Impact of Renewed Global Crisis on Gulf Economies

The precipitous drop in oil prices in the summer and autumn of 2008 served as a painful reminder of the interconnectedness of the global economy.

It paid little head to the strong macroeconomic fundamentals of the GCC economies and precipitated a sharp correction which the region still has not fully emerged from. As Europe seeks to tackle the most serious economic crisis in the history of the European Union and of the Euro-zone, external investors inevitably once again find themselves in an uncomfortable position. Worries about renewed political risk in Korea and other parts of the world are further adding to this anxiety.

Just as the Gulf countries were not immune to global woes in 2008, they will not be so this time either.

What does the crisis mean for the Gulf? Prior to the crisis, the resumption of growth in the Gulf looked likely to be driven increasingly evenly by the oil price rebound, large-scale government spending, and accelerating private sector activity.

The main vulnerabilities at the moment pertain to the first and the third of these factors. By contrast, the outlook for government spending is very favorable. Not only are many of the plans conceived last year now being realized but new ones are under consideration.

Because of the so-called fiscal lag and the laudable caution of GCC policymakers, the outlook for effective fiscal stimulus spending in the region is exceptionally benign and it promises to constitute one of the most effective global growth guarantees anywhere.

The oil price was shown to be the single main vulnerability of the GCC economy in 2008-2009. In this regard, little has changed and the implications of this are a mixture of good and bad. However sharp and painful the precipitous drop in prices in the second half of 2008, it proved short-lived.

A clear recovery took hold early 2009 and prices fairly quickly returned to levels seen during much of the economic boom of the past decade. The resilience of the oil price was particularly heartening in view of the continued vulnerability of the global economic situation.

This points to favorable fundamentals, both in terms of a fairly tight demand-supply balance and in terms of the changing dynamic of oil prices at a time when commodity investments have increasingly established themselves as a part of the mainstream portfolios. From the GCC perspective, the new ‘equilibrium’ price was comfortable, consistent with strong government and external surpluses.

As resilient as the oil price outlook may have become, it is nonetheless determined by market forces and hence remains vulnerable to cyclical corrections. The pronounced and relatively speedy retreat of the oil price following the onset of the Greek crisis at this point seemingly involves at least in part the correction of an incipient bubble in the pre-crisis months.

The oil price is likely to be tested by increased investor anxiety along with renewed concerns about the global demand outlook as growth projections for the West are once again subjected to critical review. While the underlying structural drivers will inevitably reassert themselves before long, even a limited period of oil price weakness has the potential to heighten uncertainty and dampen investors sentiment, thereby putting key elements of the recovery in the GCC effectively on hold.

Similar concerns pertain to the ability of the private sector to return to normal growth. Even though the non-oil sector in the region proved highly resilient during the crisis, it has been inevitably hit by limitations on the availability of finance.

The regional stock markets often take their cues from abroad and there is a risk that the recent recovery might stall or even be reversed in the face of the elevated investor anxiety and increased market volatility. This in turn will curb enthusiasm about IPOs. Similarly, the region’s incipient debt capital markets have been hit by increased market strains, some of them driven by regional factors, such as the Dubai World restructuring.

Even though the structural drivers of this market are increasingly strong and compelling, issues are likely to be delayed and primary activity potentially limited to a small number of blue-chip names. Even though the regional sovereign issuers have become increasingly decoupled from the more vulnerable Western names, there is a risk that renewed trouble in Europe would once again push up the cost of credit, however temporarily.

Perhaps the biggest question mark pertains to bank lending after a period of effective credit constraints. The prospect of renewed weakness in the West will help further delay any interest rate increases, thereby limiting the appetite of banks for riskier lending.

Similarly, caution will persist for longer and result in yet more weeks and potentially months of subdued activity. Some regional banks will be further constrained by regulatory limitations, for instance the efforts of the UAE Central Bank to reduce loan-to-deposit ratios. These concerns – accentuated by regional corporate defaults – helped make 2009 a lackluster year for the Gulf economies, one when then worst was convincingly avoided but also one when the GCC economies failed to fully join in the emerging market rally.

Is there any good news? As challenging as the global economic situation remains, the economic divergence between the West and the emerging markets is likely to reassert itself and persist. The GCC region will be a beneficiary of this process. It continues to benefit from healthy fundamentals, macroeconomic stability, and attractive longer-term growth drivers.

It possesses sizeable reserves as a legacy of the international economic imbalances of recent years. While these reserves have speedily been mobilized during the downturn, they remain far from depleted. Low levels of government debt and high domestic savings constitute another line of defense should the economic weakness persist.

Paradoxically, a period of renewed market uncertainty may also help rectify some of the emerging macroeconomic imbalances in some Gulf countries. The US Dollar remains one of the main safe havens globally and it looks likely to maintain its strength vis-à-vis a number of other currencies at least in the near term. This should help reduce the risk of imported inflation, a particular concern in Saudi Arabia where the headline figure has once again edged up frustratingly close to 5 per cent.

A stronger Dollar should also help rectify some of the global imbalances that emerged during the past decade. However, it will create a tougher market place for many of the region’s non-oil exporters. But overall, the GCC should in relative terms come across as one of the more attractive investment destinations globally.

Email the writer: