The “Arab Spring” and car markets in MENA and beyond

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Originally published in 2011. this paper was updated and re=-published in 2017
 

“Progress lies not in enhancing what is, but in advancing toward what will be”, Kahlil Gibran

Who predicted the Arab Spring?Only a few wise birds predicted the Arab Spring and its financial and economic impact. But, as it progressed, it didn’t take long for the immediate impact of actual regime changes in Tunisia and Egypt – and the threat of them in Bahrain and Libya – to become clear. Between the day the protests broke out in Tunisia in January, the price of oil (Brent Crude) rose from US$94.90 on the 4 January to US$116 a barrel in early March, its highest level since January 2009 when it traded at $40. Still off its $145/barrel peak of July 2008 but already worryingly high for European motorists and hauliers. Of course, while European governments wring their hands about the impact of oil prices, keep in mind that their taxes on oil consumption far outstrip the income to the oil producers. For example, in 2011 at current prices, the UK will generate about 1.8 times as much tax as the oil costs. In Germany it’s twice as much and in Italy 2.4 times in tax as the oil costs! But, if the price for long-term stability is only a few months of excruciating pump prices, many consumers might be willing to pay it. However, as we have seen, the human and financial costs turned out to be more expensive and enduring than that. 

 

Arab Spring: Refugees and Economic Migrants flee into the EU

Immigrants arriving at Lampedusa, Jan. 2011

True, oil price volatility was not the only immediate outcome. The islands of Lampedusa, Malta and Greece have all been faced with a large refugee problem as thousands of Africans from north and south take the opportunity to flee towards Europe. Unchecked, that may become a continuous stream of people looking for a better life in Europe. However, the greatest surprise to western observers is that the genesis of the ‘Arab Spring’ was not religious fundamentalism and terrorism. It was economic mismanagement (high prices and youth unemployment) and poor governance, and of the two, economics is the most dominant.

While unrest began in Tunisia, it was the fall of Hosni Mubarak in Egypt that shocked the region and the world. After all, the Egyptian government had been following the advice of the IMF in liberalizing their economy, called in Arabic the ‘infitah’ (Economic Opening), since 1974 under Anwar Sadat. But, while official unemployment is an estimated 9.7%, the true level is nearer 40%, if you include those forced to seek work outside the country. Inflation in 2008 reached almost 20%. The public finances reflect years of mismanagement. Between 2002 and 2010 government revenues rose by almost 300%, yet all of that and more was eaten away by wages for government employees, debt interest and subsidies. In truth the Egyptian government ran a deficit of between 6% – 10%, which would have been higher except for the sell-off of national assets through privatisation. By 2010 Egypt’s government debt was 65% of GDP. Updating that to 2016, debt had risen to 92.6% of GDP and inflation had risen to 30%

Egyptian Public Deficit to 2010

The Egyptian economic situation is similar to many found across the Middle East and North Africa: many governments feel that they have little choice but to defuse public discontent by maintaining subsidies, while the wealth of the state ends up in the hands of a few oligarchs, sometimes government ministers and the military, often members of the ruling elite.

But, to be realistic, both the European and the US governments are more worried about the fate of the 3 – 4MN barrels a day of oil that flows through Egyptian pipelines, than their economy.

It’s hardly surprising that another result for the Middle East and North Africa (MENA)[1] region is regional volatility for stocks, bond and currencies. In February 2011, the Egyptian Stock Exchange, EGA 100, plunged 24% but, since those dark days, the revised EGX30 has shown significant gains. The Dubai Bourse fell 13% year to date at the same time. Oman dropped 14%. What the markets recognise is that the social unrest and political instability in North Africa and the Levant would impact on the region as a whole, including the ‘insulated’ oil-rich GCC markets. The protests have been limited to Bahrain, Yemen and Oman so far – all three without significant oil resources of their own. The oil-rich GCC states have not seen protests but there are other matters that may yet infect Saudi Arabia and the Emirates. The prolonged war in Yemen, falling oil prices since 2014 and and the rift with Qatar can all be seen as later by-products. With what effect as far as the vehicle markets are concerned in the region and beyond?

