Marketplace Middle East - Blog
No 'lid' in sight

In this column and on our program we are busy exploring the efforts by Middle Eastern governments and businessmen to build a sustainable model for economic growth. It has been quite fashionable to talk about building the “software” or the people skills to leverage the “hardware” that is being constructed throughout the region.

Unfortunately, as governments are finding out now, it is not so easy. I have an image of my children erecting a Lego set in their playroom. They put the pieces together, somewhat unevenly, with many different colors. If they don’t like what was pieced together, they simply tear it down and start all over again. The leaders in this hyper belt of economic growth are realizing that on the front lines that it is not that simple.

When one looks at the headlines, Qatar’s economic growth looks impressive on its own. In five short years, the economy has expanded from a gross domestic product of $16 billion to $60 billion today. And that is not the end of it. Expect more of the same as construction begins to rev up. The problem is, the Emirate is also facing the fastest growing rate of inflation in the region -- as high as 14 percent.

During an interview this week Daniel Hanna, a visiting fellow at Chatham House (home of the Royal Institute of International Affairs) in London, outlined the challenges. We often talk about the impact of the dollar peg on the Gulf countries. With the dollar hitting new lows, the cost of imports to the region is surging. In five years, imports have gone from $150 billion to $370 billion, as they pay for goods from Europe, Japan and other non-dollar denominated economies.

Secondly, Gulf central bankers have lowered interest rates in lock step with the U.S. Federal Reserve to match economic policies due to the dollar link. The problem is, the U.S. is slowing down and the Gulf is surging. The lower rates are leading to a liquidity boom -- too much money chasing too few goods -- leading to record inflation.

In central bank parlance, policymakers talk about “calibrating” economies to keep growth moving forward, while keeping a lid on prices. This is not the time for calibration in the region. Outside of revaluing their currencies against the dollar or moving to a basket of currencies to buffer the dollar’s fall these banks, according to Hanna, have not developed other tools to tackle modern day challenges. With the exception to Saudi Arabia, these countries don’t issue short term bonds, for example, to absorb the flood of money on the market today.

This all sounds esoteric -- if you will -- but don’t say that to the flood of expatriate workers from India, Pakistan or Bangladesh who have seen their buying power eroded. In Egypt, civil servants have joined the ranks of protestors seeking pay rises to combat a 50 percent surge in prices for staples over the past year. Egyptian President Hosni Mubarak sent orders to the army and police to use their bakeries to supply bread to the market. We have witnessed long queues with people scrambling for basics.

The pressure will mount in the months ahead and governments will use short term measures to cope. Egypt for example is paying an extra $3 billion this year to subsidize bread, rice, cooking oil and petrol for cars. If you are awash with cash like Saudi Arabia that may be okay, if you are trying to create sustained growth like Jordan, Algeria and Egypt it is more challenging.

The problem, as Hanna notes, is that “you may be storing up problems for the future”. While $100 plus oil is lifting the boat for all at this moment in time, if the global economic slowdown reaches the Middle East, governments will have to deal with much more than just inflation.

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A Universe Apart

The Great Eastern Hotel near Liverpool Street train station was designed with the City of London financier in mind. Its minimalist interior, clean lines and discrete atmosphere create the right setting for business people to work on a deal or attend a mid-sized forum.

I escaped into the Great Eastern this week for a few hours at a gathering of Egyptian ministers and business people to discuss the outlook for the region’s most populated country. The talk inside the meeting room was about robust growth of 7 percent, foreign direct investment hitting a record $11 billion dollars and re-positioning Egypt to capture more than its fair share of Gulf petrol dollars.

On the way over to the meeting, I read my morning paper with headlines reacting to the Federal Reserve’s orchestrated bailout of Bear Sterns and yet another drastic cut in U.S. interest rates to help cushion the blow of the slowdown. This was followed by rampant rumors in London of an imminent collapse of a leading retail bank. The rumors sparked an investigation.

Inside the foyer I took time for a few interviews to sound out my views that we are not living in one global economy right now. “It really does seem like two parallel universes,” said Marwan Elaraby of Citadel Capital the Egyptian investment bank.

