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Europe and investors’ confidence. New investment frontiers.

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This paper attempts to address firstly the question of whether Europe is still a right place to invest by providing an analysis of what makes it an attractive location. Secondly, it offers a political and economic overview of the Middle East and North Africa (MENA) countries to understand the investment prospects that the region offers. And, it concludes that the advanced economies (including Europe) remain the main leaders of the current global activity growth. However, stronger policy efforts are still needed to fully restore confidence.

The global recovery is becoming broader. According to the IMF's World Economic Outlook (April 2014) global activity has broadly strengthened, and is expected to improve further in 2014–15. Therefore, global growth is expected to average 3.6% in 2014 -up from 3% in 2013 - and to rise to 3.9%in 2015 (see the table below).

In particular, the growth coming from advanced economies is expected to record more impetus. In this regard, a major impulse to global growth comes from the United States (UniCredit forecasts = 2.4% in 2014 and 2.6% in 2015; IMF forecasts = 2.8% in 2014 and 3% in 2015; see below the table on Comparison of annual GDP forecasts), thanks to more moderate fiscal consolidation, accommodative monetary conditions, a recovering real estate sector, and higher household wealth. As for the Euro area which has finally emerged from recession, growth is expected to turn positive (UniCredit forecasts = 1.4% in 2014 and 1.7% in 2015; IMF forecasts = 1.2% in 2014, 1.5% in 2015; see below the table on Comparison of annual GDP forecasts) due to less fiscal drag, some impetus from private domestic demand, and increase in net exports. In addition to the growth expansion in the advanced economies, global growth will continue to be driven also by developing countries: emerging and developing Asia (IMF forecasts = 6.7% in 2014, 6.8% in 2015), followed by Middle East and North Africa (Mena) countries (IMF forecasts = 3.2% in 2014, 4.5% in 2015).

In particular, in this year's more optimistic picture of the global economy, Europe as a whole has been able to overcome the most difficult phase of the crisis, and 2014 is likely to be a turning point. Thus, following two years of contraction, the economic recovery in Europe started during the last quarter of 2013, and is expected to continue spreading across countries and gaining strength.

More positively, despite the last years' recession, Europe remains an attractive destination for the Foreign Direct Investments (FDI). Indeed, the latest Ernst & Young attractiveness survey confirms that 2013 was a record year for FDI in Europe with 3,955 projects (+4% from 3,797 in 2012) and 166,343 jobs (-2% from 2012, still 15% below pre-crisis levels - 195,000 jobs in 2004-08) in 42 European countries. This confirms a sustainable confidence in the region among the business community.

Such a positive trend of the investments in Europe was recently confirmed also by the A.T. Kearney Foreign Direct Investment Confidence Index 2014, which ranked 11 European countries among the top 25 global economies where investors' appetite is higher. In particular, four largest European Union economies – the United Kingdom (4th), Germany (6th), France (10th) and Italy (20th) – improved their score in comparison to 2013 ranking. Moreover, despite its headwinds, Spain ranked 18th, while Switzerland 14th, Sweden 16th, Belgium 21st, the Netherlands 22nd, Denmark 23rd and Turkey obtained the 24th position (see the table below).

In this context, the latest joint Global business barometer of Economist/Financial Times (2Q2014) shows that the increase in investors' confidence is in direct proportion with global business conditions' improvement. The graphic below demonstrates how in Western Europe the investors' confidence improved - starting from the last quarter of 2013 - together with the economic recovery and better global business conditions.

However, the factors influencing investors' choices on the locations where establishing their business activities has changed over the last few years. In fact, the recent economic crisis has adversely affected appetites for risk. As a result, nowadays, in order to ensure the security of their investments, investors mainly prefer:

- stability and transparency of a market's political, legal and regulatory environment;

- investing in regions with large and sustainable domestic demand;

- opting for locations where they might achieve productivity-related gains due to reduced input costs, as well as creativity and innovation;

- choosing locations where labor costs are lower.

As for Europe, the investors continued to choose the region mainly due to its following attractive features:

- stable and predictable business environment;

- presence of suitable investment requirements thanks to the large and rich consumer market that the continent offers;

- capacity of European markets for innovation and the quality of their labor forces represents additional factor for fresh investments.

Most importantly, a more integrated Europe with an ecosystem-related approach to innovation and entrepreneurship remain essential for the investors demanding access to skills and labor mobility within and outside Europe, with fewer regulations. Furthermore, making European cities more innovative and "smart" is one of the best ways to demonstrate Europe's attractiveness to the world. As for the latest point, a recent research of fDi Intelligence - a division of the Financial Times Ltd. – showed that cities focusing in key areas as research, development and innovation to promote investment are ranked at the top in "European Cities and Regions of the Future 2014/15".

