Surprises Lurking in the Shadows
The noise represents the sound of expansion -- big pylon drivers bang away day and night as yet another tower looks to fill more space in the Dubai skyline.
Depending on where you are staying, big shadows are cast from these vast skyscrapers which block the bright sunlight of the Arabian Gulf. But visitors to the region in search of high growth and opportunity are finding that even the best intentions and strong will cannot overcome what is a Western-led financial crisis.
The finance minister of the region’s most populous country, Egypt, is striking a more cautious tone right now after posting the best economic growth in two decades. Youssef Boutros Ghali is an old hand in Egyptian politics and he told Marketplace Middle East he is only hoping for the best.
When asked if Egypt can hold onto at least five and a half percent growth after hitting more than seven percent last year, Boutros Ghali hedged his bets: “I am keeping my fingers cross. We have not seen the end of this problem. We have not seen the end of this crisis. My suspicion is there are surprises lurking in the shadows. ”
There are signs of concern from most camps throughout this broad region. Just two months ago, the International Monetary Fund was predicting growth in excess of six percent. That is low by regional standards, but certainly not recession. The challenge is the pillars that were projected to support that growth -- oil, property development and financial services -- are in the danger zone.
As I was waiting for a car to take me to chair the Leaders in Dubai conference this past week a banker from Bahrain shared his thoughts with me: “We don’t know where we are going,” then drawing on the metaphor of the car he was about to jump into he said, “That is my biggest fear after knowing only growth for a decade.”
It was a brief encounter, but certainly summed up the sentiment. A great deal of information is shared in the lobbies of hotels, at the coffee bars and, yes, in the taxi queues. I always find the lobby of the Emirates Towers Hotel the best hub for gathering sentiment. A year ago while taking in an espresso there, the talk was dominated by private equity players from Europe and Asia ready to fund the latest project. Today, the discussion is about which projects get completed and which ones get mothballed.
This is the modern form of the ancient agora where real time information and gossip from business peers replaces efforts by government leaders to manage expectations.
Those participating from outside the region at Leaders in Dubai were not providing the answers or inspiration that many were looking for. James Wolfensohn, the former head of the World Bank said no corner of the world will be left untouched. He pointed to outstanding derivative trades that still need to be unwound that hover over the banking sector like a dark cloud. “I can only say we are in a tough situation” said the veteran banker.
On the trip back to Dubai Marina on the Sheikh Zayed Road, one scans the skyline to see what has been completed to date and what is still under construction. This is one of those places where it is difficult to tell how much capacity is too much. There are a lot of rental signs in place which seems to square up with a report from HSBC that house prices in Dubai and Abu Dhabi fell for the first time. That seems only logical after a four-fold surge over the last decade.
Right now, global markets are not being built on logic, but on fear. That is what has taken the Dow Industrials below 8000, oil below $50 a barrel and property prices in some markets around the world down 20-30 percent.
Swept out into a Sea of Red
Who says we are not connected? What clearly is a banking crisis in the United States and Europe has spread like a bad virus throughout the emerging markets of this world, the Middle East being no exception.
In a span of a week, the Morgan Stanley’s emerging market index was down 23 percent. Equity markets from Shanghai to Sao Paolo fell in lock step. It is a pretty nasty tally in the region. Prior to the concerted effort to cut interest rates, Cairo, Saudi Arabia, Dubai and Doha were all down 50 percent or more from their peaks in 2008. Hot money flooded the region to tap into growth, but left local traders and investors stone cold on the way out.
The economies of the Middle East are growing nicely, regionally about seven percent this year. Oil revenues with prices between $85 and $90 a barrel are still strong by historical standards. So why are the major markets of the region drowning in a Sea of Red?
The simple answer is these economies cannot stand alone in isolation with all the chaos around them. They surged in part because investors are enthusiastic about the future. There was a double-whammy if you will since many of investment funds put money in thinking that the Gulf economies would soon abandon their pegs to the dollar. When leaders in the Gulf decided not to scrap that dollar peg, even after a fall of nearly 30 percent over the past few years, foreign investors looked for the exit.
All together now
It took too long for the central bankers of the world to grasp the enormity of the problem. After much delay, the major G-7 central banks cut interest rates by a half percentage point to send a signal of unity. A handful of the region’s central banks followed suit, with rate cuts of different proportions, due to the formal link with the dollar. At this juncture, it is the fear of a liquidity crunch, not inflation that is driving sentiment.
I am old enough to remember the power of speaking with one voice. That art, crafted in large part by Alan Greenspan, has been lost when it has been needed most. The February, 1987 Louvre Accord is a prime example. The G-7 gathered to send a signal that the dollar had fallen too far and they backed it up with coordinated intervention to make the point. A similar response came after the October, 1987 crash. In today’s much larger economy, intervention packs a softer punch, but unity is essential. Market traders usually lose a lot of money betting against central banks.
