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EU Contagion

Deleveraging in EU banks is one of the many issues impacting the ME economies in the 2012. Tourism, trade, investment and oil exports could also suffer as the EU crisis unravels.

All eyes are fixed on the European Union these days, as the region remains mired in a sovereign debt crisis that threatens the very future of the economic bloc.

"The whole world has an interest in the resolution of a crisis that deepened dramatically through the fourth quarter, and enveloped more and more major economies putting European leaders on the back foot as events threatened to overwhelm them," says Deutsche Bank in a report on the world's economic outlook for 2012.

Clearly, a region as large and diverse and important as the European Union will have an impact on a wide range of economic sectors across the global economy. The U.S. is dreading that the EU could upset and delay American's own slow recovery and Asia - a big trading partner of the OECD countries - is also dreading the impact. In fact, analysts expect China's nominal exports to slow from 20% in 2011 to 10% in 2012 due to EU and American woes.

The Gulf and the wider Middle East will not be any different.

North African states, especially are more aligned to the EU than they are to the rest of their own continent and are likely to continue to suffer from the EU's continued ill health.

North Africa has had a terrible 2011 with great domestic unrest in Tunisia, Egypt and Libya, and it hardly helped that its largest international financier, trading partner and tourist market has showed no signs of a quick recovery.

Slowing growth in the euro zone could delay the recovery of the Tunisian economy by adversely impacting the prospects of exports, tourism income, remittances, and investment flows, says the Institute of International Finance (IIF).

In Moroco, non-agricultural growth is expected to decelerate from 4.7% in 2010 to 3.5% in 2011, partly due to weaker investment and demand from the euro area.



The Gulf also has a great interest in the economic health of the EU. The economic bloc is the GCC's largest trading partner, and the UAE and Saudi Arabia are the EU's seventh and eight largest import partners, respectively. Tourism, trade and foreign direct investment and strong financial ties are all expected to come under pressure as the EU problem persists.



TOURISM
The International Air Transport Association (IATA) thinks Europe is the biggest drag on the aviation industry and has revised global aviation profits for 2012 from $4.9 billion to $3.5 billion.

In fact, its worst-case scenario is even more grim.

"The Eurozone crisis puts severe downside risk on the 2012 outlook as illustrated by the recently published OECD economic outlook," said IATA in a statement. "In a worst-case scenario, should the Eurozone crisis evolve into a full-blown banking crises and European recession, IATA estimates that the global aviation industry could suffer losses exceeding $8 billion in 2012."

The global aviation body says Middle East carriers are expected to post a $300 million profit, less than half the previously forecast $700-million profit, as long-haul market conditions deteriorate, in particular those linked to the weak European economies.

IATA's profit 2011 estimates for Middle East carriers stand at $400 million, down from the previously forecast $800 million, as high fuel costs squeezed profit margins on the more price sensitive long-haul traffic connecting over Middle Eastern hubs.

Not all tourism hubs in the Middle East will share the same fate. Dubai, the regional tourism hub, benefited this year from unrest in Cairo, Tunis, Manama and Damascus. The Dubai Tourism and Commerce Marketing DTCM's latest figures show the emirate's hotels played host 6.64 million guests in the first three quarters of 2011, up by 11% compared with the corresponding period last year. The guest nights rose by 26% to reach 23.68 million, while the average length of stay increased by 14% during the same period.

It's not clear from the DTCM statement where the growth came from, but anecdotal evidence shows Arab country citizens, Russians and Asians led the growth. The DTCM's last country-wide breakdown for Jan-June 2010 shows that tourists from the EU were the biggest market for Dubai, and were up 3% compared to the same period in 2009. However, the biggest markets within the EU, Germany was down 3% and the UK showed no growth.

Meanwhile, regional bellwether Emirates Airline blamed the weak euro and sterling and rising fuels costs for the 76% decline in its first half net profits.

But it's not all the EU's fault. Countries affected by the Arab Spring have traditionally attracted European tourists, but tourists from the north are not exactly making a beeline at Damascus, Tunis and Cairo airports just now.

