Capital markets in the Middle East and North Africa are relatively nascent, although significant strides have been made in developing legal and regulatory frameworks that allow them to play a wider role in financing economic activity.
As corporations gain wider access to capital market financing, their ability to raise funds for longer periods of time and at a cheaper cost is increased, fueling growth and the opportunity to create more employment. While small firms are restricted to bank and non-bank sources of finance, large corporations are in a position to access financial markets and raise long-term capital.
One means for businesses to raise funds is through equity capital increases, which can take the form of private placements, rights issues, as well as seasoned equity offerings for publicly-listed corporations. According to Zawya data, close to USD 50 billion was raised between 2007 and 2010 via 492 equity capital issues. Most of these took the form of rights issues followed by private placements with the minority of equity capital increases being in the form of seasoned equity offerings. This restricted the number of equity investments available to the general public.
The financial services industry dominates equity capital issuance in the MENA region, both in number and size of equity issues, suggesting little economic impact of equity instruments in funding the real sectors of the economy.
In addition to equity, corporate bonds are long-term financing instruments issued by corporations to raise capital at a cheaper cost compared to bank loans. The provision of long-term funds allows corporations to undertake value-enhancing capital investment projects that ensure growth. Bonds activity in MENA is generally very low compared to other markets, but corporates are increasingly tapping the bond market to make up for banks' reluctance to lend and to take advantage of historically low interest rates.
Similar to equity capital financing, corporate bonds are mostly issued by financial institutions, followed by firms from the oil and gas sector. In contrast, no corporation from the industrial manufacturing sector sought financing through bond instruments. Bond markets are essentially driven by institutional investors and there is no active secondary market for trading them.
Between 2007 and 2010, 131 bond issues were sold in capital markets, raising a total of USD 56.4 billion. These figures are low compared to equity issuance, providing little support for the pecking order theory of finance that contends that firms prefer to issue bonds first when raising external finance before they resort to equity capital.
Most of the sukuk issued in the region by companies were structured as Ijara and issued by the real estate sector, followed by financial institutions. Similar to corporate bonds, companies in the industrial manufacturing sector seem to be staying away from sukuk issuance.
Thus, capital markets activity is currently concentrated in the financial services industry. A key challenge for increasing the role of capital markets in financing the economy is to foster secondary market activity in trading corporate bonds and sukuk, which are currently constrained by low liquidity.
The development of a secondary bond market is essential for investors to drop the quest for quick profits from equity markets and move into more stable fixed-income instruments. In parallel, as large corporations resort more to capital market funding, more bank resources can be freed to finance small firms that are financially constrained, thus allowing banks to play a greater role in financing the real economy and creating sustainable jobs.
Rima Turk Ariss is associate professor of finance at Lebanese American University. She is also a consultant to the World Bank, the International Monetary Fund, and the United Nations Economic Commission for Western Asia, as well as a board member of the Lebanese Economic Association and a research fellow at the Economic Research Forum.
© Zawya 2012
