Bitter Lemons Middle East Roundtable January 10, 2008 Arab stock markets and economic liberalization

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Middle East Roundtable


Edition 2 Volume 6 - January 10, 2008

Arab stock markets and economic liberalization

• PSE reflects Palestine's extraordinary circumstances - Sam Bahour
Addressing the weaknesses of the PSE must come within the framework of the entire Palestinian problem.

• Dubai: Bridging time zones and boosting confidence - Christopher Davidson
The DIFX would now seem to represent an important opportunity for both domestic growth and access to international markets.

• Overview: A two-way street - Riad al Khouri
A handful of key shares generally tend to dominate individual Arab bourses.

• Jordan: ASE closes to good cheer - Yusuf Mansur
The outlook for the ASE in 2008 remains positive, even though there is evidence that it may be a difficult year for the economy as a whole.

PSE reflects Palestine's extraordinary circumstances
Sam Bahour

One of Palestine's many bittersweet economic achievements since the Oslo peace accords is the establishment of the Palestine Securities Exchange. Based in the troubled northern West Bank city of Nablus, the exchange shares the reality of a brutal military occupation alongside the never-ceding steadfastness and resilience of the Palestinian community's desire to build a normal life and a free market economy.

The establishment of the PSE was a sweet achievement in that it was set up under conditions of a yet-to-be nation state that was, and continues to be, under Israeli military occupation. The number of listed firms has grown even while the economic strangulation of the Palestinian economy by Israel and the international community continues unabated. The bitterness of the PSE is that many of the inherent structural weaknesses of the Palestinian economy and governance style are reflected within it. This leaves significant room for improvement.

There are only 35 companies listed on the PSE: six from the banking sector, four from the insurance sector, eight from the investment sector, 10 from the manufacturing sector and seven from the services sector. Shares are listed in either US dollars or Jordanian dinars.

Total market capitalization for the first eleven months of 2007 was $2,452,808,833 with the number of transactions 149,538, the value of traded shares $759,787,133 and trading volume reaching 283,218,841 shares. There are nine Palestinian brokerage firms located throughout the West Bank and Gaza Strip.

The market's blue chip stock is the Palestine Telecommunications Company (PALTEL); the Palestine Development & Investment Ltd. (PADICO) is the second largest company listed on the PSE. Despite a noticeable decline of the trading shares value of these two companies during the last period, their shares remain the most traded shares in the PSE and they command 78 percent of all traded shares in the market.

Over the past two-three years, growing numbers of non-Palestinian institutional and individual investors have entered the market in a significant way, one in particular from Kuwait that also acquired partial ownership in one of the leading brokerage firms.

It is relevant to note that PADICO owns a controlling amount of PALTEL shares and owns many of the traded companies listed on the Exchange, as well as the PSE itself. Until recently, the chairman of PADICO was also the chairman of the PSE, but more recently an ex-minister was appointed as chairman and also serves as the CEO. Plans to list the PSE itself on the exchange, opening a significant percentage of shares to public investment, have been floating for years but haven't materialized yet.

It has been repeatedly noted that non-institutional trading happens more on the impulse of individual traders following wealthy businessmen's (sadly all are men) investments rather than as a result of investors having any real data, analysis, knowledge or understanding of the firms they are investing in. Several leading investors have taken advantage of this market weakness to list more and more companies on the PSE, knowing that investors will follow them without understanding the core business of the companies they are investing in.

The result of this lack of individual shareholder savvy is that many IPOs are over-capitalized from the start, giving these start-up firms extra cash to create and trade securities portfolios in parallel to their main business. As the Palestinian market collapsed from the weight of the past seven years of intensified conflict and a depreciating dollar, many publicly traded firms quietly registered their traded portfolio losses with little repercussion from shareholders, who did not question why their investments were turned around and for investments in security portfolios instead of serving an intended business plan.

The Palestinian investment community is still in need of more media work, newsletters, workshops and seminars to educate it about the importance and risks of investments in securities. Specifically, the market is in dire need of independent, financial- and business-specific journalists that have the courage to undertake bold investigative reporting of the dealings of publicly traded (as well as privately held) firms.

Recently, however, the Palestinian Authority set up a Capital Markets Authority to regulate the PSE and the brokers, a proper and strategic step forward.

Brokerage firms play a pivotal role in spreading awareness among the community of investors, and their role is of great importance in attracting small investors to buy shares with their savings. However, a troubling development is the role of insider trading via the brokerage firms. With a weak legal system and a nascent regulatory authority, insider trading is taking its toll. When Gaza was overrun by Hamas in mid-2006, the market hardly even reacted, an indication that market dynamics are not the only factor at play in sustaining the stability of the PSE.

