US embassy cable - 05AMMAN2776

C O N F I D E N T I A L SECTION 01 OF 05 AMMAN 002776 
 
SIPDIS 
 
TREASURY FOR ADAMS 
 
E.O. 12958: DECL: 03/04/2015 
TAGS: EFIN, ECON, PGOV, KPAL, JO 
SUBJECT: AMMAN STOCK EXCHANGE BUBBLE: WIDER DANGER FOR 
JORDAN'S ECONOMY? 
 
REF: A. AMMAN 1087 
 
     B. AMMAN 2295 
     C. AMMAN 2050 
 
Classified By: Charge d'Affaires David Hale for reasons 1.4 (b), (d), a 
nd (e) 
 
1. (C) SUMMARY: A dramatic rise at the Amman Stock Exchange 
(ASE) over the past two years has both reflected and 
reinforced the Jordanian economy,s healthy growth since the 
2003 coalition invasion of Iraq.  The ASE was one of the best 
performers in the world over 2004, turning in one of the best 
year-on-year performances in its history.  Market growth so 
far this year has been even more remarkable.  Factors 
contributing to the increase include foreign capital, the 
entry of many small domestic investors (spurred by 
USAID-supported improvements to the structure of the market), 
and the contining influx of pension money.  However, the 
traditional mainstay of the market - banks and large private 
investors - appear to be the primary drivers of the recent 
increase in share prices.  Some analysts, sanguine that the 
increase reflects strong fundamentals and corrects earlier 
undervaluation, predict relatively flat growth and possibly a 
slight correction over the next two years, but major 
investors - and increasingly, the rest of the market - are 
more leery of the current market valuations.  To us, the 
ASE's current levels look like a bubble ready to burst, and 
we predict that the trigger might have something to do with 
the Arab Bank, which makes up roughly one third of the ASE's 
capitalization.  END SUMMARY. 
 
------------- 
A BANNER YEAR 
------------- 
 
2. (U) When, at the end of 2003, brokerage figures showed the 
ASE index to have jumped almost 55% over the year, many 
Jordanians predicted a sedate 2004.  They were wrong.  The 
ASE in 2004 turned in the second-best one-year performance in 
its 25-year history.  With an index growth rate of over 62% 
for the year, the exchange was one of the best-performing in 
the world.  It held its own even against stock exchanges 
throughout the Middle East, many of which had all-time record 
years for index growth in 2004.  The vast majority of the 
2004 price rise came in a three-month period stretching from 
the end of September 2004 until the end of the year; the 
market has increased more than 30% so far in 2005 and the 
index now stands at a valuation double that of the already 
high level it had attained 52 weeks ago. 
 
------------------ 
MONEY FROM ABROAD? 
------------------ 
 
3. (U) The popular explanation in Jordan for the dramatic 
rise in stock prices - as for rises in other prices, from 
real estate to foodstuffs - has been Iraqi money.  Iraqis 
fleeing their war-torn country, according to this theory, are 
parking their money in any kind of asset they can find - and 
ASE-listed stocks are attractively liquid, easy to sell off 
in order, for instance, to ransom a relative.  We have heard 
versions of this theory from everyone from analysts to large 
investors to bank presidents to GOJ ministers. 
 
4. (SBU) While this theory attractively conforms to Jordanian 
perceptions of Iraq and of the Iraqis in Jordan, it does not 
conform well to reality in the case of ASE prices.  While it 
is true that foreign entities and individuals hold just over 
40% of the total value of the ASE,s market capitalization, 
the vast majority of it is in the hands of long-term 
investors and strategic partners, almost none of whom are 
Iraqi.  These investors prominently include Kuwaiti, Saudi, 
and Lebanese investors who hold large stakes and seats on the 
boards of most of Jordan,s banks, and the French and 
Canadian companies that have taken large stakes in Jordan,s 
privatized telecom and mining corporations.  Market analysts 
estimate that no more than 6% of the market is made up of 
foreign "hot money" - a percentage which has not grown 
significantly over the course of 2004. 
 
