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Stock market tensions and the impact on the GCC

Jaime de Piniés Bianchi's picture
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 Fedor Selivanov l Shutterstock.comThe continuing stock market corrections in China and other Emerging Markets reflect lower growth prospects going forward.  With the exception of Eastern European economies which are connected to a slowly improving European Union, and India, Middle Income Emerging markets are revising their growth forcasts downwards.  In this context, stock markets are simply catching up with fundamentals, particularly in China, which had seen very strong equity price rises in previous quarters.

Consequently, Emerging Markets are experiencing a reversal of capital flows although the intensity of the reversal is not as intense as during the Taper Tantrum of 2013 nor the Global Financial Crisis of 2008.

The slowdown in China and the weak recovery in Europe and the United States has also impacted Commodity markets.  Oil prices, however, had held firm until the decision of Saudi Arabia in mid-2014 to support its market share rather than prices.  A sharp reversal in oil prices has followed since that.

Oil prices have fallen below the US$ 50 mark with Brent touching lows of US$ 42 recently. GCC stock markets have all been declining as well; Saudi Arabia’s stock index has been the most depressed in the last month following the same route as US oil stocks.

This situation impacts GCC economies in at least two basic ways.  Firstly, the fiscal sustainability of current public expenditure programs including subsidies will critically hinge on the duration of weak oil prices.  With the exception of Kuwait, break even prices for both budget and current account balances have already been reached in all other GCC countries which means that reserves and sovereign wealth funds are being tapped to sustain public expenditures and or public debt is accumulating.  Should oil prices remain at their current lows, Bahrain, Oman and even Saudi Arabia would deplete funds in a very few short years unless public spending is reeled back.

The second channel of transmission has to do with the valuation of Sovereign Wealth Funds and Reserves in the GCC which is not possible without a detailed breakdown of asset composition.  Nonetheless, a few generalizations are possible since during episodes of large financial price contractions the correlations amongst assets and asset classes becomes tighter, that is prices tend to move in lock step: Emerging and High Income country stock prices, and between asset categories.  So far fixed income is holding up better than equities, but the possible impact of US FED lift-off in policy rates, which admittedly may now be delayed, does weigh on valuations.  Drawing from these generalizations, SWFs and reserves are likely to be currently experiencing a net fall in valuations which needs to be added to their current drawdowns to finance public spending.

In short, GCC economies have every incentive to accelerate and implement programs to rationalize public expenditures and to expand non-oil revenues.

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