Prior to the creation of the CMA, the PSE at the outset of the second intifada placed a five percent upper and lower limit on daily trading to protect the market from collapsing. Since the CMA was established, the most significant action taken to date was to investigate and publicly announce wrongdoing in one of the major brokerage firms.

In a December 2007 front-page advertisement, the CMA announced serious infractions by the United brokerage firm and listed steps the CMA is taking to rectify the situation. The firm had been caught executing sale and purchase deals of shares in the Jordanian financial market through a Jordanian firm by using the names of several people without their knowledge and issuing fictitious vouchers on their accounts.

For Palestine, this was a bold public move that was welcomed in the marketplace and created a positive buzz that white-collar wrongdoing (in the financial markets and throughout the market as a whole) may start to be seriously and aggressively pursued and hopefully prosecuted as well.

The PSE was created to address the need to attract long-term funding for productive infrastructure projects in Palestine as well as the savings of Palestinians inside and outside the country. It is considered one of the emerging securities exchanges in the Arab world, but operates under the extraordinary circumstances of having to mitigate market risks that are embedded in a 40-year ongoing military occupation. The Palestinian economy has not yet reached a state where it can be separated from the Israeli economy due to the nature of the Paris economic protocol that supplemented the Oslo agreement and linked Palestinian financial and economic institutions with their Israeli counterparts.

The PSE has been able to persist under the difficult economic conditions caused by the Israeli occupation practices that affect all areas of economic activity, including finance and business. But addressing the weaknesses of the PSE must come within the framework of the entire Palestinian problem.- Published 10/1/2008 © bitterlemons-international.org

Sam Bahour is a business consultant based in Ramallah/El-Bireh. He participated in the effort to list two national firms on the PSE: PALTEL and PLAZA.

Dubai: Bridging time zones and boosting confidence
Christopher Davidson

For the last seven years the emirate of Dubai has been operating a domestic stock exchange, as part of wider attempts to create a vibrant, diversified economy that supports a range of non-oil related activities. Although it experienced a sluggish start and was exposed to a Gulf-wide crash, the original exchange would now seem to have consolidated its position and, most significantly, has recently been joined by a Dubai-based international financial center and an international exchange. This has attracted much interest given its pioneering regulatory framework and its ability to bridge the time zones of other global stock exchanges.

Founded in March 2000, the Dubai Financial Market grew to list several dozen companies, most of which were Dubai and UAE-based. Despite the bursting of the "Gulf bubble" in early 2006 and the loss of over 50 percent on the value of most listed shares, by the close of 2007 the DFM was nevertheless still listing about 60 domestic companies and was reporting a respectable total market capitalization of about $350 billion. Importantly, in 2004 it was decided that this DFM would be complemented by a Dubai International Financial Exchange--a new stock exchange that would permit foreign nationals to own shares and therefore allow Dubai to absorb some of the surplus liquidity being generated by hydrocarbon-rich economies in Abu Dhabi, Saudi Arabia and elsewhere in the region.

Crucially, in an effort to boost investor confidence, Sheikh Muhammad bin Rashid al-Maktoum, then the crown prince of Dubai, announced that this DIFX would be housed in a financial "free zone" that would be unencumbered by local legislation, in much the same way as the free zones for foreign internet and media companies that he had established in 2000, and in the same way that his father had allowed foreign manufacturers to set up free zone headquarters at Jebel Ali since the mid-1980s. Moreover, it was decided that the DIFX would operate in a US dollar-denominated environment and that the free zone's regulatory framework would be based on English law, not least because the majority of Dubai nationals and expatriates in the Gulf with a financial background had been trained in the City of London. Foreign experts were enlisted (from Standard Chartered and Julius Baer) to assist with the project, and in 2004 the Dubai Financial Services Authority was set up to administer the Dubai International Financial Center and its constituent DIFX. An impressive Arc de Triomphe-style headquarters building for the DIFC was constructed close to Sheikh Zayed Road and within months this gateway complex was home to a number of well-respected international financial institutions including KPMG, Swiss Private, Swiss International Legal, Merrill Lynch, and Credit Suisse.

