Outlook on MENA JAN 2021

Summary • MENA equities were dominated by the effects of the COVID-19 pandemic during 2020, with domestic governments taking unprecedented economic measures to support their respective economies. • During lockdown periods, stockpiling of necessities, During the early days of the pandemic governmen moved swiftly, digitisation, and e-commerce became key themes, providing relief measures by way of loan deferments, fee waivers, as consumers purchased goods using e-commerce liquidity-enhancing measures such as zero-cost deposits, and in platforms. certain cases, operating expense-related subsidies by way of salary • We view our strategy as well positioned to benefit from a support for citizens. rebound in the global economy and demand in 2021. We continue to favour the markets and companies trading at The MENA region saw its population shrink over the year, mainly attractive multiples, while being selective and cautious on the expat front, and especially in countries where this constitutes about the universe of companies that look expensive on a large portion of the population. This occurred for various reasons, an absolute and relative basis. including job losses as the pandemic tightened its grip globally. During this period, stockpiling of necessities was also a common theme, with the markets rewarding the sectors with inelastic demand, such as consumer staples. The sudden boost in e-commerce 2020 was challenging for populations across the globe, with the and digitisation efforts saw some consumer discretionary names COVID-19 pandemic wreaking havoc for the majority of the year. adapting to the situation and finding favour among investors. Since it began, we witnessed restrictions varying from domestic In terms of market performance, interest rate cuts and a significant curfews to national lockdowns and global shutdowns, impacting influx of liquidity through zero-cost deposits resulted in increased logistics and travel among other things, as countries struggled to trading activity in the MENA region, in line with what was contain the virus. The and North African (MENA) region witnessed globally. This resulted in and was not untouched by the pandemic and was quick to react to the recovering quickly and recouping the initial losses to become the situation. While the markets had started 2020 on a strong footing best-performing regional markets. with sound economic data providing the perfect platform for growth, the lightning pace of the virus spread surprised markets and resulted in a broad-based sharp decline. This led domestic governments to take unprecedented economic measures to support their respective economies.

