Marketplace Middle East - Blog
The Heat is on

It is certainly not the first thing on the mind of Ben Bernanke and the board of governors at the U.S. Federal Reserve, but the second aggressive move within a span of eight days is putting the heat on his counterparts in the Gulf.

Five of six members of the Gulf Cooperation Council remain linked to the U.S. dollar through a historic pegging, designed to keep inflation at bay. We are seeing the first signs of cracks with that policy and realistically one may not see the peg lasting through 2008.

In an interview from Davos last week with “Marketplace Middle East” Qatar’s Prime Minister Sheikh Hamad bin Jassem Al Thani said, “We are studying all options at the moment”, adding, “Every country has to see its way out of this, but only after consultation with the GCC.”

You don’t even have to read between the lines to get the message that there is a sense of urgency. Inflation of 14 percent in Qatar threatens to undermine the economic master plan being pursued by the royal family. A visit to Doha in the past six months opened my eyes to what is quietly in store. Education, technology, energy and financial services hubs are underway – not at the breakneck pace of Dubai, but a measured response considering Qatar sits atop the largest gas field in the world and remains a key OPEC producer. While not in competition with the United Arab Emirates, Qatar and the UAE share common traits today: Fast growth and equally high inflation.

The March to 2010

Under ideal circumstances and without the interest rate pressure applied from the Federal Reserve, GCC members would ideally like to transfer their peg to the dollar to their own single currency. Time is not on their side. Sheikh Hamad was candid in his reply; “It (2010) is just a target. I don’t think we will reach that target.” This means that the economies in the region won’t converge as planned by then and they may grow their separate ways, until they can come together by, say, 2015.

Like the Euro introduction before it, a single Gulf currency will indeed help control inflation with a single, independent central bank and it will strip out a great deal of national protectionism still afforded some of the vast trading families. Also think of all the operating costs one can strip out with a single currency for investments and transactions?

That all seems like a long way off. In the meantime, there is a test underway -- a test of wills within the GCC whether to stay with or abandon the dollar link -- a test to the concept of de-coupling. Can the Middle East sustain its fast growth, infrastructure outlay and the ability to build intellectual capital to match the financial capital?

The answer to that question will likely come after the Federal Reserve finishes its aggressive attempts to stave off recession and what many still see as a potential global credit crunch.

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The new darlings of Davos
Almost as heavy as the snowfall that greeted participants at this Swiss Alpine resort, was the cloud of anxiety hovering over the start of this year's World Economic Forum.

Stock markets around the globe were badly shaken by the potential spread of a credit crisis from the U.S. This was not lost on Middle Eastern markets which started selling-off Sunday, their first day of trading, and carried through Tuesday.

The dramatic, and what some saw as a panicked, reaction by the Federal Reserve, to cut interest rates by three-quarters of a percentage point sent mixed signals. What is the Fed seeing that others might not? Certainly the signal is that the bottom certainly has not been found on Wall Street, and for that matter some of the European banks as well.

That, however, does not mean the rest of the world should freeze in its tracks and that growth should come to a halt. The Middle East in fact is coming off some of the fastest growth in three decades. The excess liquidity of $400 billion each year from oil prices in the $80 per barrel range has changed the dynamics of the region and what these players are doing with their capital.

The International Monetary Fund estimates that $800 billion will be put into infrastructure in the region. Tall buildings, new financial centers, energy cities, new university hubs -- they are all being built. But the region can only absorb so much capital.

This is where the new darlings of Davos come in: The sovereign wealth funds. In case you missed it, the funds were the subject of front page articles on both Business Week and the Economist over the weekend. The danger from my vantage point here is that there is a lot of discussion about moving fast, taking advantage of buying opportunities (like Citigroup & Merrill Lynch), but also about competing with each other. There is a hint that some of the players are getting ahead of themselves.

Giant Stimulus Plan

There is potential here in Davos to bring like-minded players together for the greater good of the global economy. While the White House debates the merits of the $150 billion stimulus package, there is $1.5 trillion available in the Gulf. That is a serious stimulus package. As respected economist and old Davos hand Fred Bergsten rightly said, this liquidity could lead to a re-coupling of east and west. The investment money from the Gulf, China and Singapore will help avert a recession in the U.S. if, and a big "if" here, the funds are welcomed.

