Session: Emerging Capital Markets, a Look Forward

Paper: Future Opportunities for Emerging Markets in MENA countries

Presenter: Dr Robert Stone,Oxford Policy Management

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• The recent development of MENA securities markets

• What is required for a securities market to take off into growth?

• What causes financial crises?• Implications of the present crisis for

emerging markets• Opportunities for MENA securities markets

What we propose to cover

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The recent development

of MENA securities markets

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0.0

50.0

100.0

150.0

200.0

250.0

300.0

350.0

2001 2002 2003 2004 2005 2006 2007

Market capitalization (current US$bn) Value traded (current US$bn)

Source: World Bank, World Development Indicators

Figure 1: MENA Stock Exchanges, 2001-2007MENA stock exchanges, 2001-2007

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MENA Value Traded and Turnover Ratios,2001-2007

0.0

20.0

40.0

60.0

80.0

100.0

120.0

2001 2002 2003 2004 2005 2006 2007

0

5

10

15

20

25

30

35

Value traded (current US$) Stocks traded, turnover ratio (%)

Source: World Bank, World Development Indicators (T/O estimated for 2004)

Figure 2: MENA Value Traded and Turnover Ratios, 2001-2007

Left Scale Right Scale

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0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

90,000

2001 2002 2003 2004 2005 2006 2007

0

20

40

60

80

100

120

140

160

180

200

Market capitalization(current US$bn)

Value traded (currentUS$bn)

Stocks traded, turnoverratio (%)

Figure 3: High Income OECD Stock Exchanges, 2001-2007

Left Scale

Right Scale

Source: World Bank, World Development Indicators

High Income OECD Exchanges, 2001-2007

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0 50 100 150 200 250 300

 United Kingdom

 United States

 Japan

 Euro area

 Hong Kong, China

 West Bank and Gaza

 United Arab Emirates

 Tunisia

 Saudi Arabia

 Qatar

 Oman

 Morocco

 Lebanon

 Kuwait

 Jordan

 Iran, Islamic Rep.

 Egypt, Arab Rep.

 Bahrain

Source: World Bank, World Development Indicators

Turnover Ratios, 2007(%)

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Full scale Foreshortened scale

0 100 200 300 400 500 600

 West Bank and Gaza

 United Arab Emirates

 Tunisia

 Saudi Arabia

 Qatar

 Oman

 Morocco

 Lebanon

 Kuwait

 Jordan

 Iran, Islamic Rep.

 Egypt, Arab Rep.

 Bahrain

0 50 100 150 200 250

 West Bank and Gaza

 United Arab Emirates

 Tunisia

Saudi Arabia

 Qatar

 Oman

 Morocco

 Lebanon

 Kuwait

 Jordan

 Iran, Islamic Rep.

 Egypt, Arab Rep.

 Bahrain

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Market Capitalization of selected MENA Exchanges, 2007 (US$bn)

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0

5000

10000

15000

20000

25000

30000

2001 2002 2003 2004 2005 2006 2007

Amman Stock Exchange (JDm)

Market Capitalization Value Traded

0

1000

2000

3000

4000

5000

2002 2003 2004 2005 2006 2007(Aug)

Palestine Stock Exchange (US$m)

Market capitalisation Value traded

0

1000000

2000000

3000000

4000000

5000000

6000000

2001 2002 2003 2004 2005 2006 2007

Tadawul Saudi Arabia (SARm)

Market Capitalization Value traded

-

100,000.00

200,000.00

300,000.00

400,000.00

500,000.00

600,000.00

700,000.00

800,000.00

2004 2005 2006 2007 2008

Cairo & Alexandria SE (LEm)

Market capitalization Total value traded

Market Cap. & Value Traded in Selected MENA Exchanges

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What is required for a securities market to take off into growth?

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The flow of investment funds: the basic story

HOUSEHOLD SAVINGS

FIRMS

Investment

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HOUSEHOLD SAVINGS

FIRMS

Deposits

BANKS

Loans

The flow of investment funds: enter the banks

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HOUSEHOLD SAVINGS

FIRMS

Pension funds

Banks

Insurance companies Mutual

funds

Financial advisers

Securities markets

The flow of investment funds:with advisers and markets

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• An increase in contractual savings leads to a growth in the stock and bond markets

• The impact is greater where corporate information is more transparent

• The impact is greater where:– the financial system is market based– pension fund contributions are mandatory– international transactions in securities are

lowerSee G. Impavidom A.R, Musalem and T. Tressel, ‘The Impact of Contractual Savings institutions on Securities Markets’ (World Bank PRWP No, 2948, 2003)

The system behaves like a system!