The recent meeting of leaders from Germany, France, Britain and Italy to discuss the banking crisis was a perfect illustration where coordination was in short supply. They met, went their separate ways and all had a different view of the meeting and their own individual plans to move forward. This does not bode well for the European Union or the future of the single currency. This trend also does not say a great deal about enhancing the roles of the International Monetary Fund and the World Bank. One of the two institutions could serve as the global unifier, where a set of rules for 21st century trading and capital flows can be not only debated, but agreed to and most importantly enforced. This could be the new home for an expanded G-7 that includes: Brazil, Russia, India, China and a seat for the Middle East – especially with all its liquidity.
All told there is an estimated $1 trillion dollars of development projects throughout the region. Sovereign funds in the Middle East have a reported $1.5 trillion dollars under management. That is a lot of capital. While some of that money was used in the past two weeks to inject money into their local markets and banks, it could serve as a great source of funds for Wall Street and for European markets.
This major market correction, if we want to limit the description to that, is a big test for the central bankers of the Middle East. They have been working to expand their tool kit to control money supplies, battle record inflation and keep a lid on borrowing for all real estate projects which sprout up like mushrooms in the desert.
At Cityscape in Dubai, the Middle East developers showed off the latest wares with stands costing up to a reported $8 million dollars each. One new planned development outside of Dubai called Jumeria Gardens has a price tag of some $95 billion dollars spread out over a dozen years. Think about it, that is more than the $87 billion dollar bailout by the British government of their banking system.
But there is a problem in the Middle East that is similar to the challenge throughout the world – there is a lack of confidence in western banks. The sovereign funds came on strong at the end of last year with some high profile investments. After falls of 50 percent or more, they too are in no rush to jump back into this market. Until the expanded G-7 can come together, Middle East investors and sovereign funds seem content to deploy assets closer to home.
The word “contagion” is tossed around a great deal during these periods of intense selling and the word conjures up images of a bad case of the flu which is spreading from time zone to time zone.
It is not far off the mark. The World Bank officially describes contagion as “the transmission of shocks to other countries or the cross-country correlation, beyond any fundamental link among the countries and beyond common shocks”.
Bankers have found out this is no common shock. There was a widespread belief, and one shared by this writer, that the fast-growing developing countries would break out from the shackles of what really is a U.S. banking crisis. The impact of this crisis is directly felt in Europe, especially in London where there is a direct link between the City of London and the health of the British economy. Financial services make up a third of gross domestic product.
That is no surprise and the sluggishness of European and the U.S. economies has been on the cards for months. The Middle East, however, comes into this crisis with a different script altogether. Merrill Lynch’s Turker Hamzaoglu is bullish medium-term, predicting growth of 6.5 percent for the U.A.E. for example, down from the heady days of the last five years of an average 10 percent.
But the real regional concern surrounds the rapid run-up in property prices. Hamzaoglu says it is getting more difficult to manage, “It is certain that there was some kind of a speculation in the prices because I see it as a side effect of this whole macro imbalance in a way, high-inflation, high-liquidity environment, that the government or the central bank has very limited means to control.”
What is emerging is a so-called risk premium factoring in the amount of money borrowed to put more than $300 billion of real estate developments on the books in the U.A.E., a trillion dollars throughout the Middle East. At the same time, regional markets are no longer benefiting from the hot money from the U.S., Europe and Asia which was invested to capture some of the rapid growth.
Former Nomura Securities analyst Anais Faraj who recently relocated to Dubai says the reason for this current contagion is simply down to capital flows, “It is the same liquidity pool. Money invested from the Middle East into Wall Street is taking on big losses.”
Wait and See
Sovereign funds from Kuwait, Abu Dhabi and Qatar put the word out this week that there is no reason to jump and put additional money into U.S. or European banks. As Faraj noted, “No one wants to be a hero catching a falling knife.” All three of those funds have seen their investments slip 40-50 percent since they leapt in at the end of 2007 and early this year. Their forays into the British banks have held up much better.
Which leads us back to what one can expect going forward. The investment fund managers I spoke to see promise in the medium to longer term, but they add it is not a straight line up. The $60 fall in energy prices certainly will impact some of the sky high projections for revenues going forward. And everyone is keeping a watchful eye on the dollar.
The recent recovery in the U.S. currency was taking some of the heat off of regional policy makers to change course to counter record inflation. That concern will move right back onto the front burner and rekindle conversations on whether to peg to a basket of currencies before the launch of a single Gulf currency in 2010.
This story has many more chapters that need to be written, and the word contagion will be part of the text despite the rosy growth scenario still expected.
ABOUT THIS BLOGJohn 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.
SHOWTIMESFriday: 08:15, 19:45
ALL TIMES GMT
ARCHIVE• September 2007
• October 2007
• November 2007
• December 2007
• January 2008
• February 2008
• March 2008
• April 2008
• May 2008
• June 2008
• July 2008
• August 2008
• September 2008
• October 2008
• November 2008
• December 2008
• January 2009
• February 2009
• March 2009
• April 2009
• May 2009
• June 2009
• July 2009
• August 2009
• September 2009