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Middle East @ Risk Middle East @ Risk Document Transcript

  • COMMITTED TO IMPROVING THE STATE OF THE WORLD Middle East@Risk A Global Risk Network Briefing in collaboration with the Gulf Research Center
  • This work was prepared by the Global Risk Network of the World Economic Forum and the Gulf Research Center The views expressed in this publication do not necessarily reflect the views of the World Economic Forum. World Economic Forum 91-93 route de la Capite CH-1223 Cologny/Geneva Switzerland Tel.: +41 (0)22 869 1212 Fax: +41 (0)22 786 2744 E-mail: charles.emmerson@weforum.org www.weforum.org ©2007 World Economic Forum All rights reserved. No part of this publication may be reproduced or transmitted in any form or by any means, including photocopying and recording, or by any information storage and retrieval system. REF: 100507
  • Contents Foreword 4 Introduction: The Global Risk Outlook for the Middle East 5 Executive Summary: Global Asset Price Collapse 8 Executive Summary: Chinese Economic Hard Landing 10 Executive Summary: Retrenchment from Globalization 12 Executive Summary: Geopolitical and Geostrategic Instability 14 3
  • Foreword This briefing, in collaboration with the Gulf Research Center, What Are Global Risks? builds on the global work undertaken by the Global Risk Network of the World Economic Forum. Our definition: non-business risks that affect business (i.e. not operational, project or The Global Risk Network (GRN) is an unparalleled network of financial risk) industry, risk and regional experts working with business leaders and policy-makers to: • that can be strategic, exogenous and systemic • Create a framework for assessing and prioritizing existing • that are highly interdependent (i.e. do not manifest and emerging risks to global businesses over the short in isolation) and long term • Alert key decision-makers to the impact these risks may • that are characterized by uncertainty, sharp have on their environments discontinuities, non-linearity (power law distributions) • Assist leaders in their reflection on how risks may be and lack of proportionality mitigated at the global, regional, industry and company • that can’t be predicted (but can be managed) levels • Transform these global risks into opportunities The GRN was set up in 2004 in response to concern over the It is a central tenet of the work conducted by the Global Risk rapidly changing nature of the global risk landscape, with six Network and its partners that global risks do not manifest defining features raising particular concern in the business and themselves in isolation. This was apparent when the domino policy environment. effects of Hurricane Katrina briefly shook the global system. More recently, the connections between two of the most • Interconnectedness: Opportunities for contagion of risk pressing global issues for public policy and private enterprise across geographies and categories make them harder to – energy security and climate change – have reinforced the manage, and their consequences harder to predict. Risks sense that many global risks share a common lineage. The that occur in discrete geographies and with well-known correlation matrix below, drawn from the Global Risks 2007 proximate causes – such as Hurricane Katrina – can report, shows expert views on correlation between a limited cause unpredictable results elsewhere. list of 23 core global risks. • Asymmetry: Partly as a result of contagion, apparently small events can have increasingly disproportionate effects. This At the regional level, the Global Risk Network has undertaken is particularly true of geopolitical risk. work on regional risk exposures for World Economic Forum • Time compression: Some risks can develop within the meetings in Turkey, India and Latin America. The purpose of this decision cycle of decision-makers. The secondary impacts work has not been to create a final list of top risks for any region, of financial or geopolitical crises can begin to take effect but to draw together an understanding of global risks with their before businesses and governments have adequately impacts at the regional level, building up a wider picture of responded to the initial risk event, allowing a limited crisis global interdependence and a broader case for multistakeholder to expand into a systemic one. Just-in-time processes thinking and action to manage and mitigate global risk. can leave little built-in resilience. • Risk extension: Other risks are perceived to occur outside the decision cycle of decision- The Correlation Matrix makers, giving rise to the “NIMTOF” (Not-in-My- Term-of-Office) phenomenon, where mitigation Key: costs are immediate and known, and mitigation STRONGER CORRELATION benefits are long term and/or unclear. Climate change is a prime example of an extended risk. Current account Oil price shock deficit/ Fall in US$ • Noise: The profile of an emerging risk is rarely Proliferation of WMD International terrorism clear before it occurs, with salient indicators Spread of liability regimes hidden by surrounding “noise”. Pandemics • Rise of “infodemics”: The rapid and uncontrolled Loss of freshwater services Climate change spread of information – including inaccurate information from new, unreliable and uncontrollable Breakdown of CII Retrenchment from sources – can skew responses, generating globalization information-driven impacts greater than those of Coming fiscal crises the primary risk event. China economic hard landing Failed and failing states At the global level, the Global Risk Network has Middle East instability identified some 23 global risks to the international NatCat: Tropical storms community over the next 10 years. It has advanced Developing world disease (HIV/AIDS, TB, malaria) thinking on how to conceptualize their interaction and Emergence of nanotech risks how to design strategies to mitigate them including NatCat: Inland flooding the “5i” framework. The Global Risks 2007 report, Asset prices/ excessive NatCat: Earthquakes indebtedness released at the Annual Meeting 2007 in Davos, and Transnational crime Chronic disease in and corruption other publications by the Global Risk Network, are Interstate and developed countries civil wars available at www.weforum.org/en/initiatives/globalrisk. Source: World Economic Forum Global Risks 2007 4
