Sino-MENA: Reconfiguring the Silk Road

Transcription

1 Sino-MENA: Reconfiguring the Silk Road Middle East & North Africa Outlook Q3 205 Florence Eid-Oakden, Ph.D Tel: With Cyrus Sassanpour, Ph.D, Waleed Shoukry, Charlene Rahall, Hadi Makarem, MENA Outlook Ph.D, Q3 205 Yifu Jia, Nadine Mezher.

2 Outline Topic Slides Topic Slides Our View: Pockets of resilience leverage new opportunities 5 Sino-MENA: Growing trade relations 5 Global Outlook: UK and US recovery 6 Sino-MENA: Chinese high-tech gaining a foothold in MENA 6 Global Outlook: Grexit to cause further drama, and Japan, none! 7 Sino-MENA: Bilateral FDI small but rising 7 Sino-MENA: A very different future beckons 8 Sino-MENA: WiMAX licensing offers an effective means of entering the broadband market in some MENA countries 8 Sino-MENA: Recent developments in Chinese diplomacy with MENA 9 Sino-Qatar: Business ties forging ahead 9 Sino-MENA: Expanding markets through strategic partnerships 0 Sino-UAE: From strength to strength 20 Sino-MENA: Looking to upgrade bilateral ties Sino-Iran: Business as usual 2 Sino-MENA: The energy dynamic 2 Sino-MENA: A walk on the wild side 22 Sino-MENA: Escalating dependency on MENA 3 Sino-MENA: Deepening economic and political ties 23 Sino-MENA: It s not all about oil anymore 4 Sino-MENA Market Monitor: Major deals & projects May-June

3 Outline Topic Slides Topic Slides Iran Market Monitor: Hope at last for banking? 25 MENA Credit Markets: Bond Z-Spread Analysis 40 Iran Market Monitor: The politics of a nuclear deal 26 MENA Credit Markets: Sovereign Sukuk Bond Z-Spread Analysis 4 MENA Credit Monitor: Macro Themes Sovereign Credit MENA Credit Strategy: Outright CDS & Bond analysis 27 MENA FX Markets: FX Levels Analysis MENA Credit Analysis: Arabia Credit CDS Monitor 43 MENA Credit Strategy: Relative value CDS & Bond analysis MENA Credit Analysis: Arabia Credit Bond Monitor 44 MENA FX & Local Markets Monitor: Macro Themes Sovereign FX 33 MENA FX Analysis: Arabia FX Monitor 45 MENA FX Strategy: Outright FX analysis MENA Local Markets Analysis: Arabia Local Markets Monitor 46 Arabia Credit Monitor: 5-yr CDS vs. Credit Ratings 37 Arabia Credit Monitor: Credit ratings 47 Arabia Credit Monitor: Bond Z-Spread vs. Credit Ratings 38 MENA Macro Dashboard 48 MENA Credit Markets: CDS Spread Analysis 39 Algeria: Agriculture an engine of growth?

4 Outline Topic Slides Topic Slides Bahrain: Retail sector demonstrates market confidence 5 Palestine: Broken promises delay reconstruction 62 Egypt: ISIS versus ISIS? 52 Qatar: Stellar performance in banking 63 Iraq: Still beckoning, for adventurous investors 53 Qatar: What if? 64 Jordan: SMEs - small but crucial 54 Sudan: Exploiting telecom market potential 65 Kingdom of Saudi Arabia: Retail sector in the spotlight 55 South Sudan: Economy dragged down by conflict 66 Kuwait: FDI law to boost non-oil growth 56 Syria: Redrawing the front lines 67 Lebanon: Sluggish performance in construction 57 Tunisia: FDI resilience despite instability 68 Libya: At a critical juncture 58 UAE: Free zones driving non-oil trade 69 Mauritania: Favourable outlook despite low iron ore prices 59 Yemen: A faltering economy 70 Morocco: The new pioneer of Islamic finance? 60 GCC sovereign ratings update 7 Oman: A diplomat among warmongers 6 MENA ex-gcc sovereign ratings update 72 4

5 Our View: Pockets of resilience leverage new opportunities While the global economy is set for a gradual pick up, the economic outlook for MENA remains tepid, but individual countries continue to post varying degrees of resilience. Low oil prices, conflict and continued uncertainty have led the IMF to revise its regional average growth projections for 205 from 3.2% in January to 2.7% in May. Fiscal deficits are mounting, leaving the region with an average deficit of 8% of GDP in 205. The dramatic decline in oil prices since 204 has injected a good deal of uncertainty into revenue, expenditure, and GDP forecasts, but the private sector has remained broadly resilient so far. We highlight pockets of opportunity in the non-oil sector in the region. In our Country Pages, you will invariably read a similar story, namely that the nonoil side of some MENA economies is poised to do very well in 2H. - The outlook for the Saudi retail sector remains positive, buttressed by a growing population, rising disposable income and robust consumer confidence. - There could be temporary effects on banking activities if Qatar loses the right to host the World Cup. However, banks in Qatar are structurally sound and there is little to suggest that their balance sheets will be harmed by the cancellation or slowdown of some of the ongoing projects. - The agricultural sector in Algeria has always been a promising means of reducing reliance on energy, and recent developments suggest that it could start to play a role in diversification. In Libya, ongoing peace talks have failed to meet the 7 June deadline. The internationally recognised parliament dropped out of the talks in protest over a plan that would mean sharing power with rivals. - Meanwhile, ISIS is strengthening its hold in central Libya. Complete control over Sirte could cement ISIS positions on the west side of Sirte Basin (home to about 70% of the country s crude reserves). - ISIS already controls Naufaliya, 30 miles from Es Sider and Ras Lanuf. We believe that moving in on these two oil facilities is one of its goals and while they may not overrun them due to bolstered security, they could cause damage and significantly affect oil exports. Our regional theme this quarter analyses growing relations between China and MENA with a focus on energy, merchandise trade and FDI. China s energy dependency is expected to rise to 6% by end-205 and MENA countries are likely to be the major beneficiaries. The GCC in particular remains the largest source of China's crude oil imports. ; IMF. Figure MENA Vs. GCC Fiscal Balance - The share of oil imported by China from MENA rose modestly from 48% in 990 to 52% in 204, but the volume of these imports rose dramatically, from 700K bpd in 990 to 3.2M bpd in 204. Chinese investments in MENA still constitute a small proportion of total Chinese FDI (2.4%), but a sizeable proportion of MENA GDP (6.4%). - This lies in sharp contrast to the EM average which constitutes 4.9% of total Chinese outward FDI but only 0.% of total EM GDP; - These figures highlight the sizeable impact that a marginal FDI increase from China could have on the MENA region, and the significance of what is starting to unfold. - As China looks beyond oil investments, MENA s real economy and markets provide compelling new destinations for telecom, agriculture, manufacturing and consumer-driven industries. - MENA imports of high-tech products from China accounted for 4.6% of total 204 MENA imports of these goods, and only 4.2% of China s global exports of high-tech products, underscoring ample room for growth. The proposed Free Trade Agreement between GCC and China acts as a step towards achieving more synergies. 5

6 Global Outlook: UK and US recovery Since the onset of the global financial crisis in , central banks around the world have cut interest rates multiple of times, but economic recovery has been at best uneven (Figure ). In the UK, the best performing major economy in Europe, recovery has gained momentum, supported by a robust housing market and expanding credit. - The UK economy grew by 2.6% last year, the fastest pace since 2007 and up from.7% in The inflation rate turned negative in April 205 for the first time since the 960s, with prices falling by 0.% YTD due to a slower rise in transportation prices and a 3% decline in food prices. This should primarily have a beneficial impact on the economy by boosting consumers' purchasing power. - Inflation will likely rise gradually by end-q3 and hover around % for the year, well below the 2% Bank of England (BOE) national target. As recovery broadens and inflation remains contained, the Bank of England is expected to begin modest tightening in 2H 205. The US economic outlook is still positive despite a harsh winter that stalled growth in Q 205 (GDP contracted by 0.7%). For several years, we have seen significantly slower GDP growth in the first quarter followed by considerably stronger readings during the remainder of the year. As such, we minimize the importance of this first-quarter estimate in assessing the likely growth trajectory over the remainder of the year. The labour market has been one of the bright spots of the recent economic recovery. Unemployment has been falling steadily and could reach about 5% by year-end, from the current 5.5%. At its recent peak in August 204, the unemployment rate touched 6.2%. Since then,.7 million jobs have been created but there is no evidence of any significant wage pressure. ; IMF. Figure GDP Growth Rates - Housing market conditions have also improved due to a stronger job market and a prolonged period of historically low mortgage rates. The fall in oil prices has also boosted real household incomes, maintaining private consumption as the main source of growth in 205 (GDP expected at 3%). - Contracts to buy previously owned homes rose for a fourth straight month in April to a nine-year high, buoying the outlook for the housing market and the overall economy. Inflation is projected to remain below the Fed s 2% target in 205 6, partly as a result of lower energy prices and a strong US dollar. The strength of economic recovery in 2H will determine the timing of the Fed s first move on interest rates. If the recovery is sustained, we anticipate -possibly 2 modest rate hikes before the end of this year, in September at the earliest. Further modest hikes are expected in 206, but in no event would we expect rates to climb to their historical normal levels over the next 8-24 months. 6

7 Global Outlook: Grexit to cause further drama, and Japan, none! GDP in the euro area rose 0.4% in Q 205 after expanding 0.3% in the previous quarter. The region has benefited from the sharp drop in oil prices since 2H 204, a weak euro and ample liquidity injected into the economy through the European Central Bank s (ECB) largest-ever stimulus program. Overall real GDP in 205 is currently expected to rise by.5% in the euro area, but economic performance is uneven across countries. - Economic activity has been weaker than anticipated in Germany, Europe s largest economy. German GDP grew by 0.3% in Q 205, down from 0.7% the previous quarter - Spain, where the government has taken steps to liberalise the labour market and tackled the legacy of bad debt held by banks, recorded its fastest growth in seven years in Q 205. The economy is projected to grow by 2.5% in However, Greece s economic problems continue to create systematic risks for the region and fray investment sentiment. Unless Greece manages to reach an agreement with its main creditors (the EC, ECB and the IMF), it could very well default on its foreign obligations by the end of June. o The prospect of a Grexit (Greece exiting the eurozone), low in our opinion, is once again causing market shivers, and is even welcomed by some economists who argue that Greece can no longer maintain a sustainable economic recovery while shackled by the rigid requirements of the common currency. The Greek economic saga, combined with the ECB's unprecedented monetary easing to ward off deflation, are distracting attention from the euro area's prime problem: debt. - The EU area s debt-to-gdp ratio now stands at 89% -- higher than in 2008 at the onset of the last recession (Figure ). - Nonfinancial corporate debt exceeds 00% of GDP in Belgium, Finland, France, Ireland, Luxembourg, Netherlands, Portugal, and Spain. And, gross government debt is close to, or exceeds this threshold in Belgium, France, Greece, Ireland, Italy, Portugal and Spain. ; Eurostat. Figure Euro Area Debt-to-GDP Ratio The Japanese economy limped into Q2 as household spending fell, people left the job market and the central bank's key inflation gauge slowed to zero. Consumer prices were unchanged in April from a year earlier. Japan relies on domestic consumption for about 60% of its economic activity. Domestic consumption has been recovering from a sales tax hike last year which caused household spending to fall unexpectedly by.3% in May 205. Suffering under the burden of an aging population, Japan s debt reached USD 8.7T at the end of March, the highest among the major countries in the world and three times larger than the combined GDP of the ASEAN countries. - Japan s failure to tackle its debt could eventually lead to a downgrade. - About a quarter of Japanese are over 65 years old, making Japan the oldest country in the world. Pensions and old age care have been consuming a large share of public resources. 7

8 Sino-MENA: A very different future beckons Aided by consistent double digit economic growth (Figure ), China has gained prominence in the global arena over the past few decades. The country s exports have increased from USD 970B in 2006 to USD 2.3T in 204. In MENA, the GCC in particular has become a major trading partner for China. As Beijing implemented its Going Out strategy for economic growth, China became more commercially and diplomatically engaged in MENA. Recent developments such as rising Chinese investments in Iran s energy sector and broader efforts to sell more Chinese goods and services to the MENA region have underscored China s increasing presence in the vast area stretching from Morocco through the GCC to Iraq. In turn, with China s stature in the region growing, some MENA countries are responding by looking east for an alternative partner. In this report, we tackle questions such as: - How has trade between MENA and China evolved over the years and what countries dominate trade ties? - Is energy the sole winner of trade between the two trading blocs or can trade relations extend beyond oil and gas? - With the GCC-China FTA underway, can this be a game changer? - What is the investment flow between the two regions? - Would a nuclear deal undermine Sino-Iranian economic relations or enhance them? We share some insights here: The Xi Jinping administration has voiced considerable optimism about the future of Sino-MENA trade, forecasting that trade value could exceed USD 600B by the end of the decade. If China s RMB internationalisation strategy and its Silk Road Initiatives make headway in MENA, there is a good possibility that this target could be reached or even exceeded. Although efforts to conclude a Free Trade Agreement (FTA) with GCC countries had stalled, the two sides are back at the negotiation table and an agreement is expected to be signed in Doha in 206. Chinese investments in MENA constitute only 2.6% of total Chinese FDI but 3.8% of MENA GDP. This is in comparison to the EM average which constitutes 4.9% of total Chinese outward FDI but only accounts for 0.0% of total EM GDP, highlighting the sizeable impact that a fairly small investment from China could have on the MENA region. While many believe improved ties between Iran and the West, particularly the US, could undermine currently strong Sino- Iranian economic relations, we attach a low probability to this scenario. Given the investment opportunities that exist in both China and MENA, their strong growth rates and the sheer size of capital surplus in GCC countries, it is fair to say that Sino-MENA relations are far from having realised their full potential. Figure China GDP Growth ; Ministry of Commerce, China. 8

