Experts from the EU and its Mediterranean partner countries last week highlighted the need for modernising the region's financial sector to induce private sector-led growth. Niveen Wahish reports from Luxembourg Comparing capital markets in the Middle East and North Africa (MENA) with their global counterparts is a disappointing exercise. The results reveal an imbalance between the various intermediaries in the financial system. While in the world market structure bank assets constitute 33 per cent, debt securities constitute 42 per cent and the stock market capitalisation represents 25 per cent, in the MENA region bank assets represent 85 per cent of the capital market structure, stock market capitalisation is only 12 per cent and debt securities are a mere three per cent. These were some of the findings presented by Mazen Soueid, an economist with the International Capital Markets Department at the IMF, during a presentation to the third Experts Committee meeting of the Facility for Euro- Mediterranean Investment and Partnership (FEMIP). FEMIP was set up by the European Investment Bank in 2002 to assist Mediterranean Partner Countries (MPC) in their social and economic modernisation and regional integration. The experts meeting, held in Luxembourg last week at the European Investment Bank headquarters, reviewed the general status of the financial sector in the Mediterranean region with the aim of coming up with recommendations and ideas to put forward to the Ministerial Committee of the Economics and Finance Ministers of the EU and MPCs scheduled to be held in Morocco on 20 June. One of these ideas is the possible integration of the financial markets of the EU and MPC. EIB Vice-President Philippe de Fontaine Vive told Al-Ahram Weekly, "the free trade area EU and MPC countries are currently working towards is insufficient." "We are working on the integration of the financial system," he said adding that the aim is to enable MPCs to accelerate their alignment with EU internal market and to further encourage the flow of much-needed investment into the region. But there is a long way to go before such integration takes place given the status of the Mediterranean financial sector. The heavy reliance of the region on the financial intermediation of banks, IMF's Soueid pointed out, is much higher than that in other emerging markets. The share of bank assets amounts to over 80 per cent in MENA compared to 48 per cent in developing Asian countries. That structure has affected lending to the private sector, Soueid said, particularly since the state retains a dominant role in those banks. And it has led to the fact that "private sector lending remains relationship based, short term and trade related with relatively little directed to long-term investment." In Egypt, the share of total loans with less than one- year maturity of total loans is 70 per cent, and in Jordan and Saudi Arabia it is 60 per cent. To deal with state ownership of banks Zoubida Allaoua, Private Sector Development and Finance Sector manager for the MENA region with the World Bank Group, pointed out that changing the management alone is not useful. She explained that "when the government retains ownership, it retains the ability to influence decisions in ways that are not conducive to the efficient allocation of resources." The best approach, she argued, is through the privatisation of existing banks. Many of the countries that have welcomed foreign banks while continuing state ownership of domestic banks have been unsuccessful. "State banks would continue to benefit from the environment, whether through the explicit subsidies given to them or through monopoly power they retain or through the fact that they have privileged access to some information," she said. Besides improving the banking system's efficiency and competitiveness to provide for better services to the private sector, the need for the development of local capital markets and the various instruments it offers was another issue discussed by the experts. "The dilemma is that while banks are performing poorly in channelling savings into investments, capital markets are not deep enough to intermediate," said Soueid. He continued that MENA has been relying on very little capital market financing and has slipped below Africa in 2003 as the lowest issuer of equities, bonds and international loans. Marawan Barakat, head of research at Audi Saradar Group in Lebanon, reiterated a similar view. Speaking about the non-bank financial sector, he observed that "we have a low level of liquidity. We have relatively few listings and we have an inactive secondary market for financial instruments." The MENA countries with the best non-bank financial instruments index are Jordan, Egypt and Bahrain, he said. While dealing with the banking sector and the capital market, participants also stressed that such reform must be accompanied by the implementation of sound regulatory systems in the financial markets. "When you liberalise, you increase risks which leads to the need for proper regulatory frameworks," said Vive. The experts meeting was not all about criticism and recommendations. European Investment Bank (EIB) officials on their part attempted to display innovative financing instruments that FEMIP can develop. Among those is financing through EIB local currency lending. Dick Clark, head of the division for non-EU Europe and Africa with the EIB finance directorate, explained that the rationale behind this is that local projects generate local currency revenues, thus lending in foreign currency is not practical. This should aid in the development of the local currency bond market, he pointed out. Clark mentioned that EIB is currently exploring the possibilities of such a bond issue in Egypt and Morocco. Whether a country is eligible for it or not depends on the depth of the market and whether the governments request it, a process that Clark said may last up to five years. Another available FEMIP tool is technical assistance. Technical assistance is provided by FEMIP through its Trust Fund, established at the end of 2004 with initial pledges of 31.5 million euros, with help from the Technical Assistance Support Fund. EIB's Daniel Ottolenghi, chief development economist, said that a number of countries have asked for EIB's support in building up their capacities to better conduct their long-term lending and assist in credit risk management. Another instrument is the Trust Fund. The EIB's first activity within the trust fund was to join forces with the IMF's Middle East Technical Assistance centre in Beirut to provide technical assistance that is not directly related to EIB projects, but broadly to economic reforms. "We will be working on regulatory reforms and technical assistance for the restructuring of public banks," Ottolenghi said. FEMIP is also helping out with its risk capital financing to strengthen companies equity. One such contribution to the Egyptian market is EIB investment in the Egyptian Direct Investment Fund, set up by Concorde International. The fund specialises in direct investments within Egypt, buying majority share holdings in Egyptian companies. These funds have a certain life span at the end of which they exit the companies they have invested in. The year 2004 proved remarkable for FEMIP, with contracts signed for 25 operations worth 22 billion euros, a five per cent increase over 2003, when 22 operations were carried out. All in all, 2.2 billion euros were lent while grants under its Technical Assistance Support Fund reached 13.8 million euros. One third of the loans was aimed at supporting SMES and FDI in the region. In 17 June the EIB will be opening up a third office in the region in Rabat, Morocco, adding to its existing ones in Cairo and Tunis. More funds may also be available should Turkey become an accession country. According to Vive, in that case Turkey will benefit from EU funds available for accession countries. Furthermore, MPCs will have more FEMIP funds to split between them should the situation remain the same and other countries like Libya not join yet.