------------------------ 
ENTRY OF THE COMMON MAN? 
------------------------ 
 
5. (SBU) An alternative explanation is posed by several 
market insiders.  According to these investors and analysts, 
the combination of the substantial 2003 bull market and 
changes in the structure and rules of the ASE (to which USAID 
gave substantial technical support) have fostered a deep 
interest in the stock market among the "common man." 
Particularly significant among these changes, some say, was 
the new ASE rule requiring publication of quarterly reports 
for all listed companies.  One analyst notes that the 
beginning of the massive rise at the end of 2004 almost 
exactly coincided with the publication of the first-ever 
mandatory quarterly reports, which provided a level of 
transparency not previously available and at the same time 
showed the sharp profitability growth that Jordanian 
companies had experienced over the previous six months. 
Several analysts and investors had stories of taxi drivers, 
housewives, and other nontraditional investors who now would 
converse only about the market and its prospects. 
 
6. (SBU) Optimists, who include most of the younger analysts 
to whom we talked, see the entry of more small investors as a 
long-term inflationary trend that will only grow in the 
future, giving the market a higher "natural" valuation as 
investors grow comfortable and eliminate part of the risk 
premium.  The larger number of small investors is a healthy 
sign and could be a stabilizing force in the market.  Some 
brokers, however, regard the entry of small - and largely 
uninformed - investors into the market as an alarming sign 
that the ASE is now a full-blown bubble. 
 
7. An adjunct to the "small investor" theory of the ASE rise 
notes the role of Jordan,s Social Security Corporation 
(SSC).  The SSC is prohibited by law from investing anywahere 
but in Jordan.  Its stakes are primarily strategic, but its 
large surplus (resulting from Jordan,s population structure) 
ensures that more money is constantly flowing into all of its 
investments, approximately half of which are equities traded 
on the ASE.  The SSC,s holdings make up around 11% of the 
total capitalization of the market, slightly up from 2003, 
with an overall valuation of JD 1.7 billion ($2.4 billion). 
While its investments in the market remained statutorily 
capped and its active portfolio (JD 30 million = $42 million) 
is in relative terms quite small, the constant stream of 
money entering the market on a predictable basis adds a 
long-term inflationary force to the stock market. 
 
-------------------------------- 
A SHORT-TERM SHIFTING OF CAPITAL 
-------------------------------- 
 
8. (SBU) While the entry of small investors is beginning to 
change the face of the market, however, its input on market 
movements has to date been relatively limited.  The 
overwhelming proportion of non-strategic investors are the 
same large-scale individuals and institutions who have 
traditionally been the major players in the ASE - and who 
have now simply decided to allocate more of their capital to 
portfolio investment.  While the excellent recent 
profitability of many ASE-listed companies and the 
above-mentioned increase in the ASE,s transparency drive 
some of this reallocation, short-term regulatory decisions 
and the peculiarities of Jordan,s financial system are also 
contributing factors. 
 
9. (SBU) The low interest rates maintained by the CBJ 
(following the Fed,s lead) over the past several years have 
been one such factor.  Many investors who traditionally have 
held large balances in deposit accounts have come to believe 
that their returns were destined to remain smaller than the 
inflation rate.  Meanwhile, the large spreads maintained by 
the oligopolistic behavior of Jordanian banks have reduced 
the returns for investors wishing to fund productive projects 
with the assistance of borrowed capital and have maintained 
depositors, interest rates at a low level even after recent 
rises in CBJ interest rates.  The result has been a flight to 
assets such as stocks and also real estate, which has 
similarly experienced a superb recent performance. 
 
10. (U) Another regulatory decision contributing to the shift 
of capital by major market players into the ASE has been the 
CBJ,s requirement that all banks raise their paid-up capital 
to JD 40 million ($56.4 million) by the end of 2005 (ref A). 
The order, meant by the CBJ to spur a wave of mergers, 
instead has led many banks to hold private offerings of extra 
shares at reduced prices to their shareholders.  The constant 
stream of offerings have created substantial excitement the 
market, by creating the impression among stockholders that 
they were receiving "inside" deals, and prompting those not 
already invested in banks to pile in.  The fallout from this 
dilution of shares has not yet become apparent, as excitement 
- and share pricing - remains high after the private 
offerings launched by many of these banks. 
 
------------ 
CAN IT LAST? 
------------ 
 
11. (U) Virtually every analyst with whom we have spoken is 
willing to predict moderate growth over 2005, despite the 
substantial run-up of the last two years.  One reason for 
this prediction is the considerable growth in profitability 
that large sectors of the Jordanian economy has realized over 
that period.  This profitability growth has been most 
pronounced in the industrial and transportation sectors, but 
the resurrection of tourism to Jordan has vastly improved 
returns to that sector - a long-term improvement likely to 
become even more pronounced over the coming year, in part due 
to events in the region (septel). 
 