  • Introduction: The Global Risk Outlook for the Middle East The Middle East is a focal point for global risk and its mitigation. This is particularly clear with geopolitical risk – with a high concentration of destabilizing geopolitical events having their origin in the wider Middle East region. But it is also true of two of the great intersecting global risks of the early 21st century – energy security and climate change – and of the risks relating to global economic imbalances: Middle Eastern external surpluses far exceed those of China. Some Middle Eastern economies (particularly those of the Gulf region) are heavily integrated into global trade and financial flows. Others, often the largest economies in the Middle East, have not yet overcome the dominance of the state sector and remain relatively unattractive to foreign investment. The vulnerabilities of these different economies – and of different political structures, geographies and religious compositions across the region – inevitably mean that global risks will play out differently. However, the Middle East shares a number of global risks, and a number of solutions to those global risks. The region is interconnected by webs of investment, of geopolitics of religious affiliation – as well as physical infrastructure of pipelines for oil and sources of water, an increasingly precious resource. Many of the possible mitigation measures to deal with the consequences of global risks stem from within the region. Indeed, many of the mitigation measures can only be managed and controlled by acting in frameworks of regional cooperation. This briefing does two things. First, it provides a brief overview of a range of 9 of the most salient of the 23 global risks extracted from Global Risks 2007, and outlines major trends as well as the impact on the Middle East region. Second, it provides a deep dive into four areas identified as being of particular interest: a global asset price collapse, a Chinese economic hard landing, retrenchment from globalization, and wider geopolitical and geostrategic instability in the Middle East. The intention is not to provide a prioritization of risks to the Middle East, but to highlight some of the common choices that the region faces and the common risks to prosperity and security, from the future of freshwater services to the future of the Middle Eastern currencies’ peg to the dollar. Raising awareness of common risks raises the bar for shared responsibility for action and opportunities that will derive from timely, proactive policies to prevent global risks overwhelming the Middle East region. 5
  • Middle East@Risk Matrix Risk Description Trends to watch Impact on the Middle East Oil price In the short term, a Rapidly expanding demand, 80% driven by Any short-term supply disruption – shock/energy hydrocarbon price spike BRICS; fears that underinvestment in for example as the result of a supply caused by geopolitical capacity (in the Middle East and elsewhere) terrorist attack – would undermine interruptions tension or terrorism – will mean production shortfall. the economic foundations of current disruption to secure economic growth in the Middle East. energy supply. In gas, discussions of a possible producers’ agreement – including Iran, Russia and Qatar Excess capacity needed to manage In the longer term, a – remains complicated by internal differences oil prices is low, and the resurgence plateau of high and existing bilateral supply agreements. of non-OPEC supply has led to some hydrocarbon prices as to question the ability of Middle East the supply of products Increasing concentration of hydrocarbon oil producers to achieve price targets. fails to keep up with resources driving geopolitical attempts to demand, particularly “lock in” future supplies. The growing concentration of future oil from emerging markets and gas supplies in the Middle East – unsustainability of Debate over possible “peak oil”, including has strengthened NOCs compared secure energy supply. some doubts about official Middle Eastern to IOCs and may lead to renewed reserves. downstream NOC investments. Growing awareness of anthropogenic climate But, in the long term, concentration change. of hydrocarbon resources in the Middle East may hasten the end of Models of future oil demand are subject to the oil era, as major Western major uncertainties around China, including a countries cite geopolitical concerns. possible decision to invest in nuclear power “The oil age will end long before the or coal-fired generation or any mandated world runs out of oil.” improvement in vehicle emissions standards. Whether prices remain high or eventually Any movements towards effective fall back, economic diversification hydrocarbon substitutes for transport. must remain a top priority. US current Unsustainability of the Global picture of high US current account Many Middle Eastern currencies are account US current account deficit sustained by Asian savings and pegged to the US dollar and Middle deficit/fall in deficit, triggering a Middle Eastern petrodollars. Eastern