9 Sino-MENA: Recent developments in Chinese diplomacy with MENA In Chinese diplomacy, it is very common to see different types of cooperation/partnership jargon used to describe relations with other countries -- such as friendly, strategic and comprehensive strategic. The titles denote China s different positions and sentiments towards its foreign partners. - Friendly reflects good political relations, while Cooperation points to mutual coordination and support. - Strategic means the partnership goes beyond economic cooperation and entails mutual interests in major international affairs. - The use of Comprehensive refers to the highest level of collaboration in various fields, including security, politics and environment. In April 204, China and Algeria established a Comprehensive Strategic Cooperation Partnership, the first of its kind for China in MENA. Algeria was one of the first countries to recognise the Peoples Republic of China in the late 950s. This relation upgrade is a strong indication of future Sino-Algerian relations. In November 204, Qatar and China agreed to build a Strategic Cooperation Partnership. Moving into the financial area, China decided to establish a renminbi clearing centre in Doha to support expanding trade between the two countries. In addition to its relative stability, Qatar is now the largest exporter of natural gas to China, meeting around 20% of Chinese energy demand. Sino-Egyptian relations were upgraded from a Strategic Cooperation Partnership to a Comprehensive Strategic Cooperation Partnership during President Sisi s first visit to China in December Table Sino-Egyptian Agreements Egypt is a particularly interesting case, as the country has enjoyed a close partnership with the US going back to the early 970s. - More recently, US-Egyptian relations have faltered in the wake of the political turmoil in Egypt. - Both former President Morsi and current President Sisi made a point of reaching out to China to reduce Egypt s dependency on the US. Morsi s first official trip abroad was to Beijing. Egypt and China agreed to work together on the One Belt One Road Initiatives. The New Suez Canal project is a natural fit for China s Maritime Silk Road vision. Egypt and China signed a number of agreements during the Economic Development Conference (EDC) in March 205 (Table ). A notable trend in Sino-Egyptian relations is the push by Cairo for technology transfer. 9

10 Sino-MENA: Expanding markets via strategic partnerships China benefits from a Strategic Friendly Cooperation Partnership with Saudi Arabia since China views Saudi Arabia with great importance for several reasons, mainly because the kingdom is the largest exporter of oil to China, accounting for about 6% of the country s oil imports in At the same time, Saudi Arabia is adopting a look east policy and views China as one of the most important strategic markets for its oil exports. - Since the 9/ attacks, Saudi Arabia has been seeking to rebalance its relations with major powers, entailing stronger relations with Asia. A Strategic Cooperation Partnership was set up with the UAE in January 202. The UAE is China's most important non-oil trade partner in the GCC, serving as a hub for Chinese products (nearly 60% of Chinese exports to the UAE are re-exported to other GCC countries, Iran, Africa and even Europe). After Qatar, the UAE will be the next country to conclude a Bilateral Swap Agreement with China; it had already inked a tentative agreement in 202. Given these trends, we expect Chinese presence in Dubai to grow further, facilitating greater passage of manufactured Chinese goods and industrial equipment.. Official Visit Date Details Gao Hucheng, Chinese Minister of Commerce to Algeria Apr-205 7th Sino-Algerian Economic and Trade Commission HE Abdelmalek Sellal, Prime Minister of Algeria to China Yang Jiechi, Chinese State Councilor to Egypt HE El-Sisi, Egyptian President to China HRH King Salman to China Wang Yi, Chinese Foreign Minister to the UAE HE Reem Al Hashimi, UAE Minister of State to China Apr-205 Jun-205 Dec-204 Mar-204 Feb-205 May-205 Highest state-level visit to China since its independence Chinese President's visit to Egypt postponed from March 205 Sisi's first visit to China since his presidency During HRH's previous position as Crown Prince Enchancing ties and promoting AIIB, which the UAE joined in April Inauguration of the Dubai Week in Beijing 0

11 Sino-MENA: Looking to upgrade bilateral ties Kuwait is working towards greater engagement with China. Kuwait s crude oil exports to China nearly tripled from a year earlier to 395K bpd in April 205. Figure Sino-MENA Partnerships - In August 204, Kuwait signed a 0-year agreement with China s Sinopec to export 300k bpd of crude oil to China (6% of Kuwait s total oil exports). - Kuwait s share of Chinese crude oil imports in 204 remained unchanged from a year earlier, but we expect this share to rise following the agreement. Kuwait was also among the first countries to join the China-backed Asian Infrastructure Investment Bank in 204. Since 2002, trade and investment relations between China and Morocco have steadily improved. China has been involved in a number of projects in Morocco. These include a USD 2M hospital project and two highway projects worth USD 257M. Morocco s largest private bank Attijariwafa began trading in Renminbi in 204 to help local and African businesses develop commercial partnerships with China. Morocco s strong presence in the financial sector in West Africa appeals to Chinese firms looking to expand in the region. - The Export-Import Bank of China (China Exim Bank) opened a representative office in Rabat in May of this year. - This is the first Chinese financial institution to set up in Morocco, aiming to serve Morocco as well as and 26 African countries in North, Central and West Africa, and to offer financial services for Chinese companies in the region. - This is expected to further promote Morocco s role as a financial and trade hub for North/West Africa. Royal Air Maroc is planning to launch 3 direct flights weekly from Casablanca to China this month. This should help realise Morocco s target of attracting 00,000 Chinese tourists by

12 Sino-MENA: The energy dynamic China's crude oil production has hovered around the 4M bpd since 200 but this only meets around 50% of its demand. Imports as a ratio of total demand have risen from 30% in 2000 to about 57% in 204. The Chinese government has estimated that its foreign oil dependency will increase to 6% during the five-year planning period ending December 205. China's oil demand growth has been driven by a confluence of factors including domestic economic growth and trade, transportation sector shifts, refining capabilities, and inventory builds - In 204, China consumed an estimated 0.7M bpd of crude oil and only produced an estimated 4.6M bpd (Figure ). - Since 2003, China has been one of the fastest growing economies in the world (real GDP growing at a rate of 7-0% YoY). Figure Oil Production & Consumption - In addition to industrialisation, the growth in oil consumption has also reflected large increases in demand for petrol due to the mass transition away from bicycles toward private automobiles. China imported 6.M bpd of crude oil in 204, a 9% rise from 203 (Figure ). Imports in the first few months of 205 climbed to a recordhigh of 7.4M bpd in April 205 as falling international oil prices encouraged stockpiling. In 204, China overtook the US to become the world s largest gross oil importer (Figure 2) as large volumes went into filling its Strategic Petroleum Reserve (SPR). - Rapid Chinese oil demand growth, over the past few years pushed China ahead of the US as an oil importer. Figure 2 World Oil Imports by Country ; EIA. 2

13 Sino-MENA: Escalating dependency on MENA MENA, particularly the GCC, remains the largest source of China's crude oil imports, although African countries, particularly Angola, started contributing more to China's imports in the past decade. The share of oil imported by China from MENA rose modestly from 48% in 990 to 52% in 204, but the volume of these imports rose dramatically, from 700K bpd in 990 to 3.2M bpd in Other regions that export oil to China include Africa with.4m bpd (22%), the Americas with 667K bpd (%), Russia and the former Soviet Union with 778K bpd (3%), the Asia-Pacific region with 27K bpd (2%), and 27.3K bpd (<%) from other countries. - Saudi Arabia is the largest single exporter of oil to China, accounting for 6% of the country s oil imports in 204 (Figure 2). This interdependence is set to grow given China s energy security concerns and Saudi s shift eastward. Iran s oil exports to China reached 707.4K bpd in April 205, accounting for 9% of China s total oil imports. Future crude imports from Iran hinge on the outcome of the nuclear agreement and how quickly oil-related sanctions are lifted. Despite China s efforts to lower dependency on MENA by pursuing investments in the oil sectors in Angola, the Congo, Russia and Kazakhstan, we expect its demand for MENA oil to continue to grow over the next decade. China s dependence on crude oil imports in the long term will be determined by a host of factors, including the sustainability and growth of domestic oil production, the increase in oil consumption, the speed of its SPR fill, fuel efficiency gains in transportation and the substitution of oil with natural gas. Figure China Oil Imports by Country 203 Figure 2 China Oil Imports by Country 204 ; EIA. 3

14 Sino-MENA: It s not all about oil anymore China s non-oil economic strategy towards MENA is multifaceted and reflects continuities from the Hu Jintao administration (2002-2) to the current Xi Jinping government. Firstly, the strategy is aimed at facilitating greater inter-regional trade and investment to sustain continued economic growth in China. - A key component of this strategy is the creation of institutional and commercial platforms for engagement between China and regional blocs. Secondly, the strategy seeks to support the internationalisation of Chinese companies under the umbrella of the so-called Going Out policy launched in Thirdly, the strategy seeks to attract greater MENA investment to China, and more specifically, to China s Muslim regions in the Northwest which remain relatively undeveloped. This also supports Beijing s policy for promoting greater infrastructure and logistics linkages across Asia. China also seeks to utilise cultural and religious links with the MENA region to attract FDI, for instance by permitting Islamic banking and establishing halal industrial zones. The development of an Islamic capital market in Ningxia could help promote the financial relationship between China and MENA. - The Islamic banking industry has a strong presence in the GCC, the MENA region, and Asia, but not yet in China (Figure ). - Ningxia, a region where a third of its 6.5 million population is Muslim, is spearheading the development of a halal market in China, which could play an important role in boosting the country s ties with the Muslim world. - In September 204, Ningxia Halal Food International Trade Certification Centre became the first halal certification body in China with the government s stamp of approval. This is an important signal that China is serious about shari a-compliance. ; Thomson Reuters. Figure Islamic Banking Assets (USD, B) - Qatar International Islamic Bank and its compatriot Qatar National Bank (QNB) Capital recently signed an agreement with China-based Southwest Securities to develop shari acompliant finance products in the country. o o These banks are no doubt attracted to the 300 new infrastructure projects costing USD.T that were approved in January 205. With Qatar planning to spend 9% of its GDP per year on infrastructure projects through 2020, and expressed interest in Islamic finance for projects ranging from hospitals to metro stations, there is undoubtedly a vast market to tap. - However, it is yet too early to assess the impact of these initiatives. 4

15 Sino-MENA: Growing trade relations Sino-Arab trade grew from USD 50B in 2004 to USD 250 in 204, averaging a 32% increase per annum (Figure ). Just over half of this trade - USD 75. (54% of total) in was with the GCC countries given the dominance of their energy exports. The Xi Jinping administration has voiced considerable optimism about the future of Sino-MENA trade, forecasting that trade value could exceed USD 600B by the end of the decade. If China s Renminbi internationalisation strategy and its One Belt One Road Initiatives make headway in the MENA region, there is a good possibility that the target could be reached or even exceeded. Beijing is also renewing its efforts to conclude a Free Trade Agreement (FTA) with GCC countries. - Negotiations had stalled due to differences on petrochemical tariffs and China s position on Syria. - However, the two sides are back at the negotiation table and an agreement is expected to be signed in Doha in 206. Although Sino-Iranian relations have been historically based on energy trade, international sanctions and China s increased economic significance have altered this picture. Total trade between Beijing and Tehran has increased dramatically since 2003, when China replaced the EU as Iran s largest trading partner. Bilateral trade totalled USD 50B in 204, with non-oil trade making up 26% of the total. - We expect this figure to rise considerably once sanctions are lifted. - China is already positioning itself to capitalise on any sanctions relief that comes with a comprehensive Iran deal. Iran has been officially accepted as a founding member of China s Asian Infrastructure Investment Bank (AIIB), another small step toward integrating Iran into its own multilateral organisations of the future. Figure Sino-Arab Bilateral Trade (USD,B) Figure Sino-Iran Bilateral Trade (USD, B) ; China General Administration of Customs. 5

16 Sino-MENA: Chinese high-tech gaining a foothold in MENA The average merchandise correlation index between China and MENA is negative, indicating low competition/high variation between MENA s exports compared with China s (Figure ). China's major exports to MENA include machinery & transport equipment, manufactured goods and primary commodities. China s major imports from MENA include petroleum & petroleum products, precious metals, stones, gems & jewellery, minerals, chemicals and wood. The synergy is clear: China seeks energy dependency while MENA seeks cheaper manufactured goods. Figure China Merchandise Correlation Index Following the sixth ministerial conference of the China-Arab States Cooperation Forum held in August 204, China and the Arab League states signed the Beijing Manifesto, a blueprint for regional cooperation over the next decade based on the so-called +2+3 strategy. refers to increasing energy cooperation, 2 to expanding investment and trade relations, and 3 to furthering technological cooperation in such fields as nuclear, green technology and aerospace. MENA markets have gradually developed an appetite for Chinese hightech products. MENA imports of high-tech products from China accounted for 4.6% of total 204 MENA imports of these goods and only 4.2% of China s global exports of high-tech products, underscoring ample room for growth (Figure 2). As MENA demand for high-tech products grows, it could become a sizeable market for Chinese high-tech products, particularly given their restricted access to the US market. Soon, the ubiquitous Made in China label could shift to Created in China on such products as aerospace components, renewable energy equipment, railway and telecom products originating from China. ; UNCTAD. Arrows indicate the ratio of global MENA exports compared to MENA imports from China, highlighting potential opportunities for scaling up. Figure 2 High-tech Export Opportunity 23.6x 6