Finally, the competitiveness remains key to sustainable growth and a more attractive Europe. The figure below shows a comparative analysis between Europe and the large emerging BRIC economies, which in recent years have rapidly become global players and, in spite of their slowing growth, are still regarded as a global benchmark. Overall, the 13 countries that have joined the EU since 2004 and the BRIC economies perform in a similar fashion, especially in terms of developing smart economies, most notably in the enterprise environment and innovation pillars. The biggest difference among the two groups appears in the social inclusion pillar, where emerging economies still face a considerable gap.

As for a comparison between the EU and its comparator economies (see the figure below), the EU continues to benefit from comparatively high levels of social inclusion. However, it is trailing its comparator economies in creating gainful employment for a large share of its population, and it is significantly outdistanced in laying the foundations for smart growth, as other economies press ahead.

Overall, maintaining momentum for economic growth, new investment opportunities and investors' confidence will of course depend on a series of factors. Indeed, the global recovery is still fragile despite improved prospects, and important risks - both old and new - remain. Risks identified previously include finishing the financial sector reform agenda, high debt levels in many countries, stubbornly high unemployment, and concerns about emerging markets. New worries on the horizon include persistently low inflation in advanced economies, a weaker outlook for emerging markets than thought in the second half of last year, and recent geopolitical strains (e.g. developments in Ukraine).

As regards to Europe, stronger policy efforts are needed to fully restore confidence and ensure a durable and sustained recovery. In this context, measures to increase potential growth – such as rethinking the shape of labor market institutions, increasing competition and productivity, rethinking the size of the government, examining the role of public investment - become crucial.

Almost four years since the Arab uprisings, the political uncertainty and security issues have again emerged as the dominant analytical framework through which events in the Middle East and North African (MENA) region are being judged and interpreted by the outside world. The initial optimism that many had welcomed the spread of popular protests with in 2011 is gradually being replaced by a more somber realization that the slow, and in some cases non-existent, pace of socio-political reform in Arab transitional countries is creating a breeding ground for resentment amidst the flourishing of sectarianism, extremism, and political violence across the Arab world, as recently seen once again in Iraq or in Libya.

The hopes and ideals that had sparked the toppling of longstanding authoritarian regimes in Tunisia, Egypt, and Libya seem like a distant memory as the promise of a new "Arab awakening" collides with the harrowing scenes coming from Syria's civil war (the recent presidential elections - June 2014 - which confirmed al-Assad as the country's President, might hamper the prospects for political solution that Syria so urgently needs), and a deep political and security vacuum in post-Gaddafi Libya. As for the latter, despite the recent political elections (June 2014) are seen as a fresh start, the underlying divisions involving political and armed groups, which are seeking to overrule each other, remain. Until a compromise is not reached, the tangible progress many hope for will stay out of reach.

On the other hand, positive results in the political sphere were achieved in Tunisia due to the approval of the new Constitution and the formation of an interim Cabinet which will lead the country to new elections until the end of the year. Similarly, in Egypt a new Constitution was approved and, in 2014 elections the former head of armed forces al-Sisi became President, paving hopefully the way for a more smooth transition. These positive developments in the political scenario of the transition countries combined with the global economic recovery, might set the stage for gradual improvements also in the economic prospects in the MENA countries, provided the necessary reforms are advanced.

Following the Arab revolts (2011), growth has been tepid across the region. In 2013, declines in oil production held back growth in the oil-exporting countries. Weak private investment, amid political transitions and conflict, continued to take a toll on economic activity in the oil-importing countries.

However, growth in the MENA countries is expected to strengthen this year in line with an improved global outlook. Indeed, compared with the previous three years, 2014 seems hopeful and 2015 might be a turning point for these countries (growth is expected to be 3.2% and 4.5% in 2014 and 2015 respectively - please see page n.2; while for single countries' growth forecasts see the table below) and, many of the region's countries will likely start to benefit from stronger external demand in the high-income economies, as the global economy is set for a rebound in 2014.

Regional growth is expected to boost and current spending to rise, thanks to the large stimulus packages in the GCC countries together with the flow of funds to the rest of the region, particularly Egypt and Jordan.

However, the pace of economic recovery will vary across countries within the region:

Oil exporters countries: especially the GCC countries are expected to lead the regional recovery with growth exceeding 4% in 2014 and 2015. Growth in Iran is expected to turn positive after two years of contraction that resulted from the sharp decline in oil production and trade following the tightening of international sanctions.

