Could the Middle Eastern unrest start to unsettle financial markets?

January 31, 2011

-”Kathleen Brooks is research director at forex.com. The opinions expressed are her own.”-

The peoples of the Middle East are rising up and letting their political views be known. In Tunisia, Egypt and Yemen protestors have taken to the streets to demand political change, and in the case of Tunisia they have succeeded. These tensions between the people and their governments have caught the global media’s attention. It has also set off something of a domino effect with other autocratic regimes in the region worrying that the same could happen to them.

The protests were sparked initially by rising food prices. They are a sensitive issue in the Middle East; in Egypt, for example, they have been rising at a 17 percent annual rate. With approximately 15 percent of Egypt’s population living in poverty, the rising price of food erodes living standards and fuels resentment at governments perceived as turning a blind eye to the plight of the poor.

However, as the protests gather momentum criticism of food policies has spread to criticisms of the ruling elite and charges of corruption and economic mis-management threaten to topple more than just Tunisia’s Zine El Abidine Ben Ali. Adding fuel to the protests are high youth unemployment rates – it’s running at 35 percent in Egypt. When more than half the population is under 25, the lack of opportunities for ambitious, energetic young people is a deeply de-stabilising force.

Interestingly, the latest global economic update from the International Monetary Fund (IMF) in October 2010 sounded a note of warning on the social issues facing the Middle East. Although it noted that growth prospects had improved markedly for 2010 and 2011, it also pointed out that governments should concentrate on raising growth and creating jobs for expanding populations. Although rising oil prices will boost revenues for oil producing nations, this will come with its own challenges. The report added that rising revenue streams could fuel inflation, which would require tighter fiscal conditions. It recommended that government spending should be focused on long-term goals including social and development needs.

But what about the effects on the market?  The domestic stock markets have been hit the hardest as most currencies in the Middle East are still pegged to the dollar. Egypt’s market had to be closed after a plunge of more than 10 percent in a matter of minutes last week. The Bloomberg GCC 200 stock index has also come off its highs. Added to this, Egypt’s sovereign credit outlook was revised to negative from stable by a leading credit ratings agency. But so far the problems haven’t spread to global financial assets and outside of the Middle East risky assets have continued to perform well.

In the short-term, as protests continue, hot money flows will abandon the markets of the most troubled nations, or those that look like they could be next, which will hurt domestic asset prices. There could be more credit rating downgrades and depending on the duration of the protests they might hit first quarter growth. But, in the long-term a change of government for some of these nations may be no bad thing. Getting rid of corrupt (Tunisia) or tired governments such as the 30-year regime of Egypt’s Hosni Mubarak may be no bad thing. These old autocracies are falling behind the pace of change that is transforming the daily lives of their citizens who have information at their finger tips and use social media sites and mobile phones like their counterparts in the west. But a concomitant rise in living standards hasn’t materialised with the introduction of new technology and the people want this to change.

If this can be achieved then the opportunities for investors are immense. There has been plenty written about the potential that could be derived from the Middle East’s youthful populations, if these nations can get their young people into jobs then that potential could be realised. Without an improvement in living standard, however, these opportunities are merely pipe dreams.

The big test is getting the right people into power to implement these changes and improve the lives of their populations. Forcing change is one thing, ensuring that the next generations of leaders are an improvement on their predecessors is quite another. This is what investors should be thinking about at this juncture in the modern history of the Middle East.

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