17 Sino-MENA: Bilateral FDI small but rising Chinese investments in MENA still constitute a small proportion of total Chinese FDI (2.6%), but a sizeable proportion of MENA GDP (3.7%). This is in comparison to the Emerging Markets (EM) average which constitutes 3.8% of total Chinese outward FDI but only accounts for 0.0% of total EM GDP, highlighting the sizeable impact that a fairly small investment from China could have on the MENA region. Saudi Arabia only captures 3% of China s FDI in MENA. This compares poorly with Iran for example (39% of China s MENA FDI). A sizeable infrastructure pipeline in the kingdom (over 0% of GDP) presents an attractive opportunity for Chinese construction firms. Going forward, as China looks beyond oil investments, MENA s real economy and markets provide compelling investment destinations in agriculture, manufacturing and consumer-driven industries. We expect the volume of Chinese investments in MENA to grow by 22% YoY through 2024 and contribute to diversification in the region. Thanks to unprecedented current account surpluses, especially in the GCC, MENA outward FDI has grown significantly in recent years, particularly toward China. All major GCC sovereign wealth funds have already made significant investments in China. For instance, Qatar and its SWF, the Qatar Investment Authority, plans to invest as much as USD 20B billion in Asia by Although compiled statistics remain sparse, transaction flows suggest that GCC investments in China are diversified and growing. - For example, in the financial sector, three SWFs - Abu Dhabi Investment Authority (ADIA), Kuwait Investment Authority (KIA) and Qatar Holding (QH) -- have obtained approval from the Chinese authorities to enter China s bonds and securities markets. - In the hospitality sector, Jumeirah, the Dubai-based hotel group, plans to construct luxury hotels in Guangdong, Hainan, and Zhejiang provinces, and Shanghai and Macau. Table GCC Current Account Balance (% of GDP) - In the textile sector, Ajlan and Brothers Co. -- the Saudi private investment firm -- has invested some USD 632M in 20 factories producing synthetic fabrics, cotton textiles, shimags, shoes and accessories. - In the e-commerce sector, Saudi Arabia s Kingdom Holding has a stake of 2.5% in Jingdong, one of the largest online retailers in China. - In the aviation sector, the three GCC airlines Emirates, Etihad and Qatar Airways, have routes not only to major cities of Beijing, Shanghai and Guangzhou, but also to second-tier cities such as Chengdu, Chongqing, and Hangzhou. ; IMF. 7

18 Sino-MENA: WiMAX licensing offers an effective means of entering the broadband market in some MENA countries Telecom presents profitable opportunities in MENA, where despite relatively high GDP per capita, broadband penetration has yet to reach levels of EMs. We highlight mobile data services as a growth area. Though mobile penetration in MENA is over 60%, saturation differs across countries. Internet penetration still has some way to go. - Lenovo, Huawei and Xiaomi, ranked 3rd, 5th and 6th in the 204 global smartphone sales market, could leverage the opportunity to provide mobile devices for MENA mobile users who still lack access to the internet. - China s major smartphone brands are expected to account for more than 30% share of the global market in 205, many of them consider MENA as a major overseas market to penetrate. Huawei, a leading global information and communications technology solutions provider from China, is now expanding its presence in telecom technology services in MENA markets. - In 204, Huawei Europe, Middle East and Africa reported a 20% rise in revenue to reach USD 6.27B. - Huawei's EMEA business accounted for 35% of its overall revenue, similar to its revenue from China (37.8%). - Huawei s MENA business is expected to grow at 36% a year until 208. Some MENA operators continue to aggressively pursue M&A transactions. For instance, UAE s Etisalat signed a deal with Huawei to support the UAE government s wider infrastructure plans for the Smart City project and Expo For the first time, Etisalat and Huawei will cooperate in the development of 5G, mobile broadband. - Huawei s business network has also expanded to Saudi Arabia, Qatar, Lebanon, Algeria and Egypt, among others.. Spectrum is becoming available in bands that would be suitable for WiMAX services. Liberalisation has progressed further in mobile markets than it has in fixed markets in the MENA region. While many MENA states are quickly approaching peak penetration levels in the mobile phone market, internet access is not yet as widespread, partly because traditional DSL and dialup internet services require the same wired infrastructure that inhibited landline phone service growth in the past. For this reason, the development of a wireless broadband internet technology WiMAX has generated excitement in the telecom industry across the world as a cheaper, less-labour intensive and more effective means of providing broadband internet service. Table Countries with WiMAX Services Algeria Yes Yes Algérie Télécom uses WiMAX to fill gaps in its wireline broadband coverage Bahrain Yes Yes Egypt No No In 2007, Zain launched WiMAX to compete with Batelco s fixed, broadband and mobile services The government is still holding discussions with relevant stakeholders to determine the best policy framework for introducing WiMax into the market through existing or new operators. Oman Yes No Nawras launched WiMAX in 200. Saudi Arabia Yes Yes UAE Yes Yes The second MNO, Etihad Etisalat (Mobily), launched WiMAX services in September 2008, following its acquisition of Bayanat Al Oula. EITC (du) and Emirates Telecommunications (Etisalat) are licensed to offer WiMAX services, launched in

19 Sino-Qatar: Growing business ties China is promoting internationalisation of RMB in MENA, concluding its first 3-year Bilateral Swap Agreement (BSA) for USD 5.7B with Qatar on November 204 (Figure 7). The two sides established an RMB clearing house in Doha and extended the (RQFII) scheme to Qatar with an initial quota of USD 4.9B. The Sino-Qatari agreements (BSA and RQFII schemes) are part of a larger process of RMB internationalisation and attracting FDI into China, with a potentially positive impact on the future development of Sino-GCC trade relations. For its part, Doha has expressed readiness to fulfil Beijing s energy requirements. Cooperation in LNG is the driving force in bilateral economic ties. Qatar ships gas to China under long-term contracts and spot cargoes, and was the largest LNG supplier to China in 204, accounting for 34% of China s total LNG imports (Figure 8). To meet projected long-term demand increases, China is expected to continue importing natural gas in the form of LNG from Qatar. In March 205, Hamad bin Suhaim Enterprises and Qatra for Investment and Development agreed to invest about USD 5B for a 49% stake in Shandong Dongming Petrochemical Group to help the Chinese build an LNG receiving terminal. Table Bilateral Swap Agreements (RMB, B) Table China LNG Imports by Country 2 ; Bloomberg. RMB= USD (23 June 205). 2 ; EIA. 9

20 Sino-UAE: From strength to strength Sino-UAE economic cooperation is rapidly expanding and diversifying from trade and infrastructure development to finance and technology. The UAE is anticipated to account for the bulk of MENA non-oil trade with China which is projected to reach USD B by China is on course to becoming the UAE s number one trading partner (India is in the lead now). Trade between the two is valued at USD 54.8B in 204, a 4% rise from Sino-Dubai trade accounted for 87% of the total value in 204. Dubai already hosts a Chinese community of over 200,000 people (0% of Dubai s total population) and several major Chinese banks, and is a major re-exporting hub for Chinese goods. Dubai handles 60% of China s exports to Africa and Europe. Through leveraging the expertise of the Dubai International Financial Centre (DIFC), Dubai is well set to consolidate its position as a major hub for Chinese investors and companies. - Industrial and Commercial Bank of China (ICBC) issuance of a USD 4B Euro Medium Term Note (EMTN) programme in Dubai through its DIFC branch would be a further step for the bank to step into the MENA corporate network. The Chinese internet search engine Alibaba has decided to set up a base in Dubai to seek business from the region and will be working with Dubai s Meraas Company to develop applications and large data operations in areas such as payment solutions. With a rapidly growing Chinese tourist community (a 25% YoY increase in 204 to 344,000), we expect an increase in the number of Chinese investors in the UAE real estate market, particularly in Dubai. In 204, more than 40 nationalities invested in the Dubai real estate market, with total transactions amounting to USD 59.4B. Among them, Chinese investors spent nearly USD 48M on properties in,023 transactions, up from USD 364M in,050 transactions in 203 (Figure ). ; JLL. Figure Chinese Investment in Dubai Property Market - With the number of Chinese investors representing less than % of the market, there are undoubtedly great opportunities for growth. - Dubai is competitive compared to other prime property markets. For instance, a 2-or-3-bedroom apartment in the top-class Burj Khalifa in Dubai costs about USD 7K a sq m, compared to about USD 32K a sq m for a similar development in Hong Kong and USD 30K in London. The slower pace of Dubai s real estate market compared with the speculative period which led to the collapse of the market in , is positive in the long run, as it alleviates concerns about another housing market bubble. Dubai s plan to upgrade the city for the Expo 2020 through infrastructure spending and by encouraging foreign investment in various sectors will provide a measure of market support over the next five years. 20

21 Sino-Iranian Relations: Business as usual While many believe improved ties between Iran and the West, particularly the US, could undermine currently strong Sino-Iranian economic relations, we attach a low probability to this scenario. China saw no reason to conform to sanctions applied unilaterally by many Western countries, particularly the US (China only abides by UN sanctions). As a result, Iran has been able to side step a host of Western sanctions by developing strong ties with Beijing. Since sanctions were imposed in 200, China became one of Iran s most reliable trading partners. China s crude oil imports from Iran jumped by nearly 30% in 204 to 550K bpd at the same time that its imports from top exporter Saudi Arabia were down 7.9%. With the 4 th largest reserves of crude oil in the world (approximately 50B barrels), Iran is China s 5 th largest supplier of crude oil with a 9% share (after Saudi Arabia 6%, Angola 3%, Russia %, Oman 0%). The value of bilateral trade between Tehran and Beijing reached USD 5.8B in 204 from only USD 7B in Western sanctions have led to Chinese companies reinforcing their foothold in Iran's strategic economic sectors, particularly in infrastructure and energy (Table ). The strengthening of trade and investment relations between Iran and China, could not have come at a better time for Beijing given its top priority of developing a new land and maritime Silk Road economic belt. The land-based Silk Road is meant to ultimately traverse through northern Iran en route to Venice where overland trade would link to the maritime Silk Road. In combination, the Silk Road economic belt is set to allow China to solidify its trade and cultural links across three continents. Chinese assistance in building infrastructure along the land Silk Road will further ensure economic development in Iran (and elsewhere in the Middle East) that is also advantageous to China s domestic economic trajectory. As Iran-P5+ negotiations on the nuclear dossier is proceeding, it appears that the West is aiming to drive a wedge between the strategic Sino-Iranian partnership. And this strategy seems to have created some volatility. Table Chinese Investment in Iran - In April 204, for instance, Iran abruptly terminated a USD 2.5B deal with China for the development of the Azadegan oil field. - But by June, another large Chinese investor in Iran - Sinopec -- doubled its production of Iranian oil at the Yadavaran oil field to 50K bpd. As recent months have shown, where one deal falls through, the Chinese have promptly found other opportunities to tap back into the Iranian energy opportunity set. But it is likely that China and Iran will work to strike a mutually beneficial, but tenuous, balance as nuclear negotiations move forward. - Both Iran and China have far too much to lose if these talks collapse, or if Iran does not follow through with its commitments. - Beijing needs Iranian oil supplies to fuel its domestic growth and uninhibited access to northern Iran for the Silk Road trade route. Tehran needs China s reliable energy outlet, as well as any benefits that can be derived from China s Silk Road development.. 2

22 Sino-MENA: A walk on the wild side For much of the past four decades, China has remained aloof to the crises in MENA. But maintaining this policy is proving increasingly difficult and costly for China. China s national oil companies have suffered setbacks to their investments in politically-unstable countries. - In Iraq, continued unrest is threatening China s combined 472K bpd production entitlement -- 25% of all Chinese overseas oil output. China has always considered Iraq to be a replacement for reduced oil flow from Iran. - Similarly in Libya, fighting cut exports to China by more than one-third in 203. Beijing has since been involved in discussions concerning its pre-20 contracts. The main challenge, however, is one of a political nature -- the two Libyan governments have indicated that those countries which supported their revolution would receive preferential treatment in the future. China did not offer any support to the revolution, and was the last of the five permanent members of the UN Security Council to recognise the National Transitional Council (at the time). - In Syria, Chinese companies total production dropped to 53K bpd in 203, from a high of 84K in 20. By the end of 203, China s major oil companies withdrew from the country. Importantly though, China s support of the Assad regime has strained its relationship with the GCC, particularly Saudi Arabia. But it appears that both sides have reconciled themselves to the realities of China s foreign policy, with the GCC largely blaming Iran and Russia for propping the Assad regime. - In South Sudan, oil output from China National Petroleum Corp. and China Petroleum & Chemical Corp., the two largest producers in South Sudan, dropped to 84k bpd at the end of 203 from 20k bpd in 200. The rise of ISIS in Iraq and Syria is attracting hundreds of Chinese Muslims foreign fighters. ; World Bank. - According to Chinese authorities, 300 of their nationals are believed to be fighting alongside ISIS, some of whom have returned to take part in terrorist plots at home. - As China became increasingly concerned about ISIS influence on would-be jihadists at home, it made political overtures in recent months to support the Iraqi and Syrian governments in their fight against the group. o In December 204, Beijing announced that it was considering assisting in the fight against ISIS, which would be an unprecedented act of foreign military intervention for China. o Interestingly though, Beijing has made it clear that such military assistance would occur outside the USled coalition. China is now relaxing its traditional non-intervention policy to protect its economic interests and secure its citizens safety. Chinese expatriates have been rescued from the violence gripping several countries. - China evacuated 35,000 nationals from Libya during the 20 revolt that overthrew Muammar Qaddafi. - In May 205, more than 400 Chinese workers were evacuated from South Sudan due to growing violence. China s mediation efforts between Sudan and South Sudan (given its stake in the gold mining industry in the former, and the oil industry in the latter) are reflections of this. We have already mentioned China s balancing act between Iran and Saudi Arabia, two countries in which China has significant economic stakes. As China s economic role in the Middle East starts to resemble in magnitude that of the United States over the past few decades, the question is whether a political role will follow, or whether things will look different in a multipolar world. 22

