Financial Turmoil, Arab Spring & Economic Freedom
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The document discusses how financial turmoil following the Arab Spring uprisings is influencing economic freedom in the region. It presents empirical evidence showing relationships between changes in economic freedom and stock market returns, currency exchange rates, and government debt yields. Recent declines in foreign investment, private equity funding, and public stock markets in Arab countries indicate decreased economic freedom. Policy decisions going forward will impact areas like subsidies, capital controls, privatization, and transparency. Delays in political transitions threaten further credit downgrades and reserve declines in Egypt.
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Financial Turmoil, Arab Spring & Economic Freedom
- 1. FINANCIAL TURMOIL & THE ARAB SPRING Factors Influencing Economic Freedom Marshall L. Stocker MBA CFA www.freedom-economics.com
- 2. REMARKS What Financial Turmoil ? Empirical Foundation Arab Spring: Economic Likelihoods Implications “Prospects of stability and internal conflicts in the Arab world are still fundamental stumbling block to economic freedom.” –Economic Freedom of the Arab World 2010 2
- 4. 4 OCTOBER 2011 Egypt 92% decline in FDI Libya 87% decline Syria 65% decline 4
- 5. “Some 218 investments were made by these regional private equity funds from 2004-09, out of which only 14 have reached exit… „Those GP’s will not raise new funds and will disappear‟” 4 OCTOBER 2011 5
- 6. Tunisian President Ben Ali resigns (January 14, 2011) Egyptian stock market down 44.1% EGYPTIAN STOCK MARKET: 13 OCTOBER 2011 6
- 7. EGP TO US$ EXCHANGE RATE : CENTRAL BANK’S LOCAL ASSETS SKYROCKET 7
- 8. EGP TO US$ EXCHANGE RATE : 5-YEARS CENTRAL BANK’S LOCAL ASSETS SKYROCKET 8
- 9. EGP TO US$ EXCHANGE RATE : 5-YEARS CENTRAL BANK’S LOCAL ASSETS SKYROCKET 9
- 10. Brazil‟s Central Bank used currency reserves to defend Real over two years 1997-98 Foreign currency reserves dropped 40% ($60 billion to $36 B) = Received IMF foreign currency loan ($41 billion = 8.7% of ? GDP) Real peg broke (Jan. „99) Announced 8% devaluation become 66% HISTORY LESSON (?) 10
- 11. FINANCIAL TURMOIL SUMMARY FDI plummets Private equity broken; no funding Public equity market crash Foreign currency reserves depleting (Egypt) Egyptian currency peg holding…. 11
- 12. FINANCIAL TURMOIL SUMMARY “Its an off the record conversation, but am truly terrified now. After my meeting at the ministry of finance, I would like to assure u all: we are humped. Totally, irrevocably, HUMPED! Btw, the strikes are not why we are humped. We are for other reasons entirely.” 12
- 13. EMPIRICAL FOUNDATIONS FOR IMPLICATIONS TO ECONOMIC FREEDOM 13
- 14. EMPIRICAL FOUNDATIONS (∆) Economic Freedom (∆) Financial Conditions “Equity Returns and Economic Freedom” Stocker, M.L., Cato Journal, Vol. 5, No.3, Fall 2005 “Economic Freedom: A New Investment Heuristic” Stocker, M.L., working paper 14
- 15. EMPIRICAL FOUNDATIONS Equal Weighted Average Equity Returns (1970-2002) Equity Returns & Economic Freedom 10% 8.55% 6.68% 7.51% Equity Market Return Average Annualized 5% 0% Bottom Fourth Third Second Top -5% -3.75% -10% -9.45% % Change Econom ic Freedom Quintiles “Equity Returns and Economic Freedom” Stocker, M.L., Cato Journal, Vol. 5, No.3, Fall 2005 15
- 16. EMPIRICAL FOUNDATIONS: STOCKS REACT ∆ Economic Freedom ∆ Stock Index Price Stock Index Price ∆ Economic Freedom 0.394** ∆ Size of Gov‟t n.s. ∆ Legal System & Property 0.229** Rights ∆ Sound Money 0.158** ∆ Freedom to Trade Int‟l 0.202** ∆ Regulation 0.438** “Equity Returns and Economic Freedom” Stocker, M.L., Cato Journal, Vol. 5, No.3, Fall 2005 16
- 17. EMPIRICAL FOUNDATIONS Annualized Percentage Currency Change vs. US$ by Economic Freedom Quintile EMERGING MARKETS 1970-2004 6% 3.0% Annualized Currency Return 4% 2% 0.9% 0% -2% -4% -2.2% -6% -8% -10% -8.2% -8.1% (LOWEST) Freedom Economic Freedom Quintile (HIGHEST Freedom) “Equity Returns and Economic Freedom” Stocker, M.L., Cato Journal, Vol. 5, No.3, Fall 2005 17
- 18. EMPIRICAL FOUNDATIONS 10-Year Sovereign Bond Redemption Yield Spread over 10-yr U.S. Treasury by Economic Freedom Quintile 1985-2004 140 Yield Spread (basis points) 120 Yield Spread 100 Yield Spread w/o Japan 80 60 40 20 0 (LOWEST) Freedom Economic Freedom Quintile (HIGHEST Freedom) “Economic Freedom: A New Investment Heuristic” Stocker, M.L., working paper 18
- 19. EMPIRICAL FOUNDATIONS Annualized Percentage Currency Change vs. US$ by Economic Freedom Quintile ALL MARKETS 1970-2004 6% 3.9% Annualized Currency Return 4% 2.9% 1.8% 2% 0% -2% -1.1% -4% -6% -8% -6.3% -10% (LOWEST) Freedom Economic Freedom Quintile (HIGHEST Freedom) “Economic Freedom: A New Investment Heuristic” Stocker, M.L., working paper 19
