Re-assessing Risk

The global economic crisis has led to a significant and in many ways unprecedented reassessment of the relative standing of emerging markets in the global economy. Investors have been consistently impressed with their economic stability, technocratic policy-making, and powerful internal growth drivers. Unlike during previous crises, emerging economies have not let their admirers down. Their growth performance has consistently outshone that of their advanced economy peers. Increasingly, they have driven the global economy forward and in many cases actually exceeded the growth projections made for them.

The positive perceptions of emerging markets endured even bouts of instability in countries such as Thailand and Pakistan. Whatever instability has been observed, has typically tended to be relatively isolated. The larger emerging economies typically surprised on the upside with orderly transitions of government and a firm, broad-based commitment to rules-based economic policy. This has underpinned general optimism about emerging economies as the strong point of the global economy.

Now, however, that optimism is once again being challenged by a significant, unexpected change in the political situation. I am, of course, referring to the evolving situation in North Africa with a change of government in Tunisia and a potent popular challenge to the current incumbents in Egypt. The assumptions of continuity and stability appear to have been fairly abruptly invalidated. And this sharp turnaround has in turn resulted in considerable market anxiety. As regional investors worry about contagion, international investors are inclined to take a closer look at the broader emerging markets universe.

As unsettling as the news may be, especially by challenging the validity of the default assumptions of investors, it is not clear that they will in the end amount to a paradigm shift in investor attitudes to emerging markets. After all, the focus of the unrest in North Africa has not been on factors that might jeopardize the growth performance of these economies. Rather, the demands have tended to focus on greater accountability and governance, something that ultimately should foster growth. We naturally need to recognize the risks of a long, drawn-out, bumpy transition. But without wishing to take a position on what might follow, we also need to recognize that there is little in the demands of the protesters or the political agendas on offer that would jeopardize the positive progress made to date. Nor is there anything in them that invalidates the structural growth drivers of these economies.

Nonetheless, markets are inevitably faced with the prospect of at least short-term instability. Oil investors are worried about the free flow of goods through the Suez Canal and the Suez-Mediterranean pipeline. These account for some 5 per cent of the global supply of oil and have the potential to significantly destabilise the market in the short term with some analysts suggesting a hike to $150 per barrel even if the risk of discontinuities remains hypothetical. While the near-term impact of such a price hike would probably be generally favorable for the GCC markets, they would naturally cast a shadow over the global recovery.

The main concern for the regional equity markets is likely one of the type of malaise and contagion fear that prevented a fundamentals-driven rebound due to concerns about Dubai World and other corporate restructurings. Markets abhor uncertainty and even a relatively low risk of a very negative outcome will result in a risk premium. The sooner the way forward in Egypt is known, understood, and accepted, the sooner market behavior can revert to something more linked to fundamentals. In the meantime, it is likely that some investors will look elsewhere, many of them to the advanced economies where a recovery now seems underway and is further underpinned by an ultra-loose monetary policy.

But the developments in North Africa are likely to have longer-term implications as well. In particular, they should result in policies that are even more focused on sustainability and inclusiveness than has been the case to date. The starting point in the Gulf is generally positive, but the global crisis has repeatedly highlighted the need for a constant review of policymaking. After all, many of the assumptions that were globally regarded as dogma over the past decade or two resulted in major vulnerabilities and paved the way for the sharpest postwar downturn. Now all fingers are pointing at the shortcomings of regulation whereas before people were dismissing it as overly burdensome. In terms of the necessary refocusing of policy, the unprecedented investments in education and training are an important step in the right direction, but even more can be done to foster entrepreneurship and SME development.

The resilience of the Gulf economies during the global crisis has demonstrated the value of technocratic policymaking, anchored in objective analysis of the evolving needs of the economy and clear medium- to long-term strategic objectives that anticipate the evolution of the economy. Such large-scale efforts cannot be expected to yield results immediately but that cannot serve as a reason for deviating from what is a necessary course of action. A key element of successful policy has to involve effective communication of the measures taken and planned as well the successes and challenges. This model was applied with great success in East Asia and even parts of Europe. Its track record is compelling and alternatives to it non-existent. Even as investors may question some policy choices and the scale of some of the challenges facing the region, the foundation for sustainable growth is increasingly compelling. With a candid and critical assessment of the track record to date, the effectiveness of the choices made to date can be further amplified.

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