Middle East: This time it is different (page 3 of 3)

Meanwhile, given the size of some of the suggested investments - for instance, the UAE's plans to invest up to USD 20bn in Morocco with a GDP of USD 52bn in 2005 - investors will have significant bargaining power which could lead to an improvement in business environment and thus long-term growth potential. Indeed, many of the countries in the region, particularly in North Africa, are already focusing on the need to increase foreign direct investment in order to create the number of jobs that will be needed in the coming years to keep unemployment under control.

The main risk to our view is oil prices fall below our implied forecast of USD 40pb average by 2010. Markets have got used to a strong growth/low inflation environment and, in our opinion, are not adequately pricing for the risks facing the global economy. In this environment, and with supply expected to increase only gradually in the coming few years, then many believe that the recent rise in oil prices are not an aberration, but indicative of things to come.

The biggest risk to this view, and possibly even ours, is the fact that global imbalances continue to balloon. Of course, if they are corrected by significant USD weakness without this feeding through into a dramatic slowdown in the global economy, then oil prices could actually go significantly higher. However, it is interesting to note that the US current account deficit actually widened from 2002-2004, despite a significant decline in the USD. Therefore, while the central scenario over the course of the next 12 months remains for a gradual slowdown in global economic activity, the risks increase the further forward we look. If demand were to fall sharply, this could lead to a slump in oil prices even more than we are assuming and this would have a detrimental impact on growth in two ways.

First, and most obvious, is that lower oil revenues would directly hit nominal GDP in the oil-producing region. Second, once oil prices start falling below USD 30-35pb then some GCC countries would start to experience budget deficits. This would undermine their ability to invest both locally and regionally, although as mentioned above the improved financial position of the economies this time around would mean that growth could be sustained for longer than in the 1980s. This suggests that the melting away of the economy seen in the 1980s can be avoided.

Another risk is that economies may be unable to fully absorb labour market entrants and that this leads to significant social instability and a resultant deterioration in the investment climate. This looks to be a low probability in the foreseeable future given the strength of public finances and the ability to alleviate any economic pain felt by the unemployed.

In conclusion, the region has a huge opportunity to move away from being seen as just a source of oil and gas to one that becomes increasingly integrated into the global economy in different areas, both services and industry. Reform has started, but clearly more needs to be done to ensure that growth is sustainable into the long-term. The good news is that there appears to have been a shift in mindset in recent times which should mean that this time is, indeed, different.