investments are held in US$ major fall in the US dollar-denominated assets. A sharp dollar, with impacts US dollar remaining the global reserve decline would import inflation, lead to throughout the financial currency; other currencies (e.g. the euro) questions about long-term viability of system. playing an increased portfolio role or even pegging to the dollar and acting as denominating currency for some denomination of oil prices in dollars. commodities. Chinese Sharp slowdown of Debate around the long-term sustainability of See deep dive on Chinese economic hard China’s economy – China’s current growth given infrastructure economic hard landing below. landing potentially as a result of constraints, environmental concerns and protectionism, internal political risk. political or economic difficulties. Evidence of some backlash against Chinese exports (in the form of anti-dumping duties); concerns about the stability of the Chinese financial system and the extent of potential defaults. Blow up in Collapse in house A correction in house prices is underway in See deep dive on global asset price asset prices prices (e.g. in US and the US, and in some European markets; collapse below. southern Europe) and questions over particularities of the US other asset prices market compared to other markets. The rate causing recession, with of a US slowdown, and its wider global contagious effects consequences are not yet known. globally. Financial market volatility remains low and risk appetites high, despite minor correction in February 2007, but market complacency may not last the year. Climate Increased temperatures Consensus around climate change moving Besides indirect effects of reduced change around the globe, with to a debate around impacts, possible Gross World Product as a result of impacts on rainfall mitigation or adaptation measures. unmitigated climate change, the patterns. chief indirect impacts from climate Success or failure in involving major future change come from potential Increasing frequency of emitters in any future post-Kyoto agreement changes in rainfall patterns and the extreme weather events over the next few years will likely determine overall rise in temperatures expected from man-made climate the overall emissions pathway, and thus the across the region. change with severe extent of climate change. impacts on critical infrastructure, 6
  • continued Risk Description Trends to watch Impact on the Middle East agricultural yields and Leading indicators of the impacts of climate Agriculture in the Middle East is human lives. change in most affected regions, causing likely to become increasingly population movements, tension within marginal; some inland regions may countries and between countries. be no longer habitable; overall costs of living and doing business are Any movements towards effective likely to be increased with hydrocarbon substitutes for transport. adaptation no longer a viable option. Climate change may encourage use of hydrocarbon substitutes, undermining the Middle East’s most valuable export. Loss of Growing penury of The two main factors affecting future water World Bank suggests water freshwater freshwater supplies, scarcity in the Middle East are water use, available per person in the MENA services partly as a result of and patterns of supply. Without greater public region could fall by half by 2050. climate change, partly accountability, and without moves to as a result of increasing reallocate water supplies, demand will increase The Middle East is well experienced burden of overuse. as populations expand. If climate change in managing water scarcity, but patterns accelerate, freshwater service increased penury is likely to divert supplies are likely to become more erratic. development funds to desalinization and water transport schemes, and MENA countries are already using more promote geopolitical conflict water than they receive each year; growing between headwater and tributary awareness of the need to manage countries. freshwater throughout the cycle, as opposed to managing discrete portions of supply. International Acts of terrorism (both In addition to the spread of the Al Qaeda The Middle East region suffers from terrorism internationally organized “franchise” – including to North Africa – there international terrorism on multiple and inspired, and local) are fears Al Qaeda may be regaining levels: as a direct victim of attacks, with the capacity to organizational strength. This would imply the as a perceived centre of instability cause extensive ability to carry out attacks beyond those (reducing foreign investment physical damage, which are locally planned and executed. appetites) and as a perceived spread terror and source of terrorism in terms of undermine social Iraq has become a major recruiting and personnel, training and ideological cohesion. training ground for international terrorism; background (reducing opportunities should the situation continue to deteriorate for knowledge transfer and personnel its role in international terrorism will most exchange with Western countries). likely increase. A number of Middle East regimes are specific targets of Al Qaeda as the “near enemy”. Proliferation Proliferation of weapons Key short-term issue: the management of Iran is several years away from of weapons of of mass destruction Iran’s alleged attempt to build a nuclear being able to test a nuclear device, mass and the likelihood of device. and denies that this is the purpose destruction their use, inviting major of enrichment. However, should retaliation, furthering Key long-term issues: future of the Nuclear international and regional pressure global insecurity and Non-Proliferation Treaty, expansion of