Different challenges

There are many reasons for one to be positive about the prospects of Gulf Co-operation Council (GCC) economies. My view is that the rapid growth we have seen over the past few years is merely the beginning.

Even at a time when the US economy is falling into a recession and the world economy is slowing, surpluses and investment in infrastructure will keep the economy on track. However, I think it is premature to conclude that the GCC economy has decoupled. Decoupling is a long-term process.

It is true however that the GCC is facing very different challenges from the rest of the world, particularly the US and the West. At a time when Gulf economies are booming, it is very easy to get carried away in the euphoria and ignore the risks.

And the main risk facing the GCC is not the deceleration of the US, but rather the sharp expansion in the country's money supply and the ample liquidity that comes with it.

It is important to be aware of the positives and the opportunities but at the same time to acknowledge the potential pitfalls along the way.

The GCC enjoys structural positives. This is perhaps the first time that the proceeds of the oil price boom are being invested at home, and not just abroad.

One cannot overemphasise the importance of this development.

By investing domestically, GCC authorities are not only showing their faith in their economies, they are also creating the prospects for sustain-
able development.

The fact that GCC countries enjoy substantial budget and current account surpluses, high foreign exchange reserves, and a wealth of foreign assets suggest that the economies are to a great extent insulated from the global slowdown.

This is also an indication that investment in the region can indeed continue, even if the global environment deteriorates further. Beyond the long-term benefits, this investment will be an important source of growth itself.

The challenges the region faces are related to its own success. The latest numbers from the Qatari Central Bank showed the broader definition of money, M3 money supply, growing by 32% y/y. Likewise in the UAE M3 money supply grew by more than 36%.

One does not really need to look far back to understand the problems cheap credit and rapidly rising liquidity can create. It was not so long ago that the US economy was awash with liquidity, enjoying an economic boom and rampant asset prices. It did not take long for the situation to reverse.

Some of the biggest financial crises and the longest recessions have followed booms that were sparked by ample liquidity.

The great depression in 1929 was preceded by a liquidity fed boom in the 1920's. Mexico in the 1970's was enjoying high oil prices and had its currency pegged to the US dollar.

This led to a rapid rise in liquidity and inflation, until it all came to an end in 1982, when the markets crashed and the economy entered a recession. Japan's boom and asset price rally in the 1980's was followed by a crash and a decade of no growth in the 1990's.

Furthermore, a period of high inflation and rapid money growth set the stage for the Asian crisis of 1997. The lesson learned is that if prices and liquidity are allowed to grow to an unsustainable level, the only way they come down is through an economic downturn.

The US economy is falling into a recession, and the Federal Reserve is using all the tools at its disposal to smoothen the downturn. The Fed has so far shown that it will keep adding liquidity into the system to boost the money supply. This is the correct response to the problems faced.

However, the problem in the GCC is that this expansionary monetary policy is being imported, both because of lower interest rates but also because of the weakening currency.

The challenge is to tighten policy and to manage the boom.

The GCC enjoys strong economic fundamentals. And what has been achieved here, with the ambitious but very real plan to diversify the economies, is simply admirable.

Growth here can indeed be sustainable. The surpluses cushion the region from external shocks.

The past few years of unparalleled growth and progress can be seen as merely the beginning of a long period of out-performance. But for this to continue, it is important to control money growth, tame inflation and manage the boom.

The challenges are to a great extent the result of the GCC's own success. But they remain challenges nevertheless.

Marios Maratheftis is regional head of research for ME, North Africa and Pakistan at Standard Chartered.

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