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• The contractual savings institutions (pension funds and life insurance companies) need the securities market – they must be able to select assets with varying risks.

• The securities markets need the contractual savings institutions – they must have institutional investors

The NBFIs are systematically linked

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Moving from a ‘Pay as You Go’ system toa funded system

PILLAR 1 State pension

PILLAR 2 Mandatory pension

PILLAR 3 Voluntary pension

Pensions: the Three Pillars

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00

2020

4040

6060

8080

100100

19941994 19951995 19961996 19971997 19981998 19991999 20002000 20020011

pension funds

insurance companies

mutual funds

Source: D. Linneberg, ‘The Future of Capital Markets in Developing Countries.’ (Brookings-WB-IMF FMD conference, 2003)

Chile: financial savings by institutional investors (% of GDP)

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(total outstanding)(total outstanding) (Issuance)(Issuance)

00

11

22

33

44

55

66

77

19941994 19951995 19961996 19971997 19981998 19991999 20002000 200120010,00,0

0,50,5

1,01,0

1,51,5

2,02,0

2,52,5

3,03,0

outstanding

issuance

Source: D. Linneberg, ‘The Future of Capital Markets in Developing Countries.’ (Brookings-WB-IMF FMD conference, 2003)

Chile: deepening the domestic corporate bond market (US$ billion)

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DateShare offerSectorValue US$m

07/1994EgisPharmaceuticals44.6

09/1994Richter 1Pharmaceuticals60.0

07/1995OTP 1Banking88.9

11/1995Richter 2Pharmaceuticals48.6

11/1995MOL 1Oil & Gas237.0

03/1996BorsodChemPlastics74.7

07/1996TVKPetrochemicals176.2

05/1997MOL 2Oil & Gas303.8

05/1997Richter 3Pharmaceuticals218.4

10/1997OTP 2Banking212.8

11/1997MATAVTelecom1,013.3

03/1998MOL 3Oil & Gas331.4

Privatization Public Offers in Hungary,1994-1998

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Share offering and datePercentage sold

Residual Stateholding

US$ offerprice

and proceeds

Value of residual holding

MOL 1November 1995

42%58%$8.10Proceeds $237m

$462m

MOL 2May 1996

22%36%$16.25Proceeds $304m

$575m

MOL 3March 1997

11%25%$30.00Proceeds $331m

$738m

Source: OPM research

The more you sell, the more you get – the privatization of MOL,

Hungary, 1995-1997

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• 40% sold to France Telecom in 2000 for $508m• Investment of $500m in upgrading systems• 10.5% sold by Government in public offer in

October 2002• Proceeds were $86.2m• 90% of the offer was subscribed by Jordanian

investors …• … including 33% ($28m) by Jordanian retail

investors

The privatisation of Jordan Telecom

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What causes financial crises?

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Charles Mackay in 1852, Extraordinary Popular Delusions and the Madness of Crowds: –

• Money, again, has often been a cause of the delusion of multitudes. Sober nations have all at once become desperate gamblers, and risked almost their existence upon the turn of a piece of paper. …

• Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one.

This is not a new phenomenon!

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Financial crises inevitably cause major set backs to “financial development” in any country). They are also regular occurrences in both rich and poor countries– sub-prime plus Northern Rock plus Bear Stearns plus private

equity/hedge funds in the rich countries in rich countries 2007/8 and the second wave of failures in September/October 2008

– LTCM (1998), the Savings & Loan crisis in 1980s and many others before that in USA and in the rich West and East

– in the Emerging Market Economies, Mexico, Russia, Thailand, Korea, Indonesia, Turkey, Russia, Argentina – all since 1990

– in other developing countries, many examples – a total of 112 examples in 93 countries in 1970-2000 with another 51 incipient crises

Recent crises

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Proposition: there are a number of different causal factors but a broad similarity in how any initial spark of crisis can becomes an inferno.

Five Elements to the pathology:1. Increases in interest rates / tighter liquidity2. Increases in general uncertainty3. Asset market effects (negative) on balance sheets of both

companies and banks4. Intensified informational Problems for lenders

and possibly 5. Bank runs and panics

Causes versus the Pathology of Crises

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TRIGGER SHOCK

Stock Market decline and/or

other assetprices fall

Increase in uncertainty

Real interest rates rise

Bank Panic?

Further asset prices fall and rises in real

interest rates

Economic activity

declines & balance sheets

worsen

Unanticipated GENERAL

decline in price levels

Economic activity declines

& balance sheets worsen

REAL debt burdens rise everywhere

Asymmetric information

effects worsen

(A) Crisis in the Financial Sector

(B) Debt deflation - real burden of debt increases

Government interevention at this point can prevent a recession becoming a depression!

