London, Asharq Al-Awsat- What will the euro zone crisis might mean for Arab economies? If I am honest I would have to say that I probably do not know – yet. But that would be too easy so let’s explore it.
The euro zone issue is one of sovereign debt rather than part of the 2008 banking crisis. Policy-makers knew what they had to do to prevent a 1930s style depression as they took action in 2008. But the euro zone crisis is different and there is no textbook response. The European sovereign debt crisis and fears of a new global recession have led to a breakdown of investor appetite for risk. Concern about rising government debt levels across the globe together with a wave of downgrading of European government debt created alarm in financial markets. The current crisis was built up over many decades and those who think it is new have not read sufficient twentieth century history.
Market credibility must be re-established to re-build confidence in the euro. Due to the long accumulation of sovereign debt the problem is also political. Now that Italian PM Silvio Berlusconi has resigned and Lucas Papademos has been sworn in as prime minister in Greece, some confidence may return.
But going answer the question, before we look forward it helps to know a little of the past.
In the last weekend of October 1990, British PM Margaret Thatcher was at a European summit in Rome at which European Monetary Union was high on the agenda. Thatcher predicted that Germany would be obsessed about inflation, while the euro would prove fatal to the poorer countries because it would “devastate their inefficient economies”. Much of Mrs Thatcher case now seems reasonable.
No one has had to sort out such a debt explosion, so there is no point of reference. Despite the indecision of the political elite, the euro zone leaders’ strategy is not just procrastination. It is about finding a way of dispersing the energy of the debt explosion.
It could be argued that the bond-market run on Italy has increased the chances of an eventual break-up of the euro, although no one can be sure how likely that might be. If Italy is unable to finance itself at reasonable rates, and the resources of the rest of the euro zone cannot or will not stretch to a bail-out of such a big, indebted sovereign, then one of the attractions of euro membership (low interest rates) is gone. That weakens the argument for staying in.
Personally I do not believe that the euro zone will collapse. The financial and social chaos that would follow seems to be vastly under-estimated. It would be a gigantic financial shockwave. For a while credit could collapse. There would be a dash for cash and businesses short of it would go under.
What are other major countries thinking?
US Treasury Secretary Timothy Geithner said last week that he believes that European leaders will incorporate some lessons and methods employed by the United States during the financial crisis as they work to quell their sovereign debt anxiety.
The People’s Daily in China suggests that the debt crisis across the euro zone will hurt China by sapping demand for exports. I have been involved in major infrastructure projects in China for more than fifteen years and have enjoyed reading The People’s Daily. I would say that some of its comments can be perceptive.
When Europe stabilises, which I believe it will, we may find that growth has been harmed by the scale of the crisis so far. Avoiding this provides a strong motivation in those economies that have the capacity to do it, to act now to strengthen growth.
The effects of the global financial turmoil on Arab countries may be more manageable compared to other parts of the world due to their fundamental strength. Most Arab countries have not been at risk from the financial impact of the crisis so far.
However, the impact on the real economy is still emerging, and could be significant in many countries. Governments with fiscal space going into the crisis will be in a stronger position to respond to the impact of the crisis on the real economy. However many Arab countries were running a fiscal deficit. The biggest direct upshot of the euro crisis will be on the global demand for oil. Any rapid decline in oil prices or a prolonged lower level of pricing as a result of a global economic downturn would bring about a decline in export growth.
Arab countries can be broadly grouped in four categories – oil exporters with large financial capacity and small populations; oil exporters with large populations; non-oil exporting countries with strong linkages with GCC countries; diversified countries with strong linkages with Europe in trade and tourism.
The GCC oil exporters with large financial capacity and small populations are in the best position to absorb the economic shocks. They entered the crisis in exceptionally strong positions. This gives them a significant cushion against the global downturn. Steadily declining oil prices would, nevertheless, force them to draw down reserves and reduce investments. I would suggest that this is a reasonably unlikely scenario.
The next group are oil exporters with significant oil revenues, but with large populations and large social commitments, which makes it difficult to adjust expenditures in a downturn. These countries entered the global financial crisis with weaker fiscal and external positions than GCC oil exporting countries. Fiscal challenges are likely as governments try to meet long-term social challenges.
After these countries come the non-oil exporting countries with strong linkages with GCC countries through remittances, FDI and tourism. These countries entered the crisis in the weakest position, both in terms of fiscal and external balances. Sustained low oil prices would make these countries vulnerable to declines in remittances and FDI from the GCC. Social pressures would emerge with the return of migrant workers.
Finally there are the diversified countries with strong linkages with Europe in trade and tourism. They will feel the greatest economic impact through the depressed European demand for imports and tourism spending and will also receive less FDI from Europe. This euro zone effect will add to other relatively less important channels through which these countries might be impacted.
One way out for all Arab countries would be to accelerate the development of infrastructure and social developments and to harness the capacity of the private sector. To do this better business plans will be required to attract funding. Funding has not gone away. It has just become more difficult to access and requires professional and bankable business plans. The euro zone sovereign debt crisis is a problem but also presents opportunities for valuable long term repositioning of some Arab economies.
* Sir John Davie is a visiting professor at London Metropolitan Business School and chairman of Altra Capital