June 2009

A recent SABB report expressed concern about declining business confidence in KSA in Q2'09 but maintained a positive outlook for Q3 and Q4. The report, surveying around 950 business respondents, describes that businesses are expecting growth in revenue and overall business in H2.

The single most important downward pressure on the index is due to bank lending restrictions imposed by major financial institutions of the country. The domestic equity market is expected to benefit as the property sector struggles.

The SABB report also comments on the Saudi economy's growth expectations, rising oil prices and their impact and declining inflation in the aftermath of the global financial meltdown. Even as sentiment improves, public equities, cash deposits and fixed-income products continue to act as investment haven for local investors. Read the complete report here.

The World Economic Forum on the Middle East was held in Jordan on May 15th/16th. The event was marked with various key discussion forums for the regional business community. The response to the economic crisis was to put more emphasis on reform rather than intervention by governments.
 
Bahrain's Finance Minister said, "The challenge is not to address the immediate challenges of liquidity but to put in place reforms for sustainable growth." He was cautious regarding the current situation and expected regional economies to move forward instead of resorting to the norms where 'government knows better'.
 
Egypt's Minister of Trade and Industry said, “The real big story is reform, change and managing the transition". It is clear that the reform agenda is integral to the strategic plans being adopted by regional economies. He added, “This is not about a rescue package”.
 
The panel on education and technology in the Middle East discussed the possibility of innovation in technology as the best route for the region to emerge as a stronger force in the global economy. This approach would also address global concerns such as the environment and energy supplies.

Discussion panels revolved around the need for more transparency, educational reforms, diversification, liberalization and building regulatory and supervision capabilities. All these elements are key ingredients for a business friendly environment in the region. However, the region is yet to see a coherent approach being adopted to address these issues on a boarder scale.

Source: World Economic Forum - Jordan

There is little doubt as to the role expanding credit has played in bringing about the current recession. An increasing number of economists believe this recession is the start of a long-term deleveraging of the global economy. They are not without reason: US credit market debt as a percentage of GDP currently stands at 350%. The only other significant rise historically was during the Great Depression. Whether we are on the cusp of a long-term deleveraging of the global economy is still arguable, but a few early signs in US and Europe show that indeed this may be the case: greater regulation of the OTC derivatives market, as indicated by Tim Geithner recently, a potential reinstatement of Glass Steagall act in the US as well as a general aversion to over-leveraged companies, a so-called ‘flight-to-quality’ by the investing public are just some of the signs.

Looking at the data reveals that credit in the US economy has been expanding since the late 1970s, when the world was coming out of the oil crisis. The 1980s saw the coming of age of financial engineering, when the gaining popularity of Leverage Buyouts (LBOs) by early Private Equity giants like KKR ushered in an array of structured finance products and securitization instruments.  With a temporary hiatus in the credit market during the late 1980s, caused by the collapse of the junk bond markets, the credit markets rebounded during the dizzying 1990s, with hedge funds sprouting all sorts of new derivative instruments like interest swaps, credit derivatives, even weather derivatives (instruments that essentially bet on the weather).

The existence of a healthy credit market was one of the key ingredients driving large buyout firms. The credit market is where the big private equity firms go to raise debt for acquisitions, debt that would largely sit in the acquired company post-acquisition. In recent years, buyout giants like the Blackstone Group, TPG and Oak Tree have been able to raise huge amounts of debt from banks, pension funds and hedge funds.

So what does a scenario of long-term deleveraging mean for the private equity industry? Well, for starters, it is definitely going to be more difficult to raise financing. At the same time, a large number of deals will not be as profitable if they are funded with more equity. In such an environment, the right strategy for such companies would be to look for opportunities for value addition, not value extraction. This means investing growth capital instead of buyouts. There is still a lot of value to be added by PEs in such situations, especially those who have a clear focus, right linkages and financial muscle. These companies can provide much-needed capital for expansion, unlock value for shareholders and bring about proper risk management and corporate governance.  In the ‘steady-state’ post-deleveraging scenario, valuations will settle at lower levels, allowing PE firms to make their required returns.

The Finance Minister of Saudi Arabia, Ibrahim Al-Assaf, addressed the Euromoney Conference in Riyadh last week (May 19, 2009) and suggested that the government had awarded contracts worth over US$11 billion up from US$5.3 billion in the same period last year.

It is clear that Saudi Arabia is committed to channeling its reserves through expansionary capital expenditure programs to boost the domestic economy. The Saudi Arabian Monetary Agency ('SAMA') has cut interest rates six times since October 2008 to stimulate growth and help the largest economy in the GCC to overcome the crisis. Inflation has eased to 5.2% in April, the weakest rate in the last two years.

With the oil price still above $50, Saudi Arabia is expected to continue its infrastructure spending program and this will cushion any slowdown the private sector might be experiencing.

Source: Saudi Gazette 20th May, 2009