the fail to bring greater transparency to threatening Proliferation Security Initiative, prevention of Iran’s nuclear programme, several globalization. weapons’ capacity while allowing spread of Middle Eastern countries will feel nuclear power. compelled to develop contingency plans, including boosting domestic understanding of nuclear technologies. The wider impact on the region would be disastrous, removing the prospect of a nuclear-free Middle East, potentially pushing Israel to declare nuclear status, and requiring massive funding which would otherwise have been spent on economic and social reform. Retrenchment A two-way risk: a Failure to achieve agreement in discussions See deep dive on retrenchment from protectionist impulse in on world trade; growth of bilateral trade from globalization below. globalization developed countries agreements. and rising nationalism in developing countries Increasing use of anti-dumping measures in (and evidence of global the developed world; spread of nationalizations inequality), driving both in key industries in developing countries. to attempt to slow or reverse globalization. Rise of political populism in both the developed and developing world. 7
  • Middle East@Risk COMMITTED TO IMPROVING THE STATE OF THE WORLD Executive Summary: Global Asset Price Collapse Will oil savings evaporate? How would an ensuing economic slowdown affect the economies of the Middle East? As the Global Risks 2007 report suggested, the financial markets are complacent as regards risk levels. Despite turbulence in the financial markets in February 2007, investors’ appetite for risk remains relatively high, volatility remains historically low, and market expectations seem to point to a benign economic scenario. Global market liquidity, including investments from Middle Eastern countries enjoying financial surpluses, may be one reason why investors remain confident. But risk factors around global asset prices and potential risks for the Middle East in particular cannot be ignored. In any future collapse, central bank capacity, diversification and the future of the US dollar will be key questions. Prices for real estate, stocks, commodities and gold are all at, or near, historic highs, while global interest Risk rates are low and bond markets are doing well. Historic correlations (such as those between high oil prices and falling equities, or high gold prices and inflationary pressures, rising interest rates, and lower bond and real estate prices) have weakened. There are two possible explanations: the market has fundamentally changed in nature, or many market participants have misread it. Many of these high asset prices have been financed by unprecedented levels of debt. Total US debt (US$ 48 trillion) is 460% of national income, compared to 186% in 1957. Corresponding debt chains are global in nature and sometimes unregulated (e.g. OTC derivatives). Cracks in these chains thus have the potential to spread across countries and regions, leading to major demand slumps and supply surges of securities via distressed selling, ergo asset devaluations. Any asset devaluation would have major effects on the real global economy, as borrowing against high asset prices and low interest rates has been a motor for consumption in recent years (e.g. US consumers taking out loans on their ever-rising house prices). Were an asset price devaluation to lead to a major contraction in consumption, the expected scenario of smooth economic growth would be sharply disrupted. In the 1990s low oil prices meant that many Middle Eastern countries became net importers of capital. Important Trends Higher oil prices in recent years have radically reversed the situation. The combined 2006 current account of the Gulf Cooperation Council (GCC) countries (US$ 176 billion) rivalled that of China, and is considerably greater as a share of GDP. Medium-term prospects for oil prices suggest external surpluses – at least of hydrocarbon-exporting Middle Eastern economies – will remain high. Foreign assets of GCC countries have risen to US$ 1.1 trillion, without taking into account individuals with high net worth. The role of some Middle Eastern economies in maintaining global imbalances and the US twin deficit is less well understood than that of China because a share of external surpluses are not held as official reserves, and buying patterns are more complicated. Sovereign wealth funds such as the investment authorities of Abu Dhabi and Kuwait are major asset holders; with the exception of Saudi Arabia (Sama) central banks play a smaller role. There are attempts at diversification. In currency terms, 65-70% of assets remain dollar-denominated, though the euro has retained some ground. In asset class terms, alternative investments such as private equity, hedge funds and structured bonds play a major role. This differs both from the dominance of deposits in Western banks during the previous 1970s windfall and from China’s investment directly in US treasuries. Investments in Asia attract considerable media attention, but lag behind growth in trade. Asian currencies pegged to the dollar, as are many leading Middle Eastern currencies, have not become meaningful reserve currencies. Over 80% of petrodollar recycling continues to be directed to Western markets. Some Middle Eastern countries, particularly in the Gulf region, have seen increasing diversification of their economic structure and a local investment boom pushing up prices for equities and real estate. In 2006, key GCC stock markets collapsed and real estate markets of the UAE and Qatar raised concerns of overheating. But in both boom and bust, GCC markets have not been meaningfully correlated with other 8 emerging markets.
