UAE markets under pressure, investors weigh Egypt tax implications

It has been a torrid week for Gulf Cooperation Council markets, with those in Dubai and Abu Dhabi in particular feeling the brunt of selling pressure due to retail investors unwinding their positions post-MSCI Emerging Markets inclusion.

The United Arab Emirates’ story remains very much intact, although valuations across certain stocks do look overstretched. The perceived negative report that came out from the UAE Central Bank regarding an overheated real-estate market, coupled with Aabar selling down a 2.72% stake in Arabtec, led to panic selling among retail investors across the board, with real estate and construction names in particular weighing.

While to a degree the selling pressure has been overdone, a bounce is widely expected, although likely to be short-lived. From here on, expect markets to trade sideways, with no major positive catalysts in the near term to drive markets higher. With Ramadan just around the corner, and a tendency among Arab investors to go to pastures more tolerable, market volumes are likely to wane.

Market speculation

On Wednesday, the Dubai Financial Market announced that Aabar and its entities sold a 2.72% stake in Arabtec. Aabar, through its entity Aabar Investments, now owns 18.85% in Arabtec as of June 11, 2014, from 21.57% on Sunday June 8, 2014. The disclosure confirmed market speculation of Aabar (which controls 50% of Arabtec’s board) having sold its stake in Arabtec.

This raises more questions with respect to whether there is more to be sold in Arabtec by Aabar, and if so, whether it will affect Arabtec’s anticipated growth. Given Arabtec’s project executions in the UAE and Egypt, Arabtec would need the support of Aabar or the UAE to execute on these. If not, what is Aabar’s investment strategy centered around Arabtec in the longer term?

Answers to these questions would be crucial for Arabtec, as it would need the support of Aabar or the UAE to execute on their order book (Egypt AED148bn housing project; UAE AED21.4bn towers project and Jordan AED5.7bn account for bulk of what is priced into the stock).

The only positive side to the market’s disclosure was that Aabar sold just 2.72% in Arabtec. The latter’s shares have corrected by almost 40% since June 2, and follows CEO Hassan Ismaik having raised his stake in the company to 28.84% from 8.03%.
Egypt

In Egypt, Abdel Fattah al-Sisi’s presidential win was never in doubt. The pressure, however, for him to bring about change could not be higher. Prior to his election, Sisi outlined an ambitious strategy with which to revive the Egyptian economy. He plans on re-dividing governorates through a “development corridor” project.

The idea includes providing infrastructure for increasing agriculture, and facilitate ownership for Egyptians who will work on them. The EGP160bn plan will see Egypt divided into 33 governorates instead of 27. Also part of Sisi’s economic plan are 26 cities and tourist hubs, 22 mining cities and eight airports.

He said financing such projects is a momentous task, so he will rely on three sources: contributions from Egyptians abroad, domestic and foreign investors, and foreign aid. According to the president, removal of subsidies must be done gradually, and cannot be implemented without first raising Egyptians’ income.

Bouts of volatility

Since Sisi’s election, the Egyptian Exchange has suffered bouts of volatility, largely due to investors booking profits in the run up to the ballot, but also on account of negative reaction by the market post news of the new draft capital gains taxes that will be imposed on equity market investors.

The imposition of these taxes was bound to happen given earlier indications post-2011 revolution. However, an argument can be made as to whether the timing can be justified when Egypt needs more investments into the stock market. With respect to the capital gains tax implication on investors, impacts of the new taxes should be felt more on local (retail and institutions) and GCC investors, given the absence of such taxes historically.

On non-Arab investors, the effective impact on Net Asset Values could vary depending on the type (corporate or individual), domicile, double taxation treaties etc, as some foreign investors might anyway be subject to taxes in the country of origin without regard to the new laws in Egypt. Assuming that the draft law gets the final go-ahead from Sisi, expect the market’s reaction to be temporary, and investors to continue chasing stocks wherever there is underlying value.

It is worth noting that the proposed capital gains tax rate of 10% is lower compared to other emerging markets - China (25% for residents), Brazil (15%), India (15% on short-term gains) and Russia (13% on individuals and 20% on corporates). The rates in developed markets such as in the European Union and North America are much higher, in some cases reaching 50%.

From the government’s point of view, while the new taxes could generate an additional stream of much-needed recurring revenue, it would also result in large income streams as and when big-ticket transactions are executed on the Egyptian Exchange.

This also means that companies that plan to list solely with the idea of avoiding taxes on capital gains would have their savings curtailed because of the 10% levy. The indirect implications on account of the new tax could also be felt on Merger & Acquisitions transactions, with multiples and pricing to be readjusted.