Business Outlook: Steady As They Go

SAFE PORT IN A STORM: Despite the coup, Turkish economic fundamentals are sound. The GCC ought to weather this storm.

Turkey’s coup won’t really affect the GCC Markets

BY Tarek fadlallah

The dramatic events in Turkey last month have led to increasing volatility in the country’s financial market, following a sharp sell-off in stocks, bonds and the Turkish Lira.

In the week after the failed coup, the Borsa Istanbul 100 Stock Index fell by nearly 20 percent in U.S. dollar terms and 10-year government bond yields rose by more than a percentage point to over 10 percent.

With stocks trading on less than ten times their historic annual earnings and the Lira near its all-time lows, bargain hunters have already emerged. But long term investors remain largely on the side lines awaiting improved visibility on the outlook —not just for the economy, but also for the ongoing political process.

Prior to the attempted coup, the fundamentals of the Turkish economy had appeared strong with growth expected to be above 4 percent this year despite weak tourist receipts. However, consumer spending is now likely to falter, while foreign direct investment and other capital inflows may slow.

In anticipation of these developments, ratings agency Standard & Poor’s have downgraded Turkey’s credit rating from BB+ to BB and acknowledged the scope for further deterioration by maintaining a ‘negative’ outlook.

While the country’s debt relative to the size of its economy is fairly low, European private banks and high net worth investors in Asia—that have been among the biggest buyers of higher yielding emerging market bonds —are particularly sensitive to political risk and economic uncertainty.

Renewed doubts have also emerged around the prospects for the Turkish currency which has been enjoying a rare period of stability after a more than 50 percent decline over the past three years. A renewal of the depreciating trend would certainly dent confidence and discourage international investors.

The direct impact of the events in Turkey on the GCC financial markets is limited. Institutions in Saudi Arabia, the UAE and, more recently, Qatar have made some investments in the financial and real estate sectors, and will experience paper losses, but these are fairly modest compared to their investments in the U.K. for example.

In the local markets, GCC investor activity remains subdued, although the gloom that was prevalent earlier this year appears to have lifted somewhat. The price of Saudi Credit Default Swaps (CDS), which reflects the cost of insuring the country’s government debt, has declined and talk of a Saudi Riyal de-pegging from the dollar has subsided.

The GCC economies are operating well below their potential, but the news flow has been incrementally improving. One example of this is the International Monetary Fund (IMF) optimistically raising its 2 percent growth forcast for the Middle East and North Africa, along with Afghanistan and Pakistan, growth forecast to 3.4 percent from 3.1 percent —even as it downgraded global growth slightly following Brexit. Saudi Arabia remains a laggard and is predicted to grow by just 1.2 percent in 2016—albeit rising to 2 percent in 2017.

The recovery in oil prices, which nearly doubled from their lows around $26 in the first quarter, was a key factor for the upgrade. And though prices have given up some of those gains in recent days, the gradual decline in U.S. inventories is suggestive of an improving balance in the market and higher prices later in the year.

Under this more benign environment, it is no surprise that the performance of the GCC stock markets has been steady, with the UAE and Oman among the better performers this year. Despite the annual anecdotes about runaway debtors and abandoned cars at airports, the Dubai stock market is up by double digits so far, and investors fortunate enough to have bought at the lows in January have enjoyed solid gains.

The upside over the short term may be limited, as aggregate corporate profits have not been particularly inspiring and may continue to drift lower. However, there is no major worry over valuations at this stage with typical measures, such as price to earnings and price to book ratios at sensible levels.

Whether the trend will turn decidedly more bullish depends on the overall outlook for next year and, in particular, the impact of the policies and reforms that are in the process of being implemented. Investors will also want to pay close attention to developments in the international markets which appear to be performing well but where elevated valuations is giving growing cause for concern.

Looking beyond the next few weeks could be difficult given that this year has already thrown up so many surprises, and is certain to deliver a few more twists and turns.

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