A
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French Version

Another year of prosperity and growth awaits Gulf states

Commentary by Henry T. Azzam

The region is expected to witness another year of growth and prosperity. Not only will the Gulf countries experience booming economic conditions, but the region's non-oil producing nations will also benefit from capital inflows seeking profitable investment opportunities in their respective countries, higher level of remittances, surge in regional tourism and growing exports of goods and services to the Gulf.

The region's unprecedented growth will be driven by higher oil revenues facilitating huge investment in infrastructure, and a more confident private sector embarking on a strategy of growth and expansion. Geopolitical risk has also been reduced as the war in Iraq becomes more contained, and markets scaling down the likelihood of confrontation between the US and Iran following Washington's intelligence report stating that Iran has halted its nuclear weapons program.

After growing at an average of 8.5 percent in 2003, 5.9 percent in 2004, 6.8 percent in 2005, 6 percent in 2006 and an estimated 6.7 percent in 2007, real GDP for the region is forecast to grow at a healthy 7 percent in 2008. Driving the economies of the region forward in the ever expanding oil, gas and petrochemical sectors, property/real estate, construction, infrastructure/utilities, transportation, communications, manufacturing, banking and other services sectors. We expect Qatar to lead the pack in terms of real GDP growth in 2008 rising by 10 percent as the country boosts its natural-gas production followed by the UAE at 9 percent, Bahrain 7 percent, Oman 6 percent, Kuwait 5.5 percent and Saudi Arabia 5 percent. Egypt and Jordan will continue to enjoy solid economic growth rates of 7.5 percent and 6 percent respectively.

Oil prices which rose from an average of $35 a barrel in 2004 to $53 a barrel in 2005 and $65 a barrel in 2006, surged by 20 percent last year to an average of $73 a barrel. Total oil revenues for the six Gulf states are estimated to have reached $500 billion in 2007, up from$400 billion in 2006 and $320 billion in 2005. External current account surpluses for 2007 are estimated at $250 billion, exceeding those of China and of Japan, and adding to the region's estimated net foreign assets of $1.6 trillion at the end of 2007. In 2008, oil prices could trade in a slightly lower range as the economies of America and Europe experience slower growth rates and markets assign a lower premium for supply uncertainty.

The main challenges on the domestic front are rising inflationary pressures and supply bottlenecks becoming more visible across various infrastructural sectors. The region will have to live with higher inflation rates, which is part of the equilibrium process where growth in domestic demand exceeds growth in supply. In 2007, inflation is estimated to have reached 12 percent in Qatar and the UAE, 5.7 percent in Jordan, 5 percent in Oman and Jordan and 4.5 percent in Saudi Arabia and Kuwait.

Inflation has mainly been fueled by a surge in food prices and rental rates, higher commodity and construction material prices, expansionary government spending and strong growth in money supply. The weaker dollar, to which the currencies of the region are pegged, contributed to higher prices of imports originating from Europe and Japan. The declining dollar interest rates pushed domestic interest rates lower and encouraged strong credit expansion. This added to excess demand conditions and higher inflation, and fueled speculation that Gulf currencies would be revalued.

However, following the GCC summit in Doha last December, it became evident that the dollar peg would not be changed. The current downturn in the dollar is perceived to be cyclical and not structural. There is every reason to expect the US currency to strengthen as the current down cycle comes to an end, which might very well be the case in 2008. Besides, if domestic currencies are revalued under the pressure of speculation, it would encourage speculators to push for devaluation when the dollar regains its strength. This is why we believe it is not the right time for revolution of the Gulf currencies and the Jordanian dinar vis-a-vis the dollar and we do not expect one to happen in 2008 to curb inflation, governments of the region should follow a less expansionary fiscal policy and issue government bonds and CDs to absorb excess liquidity and slow down lending growth.

Investors in the region's stock markets should position themselves for another year of strong performance, benefiting from low interest rates, strong economic growth supporting high corporate profitability, attractive valuation and a positive sentiment. The correction in most regional markets is over. A bottom was formed in the first quarter of 2007, with market indices ending the year up 60 percent for Oman, 45 percent for UAE, 43 percent for Saudi Arabia, 35 percent for Qatar, 24 percent for Kuwait, and 22 percent for Bahrain. The stock markets of Egypt and Jordan were up 40 percent and 20 percent respectively in 2007.

Given the projected growth in corporate profitability of 20 percent to 30 percent for 2008, the uptrend in share prices is likely to continue, and this time around it is expected to be sustainable as it is driven more by fundamental factors and less by speculation. Increasingly institutional investors, both local and foreign, are leading the way with a more confident retail sector riding the wave. The region's stock markets have benefited from the lack of correlation with global markets. The credit crunch in the US and Europe has made our regional markets more attractive to foreign institutions and valuations here are cheaper compared to other emerging markets. The average 12 months trailing PEs across the region now stand at 18, compared to more than 30 in India and China. Nevertheless, investors should expect volatility levels here consistent with other emerging market.

Saudi Arabia remains the market of choice for institutional investors because it provides diversification and large trading volumes and has the lowest level of foreign institutional ownership. The UAE, Kuwait, and Jordan look promising in terms of valuation and where a turnaround in momentum is clearly in place. Egypt will continue to do well, benefiting from structural reforms and strong investment drive by locals and foreigners. Bahrain, Oman and Qatar do not have the breadth and depth needed to attract sizeable institutional funds, but there is value in selective financial and industrial sector growth. The inclusion of the GCC markets, excluding Saudi Arabia, in the newly launched MSCI Frontier Market Index raises their visibility and will help attract additional foreign funds to these markets.

What are the implications going forward for those doing business in the region? With the continuation of booming economic conditions, the biggest issue would be inflation, supply bottlenecks, and shortage of skilled employees. It is going to be more expensive to operate here; this is why issues like outsourcing, economies of scale, strategic planning, attracting and retaining talent and forging strong relationships with leading financial institutions will become critical for companies to manage their business in bubbly market conditions.

The world is coming to terms with the new phenomenon that the rise in oil prices is not a short-term spike but rather a long-term economic reality. Persistently high growth conditions in the region are here to stay and the Middle East region will join the BRIC countries (Brazil, Russia, India and China) as leaders of world economic growth in the years to come.


Henry T. Azzam is Middle East and North Africa CEO for Deutsche

Marseille,11January2008
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