London Business School

Business Management spoke with Andrew Scott, Professor of Economics at London Business School, about financial prospects for the Gulf region.

BM. There has been a lot of talk about a slow-down in growth and downturn in economy in the global economy, but the forecast for the Gulf region is more optimistic. Why is this?
Andrew Scott. Essentially, three reasons.

• One of the current problems is a credit crisis. Countries, firms or individuals who don't need to borrow money are less affected. The GCC states are mostly substantial creditors.
• Despite the economic slowdown most commentators (not necessarily correctly) are forecasting that oil and commodity prices will continue to remain high even if they don't stay as high as they are now. This will help boost the region.
• Due to economic reform many GCC countries are showing sustained growth as they catch up with the levels of richer nations. This helps provide momentum even in bad times.

BM. Do you think this slow-down will have any effect on the region's business at all, and if so, what?
AS. I don't think the GCC states can remain unaffected. The US is slowing down sharply. The falling dollar means the euro and yen are rising and so the EU and Japan are also slowing. Therefore more than 70 percent of the world economy will see slower growth in 2008 and this will have some effect on the region. In the short term the region is likely to be little affected but looking forward a year or so I can see foresee three problems:

• Many countries in the region peg their currency to the dollar. As the dollar falls this means that inflation is increasing sharply in the region. This will have to be dealt with as a policy concern. This will result in some combination of higher interest rates and a revaluation against the dollar. This will slow the economy.
• The world economy has been experiencing a real estate boom/bubble as has the GCC region. Whilst property price strength is underpinned by fundamentals there is a clear speculative element. Financial institutions around the world are increasingly concerned about their exposure to real estate and lending practices are changing. If interest rates are also increasing there is a risk of a slowdown in real estate.
• If US, EU and Japan slowdown China will be affected although it will still grow strongly. This will moderate oil demand and see some fallback in oil prices.

BM. What effect do you think Middle Eastern sovereign funds getting involved in American markets will have on the American economy? How are these investments being viewed by the media in both territories?
AS. Most of this investment by sovereign funds is passive and so will have little affect on the economy. Currently it is most welcome as US banks need desperately to recapitalize their balance sheets. Without this investment by sovereign funds the credit crunch would not have shown the (limited) signs of improvement it has the last few months. After the crisis has passed there will be substantial regulation applied to the US financial system to try and rectify the mistakes of the past. This regulation will concern mortgages, particularly sub-prime, review bonus payments and will also investigate the role of sovereign funds. When an economy slows protectionist pressures always rise. The perception of sovereign funds as "shadowy" institutions will be a source of negative feedback.

BM. Middle Eastern markets are seeing international companies setting up in increasingly large numbers. What do you think is driving these companies to attempt to gain a foothold in the region?
AS. Because of economic reform a number of countries in the region have started to perform well in a way that suggests strong growth independent of whatever happens to oil prices. With the region also beginning to show greater signs of integration and its geography near to India this is an attractive base for companies who wish to work in services or sell to the domestic market.

BM. Do you think there are risks for foreign companies getting into these territories, given the historical instability in the region.
AS. There is always risk with foreign direct investment and firms are used to analyzing and living with this uncertainty. The region has tended to be marked political instability more than economic instability. As countries become richer political instability tends to decline suggesting in some senses the region may be becoming perceived as more stable.

BM. What does this kind of cross-global investment mean for the future of the world's economy?
AS. Cross-global investment has been increasing intensely for several decades and has a history of more than 100 years. In recent years this cross-global investment has spread from the financial sector into services. From an economic perspective the cross-global investment is healthy. It spreads risk, helps finance investment and ties countries more closely together. The dynamics of globalization can be interesting politically. As countries come closer together it increases the cost of conflict between them and leads to peace, a strong motivation for European unity. However as countries come together it also can cause conflicts and disagreement and so some fear that globalization may break into protectionist isolationism and conflict.