Despite projections in late 2008 that the oil-rich Arab states of the Persian Gulf had both the cash and incentive to cushion the blow from the slumping global economy , it has become clear over the past few months that regional economies have been more hard-hit than initially expected. Although the Gulf has proven to be far from immune to regional reverberations of the global crisis, regional states entered the current slowdown from a strong position given that it comes against a background of several years of high oil prices. It appears that the Gulf region may be better positioned to bounce back from the recession-in early 2010, according to optimistic estimates-and before the United States or Europe. But since most states that make up the Gulf Cooperation Council (Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates) have relatively little production capacity in non-energy related industries, the impact of tumbling oil prices coupled with greater investor caution has not been negligible. How much of a toll the crisis will have taken on the monarchies once the worst has passed remains to be seen. In the longer term, economic hard times may be the driving momentum behind the case for domestic policy reform in the region.

A closer look at the impact of the adjustments in commodity prices and the financial crunch on oil exporting countries is relevant in forecasting the Gulf comeback from the global financial crisis. The 2009 Energy Information Administration (EIA) energy forecast for April reports that world oil consumption is expected to drop by 1.35 million barrels per day (bbl/d) in 2009 compared with year-earlier levels, owing to the global economic recession. The EIA has raised the warning flag on falling global demand in 12 of its last 15 forecasts. The period of high prices for oil and expectation that it would be a sustainable trend prompted growing public expenditures across the region. The sheer size of the increase in oil revenues enabled these countries to enjoy large trade surpluses and to accumulate large savings. Now, the global economic crisis has put the region under greater pressure to cut-back on government spending, youth-targeted employment-generation programmes and ambitious state-led development projects. With faith that the era of cheap oil is long over, petrodollars were channeled to mega-scale investment projects, tourism and financial services sectors, and overseas agribusiness investments to ensure the Gulf's food security.

Erosion of savings and liquidity shortages

Initially, Gulf states were relatively sheltered from the global financial crisis, mostly because the government debt to GDP ratio is low across the region. As opposed to states that rely on foreign borrowing, oil-exporting countries in the Arabian Peninsula and the Gulf benefited abundantly until recently from high oil revenues. Much like the Gulf nations, the main effect of the crisis on Iran has been the decline of oil prices and the decrease of oil revenues. Iran's economy is very much dependent on oil as it accounts for almost 80 percent of the country's foreign exchange revenues. But the Gulf, and especially OPEC members, have been more at-risk to the fall-out of the economic crisis given that the region has been engaged with the processes of economic modernization and globalization. In comparison to the past, globalization has meant that private sectors in the Gulf have forged closer ties to the outside world. Companies and banks have also made significant investments outside the Gulf over the past 10 years, thereby increasing their exposure to global economic trends. So much so that earlier this year, the United Arab Emirates (UAE) spent $10 billion to bail out the former boomtown of Dubai to help it cope with the economic downturn, felt most sharply in its property markets. Dubai is one of seven members of the UAE federation, and the first one to have ever been strapped for cash at this level as it struggles to meet its financial obligations. Dubai announced later that it would issue $20 billion in long-term bonds, and that the first installment of $10 billion was fully subscribed by the U.A.E.'s central bank in a clear indication of the emirate's liquidity problems. Standard and Poor's downgraded the credit ratings of Dubai firms to investment grade ‘A-', noting that the worsening global crisis could damage critical sectors of the Dubai economy such as trade, tourism and commerce.

