Kuwait China Investment Company:
Unearthing Investment Opportunities between the Middle East and Asia

Dr Alessandro Magnoli Bocchi, a speaker at the marcus evans Middle East Investments Summit 2011, on taking advantage of the opportunities that open up as the dust settles in the Middle East.  Interview with: Dr Alessandro Magnoli Bocchi, Chief Economist, Kuwait China Investment Company

FOR IMMEDIATE RELEASE

In the recovery period of the crisis, investors with cash will benefit greatly from the acquisition of distressed assets with strong growth prospects, says Dr Alessandro Magnoli Bocchi, Chief Economist, Kuwait China Investment Company. Middle East institutional investors must start paying attention to valuable investments with clear growth prospects in order to thrive in the coming years.  

A speaker at the upcoming marcus evans Middle East Investments Summit 2011 taking place in Dubai, UAE, 23 - 24 November, Magnoli Bocchi discusses the importance of currency management and how to enhance performance through distressed assets. 

What are some of the issues challenging institutional investors in the Middle East?

Dr Alessandro Magnoli Bocchi: At the moment there is no leverage and little growth in the markets, therefore investors are facing difficulties in finding profitable investments.

Institutional Investors in the Middle East have cash to spend, but they have trouble seeing the opportunities available due to the dust in the environment as a result of the crisis. Markets are currently being driven by the calendar. One day we are focusing on Greece, another day we are worrying about the US deficit. Until this dust settles, we will not see what is ahead of us.

If you take a look at who prospered in the US after the great depression, it was those who picked up distressed assets. Investors must take this into account and look out for valuable investments with a high growth prospect, to be acquired at a discount. These investors will be those who benefit when the crisis comes to an end.

Also, it is essential to start focussing on Asia: it is the new engine of global growth. The oil-rich Gulf and an “energy-hungry” Asia are intensifying their political relations and boosting their financial ties. Heads of state are paying each other visits and building mutual trust. The linkages between the Gulf, China and India are bound to deepen every day. This rapprochement makes strategic, political, economic, and financial sense. Over the 21st century, the Gulf’s substantial financial liquidity will be available to finance Asia’s high growth, and the region will achieve a stronger global position.

Is currency volatility still an issue in the region?

Dr Alessandro Magnoli Bocchi: To do business efficiently, you must have a predictable environment, hence a stable currency. Over the past two years, most currencies’ exchange-rates fluctuated at an unprecedented pace. This high volatility is due to two global policy responses to the 2008 crisis. First, borrowing is cheap. Investors chase scarce opportunities (including currencies), but - given the fragility of global growth - money is withdrawn as soon as risks rise. In other words, excess liquidity in a frail macroeconomic environment creates foreign-exchange volatility. Second, currency devaluation is an attractive alternative to cutting public spending. Today, the US, Europe and Japan - but also China, Brazil and Russia - would prefer a weak currency to fiscal consolidation. Alas, it cannot be done simultaneously by all. If everybody exports, who imports? Somebody has to buy.

The Gulf region’s exchange rates are pegged - either directly of via a currency board - to the US dollar and fiscal policies are fuelled by oil proceeds. So far, these arrangements have served the GCC well. The dollar peg ensured predictability in the monetary value of oil exports revenues. Fiscal spending, backed by saved petroleum earnings, promoted employment and equity. In recent years, growth has been spectacular, driven by a double boom - in oil and natural gas revenues and in the real estate and investment sectors. The GCC economy has tripled in size between 2002, when it was as big as Poland is today - and 2009, when, with a nominal GDP of USD 1.2 billion, it almost reached the size of Canada.

But, going forward, can this “recipe” work as well? The world is changing fast. The recent crisis has hit the “West” very hard. The Gulf needs investments and man-power. Its fast-growing population (from 28 to 39 million between 1998 and 2008) is one of the youngest and highest spending in the world. All GCC countries are now members of the WTO, with a string of free trade agreements expected over the coming years. At the same time, China has become the world’s leading exporter, and a voracious importer of oil and other natural resources. India is on the rise.