Based on Frederick S Mishkin, “Understanding Financial Crises: A Developing Country Perspective,” NBER Working Paper No. W5600, May 1996

The sequence of events in a financial crisis

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Many of the previous financial crises have been LIQUIDITY crises – and have been correctible by plugging in lots of new Central Bank money (e.g. LTCM in 1996) or new international loans (Mexico in 1994). But not all.

Today’s crisis also involves significant INSOLVENCY elements. For example:• several 100 thousands of sub-prime and near sub-prime borrowers in USA• an increasing number of mortgage lenders and not merely the main

specialist sub-prime lenders• many home builders as order falls and cancellation rates increase• many hedge-funds and other lenders who hold the securities (especially

Collateralized Debt Obligations (CDOs) created from the original sub-prime loans

• some non-financial companies as the retreat of the hedge funds (a non-traditional source of capital and liquidity) causes bond yields to rise and availability of funds to decline relative to recent levels

• some banks ( starting with Northern Rock & Bear Stearns) whose business models have been built on the assumed availability of relatively cheap and liquid funds from other financial institutions. Mark to market is a stern

The Sub-Prime Example

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Implications of the present crisis for emerging markets: news from the IMF

29 Source: IMF, Global Financial Stability Report, October 2008

Until recently, emerging markets have been relatively much less volatile …

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…but they are beginning to be seen as more risky than they were …

Source: IMF, Global Financial Stability Report, October 2008

31 Source: IMF, Global Financial Stability Report, October 2008

…so global flows to emerging markets are falling…

32 Source: IMF, Global Financial Stability Report, October 2008

This could be good news or bad news

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Opportunities for MENA securities markets

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• You can’t rely mainly on foreign capital to build the securities market– It’s more volatile than domestic capital, partly because– It’s more subject to extraneous disruptions.– In any case, even to the extent that we want foreign capital, you

need a strong domestic market to attract it

• To build the domestic securities market, you need– More liquidity, which means– More domestic institutional investors and– More firms listing and raising capital on the market

Summary of key lessons

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0

50

100

150

200

250

2001 2002 2003 2004 2005 2006 2007

OECD market cap

OECD traded value

EAP market cap

EAP traded value

MENA market cap

MENA traded value

Figure 8: Market comparisons, 2001-2007, percentage of GDP

There is plenty of room for MENA domestic securities markets to grow

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• Preconditions for contractual savings development, and indeed development in general appear to be:– A hard core of sound banks and insurance companies– A long term government commitment to financial

sector reform and sound macroeconomic policies– A long-term commitment to the creation of a sound

regulatory and supervisory frameworkFrom: G. Impavidom A.R, Musalem and D. Vittas, ‘Contractual Savings in Countries with a Small Financial Sector (World Bank, 2002)

Meanwhile, some general principles – to recap:

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Specific factors impacting on stock market development in the Middle East and Central Asia include

-The quality of institutions-Remittances and-Natural resources

Does this also apply to North Africa?See Andreas Billmeier and Isabella Massa, “What Drives Stock Market Development in the Middle East and Central Asia – Institutions, Remittances or Natural Resources?” IMF Working Paper WP/07/157, July 2007

Specific factors in MECA markets

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Requirements that the market cannot control

• The establishment of macroeconomic stability• The evolution of a funded pension system which and insurance

companies as institutional investors in the market.• Where there are substantial enterprises owned by the state (e.g.

banks, telecommunications, minerals), the floating of such enterprise on the stock exchange through a public offering of some of their shares.

• The passing and implementation of sound securities and related laws and the establishment of efficient regulators to implement them – again as a means of reducing systemic risk.

• The development of a liquid and transparent market in government securities, which established the risk-free rate of return as the benchmark for corporate securities.

• The removal of fiscal disincentives for investment in shares and bonds.

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Asset backed securities and

derivatives

Corporate bonds and equities

Government Bond market

Treasury Bill Market & Foreign Exchange Markets

Money Markets

Banks

Stock M

arkets

Derivatives m

arkets

Source: V. Sundarararjan, ‘Financial Market Development: Sequencing of Reforms to Ensure Stability.’ (Brookings-WB-IMF FMD conference, 2003)

Sequencing: the hierarchy of markets

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• for brokers to shift some of their focus from trading to origination – they need to become corporate financiers, not just dealers;

• for stock exchanges to ensure appropriate listing rules and for bonds and equities, rules which minimise delays and excessive regulation while ensuring transparency;

• for adequate supporting infrastructure to be developed, e.g. trading platforms, clearing & settlement, depositories, etc

• for insurance companies and mutual funds to work with the exchanges and brokers to ensure favourable conditions for underwriting new issues and large scale trading.

What is required of the markets

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