- 20. EMPIRICAL FOUNDATIONS Currency Return OUTLIERS by Economic Freedom Score ALL MARKETS 1970-2004 50% Annualized Currency Return vs. US $ 40% 30% 20% 10% 0% -10% 3 4 5 6 7 8 9 10 -20% -30% -40% -50% (LOWEST) Freedom Economic Freedom (HIGHEST Freedom) “Economic Freedom: A New Investment Heuristic” Stocker, M.L., working paper 20
- 21. EMPIRICAL FOUNDATIONS SUMMARY Change in Economic Freedom Equity Returns Economic Freedom Government Debt Yields Economic Freedom Currency Exchange Rate 21
- 22. EMPIRICAL FOUNDATIONS SUMMARY: THEIRS Equity Market Size as Percentage of GDP (Li 2002, LaPorta 1997) Total Market Capitalization Increases after Capital Control Liberalization (Levine, Zervos 1998) Privatization Effects Excess Market Returns (Perotti, van Oijen 2000) Idiosyncratic Equity Market Liberalization leads to Excess Market Returns (Henry 2000) GDP Growth, Investment & Productivity Rates (Gwartney, Lawson 2004) 22
- 23. ARAB SPRING: FACTORS INFLUENCING ECONOMIC FREEDOM 23
- 24. ECONOMIC FREEDOM OF THE ARAB WORLD Current financial markets may indicate a current decrease in economic freedom. Subsequent policy decisions that increase Economic Freedom may quickly appear in financial markets as financial euphoria. 24
- 25. FINANCIAL TURMOIL & ARAB SPRING INFLUENCING (AREAS OF) ECONOMIC FREEDOM Subsidies (expansion or rationalization) Capital controls Privatization: Nope; Entrepreneurship: Yes IMF: Foreign Currency loans Transparency Monitor (yields, reserves, stock market) 25
- 26. “The economic uncertainty has been exacerbated by deteriorating security …The …lack of efficient policing has brought higher crime levels, with armed gangs robbing motorists and attacking factories and warehouses.” 9 October 2011 DON’T FORGET SECURITY 26
- 27. IMPLICATIONS FOR POLICY MAKERS & INVESTORS 27
- 28. EGYPT’S CREDIT RATING DOWNGRADED (10-10-11) Downgraded Egypt‟s long-term default and currency ratings to “negative” as wavering political decisions continue to delay economic growth. “Fitch has previously said it expected the sharp fall in foreign currency reserves…to start being reversed by external support in [quarter four;] the delays to the political transition are now causing concern, with reserves continuing to fall, and the global backdrop less supportive.” 28
- 29. Over the past month, while affirming that the country is “committed to a free market” the interim government also banned three privatized companies; two of which were owned by foreign investors. -Daily News Egypt 10-10-11 WHICH IS IT? 29
- 30. FINANCIAL TURMOIL & THE ARAB SPRING Factors Influencing Economic Freedom Marshall L. Stocker MBA CFA www.freedom-economics.com
Notas del editor
- Egypt Central Bank’s Foreign Currency reserves are down close to 40%Local Currency assets are up 200% (3x’s) since Januaryhttp://www.cbe.org.eg/public/All_Monthly_Statistical_Bulletin_PDF/2011/Bulletin_2011_09_Sep/11_01_Reserve_Money_and_Counterpart_Assets.pdf
- Egypt Central Bank’s Foreign Currency reserves are down close to 40%Local Currency assets are up 200% (3x’s) since Januaryhttp://www.cbe.org.eg/public/All_Monthly_Statistical_Bulletin_PDF/2011/Bulletin_2011_09_Sep/11_01_Reserve_Money_and_Counterpart_Assets.pdf
- Egypt Central Bank’s Foreign Currency reserves are down close to 40%Local Currency assets are up 200% (3x’s) since Januaryhttp://www.cbe.org.eg/public/All_Monthly_Statistical_Bulletin_PDF/2011/Bulletin_2011_09_Sep/11_01_Reserve_Money_and_Counterpart_Assets.pdf
- Egypt budget deficit to be US$22 million.IMF loan to be $4billion – 1.8% of GDPMust have enough foreign currency to convert for all people who want to convert.Brazil:Over the previous two years, the central bank was able to use its foreign exchange reserves to preventthe currency from drastically depreciating. Between 1996 and 1998, Brazil’s reserves dropped by$24 billion or 40%. While the IMF provided a $41.5 billion loan in 1998 to help Brazil defend itscurrency, the central bank decided to devalue the real by 8% in January 1999. By the end of themonth, the real depreciated 66% against the U.S. dollar. 1996-97 $30 billion in capital flight. http://www-personal.umich.edu/~kathrynd/Brazil.w06.pdfIn an article titled “Endgame for Egypt,” economist David P. Goldman, who specializes in analyzing the economies of the Arab world, says that the “Arab Spring is really “a convulsion of a dying society. Egypt imports half its caloric consumption, 45% of its people are illiterate, its university graduates are unemployable, its $10 billion a year tourism industry is shuttered for the duration, and its foreign exchange reserves are gradually disappearing.“Western economists can concoct all the economic recovery plans in the world,” continues Goldman, “but a country that can’t teach half its people to read, and can’t produce employable university graduates, and can’t feed itself, is going to go down the drain.