12. (U) More convincingly, market optimists point to other 
factors that have little to do with market fundamentals.  The 
ASE in 2005 is likely to see several events that will 
heighten the excitement of investors.  Several major IPOs are 
planned for 2005, to include (definitely) Fastlink, Jordan,s 
dominant mobile telephony operator and one of the most 
profitable firms in Jordan, and (possibly) all or parts of 
the Nuqul Group, the paper-products and consumer-goods empire 
belonging to the richest man in Jordan.  Sales of all or 
parts of the GOJ shares in major corporations such as Jordan 
Telecom and the Jordan Phosphate Mines Company will likely 
add to the attractiveness of these major Jordanian companies 
while adding volume to the market (ref B).  Jordan,s 
Palestinian community is excited by the probable listing of 
Palestinian Territories, two corporate heavyweights, the 
Palestinian Development and Investment Corporation (PADICO) 
and the Palestinian Telecommunications Corporation (PALTEL) 
on the ASE in late summer/early fall of this year. 
 
13. (U) Most anticipated of all, however, is an upcoming 
10-for-1 split in Arab Bank,s stock.  The most respected 
Palestinian corporation and a reliable engine of profit for 
over seventy conflict-ridden years, Arab Bank currently 
boasts a stock price so high that, combined with the Bank,s 
minimum purchase limit (20 shares), it excludes any investor 
unable to put up JD 6,050 ($8,530) or more.  The radical 
split of this stock will finally open it up to small 
investors looking for a safe bet.  Market optimists see 
hundreds of millions of dollars flowing into Arab Bank stock 
from Palestinian small investors around the world - and the 
upward rise of Arab Bank stock, which makes up over a third 
of the ASE,s overall capitalization, can be expected to 
inexorably pull the market with it. 
 
----------- 
PERHAPS NOT 
----------- 
 
14. (C) This optimistic view, however, is far from universal; 
indeed, it seems to be taken primarily by younger analysts 
and by people who have recently entered the market.  The view 
of those who actually have the potential to affect market 
movements, on the other hand, is more grim.  Since the 
beginning of 2005, we have been hearing a steady drumbeat of 
negativity on market valuations from major investors and bank 
presidents; recently, assessments from this group have taken 
on a tinge of alarm.  These assessments are echoed, with a 
bit more finesse, by Henry Azzam, a well-respected 
commentator on the market and head of the Jordinvest 
brokerage house.  Azzam told us privately in February that he 
looked forward to a fall in the market because it would force 
investors to find productive uses for their capital rather 
than adding to the inflation of asset prices.  Recently, he 
has gone public with his worries, arguing in a column 
syndicated in newspapers throughout the Arab World that the 
CBJ should raise interest rates until the ASE bubble is 
pricked. 
 
15. (U) Market pessimists point to several hard facts of the 
market as justification for their outlook.  The ASE,s total 
valuation currently stands at around 220% of Jordan,s GDP, 
one of the highest rates in the world (for sake of 
comparison, the valuation of the NYSE is just over 100% of US 
GDP).  This figure is not significantly above the relative 
valuations of the exchanges in several GCC countries; 
however, Jordanians doubt the rationality of the GCC 
exchanges, valuations as well, and the oil-fueled GCC 
economies have seen sustained growth over the past three 
years that Jordan,s economy has not even approximated.  It 
is significantly above any level ever reached in the history 
of the ASE; at the market,s last peak, in 1993, its 
valuation stood at 90% of GDP. 
 
16. (U) Productivity growth alone does not account for the 
state of the market; in fact, the average P/E ratio of stocks 
on the ASE is at its highest level in history, around 25 
(average P/Es for stocks in emerging markets worldwide 
generally fall in the range of 14-15).  Many of the 
best-performing stocks listed on the ASE are those of 
financial companies, whose performance has been inflated by 
paper gains from their investments in the ASE itself.  All 
signs seem to point to a market at a cyclical peak, last 
reached in 1993 and prior to that in 1981-2.  The difference 
this time around is the unprecedented size of the peak. 
 
