Global economic activity has been shifting both towards emerging markets and eastwards for a number of years and this process has been accelerated to a degree by the global financial crisis. The Middle East benefits from being both a part of this emerging new region and from being a bridge between the economic powerhouses of the Far East and the West. MENA Fund Review spoke to Francesco Pavoni and Joe Nakhle, strategy consultants at Roland Berger, about the growing trade and investment ties between the Middle East and Far East
This changing economic order and the accompanying change of focus of international investors has enveloped the Middle East to one edge and further east the growing economic powerhouses of China and India. Other countries have also emerged to take their place in the emerging global order, including Malaysia and Vietnam.
This emerging market growth has given rise to the phenomenon of rapidly rising intra-emerging market trade and investment. The Middle East with its wealth in resources, sustained government spending and high number of wealthy investors, has come increasingly onto the radar of the growing number of investors further to the east. And as developed Western markets have floundered, Middle Eastern investors have begun to look back towards those other developing markets for opportunities.
The growth in trade and investment ties between the Middle East and Far East can be seen by a growth in Chinese and Indian firms attending Middle Eastern asset management conferences as well as in the rising number of events promoting links between the two regions.
According to Francesco Pavoni, a strategy consultant at Roland Berger, “Globalization and global commodities trade flows are making these two regions the prime growth areas of the world. More specifically, the supply of commodities by the Middle East and the consumption of commodities by the Far East are resulting in the two regions becoming increasingly interconnected.
“In both instances however, infrastructural development is underpinning economic policy as the regions continuously seek to build sustainable growth in the quality of life for its constituents,” he says.
Turkey is one of the most important hubs in the globalization process. Many Turkish firms have expanded towards China and India already and others are seeking to follow. These firms have been in sectors such as white goods and services.
Conversely, companies from the Far East have been moving into sectors of the Turkish economy such as financial services and industrial goods, using it as an export hub as well as a door into Europe.
This globalization process involves finance, and this in turn drives many processes in the financial asset management chain, according to and Joe Nakhle, a strategy consultant at Roland Berger.
“International asset managers are looking at new investment opportunities, whereas the geographies in scope are certainly bountiful. Of course, the development of a sound market infrastructure as well as strong and safer regulations are prerequisites for ‘accelerating’ the ‘financial globalization’ process.
“In addition, Middle Eastern wealth, historically invested in Europe and the USA, is increasingly being repatriated back into the region, as well as into more profitable investments in the Far East.”
In both the Middle East and Far East regional players are making strategic direct investments, according to Nakhle. Capital markets are relatively restricted for foreign capital and are still lacking in maturity. With this backdrop, foreign investors generally opt for direct holdings via foreign direct investments or other channels to gain exposure to Middle Eastern and Far Eastern investment opportunities.
The Shariah link between parts of the Far East and the MENA region is playing an increasingly important part in the growing trade and investment ties between the two regions. Surveys among Muslim investors on the subject have found in excess of 80 percent of respondents would prefer Shariah compliant banking or investment products if all other features were equivalent.
This is no doubt a factor driving cross-regional interest in investment opportunities. Asset managers able to offer a good Shariah compliant product are likely to find it easier to gather assets quicker and should be able to spread their investor net across a wide geographic area spanning from North Africa to the Far East.
The geographic position of the MENA region, between the Far East and the West is also an important factor in its growing ties and importance. This is something several Middle Eastern countries and numerous companies have realized and reacted to.
“The Middle East is currently in the midst of an economic post-crisis growth era,” according to Pavoni. “As such, both trade and financial activities across regions are growing again.”
Tax-free incentives and financial infrastructure investment – such as the development of the Dubai International Financial Centre or Qatar Financial Centre – are also enhancing the Gulf’s competitive advantage in attracting financial institutions and key international companies away from neighboring regions.
This resilience to the global financial crisis, characterized by a quick rebound in economic fortunes, is driven in part by the growing links to the Far East. As in any environment, certain industries are benefiting more than others, or are poised to reap the rewards of growth.
Energy is an obvious sector that presents growing opportunities, but there are others. Infrastructure too is presenting an increasing array of investment angles as governments in the region aim to diversify their economies away from hydrocarbon dependency. This requires them to build significant new infrastructure to support and facilitate this structural change towards broader manufacturing- and knowledge-based economies.
The private education sector is also growing significantly, according to Pavoni, as around 60 percent of the region’s population is below the age of 30.
“This sector is attracting significant public and private investment,” he says.
Healthcare is also an increasingly attractive investment prospect, “given the increase in wealth levels and liberalization of the health care and health care insurance markets,” he adds.
