Focus on the Middle East
co-written with RGE Monitor’s Lead Analysts
There is no shortage of reasons to draw our attention to the Middle East this week. President Bush makes a return visit to the region this week to celebrate Israel’s 60th anniversary and to open the World Economic Forum on the Middle East on Saturday in Sharm-el-Sheikh, Egypt. With oil at $120 a barrel, the decisions of how oil-rich nations invest their windfall becomes only more important.
The IMF’s latest regional outlook for the Middle East – released on Monday – suggests that high oil prices will continue to fuel both government spending and private sector investment – making the Middle East the only region likely to maintain its 2007 growth rate (of about 6%). See “Middle Eastern Economic Outlook 2008: Strong Growth On Oil and Investment But Inflation a Risk”
Inflationary pressures are rising though as rising global food prices intersect with the supply constraints of fast-growing economies, leading to double digit inflation in many countries. For the dollar-peggers or dollar-trackers in the region, importing U.S. monetary easing and the inflationary effects of a depreciating U.S. dollar which raises the costs of EU and Asian imports in local currency terms doesn’t help inflation-fighting. Yet, the GCC countries have ruled out exiting their pegs or revaluing for now, preferring instead to cushion their population from food inflation through price caps, rent controls and wage hikes.
Oil importers are more constrained. Egypt has found it hard to pass on rising costs, fearing political instability, particularly as much of its population has not seen the benefit of the 7% GDP average growth of recent years. See “Will Food Inflation Destabilize Egypt?”
Although oil exporters are spending more at home – current GCC budgets targets are all below $50/barrel oil – much of the windfall from oil is being saved abroad. RGE’s Rachel Ziemba’s “What Will GCC Funds Buy?” surveys the investment strategies of the sovereign wealth funds of the GCC, noting that dollar weakness and the opportunity to purchase distressed assets in the U.S. likely contributed to a pause in ongoing diversification away from the dollar.
However, investments in emerging markets, especially Asia are on the rise, as are economic partnerships. The same applies to the MENA region, where direct and portfolio investment from the GCC is on the rise. See “MENA Riding a Petrodollar Surge?”
Ample Petrodollar liquidity has sheltered the region from the global credit crunch, but economic linkages persist. The credit contraction in industrialized countries could reduce risk aversion and shrink some of the capital inflows that have supported growth. A decrease in G3 growth would hurt non-oil exports and if it leads to lower oil demand, could trigger a sell-off in crude oil prices. RGE’s Mikka Pineda and Rachel Ziemba recently examined the drivers of the current oil boom suggesting that while the fundamental balance is indeed tight and the lack of spare capacity intensifies supply fears, it hasn’t worsened as much as the oil price has accelerated. This suggests a role for speculators and hedgers. For a short summary see “Brazil, OPEC and Oil Fundamentals”
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