  • Consequences The primary consequences of any sharp decline in US asset prices would be felt in slowing US consumption and growth. The secondary consequences would be on Asian exporters and, to a lesser degree, European economies. The rate of any slowdown would determine its contagion. Faltering demand would depress oil prices unless supply is further constrained by (a) OPEC management resulting from regained spare capacity, (b) geopolitical unrest or (c) accelerated depletion of “peak oil” regions of the US, North Sea, China (Daqing) and Mexico (Cantarell). Dollar-based foreign assets of Middle Eastern countries would fall in value. The asset/liability plans of the sovereign wealth funds and social projects they are designed to fund (e.g. infrastructure, pension schemes) would be in jeopardy. Economic diversification strategies for the post-oil age would be put on hold as oil savings evaporate. Across the Middle East a window of opportunity to reform state-centric economies would close. The dollar would fall and domestic interest rates rise. In one scenario the dollar could lose its position as a global reserve currency. Middle Eastern countries pegged to the dollar would import inflation, leading to further upward adjustment of interest rates and limiting investment. Some countries might consider moving towards a flexible exchange rate regime. Domestic markets would fall, but the direct spillover from financial markets outside the Middle East would be limited by regulatory barriers which would leave domestic markets only partially open. Contagion would be mostly limited to stock markets, but, as Gulf bonds and sukuks have become more popular with foreign investors, there might also be some contagion in nascent bond markets. Demand for alternative Middle Eastern exports such as aluminium (GCC countries project 10% of world production by 2010) and tourism would be hit. Cyclical industries such as the construction industry would enter sharp decline. Finally, any broad economic slowdown could stoke considerable social tensions, particularly in countries with high youth unemployment such as Saudi Arabia and Bahrain. Questions of inter-generational equity could become more acute, and political divisions would inevitably be sharpened. Mitigation Given the relatively small size of Middle Eastern economies, their dependence on dollars and the magnitude of global economic imbalances, effective policy options are limited. Controlled diversification of currency reserves from dollars to euros, sterling and gold, an increased cash reserve and increased holdings in blue-chip equities are less likely to be affected. Revaluation of local currencies, pegging them to a more diversified trade-weighted currency basket. This might evolve to a managed float, enhancing the means for Middle Eastern countries to conduct independent monetary policies, but requiring considerable improvements in the administrative capacity of Middle Eastern central banks. Use of any regained OPEC spare capacity to attempt to manage oil prices in the long term in the OPEC target range, considerably higher than during the 1990s but below current levels. Avoidance of overtly leveraged investment positions in local stock and real estate markets by imposing strict lending ceilings. Enhancement of transparency of domestic credit markets by the establishment of credit bureaus and improved corporate governance in banks. Examples Discussions of alternative currency schemes and asset diversification have begun in some Middle Eastern countries. OPEC successfully implemented production cuts during the recent oil price declines from US$ 78 (West Texas Intermediate) to US$ 50, pushing prices back above US$ 60. Several Middle Eastern countries have curbed lending after recent stock market declines, are working on corporate governance codes and are expanding the capacity of regulatory authorities. 9
  • Middle East@Risk COMMITTED TOTO COMMITTED IMPROVING THE STATE IMPROVING THE STATE OFOF THE WORLD THE WORLD Executive Summary: Chinese Economic Hard Landing Could a Chinese demand slump bring oil prices down? How would a Chinese economic hard landing affect the Middle East? China’s economic growth over a quarter of a century has shifted global patterns of production and consumption, altered the relative strength of labour and capital, and driven a super-cycle boom in the prices of commodities, including oil. But China’s economic success includes a number of warning signals – from the existence of bad loans to overinvestment and stock market volatility. China has made itself a crucial part of the Middle East’s economic future – as a market for Middle Eastern products including oil, as competition to Middle Eastern manufacturers, as a limited investor in the Middle East, and as a source of imports of consumer goods. A Chinese economic hard landing could have unpredictable consequences. Risk China’s economic growth over the last decade has exceeded that of any other major economy, ranging from 7.6% to 10.7%. Its cheap exports have contributed to the moderation of global inflation, while its growth and that of other BRIC economies constitute two-thirds of incremental demand for oil. China’s long boom has been spurred by high liquidity, low interest rates and high consumption in the US and elsewhere. Domestic overinvestment, a slump in global demand, social unrest or a major geopolitical upset could undo the current positive outlook for the Chinese economy with major implications for the world economy and for global oil demand. Important Trends The share of exports as a proportion of the Chinese economy is a cause for concern, jumping from 20% in the period 1996-1999 to 34% in 2004, and now approximately 40% with growth unsustainably high. Net exports represent 7% of GDP, but much of China’s imports are capital goods from other Asian NICs (newly industrialized countries) and Japan, which are used to manufacture goods for the US and other Western export markets. Moreover, the rising middle class, and the domestic demand they generate, depends ultimately on the export sector. US deficit spending drives the Chinese