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Country Focus or the economy witnesses a V-shaped recovery fuelled by government- backed spending. This in turn will depend on government budgets, oil Saudi Arabia prices stabilising, and a vaccine being fully rolled out. 2020 began on a strong footing for Saudi Arabia, backed by a strong We continue to focus on the steep rise in debt-to-GDP in Saudi set of economic data. However, the fast spread of the virus brought an Arabia, which is expected to reach 34% by 2021, against less than abrupt halt to all economic activity along with curfews and eventually 10% just five years ago. a lockdown by the end of the first quarter of 2020. Investor fears led to a steep decline in the markets. During the lockdown, stockpiling, UAE digitisation, and e-commerce became the key theme, as consumers UAE markets, which are trading at relatively attractive multiples piled up on necessities using e-commerce platforms. In order to (especially which is trading at a PE of 10),2 were hit hard by curb the rising deficit and the cost to the exchequer, the government the pandemic. While the government moved quickly to allay investor announced a VAT increase from 5% to 15%, along with a hike in concerns with economic support and stimulus packages, the fact custom duties on most products, while also rationalising yields on that a major portion of the economy is exposed to external shocks mortgages. did not help. For example, Dubai’s economy is largely driven by Swift action by the government in providing deferrals and relief tourism, hospitality, and trade, which have been badly impacted by measures targeted at the Small and Medium Enterprises (SME) sector the COVID-related restrictions. Furthermore, Dubai’s real estate along with interest-free deposits at helped alleviate any concerns is relatively more exposed to expat investments as compared to Abu regarding domestic liquidity. With the opening up of the economy Dhabi, which made matters worse. Having said that, we believe the during the second half of the year and the swift response of the nimble-footed action by the federal government, and the strong government to the pandemic, economic activity returned with strong recovery since opening up the economy, positions Dubai to be cement sales, upbeat lending data backed by the high-yield mortgage amongst the first economy to be out of the woods once vaccines are segment and low cost of risk in light of economic recovery, and strong ready for mass distribution. We believe aviation, hospitality, and retail consumer spending in the discretionary sector, to name a few. will be the key beneficiaries as global economic activity picks up, given Dubai’s high rank among top travel destinations. Despite the wider fiscal budget deficit of 12% of GDP achieved in 2020, the government is budgeting a 7% year-on-year cut in spending On the other hand, we believe Abu Dhabi, with its deep pockets, for 2021 as it is sticking to its plan to narrow the fiscal deficit with has shown strong leadership in terms of support to the entire UAE an eye on a balanced budget by 2023. Most of the spending cut is economy. The government will lead on spending in key domestic going to be recorded in capital expenditure, reinforcing the role of industries such as trade, logistics, staples, and hospitality, backed by the Public Investment Fund (PIF) in shaping the Kingdom’s future its 100 years of oil reserves. In recent times, the central extended growth and driving the capital expenditure programme through the the loan deferrals supporting SMEs and individual clients until the previously announced mega projects. From that perspective, the PIF first half of 2021, backed by zero-cost deposits with the banks, thereby announced that it plans to invest SAR150bn ($40bn) annually in further cushioning the hit to the business sector. the local economy over the next two years, compared to SAR58bn in In a nutshell, sustained backing by the government, strong capital 2019. On the revenues side, the government seems to have built its buffers with the banks amidst controlled asset quality deterioration, budget based on an oil price of $45 a barrel, which seems conservative and a pick-up in economic activity per the PMI index indicate, the and leaves room for upside. Revenues in 2021 are expected to increase UAE is well positioned to recover and grow its economy. The same will 10% on the back of taxes on goods and services related to the tripling likely be reflected in the market as it re-rates from current single-digit of the VAT and the increase in custom duties. Overall, the budget PE multiples. seems to be expansionary, especially given the PIF’s pushing ahead with its ambitious spending plan. It would be interesting to see Qatar whether this shift in the development model, where the PIF’s spending Despite an environment of low oil prices and the global pandemic, compensates for the sharp fiscal retrenchment and reduced capex by the country managed to maintain a twin surplus with its prudent the central government, proves to be effective in driving the economy expenditure policies, in line with the current situation. Thus, its stock in the right direction. market has outperformed the benchmark, given capital flight towards While Saudi Arabia traded in positive territory during 2020, we more defensive markets. Per estimates, the country has an accumulated believe the strong performance has been a result of factors beyond buffer of US$320bn (165% of GDP)3 in its . fundamentals, such as low interest rates, excess systemic liquidity, and The country has made conscious efforts to diversify its economy away COVID-related one-offs including lack of travel, that fuelled domestic from oil and over the long term expects domestic production of key spending. The recovery is expected to be gradual in our opinion, and food items to increase, in light of the embargo from neighbouring 2021 might not witness growth across all the sectors. To put things Gulf states. During this challenging period, the government ensured into perspective, the Tadawul Index is currently trading at near 20x investments into key infrastructure projects, which helped boost forward PE as against its historic average of 14x.1 As such, for market the economy and supported market outperformance. In addition, a outperformance to continue we strongly believe the market should medium-term catalyst will be the FIFA World Cup in 2022. Over either re-rate, which is least likely given the already expensive multiple, the long term, Qatar is investing into enhancing its production of 3 liquefied natural gas (LNG) in the North Gas Field by 30% by 2025 We