Middle East: This time it is different (page 1 of 3)

This time it's different. Four words guaranteed to make the hairs on the back of investor's necks stand on end. You heard it around the peak of the Nasdaq bubble in late 1999 and early 2000. Last year, in the Middle East, stock market investors were uttering these words as markets soared to unsustainable levels even assuming the rosiest economic scenario possible. Indeed, we have continued to have an almost nirvana state of affairs in the past 18 months for the region's economy and yet stock markets have plummeted from their peak. Therefore, it is with huge trepidation that we use it with regards to the sustainability of the region's recent economic performance.

We are looking for the region's economy to grow a compounded average growth rate (CAGR) of 8.1% in nominal terms from 2005-2010. For the Gulf Cooperation Council (GCC) countries, the forecast is 7.0%. On the face of it, this does not sound too impressive, adding weight to those who believe we are too cautious in out GDP projections given the region's recent performance.

However, the comparison between the 1980s and what we expect going forward is stark and illustrates that we also believe a dramatic transformation is under way in the region and that this will lead to a significant improvement in the region's long term dynamics.

Between 1981 and 1986, the region's economy shrank by almost 18% in nominal USD terms. The GCC economies were much harder hit, given their reliance on the hydrocarbon sector, contracting by almost half. It took the region's economy 10 years to pass its 1984 peak and 14 years for the GCC economy to recover its 1981 high. Putting this into an international context, this is longer than the 8 years it took for the Indonesian economy to reach its pre-Asian crisis highs, after its 58% decline in two years from 1996-1998.

Therefore, forecasting for continued growth across the region over the course of the next five years warrants some explaining. There are five main prongs of the rationale for such an out-performance versus the previous oil price induced economic boom.

First, the region's demographics are much more favourable. The dependency ratio for the region has improved with 1.6 workers to each dependent in 2002, up from 1.1 in 1980. Interesting to note is the fact that the ratio is highest for those with the most abundant natural resources, namely the UAE, Qatar and Kuwait. This bolsters our view that, in a culture where multiple marriages are allowed, the birth rate can be positively related to wealth rather than negatively correlated as in many emerging markets.

Looking forward, on a slightly different basis, the World Bank also predicts a further improvement in this ratio, rising to 2.1 in 2020 from 1.8 in 2005. However, while the historic increase was broad-based, the future improvement is expected to be dominated by the poorer North Africa and Levant countries. This may especially prove to be the case if the latest oil boom leads to an increase in the birth rate in the oil-producing countries as the 1980s boom did.

Second, our Head of Commodity Research believes there has been a structural shift in the long-term oil price dynamics. From 1984-2002, the average West Texas Intermediate crude oil price was USD 21.4pb. However, we expect the long-term average oil price to be much higher than this due to strong demand and limited supply and will average around USD 40pb.