There has been a surge in the MENA currency trading since the start of the Arab spring; risk attitudes across the financial markets in the MENA have affected individual countries differently. So far, the fiscal costs of the Arab spring are estimated by the political think tank Geopolicity at $56 billion across the region. Some have seen strong devaluation of their own currencies, thus in countries like Yemen, a strong devaluation of the Riyal saw a hike in food prices and prices of imported construction material, stopping most planned constructions and worsening  an already massive unemployment problem.

This article will analyzeTunisia and Egypt, two countries that have witnessed the toppling of their government in 2011, by looking at local stock market movements (generally a good proxy for local sentiments) and Credit Default Swaps (CDS) spreads (a better proxy for international sentiments) to get a better understanding of the respective market movements. We will then look at how these countries have been affected and the potential role and opportunities for the Gulf countries.

With the uprising wave emerging in Tunisia late December 2010, and spreading through the following year, as one can see infigure 1 below, the Tunisia stock exchange has seen an important drop in value on the 7th January, with sharp but short lived increases during mid-February, when the prime minister resigned, and mid-march, when the political party of the ousted President Ben Ali was dissolved. Since June onwards, the value of the general index of Tunisia’s stock exchange has been progressively increasing.

Figure 1: Tunisia Stock Exchange

Even though the local stock market is on the rise once more, the immediate impact of the Tunisian crisis is being felt by the local economy, with significant foreign capital leaving the country, a rampant current account deficit, both export and import values dropping and a GDP growth rate forecasted by the IMF to be close to nil for 2011. The medium term outlook is howeversomewhat more positive with a forecasted GDP growth rate at 3.9% and 5.2% for 2012 and 2013 and a corresponding increase in export volume.

When observing the exchange rate between the Tunisia Dinar (TND) and the Euro, in January onwards the value of the TND fell vs. the euro, with a short lived peak from September to November. As most of Tunisia’s imports are with the EU, it is important for the country to ensure the TND does not drop too low against the Euro, because consequently,its import costs would further damage an already fragile economy.

Figure 2: Tunisia Dinar vs. EUR

Looking at the CDS spread of Tunisia, it is not surprising to see the cost of insurance on Tunisia’s bonds increase following the uproars. However in terms of international standards,the spreads are still relatively low.In early December 2011, it cost an investor $275 thousand holding $10 million to protect against default in Tunisia, whereas in Egypt on the same date it cost an investor $531 thousand holding $10 million to protect against default. However, given Tunisia’s quick recovery from the political turmoil, the risk pricing has remained at high levels still underlining an important lack of investor confidence.

Table 1: Selected CDS spreads in Tunisia 

Also compared with Egypt, Tunisia’s risk pricing is far below one would expect from a country which saw the birth of the Arab Spring. Tunisia’s economic situation seems more appealing than its neighbors from an investor perspective, as the political reforms were quickly drafted; the country’s gross national debt and national savings are in a better condition than Egypt, showing healthier fundamentals. The events that unfolded in the previous year in the country have proven to be less chaotic that its neighbors’ and it partly reflected on the deceleration of the spread of Tunisia’s debt.

These spreads, even though decelerating, are still nonetheless increasing despite the positive political developments. International investors are often known to react quickly to new political development, but seem reluctant to react as fast to an improving situation.  Additionally Egypt and Libya have seen even less smooth political developments, which could be a main element of the lack of improvement on the spreads for Tunisia.

With the new President and prime minister sworn in, assuming continuing smooth transition, one would expect early 2012 spreads to start stabilizing and decreasing. Still, Tunisia’s spreads will be affected by the reflection of its neighbor Egypt, which has seen increasing difficulties in the transition process.

The Egyptian Stock Exchange has had a steep drop, from a higher value than the Tunisian one, and unlike its neighbor, is not seeing any real improvement for now. Since the start of the events, the Egyptian Stock Market has decreased by 40% and has been prone to significant volatility. Following the events that started on the national holiday, the central bank of Egypt has been running down its foreign reserves in order to ensure that the Egyptian Pound (EGP) does not collapse.

Figure 3: Egypt Stock Exchange

As investors were selling the EGP its value would have plummeted, if it wasn’t for two important factors. One, the Egyptian diaspora that were paid either in US dollars or another currency that had a stronger value against the EGP had a greater advantage of sending remittances back to Egypt. Important remittance flows coupled with the Central Bank selling foreign reserves to buy the EGP enabled the currency to stay afloat in the short to medium term. However, due to Egypt having run down its Foreign Exchange reserves from $36bn in January to $20bn by the end of last year, and the recent commencement of the decline of remittance flows, the country is at risk of facing a currency crisis in the near term.

Figure 4: Egyptian Pound vs. USD

Egypt’s unhealthy financial situation seems to mirror strong political uncertainty, as the military retain a tight grip on the country’s decision making process, and so far have been unable to meet popular demands. At the beginning of last year, the country’s CDS spreads were standing at 317 basis points but this moved to 513 bp by early December 2011 following renewed protests and an uncertain political outlook. Investors are clearly pricing Egypt’s debt at a higher price than its neighbors, even though as revealed in the Financial Times of the 25th of October, most of the debt is held by local actors, and are thus less prone to panic selling.

Still, the political violence Egypt is going through at this moment is clearly reflected in the spreads. On the macroeconomic side, the situation fares no better. As seen in table 2, the GDP has contracted by 76% from 2010 to 2011, and the IMF is barely forecasting a slight improvement for next year. Volume of exports, gross national savings and total investments are not forecasted to improve before 2013, coupled with the current political instabilities, the situation depicts a bleak picture for the Egyptian population and international investors. Even oil exports are not expected to pick up any time before 2013/2014.

Table 2: Macroeconomic indicators of Egypt*

The “Arab Spring” is a movement that emerged due to years of political repression and socio-economic inequalities, and the Gulf Cooperation Council (GCC) have a key opportunity, if not a responsibility, to assist the countries affected by the spring in their transitional process (so far assistance outside the GCC has only been offered to other monarchies like Morocco and Jordan). In the short term, most of the GCC are enjoying an excess of reserves thanks to a high oil price, and some of these reserves could be used to organize important structural packages focusing on restarting the growth process (similar to the development funds offered to Morocco and Jordan, but on a much wider scale). These packages could concentrate on ensuring the majority of the population benefits from the economic progress, by securing effective implementation of private property framework, stimulating private sector, monitoring closely corruption and leakages concentrating on creating job and opportunities for the youth etc.

In order to prevent a further economic deterioration which in turn would lead to continued political instability, structural economic assistance programs by the GCC states are required. For the GCC, continued political decay could have damaging consequences and there is a distinct interest to re-establish security and stability. The GCC themselves do not necessarily have the technical capabilities to oversee implementation, and monitoring how the disbursement of money is made is vital to the success of the programs. The Gulf should seek assistance from the EU, the World Bank or even EBRD to support the programs, on the one side the GCC offering the financial assistance, and the other side the institutions delivering technical implementations.

The GCC should not be afraid of the pro-democracy wave that is sweeping the Arab world.The potential advantages the GCC could derive from effective policy packages are an increase in stability in the region, fairer development of future powerful allies, and an increase in influence across the MENA.

Naël Shehadeh is an Associate Researcher at the Gulf Research Center Foundation in Geneva

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