MIDDLE EAST: Arab economies to grow despite setbacks

Analysis

The IMF's latest downward revisions of growth rate projections for 2009 place Arab countries in third place at 5.3% after China and India at 8.5% and 6.5% respectively, although World Bank figures are somewhat less optimistic. Positive growth prospects reflect two key factors:

• Macroeconomic fundamentals are positive, in particular the prospects for sustained investment growth, which will be driven by accumulated oil revenues and continuing oil incomes.
• Regional capital markets, which have been hit by the crisis, are among the smallest and least significant in emerging markets.

Investment. Buoyant investment activity is now and will continue to be supported by oil income and wealth:

• The current account surplus of oil economies is expected to double to some 132 billion dollars in 2008 against 77 billion dollars in 2007.
• Arab sovereign wealth funds (SWFs) possess at least 1.53 trillion dollars in assets, with considerably more in reserves and accumulated private wealth.
• Despite the slashing of oil revenues due to the present fall in oil prices, accumulated assets are likely to make up the difference from a regional standpoint -- although particular countries may suffer.

Intra-Arab foreign direct investment (FDI) has been rising steadily, from 8.8 billion dollars between 1985-1995, to nearly 17 billion dollars between 1995-2002, to 77 billion dollars between 2002-07, with 14 billion dollars in 2007 alone (see GULF STATES: Investment in wider Middle East to deepen - September 2, 2008):

• FDI accounts for 12% of regional capital formation compared to 7.8% in developing countries as a whole.
• GCC investors are now investing around 25% of their oil wealth in the region compared to 15% in 2003.
• In oil, gas and energy, 520 billion dollars worth of projects are planned for 2009-2013, down from a projected 650 billion dollars before the crisis; even if only 400 billion dollars worth are financed, 8-10 billion dollars a month of investment will take place.
• The crisis in Europe and the United States will strengthen the need for geographic diversification, and will confirm intra-Arab investments as a key category in Arab portfolios.
• Investors will likely diversify away from real estate and tourism into other sectors such as food, transport, and medical diagnostics.
• There have been official promises to maintain intra-Arab capital and investment flows, although the use of resources in domestic bailouts may limit the fulfilment of such commitments.

Market losses. The four largest markets -- Dubai, Egypt, Kuwait, and Saudi Arabia -- have lost up to half of their value, mirroring heavy losses elsewhere. Another four markets -- Abu Dhabi, Bahrain, Qatar, and Oman -- registered relatively moderate losses of 20-40%. All had fallen from historical highs in summer 2008.

There are a number of channels of contagion from global financial markets:

• Exits by non-Arab investors have most seriously affected the more open Arab stock markets, namely those of Egypt and the United Arab Emirates (UAE).
• Exposure to the US prime and sub-prime markets has affected players in Kuwait, Qatar and the UAE.
• A more significant channel is heightened fear and uncertainty about the unfolding global recession; the region's markets, whose trends have been dominated by excitement and herd behaviour, joined the global panic.
• Negative sentiment overwhelmed the effects of positive fundamentals, including the strong results of many listed corporations for the first half of 2008.

Mitigated impact. Yet there are good reasons to believe that the falls in Arab markets will be less enduring, and have less negative broader impact, than in markets elsewhere:

• The fall in OECD financial markets is the most severe in decades; in contrast, wild swings in the region are common.
• Arab stock markets are highly volatile, narrow and illiquid; only a small proportion of total capitalisation is traded.
• The dominance of financial institutions in market indices made their fall in the present crisis inevitable; financials constitute 56% of the S&P's Pan Arab index, compared to 16% in the Latin America index and 36% for Africa.
• Remarkably, the four smallest markets -- Beirut, Jordan, Morocco, and Tunis -- retained gains, indicating that intra-Arab investments have constituted a successful portfolio diversification strategy.

Arab markets are still constructing operational and regulatory structures. Gaping holes remain in corporate governance rules and practices, and the culture of retail investors is still underdeveloped. In 2007-2008 a series of investigations targeted insider dealings and share manipulation. Fines were handed to listed firms, brokers, and investment companies in Jordan, Egypt, UAE, Saudi Arabia, and Oman. However, the relative unsophistication of markets and their lesser significance in the broader economies has shielded Arab countries from the worst effects of the financial crisis.

Slowdown. The downside risks are not to be underestimated in a deep and complex world crisis:

• Oil revenues will be dented by declining world demand, forcing oil-rich countries to engage in belt-tightening and possibly threatening FDI flows to other Arab countries.
• The cost of finance, in terms of spreads, has already risen to all-time highs, and all types of capital raised are below 2007 levels.
• Falls in exports will cause losses across the region; many once-booming industries such as petrochemicals and fertilizers are now faced with sliding markets.
• Falls in tourism will hit players such as Morocco, Egypt, and Dubai; falls in remittances will hit North African countries (see MOROCCO: Crisis impact cushioned by past prudence - November 21, 2008).
• Dubai's fall is likely to be the sharpest, linked as it is to the bursting of an enormous real estate bubble; mortgage lending had quintupled in the last five years, and government debt is high at around 70 billion dollars (see UNITED ARAB EMIRATES: Dubai model shows vulnerability - November 13, 2008).
• Egypt, which is poor and heavily indebted, is likely to be hit hard by declines in the stock market, oil and gas income, and Suez revenues; even a moderate downturn is likely to feed growing public discontent (see EGYPT: Stability depends on Mubarak - October 29, 2008).