RGE’s Wednesday Note – Fallout From the MENA Days of Rage

The political situation throughout the Middle East and North Africa (MENA) is still in flux, with a rotating cast of countries carrying on “days of rage” and several regimes, including Libya’s, teetering. The overthrow of the Egyptian and Tunisian leaders has energized populations and opposition groups—leaders will no longer be able to rely solely on the old playbook of repression and subsidies. Regardless of how the political developments play out, all the regimes in the region have been challenged, and the populations will not be content with business as usual. In fact, many members of Tunisia’s caretaker government resigned this week as protesters demanded a government untainted by members of the old regime. In our latest MENA Focus, we consider what the recent political shake-up could mean for regional economies, their neighbors and their trading partners.

Protests have spread to oil-exporting nations, especially LibyaOman and Bahrain, but also Iraq and Iran, raising the risk of fuel-supply vulnerabilities. While we do not expect prolonged supply reductions, the escalation of violence could reduce output and impair energy and transport infrastructure, as it already has in Libya. Saudi Arabia’s efforts to boost production and redirect OPEC crude to European refiners and the reopening of key Libyan ports have dampened oil prices for now, but risks to prices seem tilted to the upside in the near term, at least until Saudi Arabia’s scheduled “Day of Rage” takes place. Moreover, international oil companies are putting both current operations and further exploration on hold in Libya, fearing political risks, the sabotage of energy infrastructure and possibly even changes in the royal regimes. If this occurs more broadly in the region, it could add to decades of underinvestment (only Saudi Arabia and Qatar have invested heavily in new infrastructure in the past decade). Continued underinvestment in MENA, which accounts for two-thirds of global oil reserves, could raise future supply risks.

Governments have responded to unrest by stepping up food subsidies, transfers to the population and, increasingly, use of force. Some regimes, like those of Bahrain, Libya and Algeria, met rising protests with violence, thereby threatening to add fuel to the fire. In Bahrain, for example, the government crackdown shifted demands from reform within the system to overthrow of the system. In Libya, where the opposition has long been suppressed, the hardline response risks breeding extremism. We continue to believe that most oil-exporting regimes in the Gulf Cooperation Council (GCC) will turn to concessions and government stimulus to neutralize risks, as Saudi Arabia appears to be doing in the wake of King Abdullah’s return. Oman turned desperately to such measures this week. But as Libya’s experience shows, not all regimes are willing to use their war chests for their populations, and others, like Kuwait, face institutional challenges in launching needed investment. Oil importers in the region have very constrained fiscal balances.

Overall, the region’s economic outlook has become more clouded, even for the oil-exporting nations that stand to benefit from higher fuel prices, at least until demand destruction kicks in. While tourism, industrial production and investment will be most affected where the protests have been most intense, the broader flight from risk could disproportionately affect other countries in the region. Our recent revisions suggest growth in the MENA region will decelerate slightly in 2011 to about 4.5%, regaining ground only in 2012. The stalled economies of Egypt, Tunisia and Libya contribute to the regional downgrade, with only a partial offset from extensive fiscal stimulus in Saudi Arabia and most GCC countries. The push to appease populations implies more government spending, which could boost consumption, as investment, private-sector growth and future productivity suffer. As rating agencies have been quick to point out, the fiscal and external deficits of fuel importers will swell, raising current and future financing costs and eating into growth. Oil exporters too will experience a sharp increase in government spending, and current account and fiscal balances will narrow, making these economies reliant on ever-higher oil prices to balance their budgets.

As RGE Chairman Nouriel Roubini examined in a recent piece, the economic costs of MENA unrest extend far beyond the region, with rising commodity prices the most significant linking factor. A further increase in oil prices would pose a significant downside risk to global growth. We expect demand destruction for fuel products to occur at lower oil prices than in 2008, as U.S. and EU consumers are more stretched. Fuel importers will suffer from higher prices, and global central bankers will face a more difficult job in setting policy. Countries like Turkey and South Korea with extensive goods and services exports to MENA countries could face two challenges from the region’s disruption: a stall in their projects with the countries and a deterioration of external balances from an increase in oil prices.

Beyond food and fuel security risks, the waves of unrest are washing up on the European continent in the form of increased numbers of migrants to southern EU nations. Already, Italy has reported an increase in Tunisians in Lampedusa, and some of the 100,000 Libyans flooding into Tunisia and Egypt may well try to make their way north. An increase in illegal migrants and refugees could stress the broader EU, which is still suffering from high unemployment rates and fiscal austerity.