23 Sino-MENA: Deepening economic and political ties It is highly unlikely that China s greater political activism in the Middle East and its growing economic stake in the region will translate into military activism. China is clearly trying to avoid being sucked into the increasingly complex MENA vortex. - Unlike its active military role in territorial disputes in the South China sea, China seems happy to assume a back-seat role to the Americans and the Europeans in the MENA region, particularly when it comes to securing MENA oil fields and shipping lanes. - The failed Western policy in the Middle East holds important lessons for Eastern powers like China (but also Russia), namely that military intervention alone cannot succeed in countries with deep religious, ethnic and tribal divides. - China is also aware that even a small military presence in the region, would not be tolerated by the US. This became evident when Djibouti President Ismail Omar Guelleh recently disclosed that he was in negotiations with Beijing over establishing a naval base in the African state s northern port of Obock, a move heavily criticised by Washington. China will probably be content to continue its back-seat political ride and instead concentrate on developing its presence in the maritime periphery and Indian Ocean. - China is far from having the military, logistical and communications technology to cover the 7,000 miles of sea lanes that lie between Shanghai and the Strait of Hormuz. - In the meantime, China is likely to focus on establishing three networks of overseas strategic support bases over the coming decades: a North Indian Ocean supply route with bases in Pakistan, Sri Lanka, Myanmar; a Western Indian Ocean supply route with bases in Djibouti, Yemen, Oman, Kenya, Tanzania and Mozambique; and a central-south Indian Ocean supply route with bases in Seychelles and Madagascar. This suggests that China s sight is set on dominating the Indian Ocean. ; IMF. Thawing relations between Iran and the West -- as well as between Iran and the GCC countries -- help China protect its regional interests. Iran-P5+ negotiations are boosting relations between China and the US. - Beijing and Washington are at loggerheads over everything from cybersecurity to the value of China s yuan currency. - But by cooperating closely on safeguarding the international nuclear non-proliferation agreement -- particularly regarding the Iranian nuclear issue -- the two countries have instilled positive energy into bilateral relations. A Saudi-Iranian thaw could make it easier for Beijing to protect China s contradictory interests in MENA. - As China s interests in the region continue to broaden, Beijing will find it increasingly difficult to find a balance between the two sides. - This approach has paid off (so far) -- China is now Saudi Arabia s largest non-oil trade partner, the second largest trade partner to the MENA region, the largest importer of Iranian oil and the largest player in the Iraqi oil game. China will be expected to continue to deepen its economic and political ties with the MENA region; establish new trade routes and diversify its commerce; avoid hot conflict spots; while happily yielding the defence of the Middle East oil to the Western powers, for now. 23

24 Sino-MENA Monthly Monitor: Major deals & projects May-June 205 CMC & SU Power signed a USD 2B deal with Iran to electrify the railroad linking Tehran and Mashhad. The project will shorten the trip duration by 50% to 6 hours and increase the passenger figure to 35 million per year from the current 4 million. Damac signed an exclusive deal to promote 37,000 Dubai properties to China via 5i5j. CSCEC won a USD 67M deal to build roads to the Dubai Parks & Resorts site. Dubai Gold & Commodities signed an agreement to cooperate with Bank of China. Nasdaq Dubai listed a USD 500M bond of ICBC, as parts of the bank s USD 4B Euro Mid-term Note Programme to be issued via Dubai. China s Export Import (EXIM) Bank opened its second African representative office in Morocco, after South Africa. China National Nuclear Corp. became Egypt s official partner on nuclear power projects. USD 0B deals were signed by Chinese firms to build 5 infrastructure related projects. QIA to invest USD.2B in the Hong Kong Electric. ICBC s 5 th MENA branch opened in Riyadh. 24

25 Iran Market Monitor: Hope at last for banking? Oil exports may not be the first beneficiary of the lifting of the sanctions. There are claims that once the sanctions are lifted one million barrels could be added to oil production and exports quickly. However, we believe it will take a considerable amount of time before the country s production capacity rises. - Output is currently around 2.7M bpd of which M bpd is exported. Before sanctions in 20, Iran was producing about 4M bpd and exporting 2.M bpd. - However, Iran has 40-50M barrels of condensates on tankers offshore which technically could be exported immediately. - Despite intensifying efforts by US Republicans and Israeli critics, not to mention the hardliners in Iran, to derail the talks, the momentum to reach a breakthrough is still strong. This is because all sides see a real chance of achieving a deal and also believe that the opportunity may not present itself again anytime soon. Iran has significant reserves of oil (58B barrels of oil; 0% of the world's crude oil reserves) and gas (.2T cubic feet of natural gas), but the country s ability to increase output significantly requires investment that had fallen short due to the sanctions. Notwithstanding the importance of the energy sector, the performance of the Iranian economy has also been hampered in the past few years by sanctions on its financial sector. The lifting of sanctions on Iran s banking sector would probably have the most immediate impact on its economy. Iranian banks have been burdened in recent years by non-performing loans, now reaching 4.5% of assets, but possibly much higher. - Despite this, there is interest from European and Arab investors in the Iranian banking sector, which is dominated by inefficient public sector banks. - Foreign banks are allowed to take a 40% stake in a local bank but the central bank is reviewing regulations to provide banks with easier terms in free trade zones. ; EIA. The aviation sector is also ripe for regeneration. Iran has more than 5 commercial and cargo airlines and over 300 airports serving both domestic and international destinations. In recent years, there have been air disasters that have plagued Iranian aviation; the incidents could be directly attributed to dilapidate (mostly Russian-made) fleets flying domestic routes. - The lifting of sanctions would rejuvenate the aviation industry and boost passenger volumes lost to regional and European carriers; it could also support international tourism that would, in turn, create opportunities in the hospitality sector. - The Iranian government recognises the importance of its aviation sector and had announced last year that if sanctions were lifted it would purchase 400 new planes. Airbus and Boeing are reportedly already discussing potential sales with Iranian authorities. Figure Oil Reserves by Country 25

26 Iran Market Monitor: The politics of a nuclear deal There is still no certainty that an agreement on the nuclear issue between Iran and P5+ could be finalised by the 30 June deadline. Critics are loudly audible on both sides, but there is too much at stake to allow the talks to collapse after painstakingly narrowing the gap over the last two years. In recent days, Iranian negotiators have indicated that the talks are not proceeding as well as expected and that the deadline could be extended by a few days -- as was done in the last round. Mixed signals are also coming from the other side. Apparently, the talks have stalled on two key issues: inspection of Iran s military sites and the timeframe for the lifting of sanctions. Iranian Majlis (parliament) overwhelmingly passed a resolution on 2 June rejecting the P5+ demands for unrestricted access to its military sites by international inspectors. - The vote came as no surprise since Khamenei had also earlier publicly voiced its objection to such inspections. - At the same time, the P5+ group is split on the issue: most members (including Russia and China) are seemingly staying neutral; France is demanding unconditional and unrestricted access to all sites; and the US trying to negotiate the middle ground. - Surprisingly, France has been taking a hard line in the negotiations, more or less echoing Israel s objections to a deal with Iran. In the final stages leading to the 203 interim deal, Paris made headlines when French Foreign Minister Laurent Fabius almost derailed the talks at the last minute. The UK and Germany have been taking a more pragmatic approach to the negotiations. The Majlis also voted that there should be no deal unless all sanctions are lifted upfront. The US and its allies had made it clear from the start that sanctions will only be lifted in phases.. Figure Iranian Majlis Vote Outcome - Even if the two sides finalise an agreement in the coming days, there are still important hurdles to overcome in Tehran and Washington. The Majlis has already made its position known on the key issues but will most likely go along as long as Ayatollah Khamenei is on board. On the other end, the will have to submit the draft agreement for congressional review where it is likely to meet serious opposition. - There is still a good deal of uncertainty about the final outcome, but we still believe that the two sides have too much at stake to allow this once-in-a-lifetime opportunity to pass. 26

27 MENA Credit Monitor: Macro Themes Sovereign Credit* Macro Themes for MENA Sovereign Credit EM credit spreads widened amid rate uncertainty. However, we do not see acute risk of a taper tantrum 2, not only because there is not much of a surprise factor this time and we foresee a gradual path of US rates, but also because EM credits have become less vulnerable from both fundamentals and valuation perspectives. The JPM EMBI Global Emerging Debt Index is down.5% June MTD and up +2.0% YTD. MENA sovereign benchmark bonds are also down 0.6% June MTD and up 2.5% YTD. The top June 205 MENA bond performers ADhabi9 s (- 0.%) and Bahrain20s (-0.2%). MENA bond laggards were Egypt20s (-2.0%) and Dubai20s (-.0%). MENA sovereign CDS underperformed MENA sovereign bonds, down.0% June MTD and +0.% YTD. The top June 205 MENA 5yr CDS performers were Lebanon (+.5%) & Dubai (+.%). MENA 5yr CDS laggards were Iraq (-3.9%) & Morocco (-0.4%). MENA sovereign sukuk bonds have also widened 0.5% June MTD and +2.0% YTD. The top June 205 MENA sukuk bond performers were Dubai7s (-0.%) & Bahrain8s (-0.%). MENA sukuk bond laggards were Dubai22s (-.2%) & Qatar23s (-0.7%). Figure - MENA 5yr CDS Levels Figure 2 - MENA Benchmark Bonds Z-Spread ; Bloomberg; Deutsche Bank; JPMorgan. * s Credit and FX Monitor views do not constitute trade recommendations. 27

28 MENA Credit Strategy: Outright CDS & Bond analysis* Egypt (B3/B-) Credit The macro story in Egypt is looking more favourable, with fuel subsidy cuts assisting to reduce the deficit and hard currency stress. But increased credit spread carry compensates for some of the credit delta risk. Low external debt/servicing ratio liability also somewhat limits downside risk. We maintain our overall positive outlook for Egyptian sovereign credit given sustained aid from GCC states (USD 5B+ so far and new pledges of USD 2.5B during the Economic Development Conference that occurred on 3-5 March, of which USD 6B was deposited at the Central Bank of Egypt (CBE) on 23 April. Egypt 5yr 320bps widened 0bps in June MTD and 36bps YTD. Egypt20s bond 289bps widened 48bps June MTD and 8bps YTD. CDS/Bond 32bps among the lowest level in over a year. Figure - Egypt 5yr CDS & Egypt 20s Bond Z-spread Figure 2 - Egypt 5yr CDS vs. Egypt 20s Bond Z-spread Diff. ; Bloomberg; Deutsche Bank; JPMorgan. * s Credit and FX Monitor views do not constitute trade recommendations. 28

29 MENA Credit Strategy: Outright CDS & Bond analysis* GCC Sovereign Credits GCC 5yr CDS spreads on Saudi Arabia, Abu Dhabi & Qatar are trading at their widest level for the year, all around 65bps+. GCC benchmark bonds Qatar20 s and ADhabi9 s Z-spreads are also trading at relatively low levels, below 50bps, with CDS/bond basis around 25bps. Figure - Saudi, Qatar & Abu Dhabi 5yr CDS Movement Figure 2 - MENA 5yr CDS & MENA Benchmark Bond Z-spread ; Bloomberg; Deutsche Bank; JPMorgan. * s Credit and FX Monitor views do not constitute trade recommendations. 29

30 MENA Credit Strategy: Relative value CDS & Bond analysis* Abu Dhabi (AA) vs. Dubai (NR) Dubai external credit spreads have rallied further with March s refinancing of USD 20B loan by Abu Dhabi providing cheap funding at % for the next 5 years. Dubai20s vs. ADhabi9s bond Z-spread are 84bps and Dubai 5yr CDS vs. Abu Dhabi 5yr CDS are near historic which looks set to continue its tightening trend. Figure - Dubai 20 s vs. ADhabi9s Bond Z-spread Diff Figure 2 - Dubai 5yr CDS vs. Abu Dhabi 5yr CDS Spread Diff Figure 3 - ADhabi 5yr CDS ADhabi9s Z-spread (CDS/Bond Basis) Figure 4 - Dubai 5yr CDS - Dubai20s Bond Z-spread (CDS/Bond Basis) ; Bloomberg; Deutsche Bank; JPMorgan. * s Credit and FX Monitor views do not constitute trade recommendations. 30

