Portfolio flows into emerging markets recovered sharply last month after a steep decline in May. Concerns about a further US Federal Reserve rate hike have receded and post-Brexit volatility has dissipated in anticipation of a global policy response; portfolio flows have been resilient even after an event that by most estimates is expected to reduce global GDP growth next year by 20 to 30 basis points.
Across the globe, within one week of trading activity, most markets were back at their pre-Brexit levels, and 70 per cent of the global market cap lost on June 24 has been recovered.
We see a limited direct effect of the event on GCC economies but cannot rule out volatility. As far as concerns about “who’s next?”, the credit default swap moves for countries where a referendum on exiting the EU is either a part of political debate or a real possibility have retraced after a post-Brexit spike.
We think the direct effect on the regional markets should be limited in the medium term – but do expect near-term volatility. There will probably be an indirect effect because of lower oil prices on the back of a stronger US dollar and a slower global economic growth environment.
However, we also believe the evolving dynamics of demand-supply equilibrium in the oil market are expected to materialise during the latter half of this year and will have an effect on oil prices.
The fundamental effect on GCC countries would largely be transmitted through oil prices – to the extent that this event disturbs global oil demand – as well as through global volatility, investor flows and relative valuations.
GCC currencies are on the whole pegged to the dollar, which will benefit from risk-off sentiment.
To an extent, GCC investors see regional growth as driven by domestic factors and somewhat disconnected from oil prices in the near term, as intended through reform plans.
At the sectoral level we think petrochemicals is more exposed to risk, with companies such as Sabic having a large presence in Europe. The weakening of the euro and sterling will adversely affect the profitability of these companies.
The port operator DP World also has sizeable operations in the UK and Europe. Some regional banks such as NBAD, Qatar National Bank and Qatar Islamic Bank are also relatively active in the UK and European markets. The number of tourists coming from the UK and Europe to the UAE might also be affected given that a weaker currency reduces purchasing power.
In Dubai’s property market, British citizens are among the largest investors and a weaker currency may deter further investments.
In the context of GCC government borrowing plans, a risk-off environment is expected to widen spreads but an accommodative central bank stance is expected to lower benchmark rates. Thus if investors are convinced of a credible fiscal policy, investor appetite for regional sovereigns may revert after initial weakness.
On the positive side, we think that because of the reduced probability of an increase in US interest rates regional companies and sovereigns would benefit if they plan to raise funds at a lower cost, and simultaneously existing issuers will benefit from lower cash outflow.
A consolidation drive is being witnessed in Abu Dhabi.
The Abu Dhabi Government is planning to merge two of its investment arms – Mubadala and Ipic – with combined assets of US$130 billion.
According to ratings agency Moody’s, the merger is credit positive for both entities and for Abu Dhabi. The ratings agency cited the differing business and financial profiles of Ipic and Mubadala, with Ipic having a longer operating history and investments in mature energy-related sectors. Mubadala, on the other hand, is a relatively young company focused on industries and projects that enable economic diversification. Over the years the companies’ investments have overlapped in some sectors, which can be consolidated through a merger with attendant integration and scale benefits.
The Saudi market’s performance continues to be lacklustre ahead of the results season and investor interest continues to be focused on national transformation plan beneficiaries.
On the regulatory front, the country’s capital market authority has liberalised qualified foreign investor rules, which can potentially bring forward the likely MSCI emerging markets inclusion date for the Saudi bourse to 2018, instead of 2019.
The post-Ramadan market focus will move to the second-quarter results, for which we expect soft numbers. However, progress on reforms in Saudi Arabia or more banking sector consolidation in the UAE could act as a positive catalyst for regional markets.
Saleem Khokhar is the head of fund management at the National Bank of Abu Dhabi.
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