“You drive around Dubai or the more frontier emerging economies of the region, you would never guess what is happening in the world economy. What is happening on Wall Street or the City of London seems like a universe away,” added Elaraby.

The dollar continues to tumble; oil continues to surge; prices everywhere for staples are skyrocketing. Despite the rosier economic outlook, protestors in Cairo demanded that President Hosni Mubarak do something about the cost of bread. History buffs know from Roman times that economic growth alone does not deliver votes, but affordable access to bread certainly does.

Finance is Confidence

Middle Eastern players are not ignoring the red-lights of concern flashing on Wall Street, quite to the contrary. They are hoping to minimize the impact. As co-founder of Beltone Financial, Aly El-Tahry noted: “Finance is confidence. As long as you don’t have a catalyst or something that diverts the present expectation from this negative mood, we’ll continue to have uncertainty.”

For Egypt that may translate into a drop of up to 1 percentage point of growth this year according to the country’s Investment Minister Mahmoud Mohieldin. While he acknowledged the challenge, the 42-year-old minister added some bigger picture thoughts on what this might eventually mean.

I'm much more concerned about the policy formulations in the future because the kind of extreme pragmatism that we're witnessing today could be justified in the short term by uncertainty, by requirements of having to make and to do some quick actions to fix problems,” said Mohieldin. The Worldcom fiasco led to Sarbanes-Oxley. This severe credit crunch he worries may lead a new White House occupant to move into action to limit trade or the flow of financial investments.

Let’s hope not. We however have heard very little from the three remaining presidential candidates on what they would do about the Doha trade round, sovereign wealth funds or the sinking dollar.

Meanwhile, back in the foyer of the Great Eastern, the talk remains on creating new opportunities. Egypt is in the midst of creating a new industrial investment hubs and expanding IT centers. For that to come off the minsters know that skills need to match the demands of companies such as Microsoft or Oracle who already have a presence there.

With this economic boom underway in the region, the players are looking to India and China for inspiration, not Wall Street or the City of London.

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The well's running dry

In a week where oil and gold have found record highs, it seems almost out of place to discuss the emergence of another commodity that will likely determine the viability of the Middle East and North Africa region – water.

Water, like electricity in one’s home, is taken for granted. When was the last time you thought about the source of your water, the price of water or whether it will be there when you open the tap?

About a third of the world’s population does so each and every day, because they don’t have reliable access to clean water. While it is not a desperate situation today in the Middle East, it will be tomorrow if the situation is not tackled.

The global population is expected to expand by two and half billion in 2050. Besides the obvious natural pressures of living in the desert sands, the region is also home to the fastest rate of population growth, where it is tabbed to double to 600 million by just 2020. The Middle East only receives about two percent of the world’s rainfall and has only one percent of its water resources.

This has not been lost on policymakers and the ruling families. Six of the top ten investors in desalination plants are Middle Eastern governments, totaling 57 percent of global capacity. Many of those facilities need to be upgraded and new ones need to come on line to keep pace with both economic and population growth.

There is a handsome payoff for this investment. According to Gulf One Investment Bank in Jeddah, for every dollar put into water capacity, there is a three dollar boost in productivity. This means that water is not only the source of life, but the source for future growth as well. To date Saudi Arabia has allocated about three percent of its annual budget to water infrastructure; investors say ten times that amount is needed. The Kingdom is the largest owner of desalination facilities and with the seven economic cities planned for the next two decades, demand will surge, so will the need for the private sector to play a role. Rough estimates put the sums needed at $100 billion for the region in the next eight years.

With those dollar signs flashing, investment bankers are busy working on the formation of funds to leverage the opportunity. Gulf One recently launched its Moya Holding Company. The first tranche of the two billion dollar fund has been raised and they are co-investing that money with governments in public-private partnerships. Expect many more of the same models. I recently interviewed Atif Abdulmalik the CEO of Arcapita, the Bahrain-based private equity group who says bluntly, “We as an institution are focusing on it, investing in it because we think that's the future.” The group has quietly bought water utilities in Europe and the United States and sees water as one of the most promising sectors in the region as well. As one shrewd Malaysian CEO Francis Yeoh of YTL Corporation wisely shared over dinner five years ago, utilities may not be sexy, but they are predictable and produce cash flow. That is why he too is a buyer of utility companies in Britain and Australia.