31 MENA Credit Strategy: Relative value CDS & Bond analysis* Tunisia (Ba3/NR) vs. Bahrain (Baa3/BBB-) / Morocco (Ba/BBB-) Tunisia displays positive momentum, on the political front with the successful October and December 204 parliamentary and presidential elections inclusive of all factions, and on the economic front with the growth outlook improving while reducing the deficit and hard currency stress. Tunisia 33bps widened 20bps in June MTD and tightened 22bps YTD, Tunisia 5yr 280bps tightened 0bps June MTD and 40bps YTD keeping CDS/bond basis in negative 5bps. Moroccan 2020 sovereign Bond 95bps tightened 3bps have returned.2% YTD while outperforming Morocco 5yr 9bps which have widened 8bps and have returned 0.5% YTD keeping CDS/Bond basis in negative 4bps. Morocco has the only BBB credit rating in the MENA region that offers investment grade spread pick-up value vs. Bahrain or Dubai also vs. North Africa regional credits Egypt or Tunisia that are B rated. Figure - Tunisia 5yr CDS vs. Morocco 5yr CDS Spread Diff Figure 2 - Tunisia 5yr CDS vs. Bahrain 5yr CDS Spread Diff Figure 3 - Tunisia 20s vs. Morocco 20s Bond Z-spread Diff Figure 4 - Tunisia 20s vs. Bahrain 20s Bond Z-spread Diff ; Bloomberg; Deutsche Bank; JPMorgan. * s Credit and FX Monitor views do not constitute trade recommendations. 3

32 MENA Credit Strategy: Relative value CDS & Bond analysis* Lebanon (B/B-) Lebanon 5yr CDS, and Lebanon2s bond could widen further on the back of continued uncertainty over political stability and heightened security risks. The Bond/CDS bps is the tightest in 3 months. Focusing on RV defensive volatility observations yr Lebanon CDS or Lebanon 6s bond allows us to limit downside risk. Currently, Lebanon 5yr vs. yr CDS slope 82bps tightened 0bps June MTD and widened 5bps YTD. This RV observation has performed as anticipated, as the yr 75bps has widened 5bps June MTD and 0bps YTD. Figure - Lebanon 5yr CDS & Lebanon 2 s Bond Z-spread Figure 2 - Lebanon 5yr CDS & 2 s Z-spread (CDS/Bond Basis) Figure 3 - Lebanon yr CDS & Lebanon 5yr CDS Movement Figure 4 - Lebanon 5yr CDS vs. Lebanon yr CDS Spread Diff : Bloomberg; Deutsche Bank; JPMorgan. * s Credit and FX Monitor views do not constitute trade recommendations. 32

33 MENA FX & Local Markets Monitor: Macro Themes Sovereign FX* Macro themes for MENA sovereign FX Growth and monetary policy differentials between DM and EM are likely to continue to keep EM FX on its depreciation trend. Possible reflation, a spike in the pace of anticipated Fed rate hikes, and ongoing weakness in EM FX pose risks to EM fixed income, especially local rates. Local currency pegs to USD/EUR implies MENA FX is not as dynamic as MENA sovereign credits. Still, some MENA countries are expected to maintain a wider FX movement vs. the USD throughout 205, presenting interesting opportunities in the local markets space; we highlight Egypt, Morocco and Lebanon. MENA FX underperformed vs. MENA Fixed Income, up 0.6% June MTD and -2.8% YTD. Top June 205 MENA FX gains vs. USD were MAD (+2.6%) & TND(+2.6%). MENA FX laggards were AED (-0.9%) & SAR (-0.%). Figure - MENA FX rates vs. USD (YTD % Change) Figure 2 - MENA FX Historical Volatility vs. USD (m, 3m, 6m), Bloomberg; Deutsche Bank; JPMorgan. * s Credit and FX Monitor views do not constitute trade recommendations. 33

34 MENA FX Strategy: Outright FX analysis* Egypt (Caa/B-) FX The Central Bank of Egypt (CBE) allowed the EGP to depreciate for the first time since May 204. Since 8 January, the CBE has raised the cutoff price for USD at its official FX auctions nine times, by EGP 0.05 each. The results of the CBE s FX sales determine the rate at which banks trade USD and give the central bank effective control over exchange rates. The recent measures by the CBE signal a shift in monetary policy from fighting inflation to supporting growth. Consequently, the exchange rate weakened from EGP/USD 7.5 to EGP/USD 7.63 The devaluation of the EGP comes a week after the CBE s surprise decision to cut the benchmark interest rates by 50bps. On 5 January, the CBE cut the overnight deposit rate, the overnight lending rate and the discount rate to 8.75%, 9.75% and 9.25%, respectively. The CBE thus reversed half of the tightening it had resorted to in July 204. New GCC support of USD 6B in the form of deposits at the CBE on 23 April have shored up Egypt s FX reserves to USD 9.56B, as well as grants and investments. This combination implied reduced FX weakness and spread widening. Implied yields on one year T-bills have responded in kind by increasing from 2.5% in December 204 to 2.5% Jun 205, which we anticipated the easing trend to continue on the interest rate delta. One year T-bill yields offer 2 to 3 points more yield than one year NDF forwards currently, which look to outperform in the short term given the CBE s growth supporting strategy. In our view implied for yr FX forwards outright or yr T-bill 2.5% outright offer impressive returns or vs. yr Egypt 24bps a ratio of over 5x offers downside protection if pressures reignite. Figure - USD/EGP yr FXFwd Imp Yld vs Egypt yr Trsy Yld Figure 2 - USD/EGP yr FXFwd Imp Yld vs Egypt yr CDS ; Bloomberg; Deutsche Bank; JPMorgan. * s Credit and FX Monitor views do not constitute trade recommendations. 34

35 MENA FX Strategy: Outright FX analysis* Lebanon (B/B-) FX Our constructive view on the Lebanese pound/ Lebanese T-bills is reinforced by statements from the Governor of the Banque du Liban (BDL) re-affirming the institution s commitment to keeping the LBP vs. USD band between 50 and 54. In mid-june, FX reserves stood at USD 38.9B equivalent to an impressive 23 months of import cover, reinforcing the BDL s ability to maintain the currency peg and counter any FX pressures arising from an unstable political situation. Lebanese T-bills are being oversubscribed and look attractive, with yr T-bill 5.35% outright. T-bills with a ratio of 3 times also look interesting vs. yr Lebanon 75bps. Figure - USD/LBP FX Rate Movement Figure 2 - Lebanon yr Trsy Yields & Lebanon yr CDS Movement¹ ; Bloomberg; Deutsche Bank; JPMorgan. * s Credit and FX Monitor views do not constitute trade recommendations. 35

36 MENA FX Strategy: Outright FX analysis* Morocco (Ba/BBB-) FX The Moroccan Dirham vs. USD appreciated 2.4% June MTD and down 4.8% YTD. Currently, outright Moroccan T-bills yr 3.95% rendering this strategy out the money YTD. Bank Al-Magrib s decision to cut its policy rate by 25bps in September 204 to 2.75% signals weak non-agricultural growth. Focusing on external debt markets rather than local debt markets in the near term looks attractive considering continued MAD depreciation. The trade also looks rich vs.yr Moroccan 79bps. Figure - USD/MAD FX Rate Movement Figure 2 - Morocco yr Trsy Yields & Morocco yr CDS Movement¹ ; Bloomberg; Deutsche Bank; JPMorgan. * s Credit and FX Monitor views do not constitute trade recommendations. 36

37 Arabia Credit Monitor: 5-yr CDS vs. Credit Ratings* MENA CDS is relatively cheap to EM CDS across the Credit Ratings ; Bloomberg; Deutsche Bank; JPMorgan. * s Credit and FX Monitor views do not constitute trade recommendations. 37

38 Arabia Credit Monitor: Bond Z-Spread vs. Credit Ratings* MENA Sovereign Bond Z-spread vs. Credit Ratings ; Bloomberg; Deutsche Bank; JPMorgan. * s Credit and FX Monitor views do not constitute trade recommendations. 38

39 MENA Credit Markets: CDS Spread Analysis* MENA CDS Spread Analysis ; Bloomberg; Deutsche Bank; JPMorgan. * s Credit and FX Monitor views do not constitute trade recommendations. 39

40 MENA Credit Markets: Bond Z-Spread Analysis* MENA Bond Z-spread Analysis ; Bloomberg; Deutsche Bank; JPMorgan. * s Credit and FX Monitor views do not constitute trade recommendations. 40

41 MENA Credit Markets: Sovereign Sukuk Bond Z-Spread Analysis* MENA Sovereign Sukuk Bond Z-spread Analysis ; Bloomberg; Deutsche Bank; JPMorgan. * s Credit and FX Monitor views do not constitute trade recommendations. 4

42 MENA FX Markets: FX Levels Analysis* MENA FX Levels Analysis ; Reuters. * s Credit and FX Monitor views do not constitute trade recommendations. 42

43 MENA Credit Analysis: Arabia Credit CDS Monitor* The Arabia Credit CDS Monitor has returned 53.7% since inception (April ). MENA Credit CDS Monitor * s Credit and FX Monitor views do not constitute trade recommendations. 43

44 MENA Credit Analysis: Arabia Credit Bond Monitor* The Arabia Credit Bond Monitor has returned 30.7% since inception (April ). MENA Credit Bond Monitor * s Credit and FX Monitor views do not constitute trade recommendations. 44

45 MENA FX Analysis: Arabia FX Monitor* The Arabia FX Monitor (outright) has returned 8.05% LTD since inception in March 202. MENA FX Monitor * s Credit and FX Monitor views do not constitute trade recommendations. 45

46 MENA Local Markets Analysis: Arabia Local Markets Monitor* The Arabia Local Markets Monitor (outright) in Local CCY has returned 27.2% LTD since inception in March 202. The Arabia Local Markets Monitor (outright) in USD has returned 8.3% LTD since inception in March 202. MENA Local Markets Monitor * s Credit and FX Monitor views do not constitute trade recommendations. 46

47 Arabia Credit Monitor: Credit ratings* MENA Sovereign Credit Ratings ; Bloomberg; Deutsche Bank; JPMorgan. * s Credit and FX Monitor views do not constitute trade recommendations. 47

48 MENA Macro Dashboard Real GDP Growth (%) CPI Inflation Table MENA Oil Exporters Fiscal Balance (% of GDP) Interest Rate (%) C/A Balance (% of GDP) External Debt (% of GDP) Reserves (Months of Import Cover) f f f f f f f Algeria Bahrain Iraq KSA Kuwait Libya Oman Qatar UAE Yemen Average Real GDP Growth (%) CPI Inflation Table 2 MENA Oil Importers Fiscal Balance (% of GDP) Interest Rate (%) C/A Balance (% of GDP) External Debt (% of GDP) Reserves (Months of Import Cover) f f f f f f f Egypt Jordan Lebanon Mauritania Morocco Palestine Sudan Syria Tunisia Average ; IMF. * Subject to downgrade revision. 48

49 Algeria: Agriculture an engine of growth? The Algerian economy grew by 4.% in 204 from 2.8% in 203; driven mainly by public investment. Inflation slowed to 2.9% in 204 from 3.3% in 203, thanks to prudent monetary policy and fiscal consolidation. The overall unemployment rate is about 0% (and fairly stable since 200), but the rates for youth (24.8%) and women (6.3%) are significantly higher. The fiscal deficit is expected to double to 2.9% of GDP in 205, mostly because of lower oil revenue and a sharp increase in capital expenditure. - With domestic bond issuance still limited, the deficit will be financed mainly by drawings from the Fonds de Régulation des Recettes (FFR), which is projected to decline from 3.6% to 27.% of GDP. - If oil prices remain low, the dip in gross official reserves would be accelerated; reserves have been declining during the last 3 years. The agricultural sector can play a key role in the country s diversification strategy. Since the implementation of the Agricultural and Rural Renewal Policy in 2008, the agricultural sector has grown by an average annual rate of 3%. - The sector accounts for only around 0% of GDP, despite Algeria s vast potential. Back in history, Algeria was the breadbasket of the Roman Empire - Although almost 25% of the population is engaged in agriculture (including subsistence farming), only 3% of Algeria's land is cultivated. Authorities efforts have been aimed at boosting domestic production, ensuring food security for a population of 40 million and cutting the import bill (specifically the cereal imports bill which grew by 4% in 204). - Food represents 20% of the value of imports and cereals account for 3-36% of the total food import bill each year. Last year, Algeria took its first steps toward opening up the farming sector to foreign investors, inviting bids for 6 state-owned farms focused on grains, vegetables, fruit trees and cattle breeding. ; IMF. NR/NR Table Algeria: Macroeconomic Indicators f Real GDP Growth (%) Crude Oil Production (M bpd) Oil GDP Growth (%) Non-oil GDP Growth (%) CPI Inflation (%) Fiscal Balance (% of GDP) C/A Balance (% of GDP) Total Gov t. Gross Debt (% of GDP) Total Gross External Debt (% of GDP) Gross Official Reserves (Months of Imports) Nominal GDP (USD B) The government has earmarked USD 3.2B (.4% of GDP) to develop agriculture in 205 and is spending heavily to develop food products, especially grains, mainly through financial incentives to farmers including zero interest loans. Various reforms by the Ministry of Agriculture aim to raise wheat and barley production to 6.9M tonnes by 209, from 3.4M in 204. However, there are a number of challenges holding back the sector s performance. Rural Algeria is losing manpower as the majority of rural youth are attracted to higher pay and better working conditions in urban areas. The sector employs % of the labour force, compared with the industrial and the services sector that account, respectively, for 3% and 58% of the labour force. Fracking techniques associated with Algeria s shale gas plans -- which require large amounts of water -- also pose an important threat to water supplies available for agriculture. This has been a source of social tension, in the agricultural areas in Southern Algeria following the decision of Sonatrach to exploit shale gas using hydraulic fracturing techniques. 49