economy. Despite the extraordinary achievements of China’s economy in reducing global poverty, inequality remains high, both between social groups and between rural and urban geographies. Consumption is only equal to 54% of GDP. China’s current account surplus totals US$ 238 billion and its central bank holds foreign reserves of US$ 1.2 trillion, of which 70-75% are dollar-denominated, acting as a major support to the US twin deficits. The bad loan problem has been subdued since a government bail-out in 2003/2004, but could re-emerge should the export-led economic model falter. The US Energy Information Administration (EIA) expects Chinese oil consumption to triple between 2003 and 2030. Satisfying this future demand will put pressure on Gulf suppliers, not least as Europe and the US become increasingly dependent on Middle Eastern supply. Some Gulf countries are already investing in refining capacity in China and South Korea and assisting in strategic storage solutions for crude oil. Gulf countries are venturing beyond the oil sector, purchasing stakes in Chinese banks, container terminals and real estate, though Chinese capital markets do not yet constitute a major alternative for petrodollar recycling. In turn, Chinese investments in the Middle East include oil production in Syria, the Dragon Mall in Dubai (showcasing Chinese manufacturing goods), natural gas and planned aluminium projects in Saudi Arabia. 10
  • Consequences Should demand in oil slump, oil prices could fall. However, the fall in demand required to depress oil prices, given current supply constraints, would have to be sharp. Upstream investments to enhance production and refining capacity could be put on hold. In the long term, however, if Chinese economic growth resumes at previous rates, any major cutback in investment would accentuate future supply constraints. Geopolitical tensions between China the US, Europe and Japan over future strategic control of oil supplies would ease in the short term. Faced with a domestic recession, China would probably react by closing off potential foreign investment of interest to oil-exporting countries of the Middle East, not least in petrochemicals. Middle Eastern assets in China would depreciate, but despite prominent media coverage their importance as a share of overall asset portfolios is limited. Should China decide to revive its economy by export dumping, aspiring Middle Eastern manufacturing industries would be particularly hard hit, already under pressure from Asian competition in sectors such as textiles. Should China sell part of its dollar holdings to mitigate economic downturn at home, this would lead to a steep depreciation of the dollar and would negatively impact predominantly dollar-based foreign assets of Middle Eastern countries. Mitigation Use regained OPEC spare capacity to manage oil prices for the long term, within the range set by OPEC. Diversify oil exports to Europe and the US. China: Curb Chinese liquidity growth and supply of land to cool down investment and property boom. China: Real effective exchange rate appreciation and rising minimum wages to generate general wage rise and increase domestic demand. Cooperate with China and other Asian countries in finding alternatives to dollar-focused investments and redress global imbalances. Lead a political dialogue with China on the protection of Gulf investments in the country and access to its markets. Examples China has raised lending rates four times and reserve requirements six times over the last year. It has also restricted the supply of land for development. GCC countries have started to discuss alternative currency schemes and asset diversification, although at a slow pace. OPEC has successfully implemented production cuts during a recent oil price correction from US$ 78 (WTI) to US$ 50. Saudi Arabia still keeps up its discount for oil deliveries to the US in order to remain a presence in this important market. 11
  • Middle East@Risk COMMITTED TO IMPROVING THE STATE OF THE WORLD Executive Summary: Retrenchment from Globalization Will Middle Eastern economies lose export markets in petrochemicals and aluminium? Will they protect their banking, insurance and services industries? Will Middle Eastern investors face restrictions on foreign equity investments? The Global Risks 2007 report, and discussions at the Annual Meeting 2007 in Davos, both suggested that globalization is entering an extremely challenging phase. Global inequality, concerns in some Western economies that globalization threatens existing social structures, and the imperative to ally economic growth with environmental protection are driving a potential retrenchment from globalization. Far from being an inevitable process, globalization can be slowed and may be reversed. Both the current architecture of global trade and the underlying political consensus backing globalization are more fragile than often realized. Some Middle Eastern economies have gained little from globalization; others depend on globalization to secure their economic future. Risk Gulf economies in particular are very competitive in petrochemicals and energy intensive industries such as aluminium. Should current trends of protectionism gain momentum, exports and expansion plans in these industries could be threatened. Banking, insurance and services industries across the Middle East are less competitive. Should retrenchment against globalization continue, governments could be tempted to continue protective measures for these industries against foreign competition. In the wake of the events of 11 September 2001, and with a rapidly expanding current account deficit, the US has demonstrated occasional unwillingness to allow companies from the creditor nations of the Middle East and Asia to hold sizeable equity stakes in “strategic sectors” of the economy including ports (Dubai World Ports’ bid for P&O) and oil (Unocal). This trend may expand to other economic sectors, and to the European Union. Important Trends The Doha Round of trade talks, which started in 2001, has failed to achieve further liberalization. The major stumbling blocks have been market opening measures for industrial goods and services insisted upon by leading Western economies in return for limited concessions on agricultural subsidies. As a result, the G20 trade ministers’ group has attempted to revive the talks. Resource nationalism has led to the exclusion of some Western companies from investments in Venezuela, Bolivia and Russia. The Middle East hydrocarbon sector has long been off-limits for Western investment with only minor cooperation in oil (in the UAE) and gas sectors (Saudi Arabia, Qatar). A recent report saw resource nationalism as the greatest barrier to adequately meeting future oil demand. The Middle Eastern banking and insurance markets continue to be heavily protected despite moves to open the market. 12
