GCC well placed to navigate a turbulent global economy

Posted on : Sun, 14 Aug 2011

The current economic turmoil in the US and Europe may have short term impacts on the GCC. However, the longer term impact will be limited because the economic fundamentals in the region remain strong, according to QNB Capital.

Recent weeks have seen the most dramatic developments in the global economy and markets since the credit crunch three years ago.

A key event was the first ever downgrade of US government debt, by credit rating agency Standard & Poor’s, on August 5th.

Longstanding investor concerns about indebted Eurozone countries also intensified. On the day before the US downgrade, yields on Italian government bonds hit their highest spread over German bonds since the launch of the euro in 1999. Spanish government bonds came under similar pressure. This caused the European Central Bank to start buying Italian and Spanish bonds to try and reassure the market.

The problems with government debt in the US and Europe are longstanding. They are a result of both structural deficits and the nationalisation of some banking sector debt during the credit crunch bailouts. Investors are particularly worried that the political differences within the US Congress and between EU countries may block effective action on either side of the Atlantic.

In addition, there are growing concerns that the real economy in the US might slip back into recession, or at least post lower growth than previously expected. Monthly data releases in the US on indicators, such as employment, production and confidence have been mixed.

The equity, currency and commodity markets have all reacted sharply to these developments. Most equity markets and commodity prices initially dropped sharply and have subsequently show a high level of volatility.

Meanwhile, safe havens, such as gold and the Swiss franc have touched new highs against the US dollar.

US Treasuries have also rallied. They are still seen as a safe haven despite the role of US debt in sparking the current turmoil. QNB Capital had previously argued that US Treasuries would remain the global benchmark even in the event of a downgrade. This is partly because no other bond market has the volume, range of maturities and liquidity to serve as an acceptable alternative.

Market volatility is likely to continue for some weeks as investors reassess risk. Sentiment in GCC equity markets will continue to be influenced by moves in global markets.

Oil prices have dropped to their lowest level in 2011. However they are still strong by historic standards and QNB Capital does not expect there to be a sustained decline in oil. Moreover, GCC governments use conservative oil prices in their budget assumptions and, before the current turmoil struck, were on course to post large fiscal surpluses this year.

The GCC countries’ fiscal surpluses and low levels of public debt mean that, even if oil prices were to decline, this would not seriously disrupt their spending plans. This is important, because government spending is the foundation of the region’s non-oil economy.

Separately, a weaker dollar, to which GCC currencies are pegged, could increase the cost of imports and boost inflation in the region. However, inflation is currently low in most countries. QNB Capital does not expect the impact from a weaker dollar to be significant.

The GCC is intimately connected to the US, Europe and Asia, and economic and market turbulence there will continue to reverberate in the Gulf. However, QNB Capital argues that the economic fundamentals in the GCC are still strong. Consequently it is better placed than most other regions to navigate safely through a turbulent global economy.