Political uncertainty takes its toll on regional economies

26 April 2002

When political tensions in the Middle East rise, oil prices tend to go up. This results in short-term financial gains for the region's major oil exporters, but there is also a downside. The market has shown that it cannot sustain high oil prices for very long, and the net effect of repeated political and security crises is volatility in oil prices and output levels, which creates headaches for government and corporate planners. The perception of the region as being in a state of perpetual conflict is also a factor in determining the level of foreign investment. Without significant foreign investment, MENA countries will continue to face difficulty in meeting the urgent challenges of job creation and economic diversification.

The IMF, in its most recent set of global economic forecasts, published on 18 April, reckons that real gross domestic product (GDP) growth in the Middle East will slow to 3.1 per cent in 2002, compared with 4.5 per cent the previous year and 5.3 per cent in 2000. This time last year, the IMF had a more positive outlook for the region, predicting growth of 4.5 per cent in 2002. The IMF cites the security situation and the reduction in oil output as the two main reasons for the slowdown in growth. 'The curtailment of oil production associated with OPEC agreements to limit global supply has depressed activity in the oil exporting countries although recent increases in oil prices, if sustained, will help support growth,' the IMF says. 'The security situation has also had a significant negative impact on activity, including tourism.'

So far, tourism is the main sector in the region to have been directly affected by the repercussions of the 11 September events. However, the present flare-up in the Palestinian-Israeli conflict has sparked fears of more extensive knock-on effects, as the political stability of a number of regional states with strong links with the US could come under threat. If the US goes ahead with its plans to use military force to seek the overthrow of Iraqi President Saddam Hussein, those fears about stability will inevitably increase.

The two states that appear most vulnerable to fallout from the Palestinian and Iraq crises are Egypt and Jordan, both of which have also been hit by the loss of income from tourism.

President Mubarak of Egypt has made clear his dismay with the turn of events in the region, first through staying away from the Arab summit in Beirut at the end of March, and most recently through refusing to meet US Secretary of State Colin Powell, who had planned to stop in Cairo on 17 April at the end of his mission to deal with the Israeli invasion of West Bank towns. US officials claimed that Mubarak had cried off because he was 'indisposed'. However, the Egyptian leader was apparently well enough to give a lengthy interview to the official Middle East News Agency that appeared prominently in the Cairo press the following day.

The anti-US gestures fit in with the mood on Egyptian streets, but Mubarak has had to be careful not to push things too far. Protestors have been urging Egypt to sever diplomatic ties with Israel. Mubarak says that maintaining ties means that Egypt is able to keep Israel up to its international obligations. That may be so, but it is also clear that if Egypt were to cut its ties with Israel, Cairo would be putting its economic relationship with the US at risk, given the strongly pro-Israeli leanings of Congress. Egypt receives $1,300 million in annual military aid from the US and just under $700 million a year in economic aid. The US also accounts for about 15 per cent of Egypt's exports.

Over and above these bilateral considerations, the word of the US carries weight at the IMF and World Bank - something that Egypt has turned to its advantage in the past, most notably in 1991 after Mubarak helped mobilise Arab support for the US following Iraq's invasion of Kuwait. Egypt is now looking to secure some $1,500 million in loans from the IMF, the World Bank and the African Development Bank to help deal with a balance of payments crisis provoked by the loss of tourism earnings. The new funds will only be disbursed if Egypt can show that it is adequately addressing structural issues such as the exchange rate system and the budget. The measures envisaged are likely to cause some short-term hardship, adding another ingredient to an already volatile political mixture.

The IMF is forecasting economic growth of just 1.7 per cent in Egypt in 2002, a current account deficit of some $2,000 million, and a modest rise in inflation, presumably arising from the effects of further devaluation of the Egyptian pound.

One factor in Egypt's favour as it deals with this sombre economic prognosis is that it does not have any particular difficulty in servicing its external debts. This is not the case for Jordan, which is planning to impose sharp cuts in subsidies on bread and fuel so as to secure IMF backing for a fresh round of debt restructuring through the Paris Club. The IMF is fairly upbeat about Jordan's economic prospects, predicting growth of 5.1 per cent in 2002 and 6 per cent the following year. However, Jordan is vulnerable to developments in Palestine, and also runs the risk of destabilisation in the event of a US attack on Iraq.