----------------------------- 
COMMENT: AS GOES ARAB BANK... 
----------------------------- 
 
17. (C) The market may, in fact, have already peaked.  In its 
most recent expansionary phase, from October 2004, it has 
moved almost in lockstep with the share price of the Arab 
Bank.  Arab Bank, in turn, has risen steadily (though not 
without a few hiccups - ref C) ever since the announcement of 
its plan for a 10-for-1 split, to be implemented in the 
upcoming week.  Of late, however, the stock has fallen 
approximately 7% off of its high, achieved two weeks ago. 
The ASE, taking its cue, has drifted down slightly over the 
same period.  The market appears to feel that the expected 
influx of small investors into Arab Bank stock has already 
been priced in (Arab Bank stock is, after all, currently 
trading at a jaw-dropping P/E of 37); the upcoming week 
should show whether this perception is correct. 
 
18. (C) There is reason to believe, at least on the basis of 
recent market activity, that the market could deflate 
relatively gently by itself, perhaps aided by some prodding 
from the CBJ.  CBJ Governor Umayya Touqan told visiting 
Senator Gordon Smith March 20 that he hoped to help create a 
"soft landing" for the ASE.  CBJ Deputy Governor Faris Sharaf 
confirmed to econoff that the CBJ is concerned with the 
problem and is trying to signal the market to slow down; the 
CBJ,s press release on March 26 announcing the most recent 
round of interest rate increases included for the first time 
language about the high valuation of asset prices in Jordan. 
Without any serious outside shocks, excitement generated by 
new IPOs and stock sales may help to slow the pull of gravity 
and to ensure a soft landing for the market. 
 
19. (C) An absence of external shocks, however, may be an 
heroic assumption.  Jordan is famously an oasis of calm in a 
bad neighborhood, but it is hardly immune to its neighbors' 
troubles.  A single successful terrorist attack could reverse 
perceptions and provoke a small capital flight that might 
snowball, given existing fears about the outsized market 
valuations.  The market is similarly vulnerable to the 
prospect of a sudden loss of confidence in Arab Bank, the 
major market mover, possibly sparked by events in the U.S. - 
e.g., a large judgment against the bank in the New York civil 
suits filed against it, or a problem in securing an inflow of 
U.S. dollars if the bank were unable to secure a clearing 
agent for its New York operation. 
 
20. (C) If a sharp shock were to cause panic selling, concern 
for the future of the ASE would be in order.  The market 
optimists are correct when they talk about the entry of the 
small investor, though perhaps not about the small 
investors, importance in market movements.  For the first 
time, the ASE has real resonance among Jordanians outside of 
the traditional, closed circle of market insiders - a real 
triumph both for the GOJ,s reform agenda and the USAID 
technical assistance that has backed it to the hilt.  The 
benefits of this market broadening are self-evident, but its 
dangers may become more evident in the event of a sudden drop 
in the market.  Primary among these dangers is the 
possibility that small investors would see a drop in a market 
so highly touted as a success story as a betrayal of their 
interests.  Despite all of the past few years, reforms in 
the transparency of the market - and they have been 
substantial - the primarily family-based holding structure of 
the firms that make up most of Jordan,s economy leaves the 
market highly vulnerable to insider trading.  In a sudden 
price collapse, therefore, many of the major investors would 
likely emerge relatively unscathed while the small investors 
were left holding the bag.  If this were to happen in a 
relatively public way, it might be some time before the 
public would recover confidence in the market - or in the 
forces that backed it. 
 
21. (C) The wider effects of such an ASE price collapse on 
the economy of Jordan as a whole would also likely be 
significant.  Leaving aside the heavy exposure of the Social 
Security Corporation to the ASE, there is reason to worry 
about the banking sector.  The CBJ has begun to calculate the 
amount of borrowed money currently in the market, and has 
come up with a back-of-the-envelope figure of JD1-1.3 billion 
($1.4-1.8 billion), almost all of which the CBJ believes has 
entered the market over the past year.  Given that the size 
of Jordan,s GDP in 2004 was $10.8 billion, there would seem 
to be a dangerously high level of bank exposure to the 
vicissitudes of the market.  A sudden fall in the ASE could 
well put several of the more retail-focused banks - 
especially those with large portfolios of their own in the 
ASE.  The result of one or more bank collapses concurrent 
with an ASE asset price collapse would be difficult to 
predict with exactitude, but the likely cost to Jordan,s 
"real" economy would likely be high. 
HALE