of fiscal reforms may have been dampened, implying Moody’s or S&P could act on their negative ratings outlook; worse still, there is some noise around the IMF wanting faster fiscal reforms with subsidies still costing 6.5% of GDP in 2012.
Hence, while we are still neutral on Morocco – given the pickup over other BBB rated names and the fact that the sovereign still compares well with regional oil importing peers (public debt about 60% of GDP; external debt under 30% of GDP), we are more cautious amid the weakening political outlook, which could delay a containment of the budget and current account deficits (both around ~7.5% -~8.5% of GDP this year).
In Egypt, the richer Gulf States have remained supportive providing a total of USD20 billion since the pro-democracy protests, while US aid, of between USD1.3-1.55 billion, should also continue despite the recent overthrow of an elected government.
Despite this support, we have been reluctant to change our underweight view for two reasons:
1.    One, a high level of support from the GCC donors is perhaps helping facilitate the exclusion of the Muslim Brotherhood (MB). If the MB were a small group which could be ignored, this would not be such a big problem. But former president Mursi was still polling 30-40% support in the lead-up to his exit. This is still a significant number, which may actually have been boosted with his detention, the arrest of MB leaders since the ouster, news of a freeze of the assets of MB leaders and the death of many supporters. However, with cash in the bank, the army-backed interim administration seems intent on pushing through the transition, with or without the MB.
2.    Secondly, while the large support helps Egypt meet its external financing needs (~USD19.5 billion over the next 12 months), it also means that the urgency to reform is postponed. Now if Mr Mursi came in facing high expectations, the new government that will take office around March 2014 will have even greater expectations and a fairly exhausted donor community. This implies they may have to reform deeper and quicker than what may have been the case otherwise. Deeper fiscal reforms could well have social consequences, given that inequality, poverty and unemployment have underpinned some of the reasons behind the pro-democracy movement.
Credit strategy wise, both the 20s and 40s have had a good bounce in the aftermath of Mr Mursi’s exit, and there may be further uptick when actual central bank foreign exchange reserve data is reported in early August, but Egypt’s outlook remains difficult and mired in uncertainties.
This brings us to Lebanon, with the largest weight in benchmark indices (~2.4%). Lebanese domestic politics and social stability has been hit hard by the situation in Syria, given historical links between the two countries and some sectarian similarities. Violence has already been reported both near the border with Syria and further afield, making the job of the interim prime minister even more difficult in terms of cabinet formation. With elections delayed till November next year (were due in the middle of this year), the political outlook will remain charged in the foreseeable future. This will continue to hold back macro performance – lower growth, a continuing rise in both external and public sector debt (~170% and 140% of GDP, respectively) and a lack of focus on reducing large fiscal/current account deficits (~10% and 16% of GDP, respectively this year).
But, Lebanese credit underpinned by its banking system – and while every macro indicators shows weakness, FX deposits (~USD62 billon; 145% of GDP) are stable and growing (albeit slower than before) and central bank reserves (~USD36 billion in FX and ~USD12 billion in gold) cover nearly 20 months of imports, 65% of external debt, ~80% of public debt and ~200% of public sector external debt. As long as the banking system remains resilient, a bid for Lebanese credit will remain underpinned by strong technical factors.
Sandwiched between the major oil producers and the oil importers are credits like Bahrain and Dubai, which are neither major exporters nor importers.
In Bahrain, the outlook is weighed down by the politics – the majority Shia population has continued to protest outside the capital, which has had a significant impact on the economy. More generally, all three major sectors of the Bahraini economy are experiencing headwinds:
1.    Wholesale banks which dominate the financial sector (15% of GDP) have seen their balance sheets shrink by over 40% since mid-2008. There is little reason to think this will change in the near term.
2.    Bahrain’s oil reserves are the smallest in the GCC (125million bbls in 2013; EIA), with production around 67kbpd (average 2008-11), over 80% from a shared oil field with Saudi Arabia (Abu Safaa). Coupled with rising expenditures, this has meant that Bahrain’s public debt ratios has risen rapidly (to ~40% at present) while its budget breakeven price is about USD120/bbl, highest than the GCC and even Iraq. This implies reliance on donors - particularly Saudi Arabia - will continue to rise.
3.    Tourism/services have also been hit due to political unrest since February 2011 – the cancellation of the Bahrain Grand Prix that year and the controversy surrounding the event in 2012 and 2013 is one example. There are also concerns surrounding weekend traffic from Saudi Arabia in the aftermath of Saudi-led GCC forces helping clear the streets of Manama in March 2011. This traffic brought some 9.5 million Saudis in 2010; in the first half of 2011, the latest data available, this had fallen to about 3 million, meaning a 37% decline year on year. Herein, only a sustained resolution of the political issue will ensure sustainable growth in the tourism/business services sector.
The above said, the positives in Bahrain include the spread/yield pickup over other BBB rated credits (the 18s at 3.5% yield, the 22s at 5.5%), in face of the fact that a sovereign event is unlikely (and politics now is a well-known story) while support from wealthier GCC countries (USD10 billion 10 year package) is expected to remain strong.
In contrast to Bahrain, the macro outlook in Dubai remains positive. Whether you look at tourist arrivals, cargo tonnage, room occupancy, real estate rents and prices, the economy appears to be doing quite well. Dubai has benefitted from a diverse economy, its close trading/tourism links to Asia and the Middle East, Arab Spring in competitor destinations, proven support from federal/Abu Dhabi authorities and political/social harmony. These factors will continue to underpin prospects in the near term; we remain constructive on Dubai’s macroeconomic and political outlook, particularly in relation to peers.