Some anxiety about this was expressed this morning by Mervyn King, now of Standard Chartered Bank, but formerly head of the Bank of England. He said that the funds should agree to a code of conduct for transparency or risk being labelled "irresponsible." That certainly does not set the tone for a collegial Davos-like discussion on closing the gap between those in need of capital and those who hold it right now.

Another Davos veteran, Arif Naqvi, Chief Executive of Abraaj Capital sees this in two stark colors: Black and white. The region is sitting on two commodities in great demand right now: Oil and cash.

Those commodities put the 200 or so players from the Middle East in an enviable position within the halls of the conference center; now if we can only work on the politics so the money can get to work in the right way.

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Global footprints of sovereign wealth

This week will likely go down in the financial record books as the one which redefined how the world looks at sovereign wealth funds. It is also part of a bigger geo-economic shift underway, which lends itself to the East-East moniker, meaning the wealth and trade belt from the Middle East to China.

While we have been covering the power of these government funds, where they are seeking to make a mark and the new emerging players within this space, it is only now that these funds are flashing on the global radar.

It is challenging to get hard figures on the total government investment funds under management, but there are a handful of Western banks attempting to do so. Standard Chartered Bank places the value at around $2.2 trillion dollars. I personally think this is off the mark since the Abu Dhabi Investment Authority may have more than half that amount itself

SWFs - Big & Getting Bigger

· $2-3 trillion dollars in assets
· $10-15 trillion dollars by 2015
· Bigger than private equity

(source: Standard Chartered, Morgan Stanley)

More eye-popping clearly is the path ahead. If oil stays in the range of $60-$80 a barrel over the next five years, the amount will surge to $10-$15 trillion. To provide some context, the current sum is already bigger than the global private equity pool, which made all the headlines in the past two years with record buyouts.

Is this a new phenomenon? Certainly not. The Kuwait Investment Authority (KIA) can trace its roots back to 1953; the Abu Dhabi Investment Authority (ADIA) to the mid-1960s. While they traditionally deployed assets in government bonds and currencies, that trend has changed over the past five years and accelerated in the last six months.

Chris Wheeler, banking analyst at Bear Sterns, points to global wealth surveys to illustrate the point that liquidity from record oil prices has to find a home. “A lot of excess funds are being generated which the SWFs are having to invest somewhere and they are finding interesting opportunities in difficult times in the banking sector.” Wheeler, like many others, believes the often talked about recession in the U.S. will lead them to more bargains in other sectors.

This must sound familiar. Saudi Prince Al Waleed bin Talal bought stakes in Citigroup back in 1991 at the equivalent of $2.75 a share. Even at in the mid-twenty range it is today, he is (excuse the cliché) smiling all the way to the bank. He obviously thinks this latest downturn created a similar opportunity and so did others who jumped in this week. They are not traders, but investors who hold their stakes for years, sometimes decades.

Like the financial markets, which create buyers and sellers, this market and story will continue to evolve. One of the newer players on the scene, the Qatar Investment Authority, will re-emerge after its participation in the bid for U.K. supermarket giant J. Sainsbury, and Mubadala of Abu Dhabi has recently put itself on the map with its stake in investment banker The Carlyle Group.

G-8 Wish List

· Invest on commercial grounds
· Respect national transparency rules
· Compete with private sector fairly

(source: OECD, IMF)

As the old and new sovereign funds begin to compete for Western assets, G8 countries are attempting to establish investment standards for all this capital. The U.S. Treasury Department has lobbied to have the O.E.C.D., the Paris based think tank for industrialised nations, and the International Monetary Fund in Washington put forth guidelines for best practices and greater transparency.

That effort gathered momentum a few months ago, but the calls for concrete action have faded away, as the need for capital infusions on Wall Street rose rapidly.

The World Economic Forum in Davos next week will provide a good opportunity not only for us to talk to the Middle Eastern and Far Eastern players making waves in global financial markets, but also to those who are trying to regulate their actions.

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Quietly Delivering Growth

President George W. Bush’s whistle-stop tour of the Middle East is designed to add urgency to the peace process and at the same time heal some business wounds with allies in the Gulf. Remember the Dubai Ports deal debacle? This visit is long overdue.

With instability between Israel and Palestine, the latter’s economy has ground to a halt. It does not help that there is internal friction within the Palestinian Authority as well. That inability to move has drowned out one of the more positive economic and business stories throughout the region; the performance of Israel’s economy. It has chugged along quite nicely, thank you; at 5 percent in 2006 and 2007 and 4 percent growth is projected this year, with the global credit crunch to blame for the dip.

