The Real Deal
The G20 is coming to grips with what governments are and are not willing to do over the next year in terms of stimulus plans and regulations. Most agree that the bottom has been marked during this downturn, but that the recovery is going to be less than stellar in western eyes.
The language in London has been downright bellicose when it comes to bank bonuses and re-gigging remuneration packages -- and that is what has been coming from the regulators! Whether concrete proposals actually crystallize is another matter altogether. The reality is most leaders have one hand on the populist pulse (re-elections in the case of Britain and Germany) and the other on the wheel of a ship which has been through one heck of a storm.
Collective action, including more than a trillion dollars spent to prime the banking system, has provided us with more security, or at least the perception of more security than in September 2008. On the streets of London, we all witnessed a period of about a week when one did not know whether their financial institution would remain open. All of a sudden, depositors had to learn a great deal more about deposit insurance limits.
At the start of this year when the western led downturn started to really bite, one wave of economists boldly stated the decoupling theory widely touted the previous year had been proved to be wishful thinking. The so-called BRIC countries are export dependent and cannot excel without the support of European and U.S. demand, the collective logic concluded.
It is time for those doctors of emerging market doom to re-think their prognosis. Collectively, the U.S. and Europe will be lucky to grow between one and two percent over the next year. In contrast, China is already growing eight percent and India and Indonesia better than five and the broader Middle East around three and a half percent. This is not theory, but the real deal.
This week, I sat down with Egypt’s Trade and Industry Minister, Rachid Mohamed Rachid who continues to comb the east and west for growth opportunities on behalf of Egyptian companies. These days he is logging more long-haul trips to China and India in search of joint ventures or to recruit companies for special economic zones under development.
Rachid, as a former senior Unilever executive, is acutely aware of recessions and business cycles in general.
“Today we are not talking about theory but about facts. We are seeing numbers that are totally different than the U.S. and Europe. We are seeing prospects that are more bullish than the rest of the world.”
It is not easy to navigate larger economic tankers through these turbulent times, but that is exactly what some of these fast developing countries have done. When the export machine started to falter in China, it steered the economy to a domestic infrastructure build out -- not little league spending but some $9 trillion between now and 2017. The other billion person economy, India, was in the midst of a reconstruction plan that will see new railroads, airports and the rest built over the next two decades. Those who have travelled the roads or rails on India would not argue about the need to do more at this stage of development.
Some would contend this is good sound planning by the two future giants. The fact is that luck and good timing had a lot to do with it. The infrastructure plans were on the books and were rightly accelerated to respond to the downturn.
The storyline is not dissimilar in the Middle East. The Chief Executive of GE International Nani Beccalli-Falco points to the model of public-private partnerships in the region where there is a track record of growth.
“We are getting out [of the downturn] because the so-called emerging countries, which in my mind are not emerging anymore because they have already emerged, are really pulling the global economy,” said the finely-dressed Italian from Turin, “You think about China, you think about India, you think about the Middle East, you think about Brazil.”
So while government leaders try to develop a consensus for future action, those with capital reserves will keep their taps open on a large scale. That is, what they say in business, not theoretical but “the real deal.”
Mind the Gap
As I went for my morning espresso macchiato this week I glanced at a newspaper stand and saw the British headline “Recession is officially over”.
A think tank here in London used the calculation of manufacturing output rising for two months in a row to support their premise. Everyone, including this writer, wants to call an end to the nasty times, after all this month marks one year since Lehman Brothers was allowed to go bust, which was the last nudge for the global banking system over the cliff.
The Dow Jones Industrials index is reaching out for the 10,000 mark and the FTSE 100 has recently passed the 5000 threshold, both technical and psychological barriers for investors. But no one really wants to address the ten thousand pound elephant sitting on the table: the recovery in the West will be tepid at best.
This past week on our programme we illustrated that point by suggesting we should all mind the gap — recalling the famous electronic audio call one hears in the London Underground marking the space between the train and the platform. But in this case, I am suggesting we should mind the gap of some of the global economic projections for next year.
For example, the International Monetary Fund has upped its projection to three percent, from an earlier, more cautious call of two and a half percent. The United Nations division on trade and development UNCTAD is suggesting something much less – just above one and a half percent.
Hold on a second; one is about the half level of the other which reflects the uncertainty that still hovers over next year. In the region, the outlook is brighter with the most populous country, Egypt, projected to grow about four percent and the UAE around three percent. This is where conservative banking rules and deeper pockets for the Gulf oil producers pay off.
G20 finance ministers met in London to try and work out the more delicate issues before their leaders meet in Pittsburgh September 24. Devising formulas to cap and stretch out bonuses are still on the cards as is a drive to create global regulations for derivative products that got us into this mess.
Sticking with our theme this week, there remains a gap that bankers are currently filling on their own. Current national rules governing those products don’t keep pace with those who are creating them. During the go-go days of the past decade that was okay when money was flowing in, but similar to life after 9/11 and the security that was introduced, rules to govern financial security need to evolve.
