Dubai: In mid-January, global rating agency Standard & Poor's (S&P) downgraded nine European sovereigns.
The rating agency justified its decision by pointing to a combination of economic and financial factors along with ‘insufficient' measures taken by European leaders in dealing with the crisis.
Jean-Michel Six, Standard & Poor's Chief European Economist, recently spoke to Gulf News on the outlook for European economies and how the debt crisis is impacting the Gulf economies which are also facing heightened geopolitical risks.
Partly in response to the Arab Spring, many governments in the region have increased spending on social transfers, wages, housing and infrastructure. As a result, the dependence on hydrocarbon revenues to finance this spending has increased, which is reflected in higher non-oil budget deficits and increased break-even oil prices. Despite the strong economic growth supported by large-scale government spending, the region's public finances face the risk of structural weakness.
The S&P economist anticipates that Gulf economies will grow in the range of 3.5 to 4 per cent this year and will continue to benefit from high oil prices and increases in hydrocarbon production which are bolstering government finances and external accounts.
Gulf News: The rating action last month points to S&P's view that the European economic crisis is likely to deteriorate further. How do you assess the linkage of European problems to the rest of the world?
Jean-Michel Six: The global economic environment is very difficult. Europe's economy returned to recession in the fourth quarter of last year.
The US economy is showing signs of revival, but by US standards it is still very weak. We are anticipating that the recovery this year will be about two per cent in the US, which is much lower than any previous episodes of recovery and puts a lot of pressure on the authorities on the fiscal side.
In Europe, we anticipate that the recession would last at least until the autumn. So the only bright spot in the global economy are the emerging markets in Asia, Middle East and Latin America.
We think that the emerging markets experienced a slowdown last year that is because at the end of 2010 their central banks tightened monetary policies because inflation was accelerating.
There was a simultaneous clampdown by central banks all across emerging markets. Of course it worked. Econ-omic growth has slowed down along with inflation. With all market tightening at the same, global trade also diminished. In most cases we think that those markets will be able to orchestrate a soft landing and should be able to rebound in late 2012.
In particular, we remain fairly confident that China will be able to stabilise growth of about eight per cent in the second half of this year. That is very important for the rest of the world including the GCC economies and the mature markets of Europe.
How do you think the European crisis will have an impact on the GCC economies?
The debt crisis is Europe has severely impacted the financial system. The European banking sector is deleveraging and many of them are refocusing on their home markets. The potential risks for the GCC, (I insist that it is a risk because it is not certain) is that liquidity from foreign bank funding is likely to shrink somewhat because of the deleveraging and the restructuring taking place in the West.
That is a potentially negative consequence of the European crisis on GCC economies. However, on international bond markets we see the beginning of a return of risk appetite. That bodes well for the Middle East and North Africa region as a whole.
We also note that interest rates in the developed world will remain negative in real terms. That is a favourable factor for capital inflows into emerging markets in particular the GCC.
The region is likely to see a contraction in lending while on the capital markets, the chase for yield should work in favour of GCC (debt) issuers.
GCC economies are primarily oil economies. How do you see the impact of the European debt crisis on the oil markets?
We expect oil prices to remain fairly firm driven by strong demand from emerging markets. We expect the demand from these markets to pick up further in the second half of the year.
Attractive yields are indeed a key driver in attracting capital to the region, to a large extent offsetting the shortfall in bank funding. But how do you assess the impact of geopolitical risks on investor appetite considering the rising tensions between the West and Iran?
Geopolitical factors such as that faced by the region always have a negative impact on investor confidence. I think the negative impact of an escalation in the region (tensions between Iran and the West) will be transmitted more through trade and oil movement from the region.
The likelihood of severe disruption of oil supplies through the Strait of Hormuz, through which 20 per cent of the world's oil flows, is ‘very low'. This is not our base case scenario. But if one did occur, it might boost oil to $150 or more a barrel. The prime effect is that it will kill the recovery in the West and the non-oil producing emerging economies.
If anything of that happens, as a trading hub Dubai will be severely impacted. Generally, the UAE will be affected because of recession in the rest of the world. A majority of international investors still believe that there is a good chance that extreme solutions will be avoided.
For bond investors, some economic fundamentals such as the health of the UAE economy, the debt overhang and the way the debt restructurings are carried out are of prime concern.
Despite some doubts expressed by analysts on the ability of some of the Dubai entities to meet their debt maturities, recent experience shows companies are indeed meeting their commitments. How do you assess these developments?
There is no doubt that lots of improvements have been achieved in terms of building credibility. Certainly there is scope for more. But we note that some positive steps have been taken. I was referring to the economy in my earlier comment, not on the liquidity situation. Liquidity in Dubai has improved a lot over the last year.