50 Algeria: Reform is coming! In recent weeks, Algeria has witnessed a cabinet reshuffle, changes in party leadership and a major shake-up in Sonatrach. In previous publications 2, we discussed the cabinet reshuffle that took place on 4 May and explained how young technocrats have taken the lion s share of government positions. On 25 May, President Bouteflika announced the appointment of Amine Maazouzi as Sonatrach s new CEO. - The 50-year old had previously headed strategy and business planning at Sonatrach. - His appointment immediately triggered sweeping changes at the top of the national oil company -- a total of 22 managers were replaced. In view of these changes, it is expected that the government will soon announce a set of political and economic reforms, given challenges associated with weak oil prices. Political reforms will be imperative to help manage the transition from the ailing Bouteflika to a (hand-picked) successor chosen to maintain broad political backing for future reforms. All previous presidents have come from the ranks of the National Liberation Front (FLN), the primary political party in Algeria. If this trend continues, a potential successor could be current Prime Minister Abdelmalek Sellal -- a close confidant to Bouteflika who served as his election campaign leader three times. There is also speculation over whether he recently joined the FLN in order to boost his candidacy. - A second candidate could be UN veteran Lakhdar Brahimi. Other than being a well-respected diplomat with an international stature, speculations over his candidacy are based on his frequent visits to Bouteflika in the past two years. But given Brahimi s age, the ruling elites are more likely to settle with a youngergeneration candidate. ; IMF. 2 Bracing for a hot summer MENA Monthly. Figure Gross Official Reserves (Months of Imports) NR/NR - A third candidate could be Ahmed Ouyahia, a young former diplomat and three-time former prime minister. His recent return as the leader of the National Democratic Rally, the second political force in parliament, supports his status as a serious presidential contender. - Although there will be elections, it is worth noting that Algerian presidents govern at the sufferance of the army. A reminder of this came in 992: after Islamists won the first round of elections, the army -- dismayed by the results -- removed the president, ruled directly for a year and later handpicked a new president. All in all, we expect to see a smooth transition of power as there appears to be backroom consensus to avoid the kind of instability that has rocked the rest of the MENA region. 50

51 Bahrain: Retail sector demonstrates market confidence Baa2/BBB- Despite a slight boost from hosting the Formula One Grand Prix in April, Bahrain's economic growth in 205 is expected to slow to 2.7% from 4.7% last year. Given that 90% of government revenue comes from oil and gas, the country is being affected by low oil prices. On 5 June, Fitch Ratings downgraded Bahrain s issuer-default rating one notch, to the brink of junk. - The triple-b-minus rating brings it in line with other major ratings firms. The outlook is stable and the country ceiling remains at triple-b-plus. - Bahrain could face a rising debt burden should the oil market remain weak. The residential rental market has been slightly tempered by low oil prices, affecting office take-up, job creation and by extension residential demand. Rents and values across the residential market are yet to see a notable impact. Government is expected to introduce new obligatory tenancy registration procedures that could support the market. - The most critical component of the regulation is expected to centre on lease renewal. The current draft proposal calls for an increase in rents, after a period of two years, at 5% for the residential market and 7% for the commercial market. - Landlords will be restricted from increasing rents for two years either from the start of the tenancy or from the date of the last rent increase. Unlike the residential market, the retail market remains resilient; Saudi tourists continue to visit in large numbers each weekend to benefit from Bahrain s growing retail offering. Four out of five visitors to Bahrain arrive from Saudi Arabia via the King Fahad Causeway, with nearly 90% of them Saudi nationals. - Trade between Saudi Arabia and Bahrain (which stood at USD 52B in 204) will be given a boost thanks to plans to build a second causeway running parallel to the existing causeway. - The existing King Fahad Causeway carries more than 8 million vehicles annually, though congestion on the 25km road link has seen long delays during peak travel times. Recent threats by ISIS could undermine the positive trends in the retail market. Table Bahrain: Macroeconomic Indicators f Real GDP Growth (%) Crude Oil Production (M bpd) Oil GDP Growth (%) Non-oil GDP Growth (%) CPI Inflation (%) Fiscal Balance (% of GDP) C/A Balance (% of GDP) Total Gov t. Gross Debt (% of GDP) Total Gross Extrn'l Debt (% of GDP) Gross Official Reserves (Months of Imports) Nominal GDP (USD B) Authorities are concerned that ISIS has turned its attention to Bahrain to escalate sectarian tensions with the GCC. The island kingdom is vulnerable to sectarian conflagration because of already-existing tensions between Sunnis and Shi as, which have become more pronounced following the country s Arab Spring-inspired uprising. It is not farfetched to expect an ISIS-related attack for two reasons:. There are a number of Bahrainis in influential positions in ISIS; the most senior being Sheikh Turki al-binali (also known as Sufyan al-sulami). Such people are able to turn the organisation s attention to the island kingdom. 2. Events in Bahrain often influence what happens in Saudi Arabia s eastern province, therefore making the country an attractive target. But given the strong presence of joint Bahraini-Saudi security on the King Fahd Causeway and the high level of sea patrols conducted by the US 5 th Fleet in surrounding waters, such an operation will be hard to pull off. 5 5

52 Egypt: ISIS versus ISIS? Caa/B- Despite the Islamist insurgency, there are some hopeful signs that Egypt is getting back on its feet after four years of chaos. In the last 2 months, Moody s raised Egypt s credit rating to B3 from Caa and S&P revised the outlook from stable to positive highlighting improving economic fundamentals. - The economy is expected to grow by 4% in 204/5 (Egyptian fiscal year July-June) compared to 2.2% in 203/4. - The government is targeting a 6% growth rate by 208/9 based on expectations of the revival of investment in an environment of improved business confidence and political stability. Egypt s medium-term economic plan includes cutting the budget deficit from 3.6% of GDP in 203/4 to 8-9% by 208/9. - This will not be easy because savings from the subsidy reform and higher tax revenue will be largely channelled to social expenditure, particularly health and education which are expected to rise. - The new constitution requires that public spending on education and health rise to 0% of GDP by 206/7 from 7% of GDP this year. The successful Economic Development Conference in March was a sign that confidence is returning to Egypt s economy. Once political clarity emerges following the forthcoming parliamentary elections, we expect business confidence to improve further. Economic reforms are expected to continue. The next phase of subsidy reform is in the pipeline and preparations to introduce VAT are in the final stages. - In May, the government suspended a controversial capital gains tax for two years, resulting in the sharpest rise in the EGX 30 Index in two years (6.5%). - The government has promised to lower the maximum income tax rate for individuals and corporations to 22.5% over the next decade. Only last year, however, the rate was hiked from 25% to 30%, supposedly for three years. The death penalty requested for former president Morsi could boost President Sisi s position. But it could also add fuel to an already raging Islamist insurgency. The crackdown on the Brotherhood provides fertile ground for ISIS recruitment in two of its franchises. Northern Sinai is home to one; the other has taken root in Libya. ; Central Bank of Egypt. Table Egypt: Macroeconomic Indicators f Real GDP Growth (%) CPI Inflation (%) Fiscal Balance (% of GDP) C/A Balance (% of GDP) Total Gov t. Gross Debt (% of GDP) Total Gross Extrn'l Debt (% of GDP) Gross Official Reserves (Months of Imports) Nominal GDP (USD B) The Sinai branch has claimed attacks in Egypt s western desert, which suggests its ability to link up with its Libyan branch, offering ISIS considerable strategic depth when launching attacks within Egypt. - This became evident following the unsuccessful suicide bombing attempt at the Karnak Temple in Luxor on 0 June. - Following the 997 Luxor massacre, tourist numbers dropped by % in 998 but bounced back within a year (Figure ). - A few more attempts of this nature could seriously undermine the government s efforts to win back foreign tourists. Figure Egypt Tourist Arrivals (Millions) 52

53 Iraq: Still beckoning, for adventurous investors Despite the turmoil, for three months in a row Iraq has pumped record amounts of oil. Defying the threat from ISIS, Iraq has been ramping up exports from both the Shi a south -- where companies like BP and Shell operate -- and the Kurdish region in the north, which last year reached a temporary compromise with the federal government on its right to sell crude independently. Exports are expected to rise from 2.5M bpd in 204 to 3.3M bpd this year, benefiting from the agreement with the KRG. - Oil exports have averaged 3.2M bpd so far in June when the country exported about 800K bpd of Basrah Heavy, a new grade, the first time this month. - With the new grade, Iraq could probably be able to meet the 3.3M bpd export target by the end of this year. Investors in Iraq face both tremendous opportunities and significant challenges, especially in Kurdistan. The Kurdistan Investment Board has issued 720 licences for local and foreign investments worth USD 42B since its inception in FDI represents 20% of this total. Intrepid investors, however, are more bullish than before given the fact that, when the threat of ISIS attacking Sinjar and advancing close to Erbil came, the international community and the US in particular stepped up and vowed to protect the region. In May, Norwegian energy company, DNO revealed plans to ramp up production, export and local sales following the recently completed Tawke field capacity expansion. - In Q 205, production from the DNO-operated Tawke field in Dohuk Province was 04.9K bpd, 8% of which was sold in the local Kurdish market. - From April 205 to date, production from Tawke has averaged 46.3K bpd, of which roughly 8% was sold in the local market. Potential investors remain concerned about security, but are now more likely to cite regulatory hindrances and other barriers to doing business, ranging from corruption to bureaucratic red tape to electric power shortages. Iraq (including Kurdistan) ranks 56 th out of 89 economies in the World Bank s Doing Business Index 205. ; IMF. NR/NR Table Iraq: Macroeconomic Indicators f Real GDP Growth (%) Crude Oil Production (M bpd) Oil GDP Growth (%) Non-oil GDP Growth (%) CPI Inflation (%) Fiscal Balance (% of GDP) C/A Balance (% of GDP) Total Gov t. Gross Debt (% of GDP) Total Gross Extrn'l Debt (% of GDP) Gross Official Reserves (Months of Imports) Nominal GDP (USD B) The argument against investment is that the political situation may get worse before it gets better. The fall of the strategically-important city of Ramadi may have pushed back the timeframe for retaking Mosul. Amid reports of widespread human rights abuses, particularly by Shia militias in Sunni areas, there is a possibility of clashes occurring between the various Iraqi factions fighting ISIS. - There are simmering tensions between Kurdish forces and Shia militias. But we do not expect tensions between the two sides to blow up into a major conflagration -- both sides need each other, for now, to defeat ISIS. - There are also fears of renewed sectarian clashes if the Iranian-backed Shia militias are brought into Sunni areas, particularly Ramadi. For now, ISIS s captured territory is limited to the Sunni heartlands of Iraq. Baghdad, as well as Iraqi s Shia shrine cities to the south, such as Najaf and Karbala, and the Kurdish-controlled cities to the north, such as Erbil, are well-defended and out of ISIS reach. 53

54 Jordan: SMEs - small but crucial Jordan is looking to develop its tourism, trade, manufacturing and technology sectors by small and medium-sized enterprises (SMEs). 2 More than 90% of Jordanian companies are SMEs, which account for 40% of GDP and employ 70% of the overall work force. SMEs also provide 5% of private sector output and 96% of all exports of goods. The country hopes to appeal to foreign investors by capitalising on its values and geographical location, offering the kind of stable and secure environment currently lacking in other parts of the MENA region. However, there are several challenges limiting SMEs from accelerating growth (currently at 3.%). Access to finance for SMEs remains the main challenge. This is due to various reasons, mainly collateral requirements, the lack of awareness of financing barriers and high interest rates. - On average, SMEs in Jordan only receive 0% of the financing offered by the banking sector, compared to 6% in Lebanon and 34% in Morocco. - Although the World Economic Forum s Global Competitiveness Report ranked Jordan 34 th out of 48 countries in the Ease of Access to Loans indicator, for most Jordanian SMEs, getting a loan approved by a bank remains challenging. - As a result of these barriers, many start-ups and SMEs in Jordan have been resorting to informal lending, using funds given to them by family and friends. Given the centrality of SMEs to the Jordanian economy and to job creation in particular, local authorities are partnering with international organisations to address constraints In 204, the National Export Strategy was implemented by the Ministry of Industry, Trade and Supply with the technical assistance of the International Trade Centre. The aim of this strategy is to boost SME creation, exports of services and innovative products targeting new markets, and create a favourable business environment for SMEs to access finance. ; IMF. 2 SMEs employ between 0 and 249 employees and have a registered capital of more than JD (USD 42340). Table Jordan: Macroeconomic Indicators B/BB f Real GDP Growth (%) CPI Inflation (%) Fiscal Balance (% of GDP) C/A Balance (% of GDP) Total Gov t. Gross Debt (% of GDP) Total Gross Extrn'l Debt (% of GDP) Gross Official Reserves (Months of Imports) Nominal GDP (USD B) If the strategy succeeds, this could allow smaller Jordanian companies -- many of which are family-owned -- to become more competitive in international markets. The European Bank for Reconstruction and Development signed a partnership with Cairo Amman Bank in December 204 to provide USD 20M for lending to SMEs. In an agreement signed with the Central Bank of Jordan (CBJ) in April, the Arab Fund for Economic and Social Development committed a loan of USD 00M in credit to SMEs through local banks. - The CBJ also approved the licensing of a private credit bureau to provide information about SMEs to banks, microfinance agencies and others to enable them to extend loans to SMEs. - Lack of information about SMEs has been hampering the extension of credit to them. 54

