The simmering North African and Middle Eastern stock markets are turning into the hot stock markets for emerging markets portfolios.
Backed by annual growth rates of 4% to 8%, falling inflation, stable political regimes, low-cost labor and reforming economies, Mideastern stock markets already are adding spice to emerging markets portfolios.
But there still are risks, particularly for states directly involved in the Mideast peace process. The threat of Islamic fundamentalism also hangs over some high-unemployment countries, especially Egypt, and could foster economic and political instability.
In addition, many of these markets are just opening up to non-Arab investors, and some still have significant restrictions. Privatization efforts, however, are expected to be pivotal in reforming and expanding North African markets of Morocco, Tunisia and Egypt.
At present, the markets of Morocco and Jordan clearly are the most attractive. But others, such as Tunisia, Egypt and even perhaps Syria, hold great promise if they can reform their economies and markets. And the $45 million Oryx Fund that will invest in Omani stocks will open the door to the Gulf states for non-Arab investors.
Some emerging markets specialists believe Lebanon has the greatest promise of all. "The most dynamic bourse in the region will be Lebanon," especially if peace prevails in the Mideast, said Arnab Banerji, chief investment officer of Foreign & Colonial Emerging Markets Ltd., London.
"The whole region has a lot of potential if you look at it as an economic bloc," said Francois Gour, vice president of Fiduciary Trust Co. International, New York. Israel has the technology, Egypt the cheap labor, the Gulf states have capital and oil, and nearby Central Asian states have lots of natural resources, he said.
"You can see the type of potential you have if there is peace," Mr. Gour added. Fiduciary Trust is seeking to raise up to $35 million for its Near East Equity Fund.
Even without a definitive peace, economic prospects are strong in the North African markets.
Morocco stands out as the strongest prospect. After the government called in the International Monetary Fund to avert a financial crisis 10 years ago, Morocco has become a model of economic development. Gross domestic product averages between 4% and 5% a year, inflation has dropped to 5%, and the budget deficit has shrunk to 1.7% of GDP from 11.5% in 1983.
Only 12 miles from Spain, Morocco enjoys good access to European markets - which also dragged down growth when Europe plunged into recession in the early 1990s. A two-year drought also hurt the Moroccan economy, but heavy rains in the fourth quarter of 1993 have improved agricultural prospects and reduced unemployment, the biggest risk to political stability.
The key for Morocco and other Islamic countries is to create enough jobs to handle their burgeoning populations. "Islamic fundamentalism could flourish where poor people are getting poorer," said Jane Hakham, investment director, Beta Funds PLC, London.
Morocco needs a sustained 5% growth rate to supply jobs to its growing population, said Ms. Hakham, who oversees the $100 million Beta Global Emerging Markets Investment Trust, which is listed on the London Stock Exchange.
King Hassan II, who has reigned since 1961, serves as head of the church, thus diminishing chances of Islamic unrest. In addition, the army is loyal to him.
The government is ushering in a series of economic and financial reforms, including tax reform, a shift to full convertibility for the Moroccan dirham and banking deregulation. Foreigners now can purchase up to 100% of a company's stock, up from 49%.
Stocks on the Casablanca Stock Exchange are fairly valued, experts said, around 11 to 15 times earnings depending on estimated earnings. The market increased 20% last year and 11.6% in 1994 through mid-March.
Unfortunately, the exchange, with about $3 billion in total capitalization, is thinly traded. About two-thirds to three-quarters of trades, particularly larger trades, take place off-market, said Angus Blair, analyst for North Africa and the Mideast for Baring Securities Ltd., London.
But a $2.2 billion privatization program involving 112 companies is expected to change the market dramatically over the next few years. Last year, 51% of Cior, a major cement company, was sold privately to Holderbank of Switzerland while another piece was issued publicly. CTM-LN, a bus operator, was four times oversubscribed in the public market. Attractive future privatizations include Sofac/Credit, the automobile credit company; BCP, a regional bank holding company; and SNI, an investment company, according to a Barings report.
Tunisia, while holding out great potential, has not pursued privatization nearly as aggressively.
"In Tunisia, there's a lot of talk about privatization but it's progressing slowly," said John Niepold, portfolio manager, Emerging Markets Investors Corp., Arlington, Va. Despite some early privatizations, the market primarily consists of banks, he added.
Still, Tunisia has been liberalizing its economy since 1986. GDP growth reached 8.2% in 1992, while inflation dropped to 5.6% and the budget deficit fell to 4% of GDP, according to Morgan Stanley & Co., New York. Investors say the economy is sound and should continue to do well.
Fiduciary Trust's Mr. Gour said Tunisia "wasn't forced to do anything because the economy has been doing quite well." There's less of a need to privatize companies and admit foreign capital, he added. Investors said the country now is overhauling its rules on foreign investment in stocks.
With a well-educated population of 60 million, Egypt "has the greatest potential," Mr. Banerji said. Instead, it has been exporting workers throughout the Mideast, causing rising unrest.
"Egypt should be a rich country and it isn't," said Douglas Poulenin, senior investment manager at Asset Management UK Ltd., London, and adviser to Pictet's $480 million Emerging Markets Fund, a Luxembourg-based pool.
Islamic fundamentalists have murdered foreign tourists, causing the vital industry to shrink 40% to 60%, by some estimates.
Still, Egypt has a stable currency and the central bank has lots of reserves, said Mr. Niepold, who has invested a portion of Emerging Market's $30 million Africa fund in Egyptian stocks. Despite its problems, the market returned 58.6% last year and about 20% so far in 1994.
But the state owns about 70% of industry and the bureaucracy has stalled privatization efforts.
A turning point for Jordan was the Gulf War. Jordan sided with its neighbor Iraq. After Iraq was routed, Kuwait and Saudi Arabia cut off aid to Jordan, and some 300,000 Jordanian workers were expelled from Kuwait. But they were highly skilled and entrepreneurial and brought an estimated $1.5 billion home with them, according to a Lehman Brothers report.
Jordan blossomed. The economy grew at a 12% clip in 1992 and 6% last year. In addition, an International Monetary Fund program started in 1989 has strengthened what was then a reeling economy.
Known as the crossroads of the Middle East, Jordan thrives from its cosmopolitan population and trading skills. Tourism should become a driving force in the economy, said Michael Power, senior portfolio manager, Baring Asset Management, London. "There's a stability about Jordan which some of its neighbors envy," he added.
Its stock market also is the most developed in the region. Liquidity is strong and despite a decrease of 1.4% in U.S. dollar terms so far this year, investors still think it's a good bet.
Jordan has a lot on the line in peace talks with Israel. "If it works out, Jordan stands to benefit quite a lot," Ms. Hakham said.