The global economic crisis has had a ripple effect in other Arab states. In January, Gulf states announced that they had postponed or cancelled 60% of development projects. In Saudi Arabia, although years of high oil prices put the Kingdom's public finances in good order after years of chronic deficit, the immediate impact of the economic slowdown has been felt on the private sector, which has taken the main brunt of the shrinking credit markets. Lower oil prices and revenue, which are projected to reduce oil export receipts by almost 50 percent in 2009, will have an impact on the Saudi economy. For the time being, the kingdom is cushioned by its large foreign reserves, but this depends on how long the recession will last. A prolonged period of slowdown will put a strain on the world's largest oil exporter.
The value of assets acquired by Gulf investors in the U.S. has already declined significantly. Amid the financial turmoil, investments in the real estate sector have fallen sharply in value. Arab states had losses of $ 2.5 trillion in the last four months of 2008. Major losses resulted from a reduction in the value of Arab investment abroad by as much as 40%. Low liquidity, a sure sign that markets are close to the bottom, will take a heavy toll on the value of investments and funds among the Gulf states, where oil wealth has been sapped by falling prices. Funds dropped significantly as the credit crunch eroded the value of their holdings and losses wiped out the funds' gains from rising oil prices last year. Efforts to bolster tourism, real estate, financial services, transportation and other non-oil sectors were initially designed to counter the sharp decline in fiscal surpluses caused by the fall in demand for oil. But these sectors were hard-hit with the global downtown.
The U.S. looked to Gulf investment to tide over the financial crisis and has stressed the role of foreign investment in boosting confidence in the markets. Gulf sovereign wealth funds have invested billions of dollars in U.S. financial institutions. But given the current climate, the likelihood of investing Gulf funds abroad is now extremely low, especially with some of the funds coming under pressure to direct their assets for domestic purposes rather than foreign investment. Rampant liquidity concerns in the economies of developed countries, formally poles of attraction for Gulf investment, are, for the time being at least, not an option. As levels of Gulf-backed investment and transfer of funds to Western markets drop, Western military assistance to the Gulf region will also decline substantially.

Oil wealth varies from one oil producing country to another, depending on the costs of inputs such as labor and infrastructure. For example, global oil production costs range from $85 per barrel in the U.S., $60 in Canada, $40 in Russia and are as low as $25 in the Middle East. But despite booming prices in 2008, with an average high of $99 per barrel, prices have not pushed far beyond the $40-$50 marker this year. The International Energy Agency‘s (IEA) April monthly oil market report projects tightening of the global oil demand to 83.4 million barrels a day on average, equivalent to 2.4 million barrels a day, or almost 3%, below 2008 consumption levels. OPEC lowered its 2009 estimate by 430,000 barrels a day to 84.18 million barrels a day, projecting demand to contract by 1.37 million barrels a day this year, or 1.6 percent. This essentially means that the Arab region is left with surplus crude oil. The U.S. Energy Information Administration reported in mid April that OPEC's net oil-export revenue will fall an estimated 51 percent to $476 billion this year. According to EIA's April short term outlook, estimated OPEC crude oil production fell by 1.1 million bbl/d during the fourth quarter of 2008, reaching 30.6 million bbl/d, then fell by an additional 2.1 million bbl/d in the first quarter of 2009 to 28.5 million bbl/d.

Although crude oil production is expected to rise in line with increased world oil consumption in 2010 by some estimates; in the short-term, the region is facing the risk of liquidity shortage. Oil and gas revenues are the principal source of income for most Gulf governments and are the lifelines used to fund the daily operations of the state. In addition, falling oil prices have also damaged the Gulf's investable wealth capacity.

Recent revenue figures underline that the Gulf has been far from immune to the global financial turbulence. The UAE reported $6 billion in earnings from oil exports in the first two months of 2009, down from its average monthly earnings of around $7.5 billion in 2008, when its oil exports peaked at nearly $89 billion driven by a surge in crude prices globally. These figures are all the more alarming given that the UAE is a federation of seven emirates, with the figures showing that monthly earnings were below $1 billion per state. Kuwait's troubled Gulf Bank posted a fourth-quarter loss of $1.54 billion.

According to estimates, the investment losses made by UAE sovereign funds in 2008 totaled more than $155 billion. While Saudi Arabian funds recorded limited losses, the Kuwait Investment Authority suffered over $100 billion in losses in 2008. With earnings in the Gulf receding and demand for liquidity and the safest assets rising, the likelihood that investors will scramble to withdraw capital and think twice about investing in the Middle East is becoming stronger.

On average Gulf states need prices above $47 a barrel to keep from running budget deficits. OPEC faces record-breaking losses as the price of oil dropped to $40 per barrel in January-February of this year. According to figures released by the EIA and the U.S. Department of Energy, failing a rise in global demand, political and economic chaos in the region could be just around the corner. There is no shortage of conspiracy theories circulating in the Arab world to explain the drop in oil revenues and blame the U.S. grown economic crisis for the regional slump.

Given the current state of crude oil inventory and production costs, the Arab world looks like it will be consuming savings rather than shoring them up in the short term. In the economic climate that will emerge following the crisis, funding is likely to become more of a challenge. The price of crude oil and global demand trends will continue to be observed closely. Without a meaningful growth in demand for oil, cash flow from developing countries will be an almost impossible feat. Investments from the Gulf to neighboring states in the Middle East have already waned. Despite the building boom driven by extravagant oil wealth in recent years, cash strapped Gulf nations are finding themselves scrambling to sell more oil for less.