55 Kingdom of Saudi Arabia: Retail sector in the spotlight The outlook for the Saudi retail sector remains positive, led by a positive mix of economic, social and demographic factors. The country s retail sector is mainly driven by its young population, rising disposable income and increase in consumer confidence. The market is becoming competitive with the entry of international retailers through local partnerships. Retail sales is expected to reach USD 04.4B this year (3% of GDP), representing a 5.6% increase from Retail sales per capita is forecast to reach USD 4.K, a 50% increase from However, retail space per capita is currently lagging compared to other regional markets such as Dubai, thus providing ample scope for expansion of retail infrastructure in the future. - The sector saw profits rise 5.5% in Q 205 after a royal handout spurred consumer spending, and the outlook remains positive during Ramadan. Saudi Arabia s retail sector is the largest in the GCC. In 204, it represented 45% of the GCC retail market, followed by the UAE (26%) and Qatar (%). - The country s share in the GCC retail sector is expected to increase to 47% by 208. The UAE s share is expected to fall to 24% while Qatar s share is expected to increase to 2%. - Saudi Arabia ranked 7 th out of 30 countries in the 205 AT Kearney's Global Retail Development Index. 2 Saudi Arabia s ranking reflects that its market is large and unsaturated for retailers looking to expand. Food is the largest retail sub-sector in Saudi Arabia. Consumer spending on food, beverages and tobacco in Saudi Arabia rose by an estimated 5.9% in 204 to USD 64B, about 60% of total retail sales. - The growing spending power of Saudis, combined with a rising population, will ensure further growth in spending in the coming years. - Supermarkets contribute 26% of food retail sales in the country. ; Central Department of Statistics and Information. Aa3/AA- Table KSA: Macroeconomic Indicators f Real GDP Growth (%) Crude Oil Production (M bpd) Oil GDP Growth (%) Non-oil GDP Growth (%) CPI Inflation (%) Fiscal Balance (% of GDP) C/A Balance (% of GDP) Total Gov t. Gross Debt (% of GDP) Total Gross Extrn'l Debt (% of GDP) Gross Official Reserves (Months of Imports) Nominal GDP (USD B) On the other hand, increased demand for non-food items is leading to the growth of hypermarkets, which provides a comprehensive product offering. - The country currently has over 90 hypermarkets located in Riyadh, Jeddah and Dammam. As the largest exporter of crude oil in the world, an attack on oil-related facilities - even if unsuccessful - could rattle the markets. For now, there is no evidence that any Saudi oil production is at risk or that ISIS is even planning substantial attacks on Saudi oil fields or infrastructure. The attacks at the borders have been narrow in scope and mostly unsuccessful. Even if the group is considering something more ambitious, it is unlikely that Saudi Arabia would allow ISIS to succeed. 55

56 Kuwait: FDI law to boost non-oil growth With average growth in the GCC expected at 3.4%, at.3% Kuwait is a laggard. However, the non-oil sector has been performing well, supported by higher government investment in infrastructure and higher private consumption. While there have been some concerns that non-oil growth may be faltering, we do not think the data support these concerns. Non-oil GDP growth is expected to increase to 4.5% in 205 from 3.5% in 204. The recently approved development plan envisions spending around USD 2B on new projects, mostly in the oil sector, power generation, transportation and housing. On 27 May 205, American IT giant IBM received the first license to establish a 00% foreign-owned Kuwaiti company under the recently implemented "Direct Investment Law". Initially, non-kuwaitis could not hold more than a 49% stake in a company. Now with 00% ownership, it will be easier for foreign companies to bring technology, investment and financing. - IBM is expected to play a positive role in support of the modernisation of Kuwait s IT sector and in the diversification of the economic base. - IBM s strategy also bodes well for broader non-oil growth, which sits at the core of the country s expansive national development plan. In the past few years, a number of new laws have put Kuwait on the commercial regulatory forefront. - In March 204, the Central Bank of Kuwait announced that foreign banks could open multiple branches (before they could only have one branch). - The April 204 passage of telecommunications legislation signals liberalisation of the telecom sector (currently, only 3 private companies operate in Kuwait -- Zain, Wataniya and VIVA). Nevertheless, serious challenges remain. Barriers to investment include regulations that exclude 00% foreign ownership in the real estate sector, long bureaucratic delays in starting new enterprises, and a local business culture based on clan and family relationships that can be difficult for foreigners to penetrate and navigate. ; IMF. Aa2/AA Table Kuwait: Macroeconomic Indicators f Real GDP Growth (%) Crude Oil production (M bpd) Oil GDP Growth (%) Non-oil GDP Growth (%) CPI Inflation (%) Fiscal Balance (% of GDP) C/A Balance (% of GDP) Total Gov t. Gross Debt (% of GDP) Total Gross Extrn'l Debt (% of GDP) Gross Official Reserves (Months of Imports) Nominal GDP (USD B) The Saudi-led air campaign in Yemen has prompted outspoken criticisms by prominent Kuwaiti Shi a activists and politicians. Shi a of Kuwait are the only minority group in the GCC that are empowered to take a stand against their government s foreign policy on an institutional and official level. Despite this, the Kuwaiti government has increased its crack-down on Shi a anti-war critics in the past few months. - The most significant was that of MP Abdulhameed Dashti: the government considered lifting his parliamentary immunity following a complaint made by the Saudi Embassy accusing him of slandering the kingdom in Iranian-affiliated media. - The crackdown on Shi a critics suggests growing sectarianism and fears of the Iranian boogieman. But the policies have more to do with lower tolerance toward any opposition. - In recent weeks, for example, prominent Sunni MP Waleed Al- Tabtabaei was also detained for 48 hours over a tweet deemed offensive to the Kuwaiti crown prince. Given the country s already vigorous culture of political activism, such arrests are expected to fuel opposition voices, especially if there is a growing sense that authoritarianism is re-emerging. 56

57 Lebanon: Sluggish performance in construction As a result of the domestic and external uncertainty, growth remains disappointing. Real GDP growth is forecast at 2.5% for 205. While slightly better than last year, this is below potential. An improvement in domestic consumption due to lower oil prices will drive growth in 205. Inflation is expected to marginally decline to.% in 205 from.9% in 204, the lowest in a decade amid the effects of low oil prices. Year to date, Lebanon s foreign exchange reserves increased by over USD 300M to USD 39.2B, equivalent to 24.4 months of import cover. The construction sector is adjusting to slackening foreign interest by shifting to Mount Lebanon and other regions to meet growing local demand for those parts. Construction permits, an indicator of forthcoming construction activity, decreased by 9% YoY during the first five months of 205 to 5,8 new permits issued. The decline in construction permits may reflect weaker demand for land amongst foreign buyers. Data from 204 shows a 6% decline in the number of land sales to foreigners, particularly Arabs and Lebanese expatriates. - Foreign buyers have been investing cautiously due to the prevailing political paralysis that has gripped the country in the last year. - This wait-and-see attitude on the part of foreign investors is not unusual to Lebanon - for example, after a significant drop in July 2006 (as a result of the Israel-Hezbollah war), the number of construction permits rebounded in one quarter (77% increase). Mount Lebanon accounted for the lion s share of construction permits (47.4%), followed by South Lebanon(8.4%), Nabattieh (5%), Bekaa (.%), North Lebanon (6.9%) and Beirut (.3%). 2 Earlier this month, Lebanon sank deeper into political paralysis over security and military appointments. Ministers representing the Free Patriotic Movement (FPM) vowed to block any cabinet decision on any other matter until a new Army Commander and Internal Security Forces chief are appointed. The issue came to a head on 5 June; when Internal Security Forces chief, Maj. Ibrahim Basbous, was due to retire. - Efforts to extend the mandate of Basbous faced obstacles, given the FPM s strong opposition to such extensions. - The FPM is against similar efforts to extend the term of Army Commander, Gen. Jean Kahwaji, who retires on 23 September. ; IMF. 2 Order of Engineers in Beirut and the North. 3 Since 2005, Lebanon has been divided into two political camps. The 8 March alliance is one of the two. It is described as pro-syrian and led by Hezbollah. The other is the 4 March alliance. It is described as anti-syrian and led by the Future Movement. B/B- Table Lebanon: Macroeconomic Indicators f Real GDP Growth (%) CPI Inflation (%) Fiscal Balance (% of GDP) C/A Balance (% of GDP) Total Gov t. Gross Debt (% of GDP) Total Gross Extrn'l Debt (% of GDP) Gross Official Reserves Ex. Gold (Months of Imports) Gold Reserves (Months of Imports) Nominal GDP (USD B) The FPM is calling to replace Kahwaji out of respect for succession of power. But we see a different motive because FPM leader, Michel Aoun, is pushing to have his son-in-law, Brigadier General Shamel Roukoz, appointed as the new Army Commander. Politicians are expected to settle on a neutral candidate instead. - The FPM is supported by the March 8 alliance, but opposed by the March 4 alliance. 3 - The Lebanese Army is one of the last institutions that enjoy widespread public support. - Politicians across the March 8/4 divide realise the importance of maintaining this support for security reasons -- there is fear that politicising military appointments could trigger defections from its ranks, similar to those that led to the 975 civil war. The latest crisis, coupled with the year-long presidential vacuum and parliament s inability to legislate or elect a new president, is likely to slow down cabinet decisions even further over the coming months. - But we do not expect it to hamper the army given the ongoing battle in the Qalamoun Mountains against ISIS. - The FPM and its allies in the March 8 alliance appear unwilling to budge on their demands, at least until a nuclear agreement between Iran and P5+ is reached (whenever that may be). 57

58 Libya: At a critical juncture Libya s rival governments met in Berlin this month to discuss a power-sharing agreement put forward by UN special envoy, Bernardino Leon. The UN draft stipulates the formation of a national unity government that would create a new body composed of representatives of the two rival governments. - Both governments agreed to join a national unity government. But the Tobruk government rejected the power-sharing scheme. - A chief concern is that Khalifa Haftar, the renegade general appointed as Chief of Staff by the Tobruk government, might not put down arms, even if his political allies agree to make peace. Despite the Tobruk government s reservations, peace talks appear to have made some limited progress. - Political representatives from the two sides sat down at the same table for the first time since they established rival governments last year. - Qatar and the UAE have agreed not to criticise the peace process publicly, suggesting that the two have softened their positions towards one another, having supported what resembled a proxy war in Libya. o Qatar and Turkey have backed the Islamist-aligned Tripoli government. o The UAE and Egypt, which often take a harder line against political Islam, support the Tobruk government. - The two sides may be closing ranks because al-qaeda and ISIS-affiliated militant groups have gained ground in recent weeks. This month ISISaffiliated militants captured a power plant outside the western city of Sirte from Qatar-backed Libya Dawn, and then seized parts of the city itself. o o Complete control over Sirte could cement ISIS positions on the western side of Sirte Basin (home to about 70% of the country s crude reserves). ISIS already controls Naufaliya, 30 miles from oil facilities at Es Sider and Ras Lanuf. We believe that ISIS is positioning itself to move on these facilities. While they may not overrun them due to bolstered security, they still could cause damage and significantly affect oil exports. The shortage of funds has prompted the Tripoli government, which controls much of western Libya, to plan petrol subsidy cuts and delay public salary payments. Cuts at this difficult political juncture are a sign of just how bad finances are. ; IMF. NR/NR Table Libya: Macroeconomic Indicators f Real GDP Growth (%) Crude Oil Production (M bpd) Oil GDP Growth (%) Non-oil GDP Growth (%) CPI Inflation (%) Fiscal Balance (% of GDP) C/A Balance (% of GDP) Total Gov t. Gross Debt (% of GDP) Total Gross Extrn'l Debt (% of GDP) Gross Official Reserves (Months of Imports) Nominal GDP (USD B) Unless subsidies are cut or alternative funding is found, rival governments would be unable to pay salaries to public workers and to their fighters, although this does not mean that fighters would lay down their weapons. - Rather, this could encourage many to shift allegiances; the fighters come from different tribes, towns and militias, all involved in a number of ever-changing micro-conflicts. - The question is how many of these would be drawn by ISIS. This month, the Tripoli government imposed a ban on imports of over 32 goods for six months to save on foreign exchange. The ban, which includes cars, construction materials (notably cement), and few non-essential food items, is intended to halt the decline of the dinar which is now trading at over 2 dinars to the dollar on the black market, compared to the official rate of.3. The ban is expected to save the country USD 2B per annum on its import bill, but could take a toll on the construction sector which makes up over 60% of all private businesses

59 Mauritania: Favourable outlook despite low iron ore prices NR/NR Despite poor international conditions, notably a sharp drop in the price of iron ore -- the country s main export -- the economy grew an estimated 6.4% in 204, the third year running above 5%. This growth was driven by a revival in fisheries and a robust mining sector, which compensated for lower oil production and manufacturing. - The contribution of the fisheries sector to GDP increased to 2.3% in 204, from.8% in 203. It now accounts for more than 5% of export revenue and is a major source of employment. - Manufacturing activities declined by 4.5% in 204 in comparison with the 203 level. Mauritania s large resource endowment provides ample opportunities for development. Mining activities, mainly the start of new mines and increased production are expected to keep real GDP growth above 6% from SNIM, the public mining company, is projected to ramp up production to 22.7M tonnes per year by 2020 and 49.5M tonnes by The Tazadit underground mine is expected to start this year with an expected peak production of 2.5M tonnes per year after The Askaf mine is expected to start in 207 with peak production of 22.5M tonnes per year by Inflation is expected to accelerate somewhat but remain below 5% in 205, largely due to the decline in international food prices and lower oil prices. The medium-term economic outlook remains favourable despite lower iron ore prices. - Iron ore prices lost about 40% of their value between September 204 and March But benchmark prices have now recovered more than 39% since April to reach USD 60 a tonne. Mohamed Ould Abdel Aziz s regime continues to receive diplomatic support from both Arab and Western countries. ; IMF. Table Mauritania: Macroeconomic Indicators f Real GDP Growth (%) CPI Inflation (%) Fiscal Balance (% of GDP) C/A Balance (% of GDP) Total Gov t. Gross Debt (% of GDP) Total Gross Extrn'l Debt (% of GDP) Gross Official Reserves (Months of Imports) Nominal GDP (USD B) Mauritania s Islamist movement has become an important political force in the country, forming a common denominator across an otherwise heavily divided country that has struggled to confront its history of slavery. - The Muslim Brotherhood, Jamaat al Dawa movement, as well as Salafi groups enjoy strong ties with the regime and large parts of society. - They are also committed to continuing the fight against AQIM and publicly condemn its beliefs and goals. Islamist groups have helped attract financially well-endowed charities and investment from Saudi Arabia and other GCC countries and this has so far had a salutary effect, contributing to stability, through investment in education and healthcare, for example. Overall, continued international political and financial support for the regime and social stability created by the growing presence of a moderate Islamist movement are expected to contribute to foreign investor confidence

