It can't happen here.
In the autumn of 1997, while the bottom was falling out from under the new darlings of international investors - Thailand, Malaysia, Indonesia, South Korea - countries of the Middle East were, for the most part, keeping their cool. In fact, the turmoil that struck emerging markets in mid to late 1997, and which deflated economic growth in those markets through 1998, largely left intact the financial markets of the Middle East. For sure, exports slackened to southeast Asia and lowered growth for the region, but no virulent crisis of confidence struck the Middle East. Why?
Blessings come in many disguises. The Middle East has never been the darling of international investors, and while this lack of popularity on the international finance scene has limited inflows of capital, some degree of anonymity has had its advantages. Political instability, a limited availability of investment options and a general lack of understanding of the region have kept many potential investors away.
Take Vietnam, for instance. Geographically at the epicentre of the largest financial crisis of this decade, the country was hit by a decline in exports to its neighbours, but since access to its rudimentary capital markets has always been difficult, a complete financial implosion as seen in a country like Thailand never occurred. In essence, no stock market, no stock market crash.
The Middle East is no Vietnam, however. The region is considerably more integrated into the world economy and its capital markets more advanced. Nonetheless, except for that of Turkey and to some extent Israel, the capital markets of the region generally have insufficient liquidity, and the presence of foreign portfolio investors on the local exchanges is minute. Because of its marginal significance in emerging market investment (a scant 0.8 per cent of total emerging market capitalisation), Egypt has made use of domestic sources of investment. By April 1999, as many as 21 local mutual funds were operating in Egypt. Since these funds are, for the most part, denominated by domestic investors and underwriters, the fear of foreign investors and speculators dumping the funds is non-existent.
But lack of exposure to global vicissitudes is but one of the factors inoculating the region from crisis. Speculative attacks on regional currencies are rare because governments are committed to defending them, and most have the foreign-exchange reserves for such a fight. The speculative attack on the Saudi riyal in August 1998 met with little success because the Saudi Arabian Monetary Agency (SAMA) without hesitation spent $1 billion over the course of one day to prop up the currency.
The very presence of substantial reserves works to reinforce investor confidence and reduce the prospect of speculation. Virtually all Middle Eastern countries are either pegged to a currency such as the US dollar or trade tightly within an established exchange rate band. Though accumulating the reserves to hold tightly to an exchange rate is costly, if it can be done consistently and thoroughly, an effective firewall is secured.
That said, the cost of building and holding foreign-exchange reserves is an opportunity cost that must be weighed against the potential risk of currency devaluation and capital flight. Building reserves by having exports exceed imports inherently necessitates a cut in domestic consumption. Furthermore, accumulating currency reserves by running a trade surplus cannot be done overnight, and holding them as reserves instead of investing the funds in domestic infrastructure or private investment foregoes a great deal of real investment for the country.
But no cost is without its benefit. The reason for maintaining a fixed exchange rate, or one that trades within an exchange-rate band, is to keep a lid on inflation. Given that easy monetary policy causes inflation and subsequently erodes the value of the currency, a country that commits itself to a fixed exchange rate against the US dollar, for instance, thereby commits itself to the same manageable inflation as the United States. However, over time a rigid exchange-rate policy may cause the currency to become seriously overvalued, leading to an unsustainable trade deficit, such as suffered by Thailand in 1997. Most governments of the Middle East have opted for securing a fixed exchange rate of one sort or another, despite the costs, but none has shown signs of an impending catastrophe with the current account.
In fact, compared to even OECD countries, most economies of the Middle East have historically run current account surpluses or minimal current-account deficits. According to the Economist Intelligence Unit (EIU), in 1998 Egypt ran a currentaccount deficit of $3 billion (3.7 per cent of GDP), Bahrain $87 million (or 1.4 per cent of GDP), and Saudi Arabia $13 billion (or nine per cent of GDP). These figures show a region under the influence of an oil glut, declining world demand, and scepticism in emerging markets. Just a year previous in 1997, Saudi Arabia ran $300 million surplus, and Egypt a reasonable $710 million deficit. The implication of this is that even under the most pessimistic outlook for the region, the current accounts of Middle Eastern countries did not fall into utter disrepair. In an environment of stable world economic growth, the region fares well in terms of trade and investment.
One of the chief contributors to epidemic financial collapse is the breakdown of a country's banking system. Often the banking system is taken down with a fast-depreciating currency. This happened in Thailand in 1997, but a crisis was in the making before the currency crisis hit. Thai banks, as well as other banks in the region, had built up enormous amounts of bad loans and made poor investment decisions. In an environment of staggeringly high economic growth rates in southeast Asia, many regional banks rode on waves of optimism and offered funds to spurious enterprises.
Not so in the Middle East, where conservative banking practices are the norm. The majority of bank loans in Saudi Arabia, for instance, are short term in nature, a practice that reduces vulnerability to exchangerate fluctuations. Banks in the Gulf, in particular, are strong and are constantly increasing their transparency and technology.
In spite of the severe decline in oil prices in 1998, most Saudi banks made profits, and although returns on assets declined over the year, the returns remained positive. Solid advances in recent years have been made in facility and transaction documentation and the sharing of credit information. Higher standards of banking are slowly becoming ubiquitous in the Gulf, where the region's largest banking groups exist. Balance sheets among Saudi banks, in particular, are generally strong and remain within or sometimes well above international capital-adequacy standards.
So, the Middle East appears likely to miss any future emerging market crisis. But security also carries a price. The economies of the Middle East have missed the massive flurry of capital inflows the Asian economies received over the past decade. Growth rates in the Asian 'tigers' have been astounding, and as a result, personal incomes have risen remarkably. The dramatic collapse in 1997 shows just how fickle the global financial community can be, but by early 1999 the mercurial money had already begun its return.
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|Title Annotation:||the possibility of a financial meltdown in the Middle East; Business and Finance|
|Comment:||A financial meltdown occurring in the Middle East is a remote possibility because unlike the Asian economies, which were the favorite destination of international investments prior to the crisis, the region's foreign investment exposure is considered minute.|
|Publication:||The Middle East|
|Date:||Sep 1, 1999|
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