The G20, with Saudi Arabia and Turkey as members representing the region, want to finalize the rule-making by the end of next year and aim for implementation by 2012. In sum, lawmakers want to make sure the recovery is well in place and that there is no rush to legislate, with the approach being “let’s get it done right or not get it done at all”.
That is the positive way to view that approach. Dominique Strauss-Kahn the Managing Director of the IMF took a different view. Empowered to re-design the institution and play a leading role in the new global architecture, he said the consensus forming was impressive, but that the world is still awaiting stronger measures and definitive leadership.
The consensus seems to be moving towards boosting capital requirements to match the risks taken on by banks. This formula would provide - as U.S. Treasury Secretary Timothy Geithner suggested - shock absorbers to buffer future downturns. What seems to be missing in this equation is the ability to rein in banks during the boom times when they are taking on all the risks. Who will play the “bad cop” if you will? No one seems to have the answer to that just yet.
But that concern goes back to the failure of Lehman Brothers. In an era of globalization and consolidation, there are ever more powerful universal banks that combine commercial and investment banking activities under one umbrella. If they are indeed deemed to big to fail, will they curtail taking all that risk if big brother – the government – is willing to step in?
Probably not, but not putting safeguards in place to prevent that would mean we would be asked yet again to mind the gap in expectation of future financial shocks.
A Nasty Economic Virus
Making the right bold decision is an art. During this severe global economic downturn, which is spreading around like a bad virus we tend to become numb to big announcements -- from record investment fund fraud in New York of $50 billion to record interest rate cuts.
It is within this context that the members of OPEC followed right on the heels of the members of the U.S. Federal Reserve Board with a historic move. As their policy counterparts at the Fed know, chasing the market is proving difficult, because consumer sentiment and therefore demand is plummeting so fast.
A cut of 2.2 million barrels a day is dramatic, especially in the context of a $100 drop in a barrel of crude in the last six months. By OPEC standards this was managed in a measured way.
After convening an emergency meeting in late November in Cairo, the group gathered in the home country of the cartel’s president, Chakib Khalil. They were joined by four non-OPEC counterparts as observers from Azerbaijan, Oman, Russia and Syria. They, too, sent signals that cuts in January 2009 would hit the market. Some production was scheduled to come off anyway, but in this case producers wanted to illustrate unity.
The reason for this sudden cosiness in the oil business is simple, a sharp drop in revenues. OPEC nations have lost nearly $3 billion a day since the peak in July; they lost half their daily revenue since the start of the year. Forty to fifty dollars a barrel is not what this group has in mind especially when there is more than $1 trillion of projects either under construction or on the drawing board in the Middle East.
The reality is OPEC members were left with little choice than to take action. Prices dropped a record $28 in the month of October. It was like the global economy was walking tentatively along with concerns about recession, and then plunged off the cliff into crisis. This rings true in nearly every sector: oil, autos, housing and shipping.
I spoke to a representative of one of the largest oil and gas shipping groups who noted tanker rates plummeted 80 percent for shipments since July. No one can remember that happening in recent memory.
As a twenty year veteran of covering OPEC meetings, it also strikes me as rather extraordinary that the dramatic action was taken right in the midst of winter when demand is about to hit its peak. Respected energy consultant, Mehdi Varzi, is one who believes OPEC is acting in a near-sighted way. He sees the global economy right now as a very ill patient and higher prices will only prolong the illness or extend the recession in this case.
Varzi for one believes we could see $60 to $70 oil by the spring. This is in line with the aspirations of Saudi Arabia, Kuwait and Qatar but not high enough to prompt companies to invest in marginal fields or fund alternative energy projects either. It is the “Goldilocks scenario” we talked about recently on our program and in this column.
When that OPEC target price will be reached is a subject of great debate within the corridors of oil companies, investment houses, buyers of energy and the analyst community. Fareed Mohamedi of consulting group PFC Energy in Washington believes a price around $70 a barrel will be postponed until 2010, due to a mix of poor market sentiment and a real drop in demand. “People think we are going to go down before we go up,” says Mohamedi, and there is a “lack of trust they will deliver.”
After a full day of reporting on OPEC’s historic cut on paper, I was called by a friend who has worked in the Middle East for 20 years and was eager to mull over the action taken by oil producers. He correctly pointed out that OPEC never manages what he calls a falling market. If downward momentum begins to build, it is very difficult to turn the tide or even set a floor underneath prices. This was true in the late 1980’s (I can remember seeing for myself the rusting oil rigs in Texas fields) and again earlier this decade when recession set in.
This sell off as both Varzi and Mohamedi discussed during our interviews is more severe than anything we have witnessed in the past two decades. The market went from a period of great exuberance to great concern in a span of just three months.
The oil market and the cloud of negative sentiment that persists is a reflection of the global economy today as a whole -- it just took much longer to hit this sector. A year and a half ago the U.S. housing market started to expose real cracks of concern, followed by the sub-prime crisis during the late summer of 2007. Six months ago we were still witnessing record oil prices, which lulled ministers into believing that demand from the East would outweigh problems out West.
A full year later after the financial crisis everyone, including those who sat around the table in Algeria, found out the hard way that no one or nothing is immune from this persistent, nasty economic virus.
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.
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