February 1, 2017

Pricing the Trump Risk in Gulf Economies

U.S. President Donald J. Trump holds up a signed executive order for border security and immigration enforcement during a visit to the Department of Homeland Security headquarters in Washington, DC, Jan. 25. (AP Photo/Pablo Martinez Monsivais)

U.S. financial markets reacted swiftly to the weekend’s flurry of mixed messages generated by President Donald J. Trump’s executive order on refugee policy and immigration restrictions affecting citizens and dual nationals from seven Muslim-majority countries. The Dow Jones average declined nearly 200 points by the end of trading on Monday January 30. More importantly, investors have begun to lower expectations about any stimulus that a Trump economic policy might produce in infrastructure investment and a reduction of labor market and financial regulations. U.S. markets are expecting “Trumpflation,” the idea that Trump’s economic plans may offer some short-term growth along with inflation, which would have little positive long-term impact on the U.S. economy. There isn’t much room for expansive growth. Despite Trump’s insistence of U.S. jobs “fleeing” overseas, joblessness is actually quite low in the United States and it will be difficult to significantly increase worker productivity levels, simply because U.S. demographics trend toward older, retiring workers. Those Americans who have stopped looking for work include many who do not have skills for a post-manufacturing economy. More substantial risks include a trade war with Mexico, or China, or both; and of course, how a Trump administration might respond to a terrorist attack on U.S. soil or U.S. interests abroad.

For the Gulf Arab states, their priorities in economic growth are similar to the challenges the United States now faces. Gulf citizens need jobs that build a knowledge economy. Changing citizen employment preferences from dependable public sector roles to roles in the private sector will mean increasing citizens’ comfort with longer hours, less predictable benefits, and more competition. The similarity between the Gulf Cooperation Council and U.S. labor markets is that job seekers are often unprepared for the opportunities available to them, either because they lack the technical skills or education, or because the economy itself is in a state of transition. In the United States, this is a post-manufacturing transition; in the GCC states, it is a retreat of the state from the economy. Gulf states need to finance infrastructure investment with private and foreign resources, while making their private sectors more amenable to new business growth, especially among small and medium-size enterprises. Cutting red tape has long been a stated goal of Gulf governments, and a complaint of foreign investors in the GCC states. Volatility in the U.S. economy as a result of political changes, including expansive executive orders, could have important ramifications inside Gulf economies for a number of reasons.

First, businesses in the GCC states are global. The expansion and rise of the Gulf states have been hinged on access to global markets: in state placement of sovereign wealth funds in international equities and in real estate holdings, and in the expansion of both private and state-related entities in airlines, ports, logistics, oil services, and energy providers. Gulf gateway cities are designed to be hubs, to capture the flow of people and trade between East and West. Any disruption to these flows will be detrimental to the Gulf. The United States is certainly not the Gulf states’ only trade partner; in fact, the largest consumers of GCC exports are in Asia, and those exports are nearly entirely composed of oil and gas. However, if the Gulf states are to diversify their economies, they will need to engage the global economy (including the U.S. economy) in new ways, through traditional trade in goods, services, and tourism, but also through budding innovation hubs in e-commerce, financial technology or fintech, and Internet technologies.

Second, GCC governments are unlikely to publicly condemn the immigration policies of the United States, given their own very restrictive labor laws, lack of formal refugee policies (as nonsignatories to the United Nations’ 1951 Refugee Convention), and only the most narrow paths to citizenship for noncitizens: a case-by-case decree by a ruler. Even without a formal refugee policy, the United Arab Emirates and Saudi Arabia are major migrant destinations, hubs for the flow of people and ideas, particularly within the Near East and South Asia. According to the World Bank, the top five migrant destination countries in the world are the United States, Saudi Arabia, Germany, the Russian Federation, and the UAE.

GCC governments may not criticize the new U.S. executive order imposing travel bans on refugees and citizens from seven Muslim-majority states, but the effects will deeply sink into society. Gulf citizens do not appreciate disrespect, at home or abroad, and the vilification of Muslims as a threat to U.S. national security will not sit well with those who may have previously considered travel to the United States for investment, holiday, vacation home purchase, medical care, or higher education. The (even temporary) immigration and refugee ban in place will have a lasting chilling effect on people-to-people relations.

Third, global financial crisis and contagion effects of integrated markets tend to travel slowly to the GCC states. Gulf markets have their own internal dynamics. There is often little government data available publicly on signs of economic slowdown. Information on demographics can be particularly hard to find, so measuring the flow of visitors and migrants as a result of U.S. immigration policy will be especially difficult. Bank sector data can often underreport nonperforming loans and pressures on bank balance sheets from government spending slowdowns. If government funds invested abroad are not performing well due to volatility in international equity and capital markets, Gulf citizens may not be immediately informed. If Gulf government-related entities, including airlines, are struggling because of declining tourism numbers, a decrease in business travelers, or reduced capital expenditure in their own budgets, reporting could be ad hoc and management changes could be abrupt to markets. Additionally, home prices are notoriously hard to verify, making a realistic assessment of the real estate market inside the Gulf difficult.

The economic reform movement spreading across the GCC is driven by the fiscal reality of lower oil prices, a history of state-driven investment and economic activity, and a demographic surge of migrant and citizen population growth. These are internal challenges, yet to solve them depends on a global economy that remains open and amenable to a steady U.S. dollar and monetary policy, supportive free trade regimes, and perhaps most importantly, the continued liquidity of debt markets. Right now, maintaining access to debt markets, in both bond issues and bank loans, is a key priority to GCC states to bridge this transition period of fiscal austerity.

The timing of policy shifts (both economic and security) in the United States coincide with the most important changes in GCC political economies in half a century. This is an inopportune moment for uncertainty, particularly as the linkages between the GCC states and the United States are more intense in their financial flows, but also more stressed in their political relations. The late 2016 Justice Against Sponsors of Terrorism Act legislation is just one key example of how political risk can undermine trade and investment flows between the GCC and the United States. The beginning of the Trump administration points to, at the least, a heightened period of political and economic risk, which Gulf governments, financial institutions, and businesses will have to price, assess, and manage.

Market Watch is a blog conceived by AGSIW Senior Resident Scholar Karen E. Young seeking to provide insights from the crossroads of Gulf politics and finance.