  • Consequences Some Middle Eastern economies have gained little of the upside from globalization. The effects of any long-term retrenchment from globalization on the downside are likely to be felt most strongly in the most open economies in the region – those of the Gulf. Up to 90% of Gulf exports are in hydrocarbons. Increased trade barriers for crude oil and natural gas are extremely unlikely given their strategic importance and current constraints on supply. However, over the medium to long term there are major questions as to whether Middle Eastern oil and gas exports can sufficiently expand capacity to meet demand without capital and expertise from Western investors. The recurrent postponement of “Plan Kuwait” investments in the northern oil fields may be an example of this. External surpluses of Gulf economies, should hydrocarbon prices remain high, may become increasingly focused on the region, raising the risk of overinvestment and a lowering of aggregate rates of return. Plans for the global expansion of Middle Eastern petrochemical and aluminium industries could be hindered; Sabic’s announcement that it could withdraw an intended US$ 5 billion investment in China due to stalling over procedures could be suggestive of future problems for Middle Eastern companies in achieving global scope. The Middle East’s tourist industry would almost certainly suffer from any long-term retrenchment from globalization. A backlash from globalization would most likely reduce exposure to global competition, allowing protected industries to remain uncompetitive and reducing productivity growth as a result. Mitigation Successful conclusion of GCC free trade agreements (FTAs), continuance of regional integration and further pursuit of the Euromediterranean Partnership process. Tackling of contentious issues like petrochemicals, aluminium, services and agriculture. Diversification of foreign investments. Acquisition of foreign technology to maintain and expand upstream capacity – possibly not by giving out equity stakes via Production Sharing Agreements (PSA) but by takeovers of foreign engineering companies and buy-back arrangements. Examples The GCC already has FTAs with Lebanon (2004) and Syria (2005). The GCC is currently negotiating several further FTAs, with China, the EU and Japan. Framework agreements with India, Mercosur, Pakistan and Turkey have been signed. FTAs with Singapore and South Korea have also been suggested. Bahrain and Oman have signed bilateral FTAs with the US, while the UAE and Qatar are still in the process of negotiating. Mediterranean Middle Eastern countries have privileged access to the EU market through the Euromediterranean Partnership. The US has bilateral agreements with Israel, Jordan and Morocco; negotiations with others, including Egypt, are planned. The Arab Free Trade Zone came into effect in January 2005 marking the elimination of customs duties on trade between 17 Arab countries. However, individual states still have a “negative list” of trade items which do not qualify for exemption. A number of Gulf companies have shown an appetite to expand internationally and acquire strategic equity stakes (e.g. Sabic, Emaar, KPC, Etisalat). 13
  • Middle East@Risk COMMITTED TO IMPROVING THE STATE OF THE WORLD Executive Summary: Geopolitical and Geostrategic Instability Is the Middle East faced with a new arms race? Will US withdrawal throw the region into crisis? Geopolitical risk is the most difficult of all risk categories to adequately assess. The range of different trajectories along which geopolitical risks can develop – contingent on human decision-making on a range of other factors – makes their outcomes hard to predict with accuracy. For example, while the conditions for the outbreak of war may be easily identifiable, the exact sequence (and timing) of events which turn conditions into reality are impossible to predict. In the Middle East, geopolitical and geostrategic instability is a key economic consideration. In the short term, any instability in the Middle East is a guarantee of broader financial market volatility. Over the longer term, instability in the Middle East may actually reduce the region’s geopolitical salience as arguments for diversifying away from hydrocarbon resources will be strengthened in major consuming economies. A high level of instability is already “priced in” to Middle Eastern economies, but making progress on the region’s geopolitical and geostrategic issues could open a range of economic opportunities. Risk Unless a solution is found to the alleged militarization of Iran’s nuclear programme, other Middle Eastern countries may feel compelled to build up domestic capacity in nuclear technologies. Doubts about long-term intentions could ultimately cause a wide-ranging arms race. Whatever the ultimate outcome, spending on such programmes would divert income from urgent infrastructure projects and slow prospects for growth. A precipitous US withdrawal from Iraq would severely destabilize the geopolitics of the Middle East, and could lead to widespread sectarian tensions should Iraq split further along sectarian and ethnic lines. Iran and Turkey could engage in more active attempts to broaden spheres of influence, while global terrorist groups could be emboldened. While there have been a number of positive moves towards peace between Israel and