Combined, these factors appear to affect Egypt the most. The country's officials expect tourism revenues decline 35% this year to $9-billion, from $12-billion in 2010.



TRADE
After a shocking 40% drop in GCC exports to Europe in 2009, trade between the two countries roared back, rising 53% in 2010. The first quarter of 2011 also betrayed problems in both regions, with Gulf exports rising 75% and GCC exports rising 17%.

Figures are not yet available for the next two quarters, but it will be interesting to see how resilient trade remains between the two economies, as conditions deteriorate in the EU.







BANKING
While GCC growth seems to be shielded from weakening global growth so far, European bank deleveraging may affect GCC countries, notably where bank liquidity is tightening such as in the UAE and Qatar, says Barclay Bank in a report.

"In fact, these two countries rely on significant funding from European-based banks, amounting to USD77.7 billion and USD35.1 billion, or 26% and 27% of GDP, respectively. Most European bank lending is provided by UK-based banks and has been allocated largely to the private sector (66% in Qatar and 68% in the UAE). Should Western bank deleveraging accelerate, demand for credit is likely to shift to local domestic banks, some of which already have limited room to manoeuvre given their tight liquidity.," said the bank's Fahad Al Turki in a note to clients.

The Euro banking fallout is affecting the regional financial services sector in other ways too. HSBC, which has shut down its UAE brokerage unit, is in talks with Oman International Bank to merge its operation. The international bank has also merged its Saudi operations with SABB Securities.

Media reports say Zurich-based EFG International has shut its Dubai and Abu Dhabi offices. Other banks reportedly cutting staff or shutting down include Credit Suisse and Credit Agricole, among others.

FOREIGN DIRECT INVESTMENT



Europe has been a traditional hunting ground for Gulf sovereign wealth funds, peaking in 2008 with EUR51.2 billion flowing into European economies from Gulf coffers.

All that has changed. Gulf SWFs are sitting on the sidelines as stocks of European banks and other companies continue to freefall well below their bargain values.

Instead, the Gulf funds are more focused on domestic economies and emerging markets as they are uncertain how the endgame will play out in Europe.

Zawya's M&A Monitor shows a smattering of deals of Gulf-EU deals: Etihad Airways has been rumoured to be eyeing stakes in Air Berline, Aer Lingus, Virgin Atlantic and British Midland; Qatar Holding has been linked to BNP Paribas.

It's probably likely that once the EU debt tsunami subsides, the companies left standing will be cherry-picked by Gulf and other sovereign funds, but at this point they are all watching from the sidelines.

CURRENCY ISSUES
With five out of the six Gulf states pegged to the dollar, foreign exchange will be a key consideration in trade and investment deals.

"Under the assumption that the crisis fails to abate but EUR constituent currencies remain unchanged, we expect further declines in the euro, with the yen followed by the US dollar the primary beneficiaries," says Deutsche Bank.

"We expect the US dollar to appreciate by between 5% and 10% against the euro in 2012 and the yen to rise by more than 10% versus the euro. This is not a EUR hard-landing, although some investors may wish to protect against such a scenario."

CONCLUSION
A recession in a region as important as the EU would have far-reaching direct and indirect impact on the rest of the world, and the Middle East is no exception.

Luckily, the Gulf's increasingly close ties with emerging markets of Asia and the frontier markets of Africa would lessen the blow and help ride the EU storm.

The rest of the Middle East is not that fortunate. The Institute of International Finance (IIF) says the region will suffer.

"As the euro area is the major trading partner for Egypt, Tunisia and Morocco, slowing growth in the euro zone after an already lackluster recovery could delay the return to positive growth by adversely impacting the prospects for exports, tourism income, and investment flows," says the IIF.

Mideast oil exporters may also see a drop in production as demand eases further. Most analysts expect Saudi Arabia, UAE and Kuwait's oil production to decline modestly as global demand for oil weakens due to worsening economic conditions in the U.S. and Europe, and as prospects for the return of some exports from Libya improve.

© alifarabia.com 2011