CERTAIN RISKS, UNCERTAIN REWARDS

There are five downside risks to watch out for:

  1. Sustained rise in oil prices up to 2014 followed by sustained weakness until the 2020’s or longer. The rise was due to fear of disruptions in production and supply and growing demand from East Asia. The fall is due to over-supply, structural change in demand and switching away from oil due to environmental policies. In the longer term the accelerated switching to more fuel-efficient vehicles might lead to’Peak Oil Demand’; at worst it could trigger a period of contraction across GCC. Some oil companies will benefit while prices are high of course – mostly those not exposed to the Gulf Oil suppliers, such as Gazprom and Chevron. And, high oil prices could give a short windfall income to the Gulf States, so they can fund solutions to any domestic problems. But for most Europeans high prices will be unpleasant as long as they last. As events have shown, the oil price began to tumble in 2014 and has nowfallen to its 2006 levels.(See ‘Oil Price’ blog post)
  2. Slowdown in the economy of the GCC states, as investors seek more stable locations, reducing GCC foreign labour employment and flows of hard currency into the rest of North Africa. Essentially, if the GCC markets slow down, it will trigger reduced exports of high-end passenger cars into the GCC – a major market for prestige brands – and slowdown the recovery in labour supplying countries, such as Egypt, Jordan, etc. Due to their integration with the oil price, across the GCC all stock markets have declined in the period 2014 -2017, except Kuwait
  3. Immigration pressure on Europe from a stream of migrants, particularly into Italy, France, Germany, Spain and the UK triggering higher social costs, domestic political tensions and lower economic confidence. The longer that unrest goes on – especially in Syria and Libya – the more of their people will look to move to stable European countries for their future. Estimates vary but range from around 2MN un-documented immigrants migrating into the EU in 2011 to around 1MN in 2015.
  4. Fall in Residual values of fuel-inefficient used cars – 4×4’s, executive and prestige cars. With real incomes falling across much of Europe, prolonged high pump prices will reduce the financial attractiveness of fuel inefficient cars. Sadly for owners, while pump prices have fallen since 2014, larger cars, especially diesels, have become less attractive due to the VW (and others) Emissions Scandal and government moves to eradicate the sale of conventional engine cars entirely during the 1920’s.
  5. Reducing chance that Israel may be pressured to find a resolution to the Israeli-Palestinian-Arab conflict. If a resolution was found it could trigger a significant growth period in the region as money is diverted from arms purchases into the real economy. However, many factors mitigate against it: the attitude of both current Israeli and US governments; reducing dependence of the US on GCC oil flows; weakening threats from ISIL in the region.

ANALYSIS – WHY MIGHT THIS HAPPEN?

Oil Prices

The worst..and best.. of all possible outlooks?

Begin by suspending your disbelief. Recall that only ten years ago you may not have anticipated the global financial crisis – in magnitude, severity or contagion. That started as a domestic sub-prime mortgage problem for the US and turned into a global financial system epidemic. As many politicians will argue, at the moment we no longer have a credit crisis – quantitative easing has printed bundles of cash – but we continue to have a crisis of financial confidence. Four years ago you may not have forecast the oil price slump. That started as limited excess capacity but, with the reduction of global demand and the growth in shale oil production, the price has stayed low for years and no significant rise is in sight. The medium term impact of developments in the Middle East could be to reduce regional investor confidence further.

If you looked at the headlines coming out of the Middle East in 2011, the driving force in MENA stock markets was the civil unrest and its impact on oil supplies. That laid bare 5 common weaknesses shared by all the MENA economies, according to Insead: 1. The Youth Bulge; 2. Weak private sectors with few employment opportunities; 3.Dominant public sectors with bloated workforces; 4. Reliance on government income from oil or other volatile commodities; and 5. A Gender Gap in employment, education and opportunities.

In 2017 the key issues remain the same except conflict insecurity has been added to the list. More countries are in conflict in 2017 than were in conflict in 2012. So, the region is coming to the peak of the ‘baby bulge’- and employment prospects are even more bleak for many than they were.

Conventional wisdom is that affluent populations, like those in the GCC states, do not rebel against their governments. However, unrest has already persuaded the 86-year old Saudi King to offer a £22BN benefits package to buy-off the demands for reform by Saudi youth and remind the population that demonstrations are illegal and will be dealt with severely. While the west holds its collective breath – Saudi Arabia accounts for 45% of the world’s daily oil supply – the hope is that any unrest can be contained. [2] But, even if political demands can be suppressed, economic stagnation may be unstoppable.

