Brexit uncertainty won’t derail GCC reforms push

Brexit uncertainty won’t derail GCC reforms push
HIGH STANDARDS: German property firms expect a boom in Frankfurt as financial businesses move activities and staff out of London in the wake of Brexit, a recent industry survey showed.
Updated 11 July 2016

Brexit uncertainty won’t derail GCC reforms push

Brexit uncertainty won’t derail GCC reforms push

The United Kingdom’s recent decision to leave the European Union — Brexit — triggered volatility in global financial markets not seen since the financial crisis of 2008, but also left investors with more questions than answers as to the future of the euro zone and the UK’s role outside it.
Stocks in the Gulf Cooperation Council (GCC) region were not spared either in a global rout that stretched from London to Sydney.
The immediate impact was a flight to safe assets, while risk assets capitulated. Growth driven commodities, like oil, struggled in the ‘Brexit’ aftermath, with obvious negative read across for this region.
While there is little doubt that the UK referendum result caught many in the markets off-guard, the initial knee-jerk, sentiment driven reaction by GCC stocks was to be expected.
Such a seismic political event has the potential to keep investors and markets on edge for many months to come as the full implications of ‘Brexit’ take effect.
During this period, credit spreads and equity risk premia will continue to reflect a high degree of uncertainty.
But this shouldn’t have any lasting impact on the GCC region. Most importantly, it won’t likely derail the push by countries within the GCC to liberalize their economies and capital markets.
We continue to be encouraged by the reform momentum that remains in check throughout the GCC.
From the UAE’s deregulation of petrol prices, to the planned introduction of GCC Value Added Tax (VAT), the commitment shown to implementing prudent fiscal policy and diversifying economies away from oil should be applauded.
Nowhere else is such progress more noticeable than in Saudi Arabia, where a series of stock market reforms, under the guise of the Kingdom’s ambitious “Vision 2030” plan, is just the sort of ambitious and proactive policy making that investors want to see.
Indeed, we have seen more effort toward reform in the past six months, than we have in the last decade, and the positive changes keep coming.
Just last week, the Saudi Capital Market Authority (CMA) announced a slew of regulatory amendments, among them, the rules allowing Qualified Foreign Financial Institutions (QFIs) to invest in the Kingdom’s debt market. In addition to committing to improve the market infrastructure by addressing the trade settlement duration (to T+2) and covered short selling — both to come into effect by H1 2017, the CMA has dictated that the minimum amount of assets under management that QFIs must hold to invest directly in Saudi stocks be lowered to SAR 3.75 billion, from SAR 18.75 billion.
Make no mistake, it is positive signals such as these that will ultimately drive markets in the GCC region forward, ‘Brexit’ or no ‘Brexit’.
In many ways, the GCC region is protected from the uncertainty that is currently stalking stock markets throughout Europe.
For a start, in our view, the interconnectedness between financial institutions in the GCC, and the UK financial system, is limited, making it unlikely that any financial, or liquidity, issues will spill over to the GCC in a meaningful way.
It should also be noted that the peg between GCC currencies and the US dollar has helped ensure equities avoided much of the currency volatility experienced by some other emerging-market economies.
Another supportive factor for local markets is dividend yield.
When the outlook for economic growth darkens, investors traditionally gravitate toward companies where there is more conviction in their outlook.
These tend to be companies that have high cash-flow, operate in industries with significant barriers to entry, and are also under leveraged. With an average dividend yield of 4.5 percent, the GCC region is home to companies that pay as much as 7.5 percent, are well capitalized, and operationally sound.
Dividends aside, there are still some risks for the GCC in the immediate post ‘Brexit’ environment.
Dubai perhaps is the one regional location that is susceptible to a UK slowdown since its economy is more open to foreign investment, trade, and tourism. It is these sectors that could struggle should ‘Brexit’ drag on the UK economy in the months ahead.
From a macroeconomic point of view, a Europe induced recession, led by the UK, will be felt in the GCC mainly through lower oil and commodity prices.
But even then the GCC is already operating under the premise of lower oil prices for an extended period of time.
Governments have already been leading initiatives on the cost side, and revenue side, to try and tackle this development.
In fact, sovereign ratings by agencies like Moody’s and S&P Global Ratings already reflect a $40 a barrel oil price until 2019 in their credit assessments, which remain mostly supportive.
At this stage, no one quite fully understands how the UK unwind from Europe will evolve.
Until there is greater clarity on this path, volatility will be a frequent visitor on stocks markets around the world.
In the GCC though, it is the path to market liberalization that will provide the most comfort.

— Bassel Khatoun is chief investment officer for MENA Equities at Franklin Templeton Investments (ME) Limited.