As Aldous Huxley said “There are things known and there are things unknown, and in between are the doors of perception.”
Five years after the Arab Spring, North Africa continues to face its own macroeconomic and geopolitical challenges. The changes that swept across the region saw regimes toppled (sometimes twice) and brought a wave of hope that new governments would deliver overdue reform and improvements in social inequality and economic growth. Difficulties in meeting these high expectations have led to continued geopolitical unrest, making North Africa seem an unlikely investment destination for foreign capital.
However, the region has continued to generate strong returns for those investors with an on-the-ground presence and local insight. Why did that happen?
Largely because of the fact that buried in the rubble of the Arab Spring, there is a very interesting ‘emerging middle class’ consumer investment thesis.
Question: Which region has the largest concentration of Africa’s Middle Class consumers?
Answer: North Africa with over 40% of Africa’s total middle class population.
So what have been some of the key recent macro economic considerations:
The decline in commodity prices has affected North African countries in different ways. As the largest producer of oil in North Africa, Algeria has suffered from the drop in oil prices, however the same drop has helped to improve public finances in Egypt, Tunisia, and Morocco which are all net oil importers.
In the last 12 months, North African economies have all faced what the IMF’s Chief Economist, Maurice Obstfeld described as the “developing countries trilemma”. This implies that a country cannot simultaneously maintain fixed exchange rates and an open capital market while pursuing a monetary policy oriented towards domestic goals.
A country can consequently choose either to block the mobility of capital by prohibiting international financial transactions from being conducted through its system (thus cutting itself off from global financial markets), or it can abandon its FX controls, leaving exchange rates to be determined by the forces of market supply and demand.
Over the past decade, North African economies have all chosen to open up to the global economy to varying degrees, and in the last 12 months, all have come under pressure to devalue their currencies as a result of macroeconomic headwinds.
A closer look
As the largest and most populous market in MENA, Egypt is the economic heart of the region.
The last 12 months have seen US$ liquidity challenges, with the Central Bank of Egypt acting slowly to devalue the currency in line with other growth market currencies, spurring a parallel market for US$ where dollars were exchanged at a premium, peaking at LE/USD at 25% above the official rate.
Authorities have taken steps to resolve foreign exchange shortages by :
partially removing capital controls on individuals and a wide range of corporates to channel dollar liquidity away from the parallel market back to the banking system;
devaluing the LE by c. 13% against the USD in March 2016, signaling a move towards a more flexible exchange rate regime; and
increasing policy rates by 150 bps in an attempt to control inflation and stimulate de-dollarization.
The recent Cabinet reshuffle and the Government’s 2016-18 program presented to Parliament in March both point to a continuing positive direction of reform. Recent measures to ease FX shortages are expected to add pressure on an already high fiscal deficit (budget deficit expected to be 11.5% of GDP in FY2015/16), pointing to a likely IMF agreement which would boost investors’ confidence.
In the short-term, we expect GDP growth to settle at around 3.5% p.a. as FX shortages, import rationalisation measures and challenges facing the tourism sector put pressure on economic growth. Signing an IMF deal and implementing the reform program would potentially help improve FX shortages, gradually unlocking the economy’s potential and leading to growth moving to above 4% in the next couple of years. In the short-term, one can expect continued stop-gap funding for Egypt from Saudi Arabia and UAE while the Government continues with its structural reform measures.
Morocco has continued to show resilience and is expected to continue to perform better than its neighbors, Tunisia and Algeria in the coming year. However, 2016 GDP growth is set to fall below 1% versus 4.2% in 2015 due to a sharp decline in agricultural production, with the poor rainy season this year leading to a decline in agricultural production of c. 15%. This in turn is likely to lead to decelerating private consumption growth with c. 40% of the country’s labor force working in the sector.
Non-agricultural growth is likely to remain stable around 3% with accelerated investment growth counterbalancing weaker private consumption.
To stimulate the economy, the Government is stepping up investment in infrastructure, including renewable energy, and foreign investment is also picking up. Private sector and corporate credit growth remain weak due to a lack of confidence and poor external demand. Tourism revenues continue to contract while exports are likely to normalize in 2016 on weaker growth in the Eurozone and lower commodity prices. The Moroccan Dirham is expected to devalue by between 3% to 5% over the course of 2016.
Parliamentary elections will be held later in the year, at which the Islamist Justice and Development Party (PJD) is expected to maintain its majority.
Tunisia is in a more difficult position than Morocco. Public discontent regarding unemployment has triggered sporadic demonstrations across the country in Q1 2016. The Tunisian Dinar has devalued by c. 8% over the course of 2015 and is expected to devalue by c. 6% in 2016, as its fortunes are closely tied to those of the Euro.
Consumption continues to be a key driver of the economy and is set to grow at c. 1.7% this year; inflation is set to ease from 4.9% in 2015 to 3.9% in 2016. Ideological differences between members of the coalition government are causing inefficiencies and slowing down reform. Due to the current political and economic challenges, private investment growth is likely to remain negative in 2016 due to low investor confidence, but is likely to improve in the medium term.
GDP growth is expected to be c. 1.5% in 2016, and is expected to further rise to c. 3.5% by 2020. Controlling the growing fiscal deficit will remain elusive in the shortterm given anaemic growth and social pressures; continuing aid flows from the EU will continue to be essential as Tunisia navigates a challenging geopolitical and socioeconomic landscape.
France has promised €1bn in aid over five years to help Tunisia address unemployment. The EU has promised €500m of soft loans to help Tunisia cover its external financing needs in 2016-17. The World Bank is providing US$4bn over five years and negotiations are underway with the IMF on a US$2bn stand-by loan.
The investment opportunity
Despite the macro headlines, we believe the North African investment opportunity remains solid. The population is young, with Egypt having a median age of 24, and with over 40% of the entire African middle class being North African, we expect the demand for consumer goods and services to grow faster than the economy at large. These consumption-driven economies are strategically located to act as a gateway to Europe and Asia and the region has stable financial systems that are increasingly well regulated.
Being on the ground, we see the challenges, but also the opportunities every day through the prism of our portfolio. Our consumer facing businesses in North Africa have gone from strength to strength: Edita, a snack food business, grew volumes by c. 10% in 2015. Integrated Diagnostic Holdings, Egypt’s largest private sector diagnostics service provider, grew its number of tests by c. 10% in 2015 and our North African education business accepted c. 15% more students in Universite Centrale in the academic year 2015/16. So the North African middle class story is real, and it spills over not just into the consumer sector, but the healthcare sector, the financial services sector and even the energy sector, where our Lekela platform is rapidly emerging as one of Egypt’s leading solar and wind developers.