Within the next few years, more banks, including Mirabaud and Volaw, are likely to open branches, with many citing the DIFC's impressive infrastructure, its solid reputation and its potential to serve as an alternative location to the City of London for Islamic banking products. Indeed, the DIFC's location close to emerging markets in Muslim-dominated Pakistan and East Africa is thought to be ideal, as is its proximity and historic linkages to Bombay--a market that is likely to become enormous when the rupee becomes fully convertible and as India continues to liberalize its economy. Significantly, in the wake of the 2006 crash, the DIFX has begun to gain momentum, with many international firms believing that it will soon serve as an important way station between the time zones of the much higher volume stock exchanges in Europe and Asia. Moreover, for domestic UAE companies, most notably Dubai's Emaar Properties (which became a 67 percent publicly owned company following its flotation), the DIFX would now seem to represent an important opportunity for both domestic growth and access to international markets.- Published 10/1/2008 © bitterlemons- international.org

Dr. Christopher Davidson is author of "The United Arab Emirates: A Study in Survival" and the shortly forthcoming "Dubai: The Vulnerability of Success".

Overview: A two-way street
Riad al Khouri

In the Arab world as elsewhere, stock markets mirror the economy as a whole. When Wall Street falls, Americans feel poorer, with often-serious implications for the rest of the economy; rising shares on the other hand make people feel richer. The rhythm of the markets is sometimes as significant as the direction of share prices, with a huge climb or drop in one day, for example, having a different effect on sentiment than the same price change spread out over a week. Volume is also important: a market with a handful of companies or a modest number of their shares traded daily is not usually an accurate mirror of business.

However, stock exchanges are more than just reflections of changes in the "real" sector, especially in emerging economies. Widespread share ownership is usually associated with open economic systems as business power devolves away from states or oligarchies. Bourses are also places where people or companies raise fresh capital to set up new businesses or to expand old ones--perhaps the most important of their functions.

In these and other respects, Arab bourses--where they existed--used to be laggards, but no more. Developing regional share markets over the past few decades have served to make doing business easier, and help people become richer. When the first oil boom began in the mid-1970s, most Arab countries did not have share markets; today, the majority of regional capitals can boast a stock exchange of increasing size and sophistication. In the context of overall economic liberalization in the Arab world, the establishment, development and reform of bourses has interacted positively with other change, as more transparent and professionally run share exchanges have emerged hand in hand with liberalizing economies.

Jordan is an example of how things have gone well in this respect, with the Amman Stock Exchange proving to be an important element of the positive economic change that has characterized the country. The year just ended confirmed this trend, as the ASE general index surged 36 percent during 2007. Market capitalization surged by 39 percent to $41.2 billion, representing 289 percent of Jordanian gross domestic product. This percentage is one of the highest in the world, reflecting the importance of bourse activity in Jordan's economy. Moreover, the trend in these important indicators is sharply up, with bourse capitalization having been a mere $11 billion in 2003, closer to the equivalent of the kingdom's GDP at that time.

Before readers of bitterlemons-international.org drop everything to rush out and buy stocks on the ASE, a word of caution: the Jordanian bourse remains a delicate one dominated by the share of one business, the Arab Bank, which still makes up a big chunk of market capitalization and activity. Though robust and soundly managed, if that august institution's chair so much as sprains his wrist the whole ASE can begin to look wobbly. Not that this isn't a feature of other Arab bourses: for example on the Beirut Stock Exchange, 74 percent of total trading activity of the last week of 2007 was in one company, Solidere, the real estate developer, typical of that firm's dominance of the Lebanese bourse.

The Beirut exchange wobbled nervously in 2007 due to the country's chronic political crisis, but still managed to record a 26 percent annual rise. Though that was not as strong as some other Arab bourses, the achievement was quite good considering that the country has become a laggard in both the growth of its economy and the reform and development of institutions. The same pattern looks to be emerging in 2008, as the first week of the year saw shares zooming upward on news of an Arab reconciliation initiative to bring feuding Lebanese factions together. I hope I am proved wrong, but sadly this trend will probably not last and the next few weeks or months will mostly be ones of economic instability coupled with further delays in implementation of much needed reforms.

Though Beirut is an extreme case, a handful of key shares generally tend to dominate individual Arab bourses, partly a reflection of the still-oligarchic nature of their systems. Nevertheless, regional stock exchanges continue to diversify. For example, the 2007 climb in the ASE general share price index was due more to the 31 percent rise in industrial shares than the 14 percent gain in the financial sector, which of course is dominated by the Arab Bank. Another reflection of diversity on the ASE is that among top gainers were shares of media companies, quarrying and mining industries, energy firms and information technology and telecom entities, their sub-indices going up by 81, 70, 59 and 38 percent respectively. Banks also did well, but were not market leaders.