Peter Brabeck-Lemathe of food giant Nestle has put the issue of water at the center of his radar screen. He finds politics at this juncture have overruled common sense. Two-thirds of the world’s water supplies are going into agriculture, but how efficiently? Bio-fuels are not water friendly by any means, but the rush into production has been intense.

We know through our coverage that the Middle East is swimming in record oil revenues. There is so much around that sovereign wealth funds are investing that money at home and abroad. This is a case where oil and water do mix. All the mega development projects being built in the Gulf and throughout the MENA region from Algeria to Yemen will not mean anything without the free flow of water.

This will require a combination of proper infrastructure, new technologies and the collective efforts of business and government. Let the conservation and the exploration begin.

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Damaging dollar

There are many policymakers in the current White House who’ve silently supported a weaker dollar policy for the second term of the Bush Administration. This, the argument goes, helps support U.S. exports. True, but the downside risks today are percolating on many fronts. One can make a solid case that the common thread, which weaves through the financial markets today, is the weak dollar.

President George W. Bush was quick to criticize the 13 members of OPEC this week for not increasing oil output at their meeting in Vienna. That may be politically palatable but it seems to be short on economic realities. There is at most, as numerous leaders and analysts have outlined on our program, 500 thousand barrels of spare oil capacity within the cartel and that is not enough to drive prices down from their historic highs.

The culprit is the weak dollar. As a bet against dollar-based assets, global liquidity pools controlled by global fund managers have put money into the oil market. So the record prices we are seeing today are in part driven because these managers are looking for a more attractive return for their money.

A similar story is playing out with the hard commodities – gold, platinum, silver, iron ore. The $100 barrier for oil has been broken and gold appears to be on its way to the $1000 an ounce with its record run.

Don’t get me wrong; pressure from the developing world is intense. Countries within the broader Middle East are growing nicely and this is true from Dubai to Shanghai, from Kiev to Kuala Lumpur. As this band of growth from the Middle East to the Far East continues to expand, the pressure for the entire basket of commodities will continue to grow. But a strong dollar policy based on sound budget management in Washington would likely take out the top 20 percent of these record highs.

Keep tapping the wealth

There is a less obvious, sidebar story that has been a result of the soft dollar policy and that is the hunt for better returns by the giant and still growing sovereign wealth funds of the Gulf countries. When the dollar was solid, these funds were quite happy to park their money into the U.S. dollar and U.S. bonds. That is not the case anymore. With the coffers overflowing from $100 oil, they are re-deploying their assets around the globe, in U.S. and European equities, property deals and utility companies.

This had many crying foul, but the rhetoric this week toned down considerably. As European Commissioner Charlie McGreevy noted on our program, the debate changed a great deal in the last year. “From being looked upon as, I say 'pariahs' as it were, a year ago. I think people are now looking at it in a more balanced way and I think we've had a more balanced discussion now then we would have had one year ago.”

This is true in part because Europe and the U.S. actually need the funds as almost lenders of last resort. As a result, both the European Union and the U.S. Treasury are both talking about a voluntary code of conduct for sovereign wealth funds. The Gulf money managers I have spoken to scratch their heads and wonder out loud what that means in practice. But again, a whiff of cooperation seems to be in the air. The Chief Executive of Dubai International Capital Sameer Al Ansari said this week: “There’s little question that there needs to be more transparency.”

While a center ground is being found, the funds garnered a big vote of confidence from Warren Buffet who moved to the number one slot on the Forbes wealthiest people list. Buffet pointed the finger back to Washington: “This is our doing. Our trade equation guarantees massive foreign investment.”

As the Oracle of Omaha noted, the weak dollar may have helped sell goods abroad, but it has meant that, not only does the trade balance need to be financed, all the other products up for sale – especially banks and buildings – look like a bargain.
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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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