Markets are beginning to price a shift of contagion from North Africa to some of the Gulf economies, principally Bahrain and Saudi Arabia. The possibility of contagion spreading to Saudi Arabia remains low although markets are pricing a higher risk premium. Bahrain’s future is a leading indicator but there is not enough clarity about short-term political outcomes.
If we learned anything during the most recent financial crisis it is that markets can get it wrong. During the recent Egyptian crisis, oil prices spiked over concerns about the transshipment of oil via the Suez Canal. Markets today are beginning to price contagion effects spreading from North Africa to, principally, Bahrain. Although it is hard to predict the political outcome in the Gulf island, markets are pricing a premium on the risk of contagion to neighboring Saudi Arabia. Aside from making any definite calls on the future outcome of Bahrain, we remain reassuring about Saudi Arabia. The chances of disruption to oil production remain distant as is the likelihood of major unrest. Markets have a tendency to differentiate less during crises and, as we saw during the Dubai debt crisis in 2009, risk premiums spiked for all. Differentiation took time, however.
Saudi Arabia’s ability to carry out distributive policies is obvious, particularly in areas that have important social significance. The government announced an estimated USD36bn spending programme (as much as 8.3% of last year’s GDP) on housing, education and social welfare on top of a 2011 budget which is the largest in its history. Saudi King Abdullah recently unveiled a string of financial support measures geared towards citizens through new unemployment benefits that stand to help youths facing double-digit joblessness rates; expansion of social security safety nets set to target lower-income Saudis; and substantial funds allocated to writing off the debts of deceased borrowers and prisoners. The royal order, which includes 19 components, strives to promote job creation, expedite the supply of housing, and improve funding for education, charity associations, cultural and sporting clubs, and professional associations.
Moreover, Saudi Arabia has the capacity to underwrite similar distributive policies, without resorting to domestic or external financing. Central bank foreign assets (SAMA) were at USD444.8bn as at December 2010 (102% of 2010 GDP), which provides ample fiscal buffers. The package announced at end-Feb will be financed from these reserves. Hence Saudi Arabia is forecast to witness twin surpluses (fiscal and current account) as oil prices continue their buoyant performance. Hence, the state has the capacity to tap into its huge deep pockets to support any short- to medium-term emergency spending programmes. We believe that the chance of major unrest within Saudi Arabia is not probable. The economic changes desired and needed are not predicated on calls for a change in the leadership structure. A cabinet reshuffle is a welcome step towards political refreshment. However, the leadership cannot afford complacency and neglect as events in the wider Middle East necessitate change. Events in Bahrain should be closely watched as they could act as a regional ‘self-reflection exercise’ for the political landscape.
There is no doubt that uncertainty about the wider Middle East will continue to impact Saudi Arabia’s CDS or could at some point impact SAR forward rates, should uncertainty escalate further. The strength of events in Tunisia, Egypt, Bahrain, Libya as well as Yemen has led most to expect the worst to come for the rest. Differentiation and re-classification of risk is warranted, but it takes time for the dust to settle. Regional stock markets will continue to reflect the higher perceived risks.
We think that markets will continue to price additional risk premiums despite the arguments put forward about Saudi Arabia’s fiscal and political capacity to weather the regional crisis. The CDS spreads have widened recently. However, they remain far below the level they reached during the Ma’an – Qussaibi defaults. Spread could remain large or widen further in the short term.
Saudi Arabia’s systemic role in the global oil market is paramount for the world economy. The kingdom’s extra capacity is 4mbpd, which can be put on to the market in a short period of time and is more than twice the total current production of Libya. We think that Saudi Arabia’s oil facilities remain under no threat and the country’s oil production will remain uninterrupted. However, the market may think otherwise at some point, should tensions rise further in the Gulf.
The role of the US in the Gulf is expected to be more vigilantly active. In the case of Tunisia and Libya, the US’s role has remained subdued due to its modest historical and diplomatic ties. However, the role the US would take in the event of Bahrain’s political landscape being radically reshaped, as it is the base for the fifth fleet, remains to be tested. There is little evidence to lead us to anticipate Saudi Arabia being the next country to face domestic unrest, turmoil, violence and calls for regime change. We do believe that Saudi Arabia will embark on various economic and reforms that have a wider inclusive and distributive purpose. However, the end-game for the rest of the Middle East is far from clear at this point.