How Bad Will the Middle East Hurt?

The New York Times ran a front page story on its website Wednesday reporting on the spread of the global crisis to the Gulf. The Wall Street Journal ran a similar story on Tuesday. Both stories focused on the impact of lower oil prices on the Gulf economies and suggested that while the Gulf could withstand the lower prices, the real losers in this scenario were the Gulf's new dependent states- i.e., the Egypts and Jordans of the world. This is a theme I briefly touched on in my previous posts and one to which I will surely return in future posts. The theory here is that although Egypt, Jordan, and other non-oil producing states will benefit from a decline in inflation with a reduction in oil prices (and also, I might note, an easing of their fiscal accounts since both countries still heavily subsidize commodity prices despite modest reforms in recent years,) the potential for a slowdown in remittance payments and investment flows will have an overwhelmingly worse effect on their macro positions than high oil prices had.

Although I think the impact on the non-oil producers is definitely interesting and worth considering, I think we need to challenge the notion that the oil producers' only real problem is the decline in oil prices. In fact, I think at this point, oil prices should be the least of their concerns. Much like Bear Sterns was a sort of prophetic symbol of what was to come down the pike for Wall Street, I wonder if Gulf Bank is not serving the same function for Gulf financial institutions. Here are the things that concern me: First, we just don't know how exposed not only Gulf commercial banks but also central banks are to the West. You would think by now some of their positions would have begun to unwind, and certainly, banks in the UAE and Bahrain, for example, have admitted to losing significant cash in the subprime mess. But if Gulf Bank can admit to losing $800 million seemingly overnight as recently as late October, who else might be similarly exposed? Remember that Gulf banks (both commercial and central) have traditionally invested heavily in US and European markets. In fact, SAMA has resisted forming a sovereign wealth fund believing that the slow and steady course of holding US sovereign and corporate bonds would serve them better than holding physical assets in the long run. But because the Gulf has traditionally resisted transparency when it comes to where it's putting its money, we just don't know how bad it might get for them. Second, Gulf banks and other financial institutions aren't just exposed to the West but they are also exposed to their local markets. In almost the entire Gulf, the non-oil economy has been growing at a faster rates than oil revenue. And that growth has been on the back of foreign investment or borrowing. A large chunk of Dubai is highly leveraged as are many Qatari institutions. With credit drying up around the world and businesses of all ilk facing some measure of retrenchment, who will be left to lend money to Gulf businesses? Or, on the other hand, who will want to open new offices in the Gulf? Sure, the governments have fairly deep pockets but not even they will be able to completely bail out their private sectors.

Finally, and in my mind most worrying over the long term, is something a bit more intangible. Gulf governments, led chiefly by Muhammad bin Rashid, have tried to upend the conventional development model by building economies chiefly centered on service industries. Shipping and logistics, tourism, business travel, retail, telecommunications- build it and they will come. And they have come- in droves in fact. It's a model being emulated throughout the Gulf and now by other Middle East countries as Gulf companies pour hundreds of billions of dollars into developing real estate ventures and tourism developments from Morocco to Syria. Here's the problem though- all of these new industries are predicated on attracting consumers of a certain economic status. To put it simply, Gulf companies have been banking on wealthy customers who demand what might be considered luxury goods and services. They are developing billions of dollars in delights for people can afford it. Superiority in logistics implies that people need and want to ship goods. Telecom implies that people can afford to purchase cell phones. Tourism implies that people can not only afford to travel but want to stay at your resort. It's easy to nay say this idea now, but given that these ideas were conceived of during a period of unprecedented global expansion, when each year groups like Global Insight were benignly calling for another year of "Goldilocks," you can't really blame them. Lots of people were getting rich, particularly in the developing world. And it was the developing world the Gulf was really trying to key into while maintaining some presence in the West. Unfortunately, if Roubini and others like him are right, it was a period that may be coming to an end.

Does this mean the end to the golden period in the Gulf? Insofar as the rest of the world is "girding their loins" (to quote Joe Biden) for a multi year recession, the Gulf should not and will likely not be immune. Still, I tend to think that all is not for naught. The global economy will eventually recover and people will once again want to ship goods, buy cell phones, travel, and consume more oil. And the Gulf should be pretty well prepared to serve those needs then.