Feelings have also been running high in the Gulf Arab states about the plight of the Palestinians, and this has been reflected in the attention being paid to the issue by Crown Prince Abdullah of Saudi Arabia. However, the main direct significance of the conflict for the Gulf economies is its effect on the oil price. The combination of OPEC production curbs and political anxiety has driven the price of crude up by 40 per cent, or some $7 a barrel, since the start of the year. If prices remain at this level, it means that the Gulf states will not suffer any ill-effects in terms of their budgets and current accounts, despite the heavy cuts they have made in production. The lower output will depress real GDP growth, however. It also comes at the price of the erosion of OPEC's market share.

OPEC's share of global output declined to about 36 per cent in late 2001, from close to 40 per cent in the early 1990s, and could drop further to close to 35 per cent in 2002 if the recent cuts are maintained. 'This decline could raise concerns in OPEC about a secular decline in their ability to influence the market, and an erosion of revenue in favour of alternative producers,' the IMF says. 'The equilibrium in oil markets is thus likely to remain rather fragile as OPEC navigates the trade-off between losing market share and supporting prices.'

For Saudi Arabia, the IMF is forecasting a 0.5 per cent contraction of real GDP in 2002, 'partly reflecting the more difficult fiscal situation'. Saudi Arabia recorded a budget deficit of 3.8 per cent of GDP in 2001, as actual spending overshot the target by 18.6 per cent. The government is planning for a deficit of some 8 per cent of GDP in 2002, but with oil prices expected to be significantly higher than the assumed price of $17 a barrel, actual revenues are likely to be well above the government's stated figure of SR 157,000 million ($41,900 million) for the year.

The big question mark in the Saudi budget is overexpenditure. No detailed explanation has been given for the large increase in spending in 2001. The government had been aiming to trim spending in 2001 by 8.5 per cent, compared with the previous year when actual spending rose by 30 per cent as the economy rebounded from recession. The fact that spending in 2001 was in fact 8.5 per cent higher than the actual figure for 2000 makes it hard to believe that the 2002 target of cutting spending by 21 per cent can be achieved. Even allowing for the possibility that the 2001 figure was affected by one-off factors such as military purchases or debt repayments, the expenditure figure for 2002 is unlikely to fall that much, particularly given that the government has not applied any major austerity measures.

'The continued running of deficits and accumulation of debt is not a crisis, but is a matter of growing concern,' says Saudi American Bank chief economist Brad Bourland in a recent report on the Saudi economy. 'The trends are worsening.' The government has been seeking to tackle this problem through stimulating private investment, particularly in infrastructure. Some significant achievements have been made in this regard over the past three years, but the process is by no means complete, and has been knocked back by the failure to reach agreement on the Saudi gas initiative. The souring of the political atmosphere has not helped, if only because it has absorbed the energies of those Saudi leaders most concerned with pushing forward with economic reforms.

The IMF remains upbeat on Iran's economic prospects, forecasting growth of 5.3 per cent in 2002, based mainly on the expansion of non-oil private sector activity. However, the Iranian government faces a difficult task in adjusting to the newly applied market-based exchange rate system, and the long delays in concluding agreements with international companies for new oil and gas investment raise questions over medium-term growth prospects.

A brighter outlook is in store for those Gulf economies that have succeeded in diversifying, and reducing dependence on crude oil exports. Qatar has built the platform for sustained growth through its investment in gas exports, and Dubai's emergence as the commercial and service centre of the region has allowed for continuous economic expansion that has been immune to the effects of oil price volatility and political uncertainty.

The present pattern in the region is one of a few thriving centres, some major economies struggling to reform, and a few cases where the alarm bells are starting to ring. The developments in Palestine and Iraq cast a shadow over the region's prospects over the next 12 months. However, resolution of these two issues could provide the stimulus for the surge of investment that is needed across the region to bring infrastructure up to the required standards and create job opportunities in a variety of new sectors.

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