This to me is quite surprising. While there is no shortage of coverage on the Peace Process and work by the Quartet, we hear very little about how Israel continues to expand. Prior to the bursting of the technology bubble in 2000, we heard a lot about Silicon Wadi. The country re-engineered its highly educated engineers and scientists and re-deployed them into technology. Many of them emigrated from Russia after the fall of communism, enriching the bank of creativity.

That was then, but I was unaware that 400 high tech companies were funded in 2006 raising $1.6 billion dollars. More than 100 Israeli companies are listed on the NASDAQ exchange and there is a special index tracking these stocks. There is no doubt that the capital was coming from Silicon Valley and private equity investors or major technology companies would then want to transfer those companies to the United States.

That is quietly changing, along with the mix of trade and the mix of expertise. Israel is no longer overly dependent on hi-tech. It has added biotech, pharmaceutical and specialist chemical companies to the mix. 46 percent of its trade is now done between Europe and Asia. This only makes sense to leverage its location.

So Israel is quietly performing with the help of its secret weapon, the quiet and competent central bank governor, Stanley Fischer. The name is familiar to those who have covered the Asian financial crisis of 1998. He was at the front of the storm as First Deputy Managing Director, offering the bitter medicine many of the countries did not want to take.

Like many of the other leading economists, the Zambian-born Fischer was educated at the London School of Economics before receiving his doctorate at the Massachusetts Institute of Technology (M.I.T.). During his career he also taught at the other bastion for economics, the University of Chicago.

Which means what for Israel? The country can certainly continue to diversify and look east to capture the growth from India to China. It should try to buffer its exposure to the dollar, which remains on shaky ground. And finally stay the course and pray for peace. The economy is in a good pair of hands and if a deal can be found over the next year, there is a dividend waiting. Fischer, like many others, believes that a peace agreement could add another 1-2 % of growth each year.

Who knows, it could even open the way to Israel’s economic integration into the Middle East, although at this stage, that seems difficult to imagine.
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Wide open space, uneasy riders

The cornfields of Iowa are buried under snow in January. I could almost hear the sound of the ice crunching under the soles of the candidates in search of one last caucus goer in between their shuttle flights to New Hampshire.

I know the beat pretty well having covered presidential campaigns in the past. This election is so unusual since it is, like a Midwestern highway, so wide open. What is happening in Iowa, New Hampshire and the scores of other primaries to follow is far from the desert port city of Jeddah, but it is of keen interest there as well. Like the Iowans being polled on a daily basis, Saudis and others in the Middle East, are seeking change, not at the fringes but at the core.

This was abundantly clear over mezze at one of Jeddah’s favourite Lebanese haunts. I was in the company of four leaders of large trading companies. If you know the Middle East, you know the type. All were between 40 and 50 years old. All are well traveled, especially in the United States and all, after 9/11, sold their properties in that country they were once very fond of. Blame it on visa restrictions, on money transfer hassles and too many questions at passport control.

Ironically, it emerged over lunch; they are all proud owners of a very American icon, a Harley Davidson motorcycle. Each summer as a group and along with their spouses, they take to the road for a two-week journey. But instead of riding down Highway 1 in California, the fabled Route 66 or down the Eastern Seaboard, they are perusing the country lanes of France, the hills of Tuscany and other European bi-ways.

The big macro trends such as the fall in U.S. tourism since 9/11 and the transfer of capital from Wall Street and to London for international initial public offerings are well documented. The micro trends are less documented, such as selling U.S. assets and not sending their children to U.S. universities. Hard investments and soft dialogue through younger generations are long-term assets to build upon.

So while I was expecting to discuss the merits of the colossal Jeddah Economic City, the growth of Saudi Arabia built upon $100 oil and perhaps building a common market in the Gulf, we had a discussion about Iowa, New Hampshire, the candidates, their favourite places in the U.S. and Europe and yes, Harleys.
John Defterios’ blog accompanies the weekly business program, Marketplace Middle East (MME) that is dedicated to the latest financial news from the Middle East. As MME anchor, John Defterios talks to the people in the know, finding out their opinions on the big business moves in the region, he provides his views via this weekly blog. We hope you will join the discussion around the issues raised.
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