Given the limited access to nascent capital markets for foreigners opportunities born out of the growing Middle East-Far East trade and investment flow are strongly rooted in direct holdings. This means private equity managers are best positioned to capitalize, according to Pavoni. Opportunities for non private equity asset managers are likely to increase as markets mature and access becomes easier. Institutional and high net worth assets from both the MENA region and the Far East are largely invested offshore in more developed markets. As the shift in economic growth from West to East and from developed to developing markets continues, these assets are likely to return in increasing amounts. The intra-emerging market ties forged between the MENA region and the Far East now, could see greater opportunities for managers in each region to attract these assets.
China’s prospects:
China’s phenomenal growth in recent years is on the decline and the country has entered a “slowdown phase” according to JP Morgan.
This change of pace has been largely engineered by a year of credit tightening and government policies to cool the housing market, a recent report by the company suggests. While planned, weak external demand has now begun to cause concern that the downside to growth may be greater than expected and that consumer confidence could take a hit.
“Following a series of recent policy gatherings and ministry statements, the focus has clearly shifted towards a pro-growth bias after an extended tightening cycle when the government’s main objective has been containing inflation, both in the price of every day items and in the housing market,” the report says.
“The shift was marked in late-November by a 50bps reduction in the required reserve ratio for banks, but became more evident during December’s Central Economic Work Conference, when the government’s policy statement gave priority to the goal of maintaining stable economic growth in 2012 (with economic restructuring and managing price expectations being the other major objectives). The stronger-than-expected growth in bank lending (RMB640.5 billion) and money supply (13.6 percent YoY M2 growth) in December further indicates the shift in monetary policy towards easing liquidity.”
At the close of the National Financial Work Conference, Premier Wen Jiabao also emphasized that the nation’s financial industry must improve the real economy’s access to finance and guard against speculation and ‘virtual bubbles’, a further sign of the Chinese government’s concern and change of stance.
Another China report by SEI Investments also emphasized concerns over the Chinese economy. Since the summer of last year China has been showing signs of increasing financial distress and social tension, it says.
“The country’s policymakers are hoping to engineer a soft economic landing with current tightening measures, but we are somewhat sceptical of that happening,” the SEI report says. “If it does not, then reassurance for the masses and relief for China’s leaders might prove elusive in the short-term.”
In 2011 SEI observed growing problems in emerging markets with rising food prices. These were putting an increasing burden on household budgets and acting as a catalyst to policy-tightening measures.
“By August of this year, food prices had risen more than 13 percent year-over-year, with pork prices up a record 52 percent,” the firm’s China report states. “According to an annual Chinese Academy of Social Sciences survey, inflation was the top concern of Chinese citizens in 2010 (it was the fifth most important in 2009). It is probably not a coincidence that there were officially 180,000 “mass incidents” (protests, riots, etc.) in 2010, four times as many as in 2000. Similar increases in public disturbances accompanied food price spikes in 2004 and 2007.”
The Chinese government has reacted to food price inflation and land speculation by tightening monetary policy. This began in 2010 and has continued.
“It has hiked short-term interest rates and raised bank reserve requirements (the amount of cash on hand required relative to outstanding loans) to historic highs. It also continues to slowly but steadily raise the value of its currency (the yuan or renminbi) relative to the U.S. dollar.”
The JP Morgan report – ‘China’s Nuanced Policy Approach – Supporting Growth Without Reviving Bubbles’ – says the firm expects the Chinese government to introduce policies to boost income growth and reduce the tax burden for both companies and individuals.
“Starting in mid-2011, the government introduced a rash of policies in support of the country’s SME sector,” it says. “SMEs account for 80 percent of employment and 60 percent of China’s industrial output, but lost out during both the recent credit binge and subsequent tightening. We expect broader policy support for SMEs in 2012, as well as progress in longer-term financial reforms to redress this sector’s structural disadvantage.”
Incentives to encourage greater consumer spending may also be likely, it says, although “this cannot entirely supplant the government’s traditional reliance on investments to shore up growth.”
“The difference this time around is that incremental investments will likely be skewed towards areas of social welfare, environmental protection, in strategic industries of the future, and towards improving infrastructure in the less developed Central and Western regions of the country.”
While both reports see short-term issues arising for China, they also point to a bright long -term outlook. The SEI report – ‘A Closer Look at China’ – says the country’s long term potential remains promising and adds that thanks to a sell-off of risky assets some of the firm’s managers are finding attractive values in Chinese and China-related financial assets.
In the short-term the Chinese government’s tightening measures could cause further damage to the country’s economy given the backdrop of debt-fuelled speculation.
“Whether a financial crisis is imminent in China remains to be seen, but it is a risk that investors should at least be aware of,” the report says.
Over the longer term however, SEI believes China will be able to maintain “an impressive rate of growth given its still-significant opportunities for economic, geographic and human capital development.”
“The U.S. was similarly situated in the nineteenth century and experienced its share of excessive or misdirected investment,” its report says.
“But an economy with significant upside potential, such as the U.S. then and China now, should be able to eventually grow into and overcome earlier periods of capital misallocation.”