- Egypt # 93 which is 4th Quintile
- In particular, the size of their equity markets is negatively correlated to the size of government, as measured by government consumption as a percentage of GDP.ReferencesHenry, P. B. (2000) “Stock Market Liberalization, Economic Reform, and Emerging Market Equity Prices.” Journal of Finance 55: 529–64. On average, a country’s aggregate equity price index experiences abnormal returns of 3.3% per month in real dollar terms during an eight-month window leading up to the implementation of its stock market liberalization. This results is consistent with the asset pricing model whereby liberalization reduces a country’s cost of capital by allowing risk sharing between domestic and foreign investorsLa Porta, R.; Lopez-de-Silanes, F.; Shleifer, A.; and Vishny, R. W. (1997)“Legal Determinants of External Finance.” Journal of Finance 52: 1131–50. Countries with poorer investor protections have smaller and narrower capital markets. French civil law countries have weakest investor protectionsLevine, R., and Zervos, S. (1998) “Capital Control Liberalization and StockMarket Development.” World Development 26: 1169–83. stock markets tend to become larger, more liquid, more volatile, and more integrated following capital control liberalization.Li, K. (2002) “What Explains the Growth of Global Equity Markets?” CanadianInvestment Review (Fall): 23–30. due to government policy changes such as capital markets liberalization in emerging economies, improved legal systems and better institutions, a country's equity market can become more highly valued and "catch up" to the valuation frontier. Perotti, E. C., and van Oijen, P. (2001) “Privatization, Political Risk, andStock Market Development in Emerging a sustained privatization program represents a major political test that gradually resolves uncertainty over political commitment to a market-oriented policy as well as to regulatory and private property rights. the resolution of political risk resulting from successful privatization has been an important source for the rapid growth of stock markets in emerging economies.
- The military council recently said presidential elections will likely take place towards the end of 2012, meaning that the SCAF and the interim government will have remained in control for about two years.http://thedailynewsegypt.com/economy/egypts-credit-rating-demoted-as-political-uncertainty-weighs.html#
- required large and prolonged rises in interest rates in some countries whose currencies were successfully defendedmany of the currencies that came under serious pressure recently had suffered significant erosions of competitiveness in earlier yearsthe gross public debt/GDP ratio in Italy was around 100 per cent and rising rapidly due to the very large general-government deficit***the interest rates needed to maintain exchange-rate parities were increasingly inconsistent with domestic policy objectives during a period of cyclical weakness and rising unemploymentthree main weapons apparently available to the authorities to defend their exchange rates -- sterilised intervention, interest-rate adjustments and capital controlsInterest-rate adjustment, often in conjunction with intervention, is the most effective immediate weapon to defend a paritythe effectiveness of sterilised intervention, by itself, is limited. Currencies which come under heavy pressure can rarely be defended successfully by policies that rely solely or mainly on sterilised intervention. The amount of funds market participants can mobilise once there are serious doubts about the sustainability of existing parities is such that the volume of intervention needed to defend them makes complete sterilisation almost impossible. Second, interest-rate adjustment can be effective
- Discussion of strategies to promote the Economic Freedom of the World Annual Reports in the Arab region and to establish a network of individuals and institutions interested in networking in this field Direct communication of experts / past liberalizing ministers (chile,slovakia, estonia) to NEW Arab leadershipIf direct communication not an option, public campaign through friendly press editorials. Other country’s positive stories.Position “good guys” as known resource, await crisis.Recommendations:Media.Position any recent economic policy changes (Egypt 2005-2010) as crony-capitalism masked by macro reforms.Acknowledge hard truth that there will be a period of pain.To defend currency, prolonged rise in interest rates.