believe valuations are too attractive to be ignored with the Omani and 67% by 2030, which should help reduce the fiscal breakeven oil market trading at a PE of 9x, but the near-term macro concerns price from $53 to $42 a barrel and external breakeven down from $58 continue to pressure the economy. We thus approach the market to $48 per barrel.4 selectively, focusing on high-quality names that we do not believe deserve such a large discount. As stated above, we believe the market currently has priced in the positives, as it trades at over 18x its forward PE, against a historic average of 12.5x, mainly backed by liquidity and a low interest rate environment. A potential resolution of the political and economic Egypt was the only country within the MENA universe that saw blockage of certain GCC countries on Qatar could also be taken positive growth in 2020 and is even expected to post real positive positively by the market, even though the government has built a self- growth for 2021, as the country seems to have done an excellent job sustained and independent type of economy over the years since the implementing its International Monetary Fund (IMF) programme. embargo began. Egypt’s stimulus packages provided a much-needed cushion for private spending and demand, driving positive GDP growth. Inflation numbers were well contained during the year, averaging around 6% and within the central bank zone of 9% (+/-3%). With the steady, Historically, Kuwait’s economy suffered from the political deadlock lower inflation rates accompanied by carry trade inflows, given Egypt between the parliament and the government, with project execution still offers the highest margin of real interest rates, rates are expected rates hovering at around 48%.5 Given the pandemic and the resultant to continue their downward trajectory, on top of the 400 bps rate cut low oil prices, the fiscal deficit for 2020 is predicted to reach 14% of seen in 2020. This backdrop should be conducive for a stable currency, GDP. The country witnessed another deadlock over passing regulation in addition to a pick-up in the capex cycle for corporates which lagged to increase the country’s debt limits, thereby negatively impacting in recent years, given the historical high interest environment. Overall, liquidity. The recent parliament elections resulted in an increased this should be positive for banks and should translate into higher participation from opposition members which suggests that passing lending activity for corporates in general. Furthermore, we are positive new and much-needed reforms will remain difficult and could lead to on the healthcare, services, and consumer sectors, where a lack of increased fiscal austerity. penetration has been a common theme. Stock selection within these During the year, Kuwait witnessed a smooth transition of its rule to sectors is key to finding the right opportunity at the right valuation. the new Emir, which was well accepted by the markets. The country’s inclusion into the MSCI Emerging Markets Index provided further MENA Market Could See Rotation in 2021 impetus to the market, as many investors built up positions in the Within MENA, we have seen the development of two different likely large-cap names ahead of the move. With the benchmark universes of stock markets. The first is expensive, such as the markets inclusion behind us, and given a widening fiscal deficit and the of Saudi Arabia, Kuwait, and Qatar, which continues to attract buying government’s inability to provide funding, concerns will likely rise activity and thus outperforming. The second is deep value, mainly over whether the market can maintain its current expensive valuation. Dubai and , which continues to be neglected and trading at Oman cheap multiples. Oman was the worst-affected economy by the pandemic with a high Within this backdrop, we see two possible scenarios. One scenario oil breakeven price and debt-to-GDP close to 80%, up 20% year over would translate into continued outperformance of expensive markets, year. To further aggravate the situation, the country witnessed a sharp which would become even more expensive. Here we would need to decline in its sovereign wealth fund and a fiscal deficit that reached see corporate earnings growing enough to justify the already high 17% in 2020.6 In light of this, we believe the country needs to raise multiples. Another scenario would be where the cheaper markets start further debt along with privatising vast government-owned entities, or to attract buying interest from investors, which would translate into at least reduce government stakes in many listed entities. All that said, the re-rating and rotation of the overall market. We see the second Oman is well positioned politically to get financial support from the scenario as more probable, especially if this is combined with a strong GCC partners and other neighbouring countries, with Qatar recently rebound in economic activity in lagging markets (such as Dubai) depositing $1 billion in the banking system to enhance the country’s supported by vaccine developments. liquidity requirements. Accordingly, we believe that our strategy is well positioned to benefit Over the last few years, the government increased its investments into from a rebound in the global economy and demand in 2021, and its infrastructure, undertaken fiscal reforms, and reduced subsidies, which resulting effect on MENA markets. We continue to favour markets should help boost revenues over the medium term. Furthermore, and companies trading at attractive valuations, while being selective many of these steps undertaken were used to attract foreign direct and cautious about the universe of companies that look expensive on investment (FDI) into the energy and petrochemicals sector, and an absolute and relative basis. in the Duqm project alongside investment from China. However, given the pandemic, we believe the benefits will be delayed as some investments were postponed. Outlook on MENA

This content represents the views of the author(s), and its conclusions may vary from those held elsewhere within Asset Management. Lazard is committed to giving our investment professionals the autonomy to develop their own investment views, which are informed by a robust exchange of ideas throughout the firm.

Notes 1 As of 31 December 2020. Source: FactSet, LAM Research 2 As of 31 December 2020. Source: FactSet, LAM Research 3 As of 31 December 2020. Source: SWF Institute 4 As of 13 November 2020. Source: S&P Global and LAM Research 5 As of December 2020. Source: EFG Hermes Research 6 As of December 2020. Source: IMF

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