The economists on 2008

To gain insight into the state of the Gulf economy in 2008 who better to turn to than the region's leading economists. David Westley asked HSBC's Simon Williams, Standard Chartered's Mary Nicola, EFG Hermes' Monica Malik and Moody's' Tristan Cooper to give us their views on what 2008 holds in store for businesses across the region.

What are the threats to the GCC from outside the region? What are the dangers of the US and Europe going into recession in 2008?

Simon Williams, HSBC: The outlook for the US is troubled. Growth will slow down in the first half of the year, although quite how much is difficult to gauge at the moment. Recession is possible, but we don't believe probable.

In Europe, the UK like the US, faces difficult times. Mainland Europe is at a different phase in the economic cycle, but will feel the impact of slower growth in the US and UK over the first half of next year.

Tristan Cooper, Moodys: We consider an outright recession in either the US or Europe to be unlikely. We rather predict a slowdown in growth given the difficulties in the housing market and the persistent turbulence in financial markets. Such a slowdown will inevitably affect global growth, which is likely to decelerate in 2008 from its very strong performance over the past four years.

How shielded are the GCC economies from what happens elsewhere?

Simon Williams: The underlying story in the Gulf is robust and as well protected as anywhere in the world from a US recession.

The key issue for the Gulf is the impact of a developed world slowdown on emerging Asia.

High oil prices are premised on China's demand for energy continuing to rise, and if China's growth stalls, oil prices will fall. Historically, the link between emerging market growth and developed world trends was very close, but in recent years we see growth trends have decoupled. What we will find out next year is how thorough and how deep that decoupling actually is.

Remember, though, that the GCC does not need oil to be at a US$100 per barrel to prosper. This region needs oil to stay above US$45-50 per barrel for public finances to be in surplus and for investment projects to be funded over the medium term. I don't see prices falling below that level any time soon.

Monica Malik, EFG: Hermes Unless there is marked slowdown, and both Europe and the US head into a real recession, the GCC is fairly protected. The principal connection is, of course, the price of oil.

Traditionally the US has been the largest importer, and were demand to fall off dramatically because its economy weakened significantly, that could signal lower demand and see prices fall. For oil prices to fall substantially, the recession will also have to spread to Asia.

However, we don't predict that. We expect oil prices to remain strong. While the US remains the biggest importer, we do not see a recession, and emerging economies, particularly China, will continue to fuel demand. In addition commodities - including oil - are being used as a hedge against the dollar weakness - increasing demand, on paper, for oil contracts.

A full-blown US recession could have an impact, but also bear in mind that the GCC economies are structurally stronger, with strong foreign reserve position and continued strong surpluses. Oil prices would have to fall a long way to US$20-30 per barrel.

Most GCC budgets are based on low oil price assumptions and have budget break even points lower than the current oil price or the oil price forecast for 2008. Oman and Bahrain, the two most sensitive economies, with budget break even points just below US$60 a barrel (Brent crude). Meanwhile, the UAE and Qatar have budget break even points below US$40 a barrel.

Mary Nicola Standard Chartered: We saw a measure of how protected the GCC is with the liquidity crisis that affected the US and Europe back in August.

As the US was suffering from a liquidity crunch, the GCC was dealing with ample liquidity. It barely rippled here.

However, while the issues of sub prime [lending to a higher risk market] may not have had much of an effect on the local markets, local markets have been indirectly affected via US monetary policy. The Fed has been cutting rates to contain the problem thereby causing the GCC to cut rates as well.

We predict that by the end of Q1 2008 it will have cut another 50 basis points. If that is the case and if the GCC keeps the dollar peg, then they too will have to cut interest rates. That is at odds with what GCC economies need. GCC economies are booming and there is already ample liquidity in their markets. Monetary loosening is not what the markets need here. They should be increasing interest rates to contain inflation.

There has been considerable money supply growth across the UAE over the few years and that will have an impact in the short and long term. The GCC lacks the monetary tools it needs to absorb the liquidity. There is no bond market to soak up liquidity. Essentially there is too much money chasing too few goods.

Tristan Cooper: The key variable for the GCC is clearly oil prices given that all GCC economies continue to be dominated either directly or indirectly by hydrocarbon export receipts. The futures market still takes a rather rosy view of oil prices, as do we, despite the more gloomy global growth outlook. This is mainly because of booming energy demand in emerging markets, particularly in Asia, and the still relatively low level of spare oil production capacity among OPEC producers.

Hence, we are predicting that global oil prices will rise in 2008 compared to their average level in 2007. This is good news for the GCC.

Will inflation continue into next year? At what levels? Will that affect business in the GCC?

Simon Williams: Inflation has been the key story over the second half of this year and is going to remain the main concern over 2008.

Inflation used to just be a problem in the UAE and Qatar but we have seen price growth pick up across the board, even in economies like Saudi Arabia which previously experienced very low inflation levels.

This will cause some difficulties, but we must remember it is a reflection of the success of the broader economy. When economies double in size in just four years - as the GCC has done - it is inevitable there will be some pressure on prices. Provided we don't see an accelerating inflationary spiral, I am confident that the region can continue to prosper.

However, policy makers will need to be careful, they need to ensure that growth strategies are set for the medium term and that the expansion in domestic demand does not run ahead of what still small economies can actually sustain.

Fiscal policy - public spending - is already expansionary and against a backdrop of high oil prices and rising consumer prices, it will be tempting to agree large public sector pay increases which will feed through into higher private sector salaries, too. This would provide short-term relief but create increasingly serious inflationary pressures down the road. Monetary policy also needs to be reviewed if it is to stem, rather than fuel, inflation. Because of the dollar peg, the region's currencies are weak at a time they should be strong and interest rates are far below their optimal levels.

It may not be enough for policy makers to simply wait for a time when the US and the Gulf are back in synch. The Gulf is strong enough to take matters into their own hands and regain control of their monetary policy and currency regimes.

Monica Malik: The GCC will remain high inflation area, although the UAE will see a slight decline because of lower rental increases. Abu Dhabi will see higher inflation - rent driven - and this will be the main factor stopping the inflation rate falling in substantially 2008.

The region as a whole will see inflation continuing to accelerate in 2008. Inflation will mainly be driven by rents and food price increases. The majority of the GCC countries have embarked on an investment drive, which is leading to a greater influx of expatriates and more pressure on housing - presently the key driver of inflation in the region.

Meanwhile, the dollar weakness will import inflation for food items - exacerbated by the fact that world prices going up anyway... There is also huge liquidity in the region, and strong credit and money supply growth - real interest rates are negative in the UAE and Qatar. However, interest rates have to follow US rates.

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