Currently, the Gulf’s monetary and fiscal policies are struggling to achieve price stability and sustainable growth. Rising inflation and differing economic cycles from the US have raised questions about the dollar peg. In 2007, a pegged exchange rate forced the GCC central banks to follow US interest rates, de facto decreasing financing costs during a boom. Also, fiscal policy has been expansionary when oil prices are high, rather than when the business cycle is in a contraction.

Finally, when panic hits the market, investors go to the dollar. As a result, we have seen the dollar depreciate and appreciate time after time. Because of the peg, the Gulf currencies need to follow and adjust.

When will investments in the Middle East flourish? 

Dr Alessandro Magnoli Bocchi: There is no way back, in MENA the genie is out of the bottle. The region’s shortcomings have been irrevocably exposed by the global crisis. Bold reforms are now impossible to postpone, if the region is to avoid years of stagnation and violence. Transitioning to democracy requires courage and concessions. The opportunity is unique, and must be seized: the future can be bright.

The world has seen this before. When unemployment and headline inflation rates worsen simultaneously, people lose patience. In the 90s, similar political unrest swept through Eastern Europe, the Soviet Union and Asia. Food shortages were a big catalyst in Romania’s 1989 ousting of Ceausescu and the 1991 Soviet revolution. In 1998, Indonesia’s Suharto was toppled as the Asian financial crisis led to rising food prices.

However, when regime change was not accompanied by meaningful reforms, years of low growth and significant financial and political instability ensued. The unattainable demands of various economic groups led to higher public spending, larger budget deficits, and lower tax revenues. Rising debt levels led to defaults or - when money was printed - spiralling inflation. Sovereign spreads rose, capital outflows accelerated, and currencies depreciated. The economic transition in Romania, Russia, and Indonesia (but also in Turkey and Pakistan) entailed high inflation, falling real incomes, and recession. Economic recovery and political compromise were possible only with fiscal discipline and structural reforms.

Still, in today’s world, there is hardly a region with more potential than the Middle East and North Africa (MENA). It has everything to succeed. First, a splendid past, with one of the richest cultural heritages in history. Second, a resourceful present, as it sits on top of large shares - 60 per cent of oil, 45 of natural gas - of the world’s proven reserves of fossil fuel, and controls over USD 1.6 trillion in assets, more than a third of global sovereign wealth. Third, it is set for a bright future: MENA’s population - 300 million citizens - is younger and larger than those of the EU and US.

What advice would you give investors?

Dr Alessandro Magnoli Bocchi: While market volatility persists, capital preservation is a priority. Given high downside risks and a fragile upside, cash is king. Global investors are indeed parking record amounts in money-market funds. Still, real interest rates are negative in most countries. While a recession could create short-term deflationary pressures (because of unused capacity in good and labour markets), in the medium-term inflation is likely to make holding cash costly. Also, in an inflationary environment, borrowers will enjoy a reduction of the real value of their nominal liabilities. Distressed opportunities are likely to surface in private equity secondary market. Getting in debt to pick up assets at fire-sale prices sounds like a good idea. Safe-haven currencies will be preferred, but investors need to watch - and manage – the high foreign-exchange volatility inherent to a highly liquid post-crisis environment.

Once the crisis-induced dust settles, public market performance - now driven by news and events - will return to rely on fundamental analysis and valuations. Diverging economic performances and falling correlations are likely. In other words, future financial flows will acknowledge the structural challenges of developed economies and gradually shift their focus to emerging markets, enhancing today’s timid signs of decoupling (still more significant than in 2008).

In short: be ready to take advantage of opportunities that will soon arise. If you have cash you will have access to distressed assets and will benefit immensely when the economy recovers. Be optimistic. This is a great period that we have in front of us.

Contact:
Stacey Melvin
Journalist
marcus evans, Summits Division
Tel: + 357 22 849 400
Email: press@marcusevanscy.com

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