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French Version

Surprises that could impact on the economies of the region this year

There is an old saying in economic forecasting :
The consensus is always wrong.

This is why it is important to think outside the box and identify the wild cards that may play out differently from what the consensus expects.

For 2005, most observers believe that world economic growth would be slightly lower than last year, the U.S. dollar would drop at a gradual pace of 10 percent against major currencies, the Federal Reserve would keep lifting federal fund rates to 3.5 percent by year end from the current 2.25 percent, oil prices will stay firm, slipping slightly to an average of $35 a barrel for Brent crude from $38.5 average last year, and for the yield on U.S. treasuries to increase from 4.3 percent on 10-year maturities to 5.5 percent by year end.

In our region most observers are forecasting strong growth rates this year as well. Stable oil revenues, more bank lending and inward-looking capital inflows will add to the prevailing excess-liquidity conditions and help sustain the current boom in local stock markets. However the expected rise in share prices this year will be lower than that of last year. Domestic interest rates will move slightly higher, in tandem with U.S. dollar rates, but it will not bring a precipitous decline in real estate prices. Most observers believe that despite the elections in Iraq and the Palestinian territories, the unstable conditions in there are likely to prevail. Here are some of the surprises or wild cards that could form credible threats to the consensus view. Their importance derives from the fact that they are interrelated. A surprise in one area could trigger events and generate surprises elsewhere leaving their impact on the regional and global scenes.

1. The first wild card is a sharp slowdown in global growth. The euro area is weighed down by currency appreciation and weak domestic demand. Growth in Japan has stalled over the past few months. The tumbling dollar poses a major threat to Japan's exports which have been driving last year's economic revival. If China's efforts to cool off its economy ends up undermining its fragile banking sector, this could have major repercussions on global growth. The risk is that weak economic growth worldwide would bring forth lower oil prices and lower regional growth rates. Corporate profitability will be threatened and regional equity prices may suffer as a result.

2. Another wild card is a sudden drop in oil prices back to the $22 a barrel for Brent crude. This could be triggered by weaker than expected world demand for oil, an easing of tensions in Iraq putting it back on track to boost its crude oil production, a mild winter in the western hemisphere and majority of hedge funds reversing the long positions they are holding and selling oil contracts in the forward market. Cheaper oil if sustainable would boost economic growth in the U.S., acting like a tax break to consumers and companies. Stock prices in New York and other major markets would get a boost and the "wealth effect" would support higher consumer spending. The Federal Reserve would expedite the tightening of its monetary policy, bringing forth higher rates and stronger dollar. The oil-producing Arab countries would suffer, as tighter liquidity, higher interest rates and a reversal of the feel-good effect would leave its impact on the region's economic growth and corporate profitability. This could bring forth lower asset prices, deflate household wealth, and reduce economic growth rates in the region.

3. Another wild card affecting countries of the region is credit retrenchment. If domestic interest rates rise faster than the consensus expects and monetary authorities change statutory requirements to make it harder for banks to keep expanding credit, this could lead to lower growth with a possible correction in housing and share prices. For example, the Central Bank of Kuwait raised interest rates on the dinar five times in the second half of last year to 4.75 percent and lowered loan to deposit ratio to a maximum of 80 percent. If other countries of the region decide to follow suit and restrict credit expansion, the exposure of banks to real estate, consumer borrowing and margin lending for share price speculation would drop. The reverse of the wealth effect would reduce consumer spending and consumer confidence, triggering in the process major correction is asset prices. The bubble that has surfaced recently in certain markets, following two years of overinvestment and excessive valuation, may burst causing a downshift in demand and a decline in overall economic growth.

4. Most observers expect instability in Iraq to continue well after the Jan. 30 elections. The turmoil will make it difficult for Iraq to boost its oil production, adding to supply uncertainty in the world oil market and maintaining upward pressure on oil prices. The wild card here could be that the Sunni minority will opt to join a provisional government that will draw up a new Constitution. The majority Shiites headed by Grand Ayatollah Ali Sistani will be the real winners and will feel strong enough to establish closer ties with their Sunni counterparts. This will help stabilize conditions in Iraq, and allow the U.S. forces to pull out of major population centers. Such a development could raise expectations of higher crude-oil production coming from Iraq and will encourage the markets to start discounting lower oil prices down the road. This need not be necessarily negative for countries of the region because the decline in oil revenues will be more than compensated for by higher levels of consumption and investment, more capital inflows, and surging regional exports to a revived Iraqi market, as well as, to a world economy growing at higher rates than the consensus is currently forecasting.

5. Another wild card is the Middle East peace process and the return of a semblance of tranquility to the Palestinian territories. Most observers do not expect a major break through to take place this year between Israelis and Palestinians. On the contrary, they believe tension will prevail as Israel pursues its unilateral separation plans and completes building the wall that carves part of the Palestinian territories as defined by the 1967 border. The surprise could be that after the election of Mahmoud Abbas, Israel can no longer claim it has no negotiating partner. The new Palestinian leadership would declare its opposition to the militarization of the intifada and will call on Israel to move beyond Gaza after the evacuation and discuss its withdrawal from the West Bank. The U.S. administration and the world community will put much pressure on Israel to deliver on the peace process. A serious move in that direction would greatly reduce the perception of risk and uncertainty in the region, give a major boost to investments and bring forth healthy economic growth conditions.

To conclude, 2005 will be another good year for the countries of the region in terms of economic growth, corporate profitability, internal and external balances and stock prices. Stable oil revenues should provide the money needed by the governments to pursue their stated expansionary budgets. Domestic interest rates trending slightly higher, in tandem with dollar rates, will continue to accommodate current levels of consumption and investments. Expect the unexpected.

Henry T. Azzam is chief executive officer at Jordinvest in Amman

Amman,01 24 2005
Henri T. Azzam
The Daily Star
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