 

GCC Stock Market Fund

GCC stock markets 2012 – 2017

The collapse of the oil price in 2014 has led to stock market falls across the region and the looming threat of debt default. The reasons aren’t hard to fathom: the GCC financial markets[3] are geographically close and, despite efforts to the contrary, still have strong dependence on oil prices and labour imports. The plan for a single currency has been postponed and all the GCC currencies are pegged – and therefore exposed – to the US$. Investors are also regional – they trade in Oman, UAE and the other GCC stock markets simultaneously. So what affects one market, affects them all.

In addition, Jordan, Morocco, Pakistan, Yemen, Sudan, Syria, Egypt and Tunisia are also linked to the GCC due to labour exports. When the GCC does well each of these countries has a significant inflow of hard currency via remittances from their ex-patriots – and vice versa.

So, how could these factors work together? In the worst case, imagine that the GCC – the financial hub of the region, but actually weakly diversified economies excluding oil – encounters significant new demands on its budgets, either because they have to buy-off social demands or chronically weak oil prices or both. At the same time imagine the US raises interest rates and the dollar value rises. As Oil is denominated in US$, oil prices fall, but the non-oil GCC economy – bloated with nationals – falters as ex-pat staff are replaced. Many return to their own countries, placing further burdens on already weakened economies, services and infra-structure. Migrants continue to chance the crossing to Europe, raising social costs in their new host countries as they enter an economic upturn due to low energy costs.

If you take a look at the CDS Rates, it’s clear that banks are already worried about default from the Middle East – even with massive oil revenues – see box below right. For example, Dubai – already reeling from a collapsed property market – has to pay 436 bp (‘basis points’) to insure its soverign debt already. That means to insure a government loan of say $10MN against default costs $436,000 per year.

CDS Rates in Key Middle East Markets Feb 2011Most observers expect the ‘Arab Spring’ to herald a short-run period of volatility in financial markets and economies right across the MENA region, even where popular unrest is muted. Experience suggests that even if political unrest spreads to a region, actual disruptions in oil supply are usually minimal and short lived – but oil prices still become volatile. For example, even during the most recent war in Iraq, oil supplies were only disrupted for three weeks.  In fact, the only two times in recent history when oil supplies were significantly disrupted due to political unrest was in Iran in 1978 and Venezuela in 2002, when the unrest worried the workers in the oil fields who simply left their positions and/or the country, which required finding and training new workers. However, even if oil supplies aren’t actually disrupted, oil prices become more volatile on the expectation of problems rather than the reality.

Not that Europe or the US are immune from social pressure. The EU is experiencing growing tensions between the left and right over migration and the US is experiencing a similar tension around the ‘left behinds’ that catapulted Donald Trump to the presidency. The UK is mired in the Brexit process for similar reasons – millions of citizens feeling they are ‘only just managing’.

IMPACTS ON THE PASSENGER CAR VEHICLE MARKETS

GCC and MENA:

Within the MENA markets the GCC states retail a disproportionate volume of high value cars each year. In 2009 around 69,000 units and, prior to the recent political unrest, the market was forecast to grow beyond 200,000 units by 2022. Only China and Russia take more high-value cars. GCC high-end car imports outstrip the whole of South America and the combined new EU accession states of Eastern Europe. The risk is that a transition to a more democratic political and social system within the GCC will weaken the mix, even if overall sales volumes in the GCC remain strong. However, given the strong linkage between oil prices and revenues in the GCC, even a short-lived oil price boom will boost GCC government expenditure. While this may help the GCC markets to recover and will benefit the wider region it may help mainstream and budget car-makers at the expense of prestige ones overall.

EUROPE and the US:

As for the developed markets, Europe and the US should brace themselves for an oil price shock, which may intensify the switch to smaller, more fuel efficient cars at best and could cause an economic contraction at worst. In the best case – a prolonged period of high pump prices – the impact will be seen in lower residual values for fuel inefficient vehicles, at least for a while. In the worst case – an economic contraction – the entire vehicle market could reduce as it did in the UK in 2008/2009 combined with an accelerated switch towards ‘budget’ brands. The segment under the most pressure may well be the ‘mainstream’ brands which offer a poor trade-off between the benefits of status and high overall running costs, when depreciation is factored in.