 However, risks have sustained since the emergence of the 2009 debt crisis:
1.    As per IMF, external debt is US142 billion, of which USD35 billion is government/government guaranteed and USD93 billion attributable to government related entities. USD60 billion is due over 2013-17, wherein a combination of asset sales, support from the Dubai sovereign, additional rollover of bank debt and capital/syndicate market access will be key in meeting maturities. A sovereign event remains unlikely.
2.    Dubai sovereign’s reliance on its banks is enormous. At just one local bank, exposure to the ‘ultimate shareholder’ is around 20% of GDP. But even including this, public debt is still just ~50% of GDP. Plus, there is an argument that the UAE banking system is the remit of Abu Dhabi backed federal institutions and hence does not face unmitigated risks.
3.    Finally, there are no sovereign ratings; data availability is poor/with a lag; and there have been communication issues with markets/creditors in the past.
Finally, the strongest names in the MENA region are Abu Dhabi and Qatar. In both, the outlook remains positive. Qatar will outperform Abu Dhabi on the growth front as it spends on its way to the 2022 World Cup, but Abu Dhabi will outperform in terms of twin surpluses. No major change in risks to the outlook for both: in Qatar, the leadership transition has moved smoothly, but we are not sure if this is a precedent for other monarchies in the region. It is nonetheless a useful guide to what to expect when power in these countries moves onto the next generation.
There is also the challenge from shale gas and the continuing divergence between gas and oil benchmark prices. However, Qatar remains the lowest cost producer given the scale of its production. Hence, till North American discoveries are exploited to the point where they compete with Qatari gas for Asian/European business, Qatar should be able to retain market share.
In Abu Dhabi, the principal risk factor is the dependence on the Strait of Hormuz for oil exports, but the recently completed 1.5-1.8mbpd pipeline between Habshan and Fujairah gives direct access to Indian Ocean, bypassing Persian/Arabian Gulf. However, it is currently operating below capacity, as cost of loading in Fujairah is higher vs. Persian/Arabian Gulf.
Sub Saharan Africa (SSA)
Unlike the MENA region, where politics plays a central role in the macro/credit performance, SSA credit tend to trade on the basis of the macro outlook, closely tied to the commodity price outlook. We’re focusing on two countries at the moment - Nigeria and Angola; we will add to the country list over time.
Nigeria: broadly speaking, it’s a strong credit. Growth has and will remain around the 7% mark, underpinned by the non-oil sector and a large undocumented economy that could be as large as 75% of the formal sector. Consensus inflation forecasts and recent trends (8.4% in June) suggest that headline price pressures will average in single digits this year. However, we do not expect a cut in benchmark rates from 12% at present, in view of fiscal risks that could see expenditures rise in the run up to elections, officially due in 2015. Public and external debt indicators - ~20% of GDP and ~5% of GDP – remain low and compare favourably with peers, while fiscal and current accounts remain in balance/surplus (0.0% and 5.5% of GDP).
Credit weaknesses, such as the dependency on hydrocarbons in public finances, the need for faster institutional reforms/reducing corruption, and social/infrastructure challenges are well known, similar across regional peers and have not had a significant impact on how assets trade. Therefore, the principal risk – rates/FX wise – is exchange rate weakness, itself a function of the commodity price outlook and the perceived ability of the Central Bank of Nigeria (CBN) to defend the currency. Herein while FX reserves have risen by USD15 billion since end 2011, to currently stand at about USD45 billion, sufficient for 10 months of imports. They have been on a downtrend since April this year, cumulatively losing about USD2 billion. Note also that poisoning will also matter for the Naira/local rates, given the massive portfolio inflows (USD17 billion + in 2012). On the sovereign credit side, trying to square the challenges that Nigeria faces with the strengths, leaves me neutral. I do prefer to hold the lower duration Angolan 19s, that trade wider given how the paper is structured.
Angola: we prefer Angola to Nigeria, which are comparable credits in our view, given their natural resource endowment, currently dominated by hydrocarbons and similar rating levels. Angolan hydrocarbon reserves are smaller, but the principal driver of our view is the lack of unrest in comparison to Nigeria where at present there is an insurgency in the north with Islamic extremists, while Nigerian oil infrastructure continues to face problems in the South, despite a peace deal with MEND rebels. Given a better social backdrop, reform prospects also appear brighter in Angola – recent improvements on this front have been noted by multilateral organizations (consolidated budgets for example being produced for the first time, which is not even the case in the GCC producers). Finally, a better social backdrop, better reform prospects implies that Angola’s oil production prospects are better than Nigeria, where many international oil companies have been exiting. In contrast, press reports suggest that Angola will start auctioning onshore exploration blocks later this year.
In terms of broad macro dynamics, outcomes in Angola will be quite similar to Nigeria: growth will be moderately higher at about 8% or so, helped by higher production levels (1.8mbpd in 1H 2013; vs. 1.9mbpd in Nigeria; 1.7mbpd in 2012; OPEC); inflation at about 9.5% or so; consensus forecasts of surplus fiscal accounts to the tune of around 4% of GDP (budgeted deficits though), compared to a zero balance expected this year; current account surplus of about 5.5% of GDP, flat over Nigeria. However, import cover of 7 months (FX reserves of USD35 billion or so), public sector debt of about 30% of GDP and external debt of 20% of GDP are strong compared to similarly rated peers, but underperform compared to Nigeria.
Source: CPI Financial