In December last year the International Monetary Fund published a report entitled GCC – Enhancing Resilience to Global Shocks. At nearly 100 pages, the report mentions the Strait of Hormuz only once, almost in passing, as part of a brief reference to potential geopolitical tensions.
In contrast, the Fund’s latest regional report, released in mid-April, provides a wealth of analysis on the consequences of a full or partial closure of the strait.
It examines not only the direct impact on GCC states, but also the knock-on effects for economies such as Pakistan and Turkey, which depend heavily on the Gulf for remittances, employment and imports including oil, gas and fertilisers.
To be fair to the IMF, the December report was primarily focused on financial resilience rather than political risks. The downside scenarios it considered were the usual mix of uncertainty over oil prices and production volumes, the significance of non-oil economic activity, the value of monetary stability rooted in currency pegs, and the need for greater fiscal flexibility.
An annex on the implications of global uncertainty examined the relationship between the VIX index – which anticipates short-term volatility in the S&P 500 – and portfolio flows into the GCC, regional sovereign bond spreads and local stock market prices.
The broad conclusion was that global financial volatility has had a limited impact on GCC markets.
Since the war began on February 28, spreads on GCC bonds and sukuk have widened by 15 to 30 percent. Bahrain has seen a more pronounced widening than the regional average, while Kuwait has experienced a more limited move.
Equity markets, where local investors tend to play a larger role than global actors, have remained broadly resilient. Most indices have been flat, with some now trading above their end of February levels. Portfolio flows into the region resumed in April after a March pullback.
So the Fund’s conclusions, in December, were broadly correct.
But the war has forced us to change the parameters of our analysis and ask different questions about the GCC risk landscape.
As long as we do not know how long the conflict will continue, it remains challenging to make robust, defensible economic predictions
Most obviously, we must consider the conflict’s impact not only on hydrocarbon exports but also on essential imports into the GCC, such as foodstuffs.
Then there is the vulnerability of vital utilities, such as desalination plants and infrastructure, which may not have immediate economic importance but are nonetheless integral to long-term business activity and to the financial self-image that the GCC states have been projecting.
The Fund’s April report notes that Qatar depends on desalination for nearly 80 percent of its water supply, and Bahrain nearly 60 percent.
Before February 28, one could argue that Iran would never attack a desalination plant – so essential for the wellbeing of the general population – but we would also have said that Iran would never attack buildings in Dubai, or oil facilities in Kuwait.
We would have said that a complete closure of the strait was simply a war-gaming construct. After all, during the Iran-Iraq war of 1980-88, the strait remained open, even when Iran targeted oil tankers belonging to some of the GCC states.
As long as we do not know how long and to what extent the conflict will continue, it remains challenging to make robust, defensible economic predictions for the Gulf states.
But we can recognise that our approach to risk analysis must change.
Further reading:
Bondholders may take quite a relaxed approach even as the conflict continues into a third month. The huge financial reserves of the GCC states’ sovereign wealth funds provide ample reassurance of those governments’ ability to discharge their obligations to overseas creditors. Bahrain is an exception but can benefit from well-disposed and wealthy neighbours.
That explains the apparent insouciance of the credit rating agencies. Eight weeks after the conflict began, no sovereign ratings by any of the three big international agencies had been changed. Moody’s downgraded Bahrain’s outlook to negative, and Fitch put Qatar on negative watch, but no other changes have been made.
Sovereign credit ratings consider one thing only: the ability of governments to pay their dues to specific creditors on time and in full.
In theory, such analysis includes the buoyancy of the business environment, employment trends, and consumer spending. Still, in practice, ratings are driven by debt-service ratios and access to foreign currency.
Beyond such dry ratio analysis, by far the more interesting questions relate to the GCC states’ ability to continue their – so far successful – transformation from oil monarchies to diverse economies with vibrant civil societies.
That transformation will depend on GCC governments continuing to build crucial infrastructure and their ability to encourage local citizens to invest in and devote time to their local economies. But it will also rely on expatriate businesses and business folk having confidence in the region’s safety and security.
It is far too early to assess whether such things can be assured.
Andrew Cunningham writes and consults on risk and governance in Middle East and sharia-compliant banking systems