Oil importer countries: the economies including Egypt, Tunisia, Lebanon and Jordan, remain fragile but a slight rebound in growth is expected in the next two years (from 2% in 2012 to 2.7% in 2013-14, and 4.2% in 2015). Between 2011-13 nearly $21.5 bn has been pledged by GCC countries (mainly Saudi Arabia, UAE, Kuwait and Qatar) to countries in transition (especially Egypt which obtained more than half of the pledge). Indeed, growth in Egypt is expected to be supported in particular by the Gulf funds, and Tunisia and Morocco could benefit from the recovery in the Euro Zone.

Despite positive growth expectations, high debt and current account and fiscal deficits leave the MENA economies vulnerable to economic and external shocks.

Here below the major challenges of the MENA economies:

- Oil exporters countries: they face a longer-term challenge of reducing reliance on oil. Indeed, in recent years declining oil revenues have contributed to a downward trend in fiscal surpluses, as did increased public spending, including spending on wages and energy subsidies.

- Oil importer countries: unresolved structural problems and governance issues weigh on the business environment, and sometimes hinders the full realization of gains to exports, tourism, and FDI. High unemployment is inciting social tensions, often manifested in labor strikes. Domestic security concerns and regional economic and social spillovers from the conflict in Syria, have also negative impacts on FDI.

Moreover, the current political and social tensions represent an important risk for the economies of the region. According to the Ernst & Young attractiveness survey Africa (2014), in 2013 the number of new FDI projects in Africa declined for the second consecutive year, by 3.1%; and the job creation resulting from FDI projects slowed. This was largely caused by the decline in North Africa, due to regional political uncertainty.

Before the Arab Spring, political instability was not among the top concerns in the MENA (see the figure below on the left hand side). During the 2000s, corruption and taxes were most widely cited as major constraints to private sector growth. After the Arab Spring, concerns about corruption have become even more pronounced, while political instability has become the second most cited problem plaguing the business environment. According to the most recent set of World Bank enterprise surveys conducted in the region, nearly 65% of business owners in MENA complained about political instability and institutional weaknesses. Crime and violence have also become more of a concern after the Arab Spring, with 35% of firms complaining about these issues as constraints to their operations.

Oil exporters countries: Economic diversification would not only reduce volatility of output and fiscal revenues but also strengthen economic growth potential and create private sector jobs for the rapidly growing labor force.

Oil importer countries: Structural reforms would help boost confidence and tap into the region's vast potential for high and sustained non-oil growth and jobs. Realizing this potential requires a credible reform agenda with broad public support, spanning a multitude of areas, to create better conditions for entrepreneurship and achieve higher living standards. The region represents a vast market with a young population and a large labor force. Government partnerships with large investors to reform vocational training and align skills with job market needs, particularly for women and the youth, could help tackle persistent unemployment (see the table below) while improving productivity. At the same time, reducing large energy subsidies (while improving the targeting of social support) could help re-orient production away from energy-intensive industries towards those that promote job creation.

As for the investments, recent efforts of the governments have been seen with new initiatives in this sector. Moreover, exports and tourism will likely strengthen thanks to higher demand in trading partner countries, particularly Europe and the GCC. Indeed, the public investment is expected to rise thanks to donor financing and recent subsidy reforms. In this regard, GCC financing enabled Egypt to launch public and social infrastructure projects and clear arrears. Moreover, Morocco, Tunisia and Jordan plan to increase public investment while reducing generalized subsidies and improving the targeting of social assistance. As for the private investments, they are expected to increase gradually and conditional on reform implementation and improved confidence. As political transitions have started to mature in some countries such as Egypt and Tunisia, uncertainty is expected to decline. In fact, recently adopted Constitutions in these countries, the formation of a unity Government in Lebanon, and stable Governments in Jordan and Morocco are undoubtedly positive signs. In addition, recent structural reforms are starting to signal governments' future policy direction. For example, Morocco's diversification efforts have helped increase exports and FDI in high-value-added industries.

2014 is a very important year, considered that many countries of the region face elections (presidential elections were held in Algeria and Egypt, and political election in Libya, while Tunisians will go to polls by the end of the year). The region is in a constant process of reshaping. In this context, the economic problems, the social unrest and the security will continue to represent the main hurdles that the governments of these countries will have to tackle.

That said the longer-term outlook could turn favorable if the countries implement the important reforms and tackle the urgent challenges. In political terms, they should complete the transition toward democracy, and implement the institutional reforms. In economic terms, they have to reduce the unemployment, improve competiveness, foster economic diversification, strengthen financial intermediation, and generate more inclusive growth. Finally, the security concerns remain a crucial issue in order to ensure the peace in the region.

The above mentioned challenges are structural and interconnected. They can be addressed only through a coordinated and comprehensive strategy that involves governments, the private sector, civil society, and the international community.

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