60 Morocco: The new pioneer of Islamic finance? The approval of the Islamic finance bill pending with parliament will allow foreign banks and local lenders to issue Islamic debt. It also contains measures on takaful, which allows the creation of Islamic insurers, and will enable private companies to issue sukuk. The introduction of Islamic banking could help reinvigorate the kingdom s economy by channelling savings to further investment opportunities and helping raise growth above the 4% average of recent years. The kingdom is poised to have its first full-fledged Islamic bank as early as September as it seeks to tap the USD.8T Islamic financial industry, now dominated by Malaysia, UAE, Indonesia, Saudi, Turkey and Qatar. - Morocco is the only North African country with investment grade rating BBB-. Egypt is B-, six levels below investment grade, Tunisia is Ba3, three levels below investment grade and Algeria and Libya are not rated. - Assafaa, an affiliate of the country s largest lender Attijariwafa Bank, could become the nation s first wholly Shari a-compliant financial institution when the central bank approves its switch. The central bank has already received requests from banks in Kuwait, Bahrain, Qatar and the UAE (who have expertise in Islamic banking services) to enter the market. Morocco presents substantial opportunity for Islamic financial institutions and investors; the country is home to a majority Muslim population (32.5 million), it embodies a strong heritage of waqf 2 holds a banking asset base of USD 27B, and has no stand-alone Islamic financial institutions. Global Islamic finance assets are expected to exceed USD 3.4T by 208 from USD 2.T today. Islamic banks in Morocco could account for 3-5% of its total banking assets by 208 (about USD B). SMEs account for more than 95% of businesses, over 30% of GDP and 48% of total employment. - Traditionally, SMEs have had difficulty securing bank financing because of high collateral requirements from banks. - Islamic financial institutions could improve their access to capital by extending credit to SMEs. ; IMF. 2 A waqf, is an inalienable religious endowment in Islamic law, typically donating a building or plot of land or even cash for Muslim religious or charitable purposes with no intention of reclaiming the assets. Ba/BBB- Table Morocco: Macroeconomic Indicators f Real GDP Growth (%) CPI Inflation (%) Fiscal Balance (% of GDP) C/A Balance (% of GDP) Total Gov t. Gross Debt (% of GDP) Total Gross Extrn'l Debt (% of GDP) Gross Official Reserves (Months of Imports) Nominal GDP (USD B) This can be done through participatory schemes such as mudarabah (profit sharing) and musharakah (joint venture), which allow Islamic banks to lend on a longer-term basis to projects with higher risk-return profiles. Its political stability relative to its neighbours could help Morocco progress in an industry that is stalling elsewhere in North Africa. Islamic finance was set back in Egypt when Morsi -- whose administration pledged to expand the industry -- was removed from power, but a new sukuk law now appears underway. Libya passed a law in 203 to ban non-shari a compliant banking by this year. However, successor governments to Qaddafi have been unable to assert full control over the country which now has two rival governments and parliaments, and a number of militant factions. Even in Tunisia, which directly elected its president for the first time in November, a debut sukuk sale has been delayed at least three times. 60

61 Oman: A diplomat among warmongers Oman's economy is expected to expand by 4.6% in 205 compared to 2.9% in 204, driven mainly by a strong non-oil sector. The non-oil economy constituted services (74%), industry (24%) and agriculture (2%) at end-204. Non-oil growth is expected to be primarily driven by the country s ambition to develop its transport and tourism sectors. - The sultanate's tourism development and investment arm, has been undertaking a series of initiatives to develop tourism. - These include building three to four star hotels in various tourist destinations, creation of Atana hotel chain and plans to set up budget hotels in two to three star categories in different parts of the country. Inflation is expected to remain modest over the next two years (averaging around % in 205 and 2.5% in 206), driven by lower food prices. Assuming a deal with Iran is reached this year, the country also stands to gain from welcoming an international expansion of Iranian businesses. Oman-Iran trade almost doubled to USD 933M between 202 and 204. In March 204, Iran signed a long-awaited deal to supply Oman with 0B cubic metres of natural gas annually via a 350km pipeline linking southern Iran to the port of Sohar, in northern Oman. The pipeline will be open in 207, and Iranian gas would meet 7.4% of Oman s domestic consumption. Iran and Oman also established a direct shipping line to enhance maritime trade in April 205. The line was launched between Iran s Shahid Rajaii Port and Oman s Sohar Port with two sailings per month. The first ship operating under this agreement arrived in Sohar Port on 30 May. Although trade between Iran and Oman has doubled it is difficult to see how this strong momentum could be maintained. - UAE is by far Iran s largest non-oil trade partner and is expected to remain so due to cost, convenience and established commercial links between the two countries. - Trade with Iran accounts for 6% of total UAE trade compared with less than % of Oman s. Over the last few months, Saudi Arabia has rallied a seemingly impressive coalition for its air campaign in Yemen. Importantly, though, the Saudis roped in all the GCC countries except Oman. 3 ; IMF. A/A- Table Oman: Macroeconomic Indicators f Real GDP Growth (%) Crude Oil Production (M bpd) Oil GDP Growth (%) Non-oil GDP Growth (%) CPI Inflation (%) Fiscal Balance (% of GDP) C/A Balance (% of GDP) Total Gov t. Gross Debt (% of GDP) Total Gross Extrn'l Debt (% of GDP) Gross Official Reserves (Months of Imports) Nominal GDP (USD B) Muscat views Riyadh s strategy as misguided and has therefore chosen not to participate in the Saudi-led air campaign. This view is consistent with Sultan Qaboos traditional foreign policy of neutrality and maintaining balanced and peaceful relations with neighbours. Underscoring Oman s neutral role, the office of Sultan Qaboos recently helped facilitate a meeting between US officials and Houthi representatives in Muscat. So far, the meeting has led to the release of an American journalist, Casey Coombs, who was taken hostage by Houthi rebels last month. Oman has acted as a third-party mediator in the past. - Oman facilitated and hosted a number of secret meetings between the US and Iranian officials in 202 on Iran s nuclear programme. The talks led to the historic framework deal in Lausanne in April and negotiations are in their final phase to reach a final agreement by the end-june deadline. - We expect Oman to continue working as a diplomatic bridge between Iran and its regional allies on the one hand, and GCC countries and their Western allies on the other. 6

62 Palestine: Broken promises delay reconstruction The destruction of infrastructure, property, human loss and displacement following the 204 war with Israel continue to plague Gaza. Over 2000 Palestinians lost their lives and thousands more were displaced. Economic activity contracted in 204, following the war in Gaza in the summer and mounting political tensions in the West Bank and East Jerusalem. - Manufacturing output dropped by 28% in 204 as close to a thousand enterprises were partially or fully destroyed. - Output in the agricultural sector also declined by 3% in 204 as farms and arable land in Gaza were damaged by the conflict. Unemployment, already bad, became worse following the conflict. The unemployment rate reached 43% in Gaza and 7% in the West Bank. Youth unemployment in Gaza (60%) is perhaps one of the highest in the world. Gaza residents lack access to basic public services such as electricity, water and healthcare. - This is worsening living conditions and making the survival of.8 million residents within an area of 60 km 2 even harder. - Forty percent of Gaza s population now live below the poverty line. The reconstruction process is moving far more slowly than expected, reflecting the failure of donors to provide the aid promised, and by the restrictions that Israel has imposed on the movement of goods. Gaza requires an estimated USD 7.8B for its reconstruction. Some USD 5.4B was pledged at the international conference in Cairo last October but only an estimated 28% (USD 945M) had been disbursed as of April 205. Israeli restrictions on Palestinian imports of construction materials are delaying the reconstruction process. While there has been some progress in the provision of materials for the repair of individual houses, larger construction projects that would also help job creation are still pending. NR/NR Table Palestine: Macroeconomic Indicators f Real GDP Growth (%) West Bank Gaza CPI Inflation (%) Fiscal Balance (Ex-support, % of GDP) Recurrent Budget Support (% of GDP) C/A Balance (% of GDP) Nominal GDP (USD B) Unfortunately, other conflicts in the area and a general donor fatigue seem to have pushed the plight of Palestinians to the background. The private sector is expected to play a key role in the country s development more generally. The World Bank and the Palestinian Monetary Authority have been discussing strategies that could enhance the private sector s performance. - In April 205, a workshop was organised by the Bank to design a new Credit Guarantee Facility (CGF). - By providing credit, the CGF could increase private investment and aid economic recovery in Gaza. This initiative will also allow private companies to restructure old loans and negotiate new loans on better terms, especially for firms that lost collateral and can no longer access financial resources. ; IMF. 62

63 Qatar: A stellar performance in banking The fall in oil prices has had a limited impact on Qatar s financial services sector. Banking assets grew 0.5% in 204 with higher lending to the private sector offsetting the decline in loans to the public sector. Strong economic growth in 204 (6.%), conservative lending practices and strong regulatory supervision helped keep nonperforming loans at.7% of total loans at end-204. The average capital adequacy ratio for Qatari banks (2.8% of risk weighted assets at end-204) remains above the Basel III requirement of 2.5%. The return on equity of Qatari banks of 8% exceeds the GCC average of 4%. Domestic loans grew by 3% last year (Figure ). Private lending is expected to accelerate in the coming years -- in the 0-20% range -- as demand for corporate loans remains high. Realising the limitations of its small domestic market, Qatar continues to seek opportunities and acquisitions regionally and internationally and this trend will continue over the medium term at least. Qatar is spending USD 200B on infrastructure and development projects in the run-up to World Cup in 2022 and as part of its 2030 National Vision. The bulk of the financing for the World Cup comes from the public sector as part of the national budget. But, bank lending is picking up as the government and companies borrow to fund expansion in support of the hospitality sector in anticipation of the event. ; IMF. 2 Central Bank of Qatar. Aa2/AA Table Qatar: Macroeconomic Indicators f Real GDP Growth (%) Crude Oil Production (M bpd) Oil GDP Growth (%) Non-oil GDP Growth (%) CPI Inflation (%) Fiscal Balance (% of GDP) C/A Balance (% of GDP) Total Gov t. Gross Debt (% of GDP) Total Gross Extrn'l Debt (% of GDP) Gross Official Reserves (Months of Imports) Nominal GDP (USD B) Figure Qatar Banking Sector (USD, B & %) 2 63

64 Qatar: What if? Qatar s hosting of the World Cup has been surrounded by numerous controversies, most significant of which has to do with allegations of votebuying during the 200 bidding process. In practical terms, Qatar could lose the 2022 World Cup, and there is still enough time to find a replacement host before Legally though, this is uncharted territory and it all comes down to the interpretation of FIFA s rules. Moreover, the Qataris would likely fight with every legal resource at their disposal. - But it is not clear whether Qatar faces any serious risk yet. It has denied any wrongdoing in the bidding process. And so far, no proof has been found that it won its bid by corrupt means. If Qatar loses the right to host the World Cup, short-term economic implications could be expected. Spending on infrastructure directly related to the event (stadiums, retail and hotels) would naturally slow down. Many of these projects (such as Lusail City, the railway and metro) had been planned before Qatar was awarded the World Cup and are integral parts of the 2030 National Vision. - Direct World Cup-related spending (stadiums and hotels) is fairly small at approximately USD 6B and is only about -.5% of GDP per annum over the period. As such, we do not expect a major impact on economic activity. - There could be temporary effects on banking activities. However, banks in Qatar are structurally sound and there is little to suggest that their balance sheets will be harmed by the cancellation or slow down of some of the ongoing projects. If Qatar keeps its hosting rights, the spotlight on its labour laws will remain. World Cup-related construction projects underway have had an unexpectedly beneficial effect; it has brought with it greater exposure to the difficult working conditions of millions of expatriate labourers, who make up the bulk of the workforce in the GCC.. Figure Migrant Workers in Qatar by Country Aa2/AA At the heart of the abuse is the kafala system, which puts far too much power in the hands of the employer/sponsor. - So far, Qatar has introduced a wage protection system that makes it mandatory for companies to pay through bank transfers. - But pressure continues to build on Qatar to address other issues such as: delays in payments of migrants wages; the harsh and dangerous working conditions, poor living conditions; and the lack of enforcement mechanisms to deal with issues of forced labour and physical and sexual violence. - If this pressure is kept up, we expect the change to have an impact beyond Qatar, in other GCC countries with similarly difficult blue collar labour conditions. 64