Arab stock market crashes to slow economic growth

By the close of trading on May 10th, the Shuaa Capital indices for the top three Arab stock markets, which are published on AME Info, registered the following declines from their recent peaks: Kuwait -17%, Saudi Arabia -53% and the UAE -44%.

Most analysts agree that this necessary adjustment to stock market prices was overdue with valuations, particularly in Saudi Arabia, at unsustainable levels. In short, the madness of crowds had driven prices way beyond anything reasonable and a crash was inevitable.

However, stock markets can never be entirely isolated from the societies in which they trade. To take the Dubai Financial Market, for example, some 300,000 local residents are registered in the market, and at the very least many will have seen their savings evaporate; in Saudi Arabia some estimates suggest up to a quarter of the population may have been trading on the local bourse.

Bad for consumer spending

When people lose money they become more cautious about spending at the very minimum, and at the other extreme are the margin traders who have been wiped out and lost everything. This removes both discretionary and some non-discretionary spending from an economy.

It is easiest to perceive this through extreme examples. The trader who would have bought a fast car will not buy one. The second holiday in London will be cancelled. For the less affluent plans for a lavish wedding for a younger member of the family will go. There is also a sense in which after a period of excess spending due to stock market gains, there is no need to consume more.

Even worse for banks

So much for lower consumer spending, a stock market crash also has serious implications for the banks and financial sector. Brokers will go broke for lack of stock trades but for the banks the problems are with their profligate lending policies during the boom which now come home to roost.

The banks will see bad loans grow, and have to increase provisions reducing their own profitability and ability to lend. The slowing of credit growth in the local economy will have a further impact compounding a marginal weakening of consumer spending. Indeed, it is arguable that a credit crunch is the most dangerous side-effect of a stock market crash.

This is also the mechanism whereby a stock market crash can cross-over into the real estate sector. It is true that not all stock market investors that have lost money would have bought a home, but if the banks tighten up on lending criteria that will reduce the availability of cash for anyone who wishes to do so.

Tighter money from the banks will also impact on the ability of developers to raise cash for real estate projects, and so reduce development activity.

Thus while a stock market crash in the Arab world is not going to stop economic growth at a time of very high oil prices, this is most definitely going to slow down economic growth from what was an unsustainable level to something more appropriate for the size of local economies. This might even be a good thing in the long-run.