Franklin Templeton Emerging Markets Equity’s Bassel Khatoun and Salah Shamma share their on-the-ground view of the regional response to the coronavirus pandemic
Countries in the Middle East-North Africa (MENA) region have implemented comprehensive fiscal and monetary policy responses in a bid to combat the financial impact of the coronavirus. Franklin Templeton Emerging Markets Equity’s Bassel Khatoun and Salah Shamma share their on-the-ground view of the regional response to the coronavirus pandemic, and why they think times of exceptional stress could provide potential opportunities ahead.
Concerns over the coronavirus impact on the global economy and corporate earnings have taken financial markets by storm. Middle East North Africa (MENA) markets have also been caught up in the coronavirus crosswinds, following the lead of global markets lower. Further declines were exacerbated by a large drop in oil prices after Saudi Arabia pulled out from OPEC+ discussions and significantly increased oil production.1 We expect the virus outbreak to have a temporary, yet sharp impact to consumption and business activity over the next few months. Sectors that are most likely to be affected include retail, tourism and hospitality, which have already seen a fall in demand.
Many countries in the region have introduced strong measures similar to other countries, in order to contain the viral outbreak. These include school closures, travel bans, border closures, restrictions on religious practice, mall and restaurant closures and the cancellation of cultural events. Governments are also preparing stimulus and aid packages to support the economy. Gulf Cooperation Council (GCC) governments’ response to the COVID-19 pandemic has been swift and comprehensive. All have decisively enacted a range of measures to suppress the spread of the virus.
While the situation remains fluid as we continue to closely monitor developments, we’ve engaged with company management teams and industry channel checks, which has allowed us to draw a clearer picture of the impact of the coronavirus. We believe that most company earnings will be impacted in the first quarter and potentially the second quarter, with a likely normalization in the year’s second half and beyond. In our view, the longer-term growth potential remains strong.
In our experience, times of exceptional stress have historically provided opportunities to reallocate capital and to potentially rebalance and establish new entry points into quality names and strategies that could benefit from the eventual normalization in our markets.
We believe the current market should provide long-term opportunity for investors who stay the course or take opportunities as they arise. Consumption will come back. All countries have implemented massive fiscal stimuli directed at first containing COVID-19, but also at driving demand and consumption. Over the next few months, effective government policy will have to be directed at reducing the fear factor and providing enough economic security so that once COVID-19 is contained, people will go out and start rebuilding and consuming again. We have already seen meaningful steps being taken by MENA governments, and we expect policymakers to stay the course for the rest of the year.
This too shall pass. We believe that longer-term investors should try to look past the current crisis and not base their investment decisions solely on current events.
Our on-the-ground presence in the MENA region allows us to see the full effects of meaningful social and economic reforms that governments have implemented over the past couple of years. We’ve observed some encouraging signs these reforms have had a material impact on the overall sentiment toward regional economies. We believe we have only scratched the surface on what could be a secular shift in competitiveness and productivity.
MENA equities are also becoming increasingly prominent within the emerging market universe. With Saudi Arabia’s recent inclusion in the MSCI Emerging Markets Index and Kuwait’s inclusion slated for June 2020, in addition to several other smaller, liquidity catalysts lined up over the course of the next two years, the MENA region’s overall weight in the index could potentially increase to almost 7%.2 This would put it on par with the likes of South Africa, emerging Europe and Brazil, and should provide a continuous flow of investment from emerging market investors.
As it stands, it appears that Saudi Arabia’s decision to lower selling prices after the breakdown in OPEC+ talks in Vienna has overwhelmed an already weak market that has been reeling from lower demand following the outbreak. Both sides seem to have ample financial capacity to sustain a price war for some time. Although Russia is better positioned, we believe Saudi Arabia could be using this gambit in an attempt to bring Russia back to the negotiating table.
We believe current oil prices are unsustainable for almost all market participants. While higher-cost producers like US shale clearly cannot generate profits at these levels, cheaper producers like Russia are likely to see challenges in this price environment, in our view. Saudi Arabia, while having very low production costs, also has domestic spending needs that likely require oil prices to be higher in the long term as well. Despite this, we believe there is continued room for prices to remain lower in the short term.
Our analysis suggests that the current strategy could, more likely, result in two outcomes: bring back all major participants—OPEC, Russia and the United States—to the negotiating table and agree on shared supply cuts or maintain the current price war, which would lead to further supply reductions as more producers shut down existing wells. In both cases, we do see oil prices settling back at normalized levels as we go into the latter part of the year.
Given this new competitive paradigm, we currently expect oil prices to hover around US$30 per barrel in the second and third quarter of 2020—with the caveat that if the rhetoric from OPEC becomes more aggressive, prices could test US$20 per barrel, as they did as of March 2020—before subsequently moving up toward US$50 per barrel by the end of the year, and normalizing in the US$50–US$60 per barrel price band. Here is what is driving our expectations:
Beyond Saudi Arabia, the oil-exporting GCC governments will take a meaningful hit to fiscal revenues if crude prices fail to recover from these levels quickly. According to the International Monetary Fund, the fiscal breakeven oil price for the GCC countries ranges between US$45 to over US$100 per barrel.3 The large variances reflect the different risk profiles across the region: Oman and Bahrain continue to be highly vulnerable in this environment, while countries such as UAE, Qatar and Kuwait appear better equipped to absorb medium-term losses given their lower debt profiles and ample reserves.
It is worth noting that GCC economies have come around since the last oil price shock in 2014. Governments have had time to address and adjust their fiscal imbalances and ballooning spending. Noticeable reforms such as the removal of subsidies, introduction of taxation and rationalization of spending have been implemented. GCC debt levels are relatively low, and government reserves continue to be meaningful and well above global norms. We expect Saudi Arabia, supported by other GCC countries, to continue with the market’s share strategy as long as it finds it manageable to do so.
Naturally, lower oil prices and COVID-19 fears will continue to weigh on investor sentiment. While the price action is undoubtedly negative in the near term, our base case does suggest a potential silver lining in the form of higher crude production as OPEC members gain market share and oil prices normalize. As such, if lower oil prices are short lived, we expect regional balance sheets and foreign exchange positions to be meaningfully restored once prices recover.
Consumer
Health Care
We believe that global governments and central banks will not hold back with any further measures to improve liquidity and support consumption in the wake of the coronavirus. Additional fiscal stimulus is to be expected and should help counter the severe adverse effects of a prolonged pandemic. As investors, to bring more confidence we would need to see more action for companies—particularly smaller businesses—and for workers that may not get paid for many months.
All investments involve risks, including possible loss of principal. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Investing in the natural resources sector involves special risks, including increased susceptibility to adverse economic and regulatory developments affecting the sector. Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments. Investments in emerging markets, of which frontier markets are a subset, involve heightened risks related to the same factors, in addition to those associated with these markets’ smaller size, lesser liquidity and lack of established legal, political, business and social frameworks to support securities markets. Because these frameworks are typically even less developed in frontier markets, as well as various factors including the increased potential for extreme price volatility, illiquidity, trade barriers and exchange controls, the risks associated with emerging markets are magnified in frontier markets. To the extent a strategy focuses on particular countries, regions, industries, sectors or types of investment from time to time, it may be subject to greater risks of adverse developments in such areas of focus than a strategy that invests in a wider variety of countries, regions, industries, sectors or investments.
OPEC+ is an alliance of oil producers, including members and non-members of the Organization of the Petroleum Exporting Countries.
Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges.
The Gulf Cooperation Council is an alliance between six Middle Eastern countries: Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and United Arab Emirates (UAE).
Source: International Monetary Fund, World Economic Outlook Database, October 2019.