the Palestinians in recent months, questions over the survival of the Israeli government, the sustainability of Palestinian power sharing and the intentions of Syria and Iran mean that the situation remains fragile. Important Trends At their December 2006 Riyadh summit meeting, GCC member states announced a nuclear energy research programme, partly in response to Iran’s unwillingness to adhere to UN Security Council resolutions regarding its uranium enrichment programme. Egypt, Jordan, Syria, Turkey and Yemen have also expressed interest in developing atomic energy. Turkey is proceeding with its first nuclear plant, while Egypt’s plan to build a reactor on its Mediterranean coast has received US backing. In March 2007, the Arab League warned that Iran's drive for nuclear technology could result in the beginning of “a grave and destructive nuclear arms race in the region.” Military sales in the Middle East are on the rise. In the largest example of this, Saudi Arabia announced a US$ 70 billion deal to buy Typhoon Eurofighters in 2006. Other states have declared similar increases in defence spending. The future of the US military presence in Iraq – and therefore of a significant, standing troop presence in the region as a whole – has been brought into doubt by the domestic US political struggle between President Bush and the Congress. Middle East security will play a crucial role in the 2008 US presidential campaign, with likely effects for US engagement in the Middle East. 58% of US respondents favour withdrawal from Iraq; surveys suggest that only half of the members of the US armed forces think the war in Iraq can be won. In the fourth month of the new “surge” strategy, suicide bombings have increased both in scope and intensity. April 2007 was one of the worst months for US casualties since the beginning of the war, and also the worst month for British casualties. On the positive side, some Middle Eastern countries have taken an increasingly prominent role in peace attempts between Israel and the Palestinians. Saudi Arabia sponsored a Palestinian unity government after a long period of tension and violence; a broader Arab peace plan has been received seriously by Israel. 14
  • Consequences Without noticeable improvement in the security situation in Iraq, calls for some form of US troop withdrawal will gain further momentum, with the issue firmly on the 2008 US election agenda. Any US withdrawal would have a number of potential consequences. One is the disintegration of Iraq and the split of the country into three parts. The possible independence of the Kurdish north would bring about active Turkish intervention. Iran would use the event to spread Shi’a radicalism throughout the region, including Saudi Arabia’s Eastern Province and Lebanon. A second option is the establishment of a radical Islamic state in Iraq as the internal political process disintegrates. A confrontation between the US (or Israel) and Iran remains possible should Iran choose to take advantage of the weakness of the US and uncertainty about its long-term role in the Middle East. However, divisions with Iran, including the growing weakness of the president, may lead to moderation in Iranian policy and rhetoric. Should the situation considerably worsen either with regard to Iran or Iraq, the prospects for peace in the Arab-Israeli conflict will suffer through the use of proxy forces to demonstrate political will or through an increased disconnect between the nationalist and Islamist strains in Palestinian politics. Should Iran come under pressure, a replay of the 2006 Lebanon war cannot be excluded. Increased geopolitical tensions are likely to increase the willingness of Middle Eastern investors to place funds outside the region, increase the volatility of oil prices, and decrease the willingness of external investors to invest in the region. Should defence spending increase across the region, resources will be diverted from urgent reform and economic development projects, further reducing the probability of dealing with pressing social problems (particularly among the young) throughout the region. Mitigation Given regional complexities, a combination of national, regional and international level involvement is needed to mitigate the deterioration of the Middle East’s geopolitical situation. Given the complicated role of the US, broader engagement of European and Asian states is critical. Intra-regional dialogue between Arab states and Iran may help to strengthen those Iranians arguing the case for pragmatism in Tehran; the European Union, a potential future market for Iranian gas, may be able to play a stronger role in offering long-term commercial arrangements with Iran; the United States, still the principal security actor in the Middle East, should find ways of engaging in a broader dialogue with pragmatic elements in Iran, without compromising them. Regional leadership is urgently required, in particular from the Arab Sunni states, as a means to maintaining momentum towards Arab-Israeli peace and preventing a damaging split between the Sunni and Shi’a communities. Jordan has taken a historic bridging role between the West and the Middle East. Saudi Arabia has taken the lead in active diplomacy within the Middle East in recent months. Both should be encouraged. The business community can play a role in the political process by encouraging pragmatic moderation. Greater communication among business sectors in opposing states can help alleviate tensions. The business community may play a particular role in designing strategies to employ Middle Eastern youth which may boost long-term economic growth, reduce social tensions and create the conditions for controlled political reform. 15
  • Acknowledgements This report was prepared by the Global Risk Network, in close collaboration with the expertise of the Gulf Research Center Charles Emmerson, Global Leadership Fellow, World Economic Forum Christian Koch, Director of International Studies, Gulf Research Center Eckart Woertz, GCC Economic Program Manager, Gulf Research Center 16
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