On a larger scale, Europe may cope with the shock better than the US for two reasons. In the first place they have twice the volume of trade with the GCC than the US. Secondly, US trade is geared towards armaments. One of the casualties may be that business sector, as democracies rarely declare war on other democracies. The rosiest outcome for the MENA region would be democratization, leading to a resolution of the youth unemployment issues, and resolution of conflicts. The resulting fall in tension would allow a switch of spending away from military to civil uses giving the MENA governments the chance to meet some of the exploding levels of demand for services and infrastructure from their new electorates.

How much could that generate?

Military Spending across the Middle EastThe amount of money diverted to military uses is significant. In 2006 Saudi Arabia spent $30BN on arms alone! According to SFG, a strategic ‘think tank’, “…the opportunity cost of military spending for the period 1991-2010 appears largest for Saudi Arabia at $4.5 trillion or one third of the total opportunity loss incurred by 13 countries in the region. However, as compared to the size of its economy, Iraq has suffered the largest loss. Its GDP could have been more than 30 times of its present size. Moreover, we have used 1990 as the base year. Iraq had already spent a decade in a war with Iran by that time. If we examine Iraq’s opportunity loss since 1980 when it entered a period of warfare – first with Iran, then Kuwait and finally the West – it would be at least 50 times of its GDP in 2010.”

COMMERCIAL VEHICLE MARKETS

In a global T6+ HGV market of 3MN, Africa and the Middle East are ‘small fry’, expected to take around 150,000 units in the longer term, growing steadily from 2011 onwards. However, this remains below the construction boom led peak of 200,000+ in 2008. Although accurate registration figures for the MENA region are difficult to access outside of Dubai there is general agreement that the demand for commercial vehicles is supported by a number of factors: oil industry, construction, retail distribution and so on.

In the GCC, apart from the oil industry, there is a limited industrial base except from construction-led demand. At the same time, the growing consumer markets have fuelled the demand for medium weight trucks and LCV. As far as Dubai is concerned HCV sales peaked at 10,651 in 2003, fell back to 5,961 by 2005 but climbed to 18,714 by 2009. This is not representative for the remainder of the region. The UAE acts as an important shipment hub for the entire GCC and probably forms the regional hub for HCV sales.

SUMMARY

No-one yet knows how the ‘Arab Spring’ will finally play itself out on the regional stage. Many issues and states are in turmoil: Oil prices, Libya, Saudi Arabia, Yemen, Immigrant Labour, Oman, Bahrain, Egypt, MENA Stock Markets, Tunisia, and Morocco.

The weaknesses of existing regional structures – political leaders, the role of the US and Europe, financial markets – makes the lack of coherent policy more apparent than at any earlier time. The stereotype of the Arab world which identified Islamism, not democratization as the primary challenge turned out to be generally false. Although the error is now obvious,  a policy vacuum remains as everyone waits to see how events unfold.

Vehicle Production Statistics 2008 and 2009 for selected MENA countries

Observers in the motor vehicle industry and markets are left with a number of concerns, not only the impact of oil prices and sales volumes. While Tunisia has opted out of vehicle production, preferring to focus on components, in recent years Egypt has emerged as an important manufacturing base, due to their tax regimes and low labour costs. Those factors too may be less dependable for investors over the next couple of years.


[1] The MENA region comprises the Arab States in the Middle East and North Africa – Egypt, Syria, Saudi Arabia, Algeria, Bahrain, UAE, Djibouti, Tunisia, Mauritania, Morocco, Qatar, Yemen, Sudan, Somalia, Kuwait, Oman, Libya, Iraq, the Palestinian Authority, and Lebanon- plus Pakistan, Iran , and Afghanistan

[2] ‘QE2’ – second phase of US quantitative easing which could drive down the value of the US$ and drive up the oil price in consequence.

[3] GCC (Gulf Cooperation Council – UAE, Oman, Kuwait, Saudi Arabia, Bahrain and Qatar

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