Stock market plunge overstates Syria risk for Gulf economies

Wealthy Gulf Arab economies are probably not as vulnerable to the effects of a widening of the conflict in Syria as steep falls in their stock markets this week suggest.

A potential U.S.-led military attack against Damascus over a chemical weapons attack last week, which Western governments blame on President Bashar al-Assad’s government, might prompt Syria or its allies - Iran and Lebanon’s Hezbollah militants -to retaliate against U.S. allies in the Gulf.

Such fears triggered a 7.0 percent plunge in Dubai’s stock market on Tuesday, its biggest one-day fall since the emirate’s corporate debt crisis of 2009; the market fell a further 1.3 percent on Wednesday.

Saudi Arabia’s share market, the Arab world’s biggest, is down 5.4 percent this week. Its drop on Tuesday was the largest since late 2011.

But it is not clear that any expansion of the Syrian conflict would have much impact on the six rich economies of the Gulf Cooperation Council (GCC), except in the worst-case scenario of a direct Iranian attack on their oil exports.

Gulf states have strengthened their finances and made contingency plans since a dispute over Iran’s nuclear program flared up three years ago.

“Our markets have seen a lot of political events and weathered storms like the Arab Spring, Tunisia, Egypt, the power succession in Saudi Arabia - this is not new,” said Amer Khan,fund manager at Shuaa Asset Management in Dubai.

So far, none of these events has been as damaging to the Gulf as people feared, Khan noted.

This week’s sharp drop in the stock markets has more to do with the Gulf’s economic success than its vulnerability, he and other analysts argue: big rises early this year set the markets up for a burst of heavy profit taking by local investors.

Benefit

A limited U.S.-led attack on Syria would not necessarily draw Gulf states deeper into the war; Saudi Arabia and Qatar have been supporting Syrian rebels financially and militarily for many months without suffering major consequences.

GCC states could become targets of militant violence, or cyber-attacks similar to the hacking assault last year on Saudi Arabia’s national oil company Saudi Aramco, which damaged some 30,000 computers and was one of the most destructive cyber strikes ever conducted against a single business.

Such retaliation could be uncomfortable for Gulf governments, but it would not necessarily change the region’s economic outlook.

The Gulf’s biggest economies are running huge current account and state budget surpluses, which mean they do not need foreign capital and can ramp up government spending if necessary to sustain confidence when domestic investment flags.

The budget surpluses which Saudi Arabia accumulated over the last three years alone, for example, were together almost as large as its total state spending in 2012.

In fact, past geopolitical crises in the Middle East have often ended up enriching Gulf economies, by inflating the value of their oil exports. Partly because of this effect, the economies of Saudi Arabia and the United Arab Emirates continued growing during most of the Gulf War of 1990-1991 and the U.S. invasion of Iraq in 2003.

Societe Generale estimates that oil prices could surge as high as $150 per barrel, from around $115 now, if the Syrian war affects key producers such as Iraq.

If oil supplies were curtailed by a military conflict, the market would rely on extra output from Saudi Arabia, the only member of the Organization of the Petroleum Exporting Countries with enough spare capacity, Societe Generale said.

Parts of the GCC may also be seen as safe havens if the Syrian war escalates, attracting money and people from countries affected more directly, such as Lebanon, Iraq, Jordan and even Syria itself.

The UAE and Qatar have drawn billions of dollars of capital flight since the Arab Spring uprisings began in 2011. “I expect UAE and Qatar to continue being safe havens when this is over and one thing that benefits is real estate, equity and physical,” Khan said.

For these reasons, five-year Saudi Arabian credit default swaps - used to insure against any Saudi sovereign debt default, and therefore an indicator of geopolitical tensions in the GCC - have barely reacted to rising tension over Syria.

They are up just 4 basis points to 72 bps this week, remaining well below levels of above 100 bps recorded in 2012. This year’s peak of 90 bps, hit in June, was in response to a spike in U.S. Treasury yields, not a political event.

Threat

The worst scenario for the Gulf would probably be direct military action by Iran against Saudi Arabia’s oil production facilities, or an effort to close the Strait of Hormuz to oil tanker traffic and other trade; the GCC depends heavily on imports of food and consumer goods.

But while Iran threatened repeatedly to close the Strait in2012, it never attempted to do so, and it would have difficulty mounting an extended military campaign in the face of massive force from the United States and its allies.

Disruptions to shipping might occur, but preparations over the past several years mean they could be less economically crippling to the GCC than in the past.

Last year the UAE opened a pipeline to the emirate of Fujairah pipeline, bypassing the Strait; it will be able to carry most of Abu Dhabi’s oil exports, officials said. Saudi Arabia has reopened an old pipeline in case it needs to boost exports from its Red Sea terminals. Oman has been expanding its port capacity at Salalah, Sohar and elsewhere.

These routes could not carry all of the GCC’s oil, but beekeeping a significant level of exports going, they would buy the region time while efforts to reopen the Strait fully proceeded.

Kuwait and Qatar, which for geographic reasons lack major alternatives to exporting their oil and gas through the Strait, could be hardest hit by shipping disruptions. Their populations are small, though, and they are among the richest Gulf states per capita; they have built huge financial reserves abroad that could cushion the impact of any crisis for months or years.

The assets of Kuwait’s sovereign wealth fund are estimated at around $380 billion, more than twice the country’s economic output in a year. Qatar’s sovereign wealth fund assets are believed to be about $115 billion, nearly two-thirds of output.

Such considerations mean stock price falls in the Gulf should be seen mainly as natural volatility in bullish markets, rather than signaling a sharp deterioration in the region’s economic outlook because of geopolitics. Dubai’s market is still up 55 percent since the start of this year, buoyed by a recovery of the real estate industry from its 2009-2010 crash.

John Sfakianakis, chief investment strategist at Saudi investment firm MASIC, said there was concern in the region about Iran’s response to a strike against Syria, but the effect had been magnified in the markets by short-term traders.

“Markets in the Gulf are predominately retail-oriented and they do tend to react violently and take a short-term view,” he said. “Given that markets in the region have rallied quite well year-to-date, retail investors tend to liquidate quite fast and because of less liquidity, reaction is exaggerated.”