Diversity in the nationality of shareholders is also becoming more of a feature of Arab markets. For example, net foreign investment on the ASE was almost 49 percent of overall market capitalization at end-2007, compared to the 2004 figure of 41 percent; non-Jordanian Arabs' contribution was close to 36 percent while that of others accounted for about 13 percent. Sectorally, non-Jordanian ownership of industry stood at 52 percent while that of the financial institutions was 51 percent and other services 36 percent. Though a more smoothly running stock exchange also helped, these high percentages would have been difficult to achieve under the kingdom's restrictive investment laws of a decade ago, a change toward liberalization paralleled in other Arab countries.

Look for more of the same in 2008.- Published 10/1/2008 © bitterlemons- international.org

Riad al Khouri is visiting scholar, Carnegie Middle East Center, Beirut, and senior fellow, William Davidson Institute, the University of Michigan, Ann Arbor.

Jordan: ASE closes to good cheer
Yusuf Mansur

The Amman Stock Exchange (ASE) closed with a big bang in 2007. The surge in activity buoyed by trading in stocks of the relatively large listed companies and trading contracts, enabled investors to recoup some of the losses sustained in 2006 (although 2005 remains the star year as far as the performance of the ASE is concerned). The outlook for stocks in 2008 is mixed albeit positive; however, the overall economy paints a different picture.

The ASE General Weighted Price Index rose by 36 percent and market capitalization increased by 13 percent from the previous year. The number of listed companies expanded from 227 in 2006 to 245 in 2007. Trading volume reached JD12.3 billion (JD=US$1.41, pegged since 1995), a decrease of 13 percent from the trading volume of the previous year, while the number of traded shares increased from 2006 by 9 percent to reach 4.5 billion shares. Market value of the listed stocks in the ASE rose to JD29.2 billion (representing 289 percent of GDP) by the end of the year, a sustained increase of 39 percent over the same period in 2006.

But such a marked improvement in performance is still a far cry from that of 2005, which was a great year for anyone who dabbled in the stock market. In 2005, market capitalization doubled to more than triple GDP, value traded and daily turnover more than quadrupled, number of traded shares doubled, turnover ratio was close to 100 percent, the change in ASE General Weighted Index almost doubled, the price/earnings ratio was up 30 percent and so forth. In short, the market was a jackpot for anyone with some change to spare and spare it they did. Even non-Jordanians, wanting a share of the pie, contributed 45.3 percent of total market investment that year. Accordingly, the stock price index closed in 2005 at 9500 points, compared to 7519 in 2007.

The strong performance of the ASE in 2007 was not in synch with the GDP growth rate, which was lower in 2007 than in 2006, according to initial estimates that place GDP growth at 5.8 percent compared with 6.3 percent in 2006. Such a de- buckling may be viewed as paradoxical if it weren't for the fact that the Jordanian economy is heavily affected by regional developments and the price of oil.

Petrodollars from the Gulf countries have continued to find their way into the ASE as oil prices continued to skyrocket in 2007. Almost half the market capitalization is owned by non-Jordanians, the majority from Gulf countries. Net investment by non-Jordanians increased to JD469 million by November 2007 compared with JD181 million by the end of 2006. Also, non-Jordanian ownership increased to 48.2 percent in 2007, compared with 45.5 percent in 2006.

Another factor that contributed to the growth in the ASE in 2007 had more to do with the deceleration in the real estate market and falling levels of liquidity, which shifted investors from the real estate market to the stock market in search for quick turnaround and short term liquidity gains. Additionally, investors went for the large companies instead of the smaller speculative stocks, an indication that money was being more selective and sophisticated in 2007 than in previous years and that small investors have shied from trading in 2007.

The outlook for the ASE in 2008 remains positive, even though there is evidence that it may be a difficult year for the economy as a whole. One reason for the expected positive performance of the ASE is that inflation will be higher in 2008, which will reflect in higher stock prices. In 2007, the average Jordanian household consumed 20 percent more than it earned, the disparity between rich and poor grew to an alarming rate, and even though prices of oil derivatives were not increased, the prices of other basic commodities, consistent with the world trend, increased in spite of the introduction of some price controls. Also, failing to evaluate the JD against the US dollar added to the inflationary pressure in an economy that is a net importer with a trade deficit that reaches more than half of GDP, the majority of it in currencies that have appreciated against the US dollar.

Inaction by the government will most likely lead to a greater erosion of the purchasing power, increase stock prices, distance small investors from the market, and increase the disparity between those who have and those who have not. A mixed bag indeed.- Published 10/1/2008 © bitterlemons- international.org

Yusuf Mansur is the managing partner of the Envision Consulting Group (EnConsult) and former CEO of the Jordan Agency for Enterprise and Investment Development.



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