The liquidity shortage and diminishing cash reserves has meant that OPEC oil exporters and Gulf nations have been courting other buyers for long-term agreements, notably China. Most recently Dubai and Kuwait have been in negotiations for 2-year agreements with China. These bilateral long-term arrangements will be mean enhanced political and commercial ties between China and the Gulf states. Gulf monarchies are likely to turn to Russia and China for military assistance. This is significant. This may mean a change in the status quo-in the domestic political climate as well as broader military-security dynamics.

For now, revenue margins and fund generation capacity are on a decline in the Arab region and the Gulf. Following the oil price euphoria in effect since 2003, Gulf states are now having to find ways to move surplus production off their hands. Having been caught by the international financial recession while in high-gear investment mode, OPEC members and oil exporting nations may lean towards global financial institutions for help. Kuwait is likely to follow Dubai's example. The UAE may soon follow suit. But there are signs of hope on the horizon and the trend of tumbling oil prices may reverse-the world's appetite for oil will return after all, and it's a matter of when, not if. More of an issue is just how strong the consumption bounce back will be. Measures for efficiency, expanded offshore oil exploration, China's moves to source its demand from Africa, improved technologies and opportunities for alternative energy sources, and improved consumer energy conservation habits may mean lower prospects for sustained higher prices over the long term.

The private sector and rising unemployment

The pinch in the private sector has started to be felt more noticeably, especially in relation to ambitious construction projects in the pipeline. The housing boom in the Gulf was powered by cheap labor supplied by millions of workers from India, Pakistan, Bangladesh and other nations. With many construction projects now on hold or cancelled, an average of 600 workers per day have been laid off, with contracts and work visas cancelled in the first two months of this year alone. Rent and housing prices have dropped. Recent industry reports show that apartment rents in Dubai have fallen by 22 percent with villa rents dropping by 34 percent during the first quarter of 2009. The sizeable expatriate population in Saudi Arabia has been negatively impacted, with large numbers of migrant workers in construction expected to be increasingly vulnerable to lay-offs in the coming months. In smaller Gulf states, the ratio of expatriates to locals is almost 90:10. In Dubai, large scale private sector redundancies have been reported recently, and the government has instituted legislation outlawing the laying off of UAE citizens by private sector entities. In Saudi Arabia too, the current slowdown may just offer the government the opportunity to achieve some of its targets to achieve the "Saudization" of the local workforce in the years to come.

This has brought to the fore the irony of the GCC's dual labor markets, which have created millions of jobs for immigrant workers, but have left national youth unemployed. With cutbacks in government expenditures, the problem is likely to only get worse. In the countries with the largest youth populations-Saudi Arabia and Iran-youth unemployment is in excess of 25%.

Tightening of global consumption, lower oil prices, and bruised investor confidence means social and political unrest may be ahead for the Gulf. With assets eroding, liquidity shortages, and access to credit tightening, regional governments will find it more difficult to provide financing services to local investors at home and continue providing subsidies to the public. The economic and political implications of government cut-backs on subsidized fuel, food and other commodities will be significant. The end result of the economic woes, diminishing reserves and financial maneuvering capacity in 2009 will likely be more persuasive public dissent and calls for internal government reforms in the longer-term. EU predictions as to the possible political scenarios emerging from the Gulf after the worst of the crisis is over include growing popular protests over the revelation that the region's leaders have been building their personal wealth in foreign accounts, while racking up budget deficits at home. Regional governments may resort to increasingly repressive tactics to keep a tight lid on public unrest or risk facing public protests and riots which may destabilize the fragile balance in the region. But the fact that government savings from previously booming oil revenues will curtail large-scale cuts in public expenditures will likely cushion the blow and help boost the flagging private sectors. Abu Dhabi, Kuwait, Qatar, Oman and Saudi Arabia have all built up substantial offshore financial assets.

Regimes that were able to dismiss calls for political and pro-democracy reform, harboring behind spectacular domestic spending and high per capita income will come under increasing pressure to open up. The safety net of their economic systems will begin to unravel. The political backlash of feeding the public unrealistic expectations about the economy and high levels of social spending thanks to last year's oil boom will likely take its toll. The current recession offers both an impetus for greater political and economic change in the internal dynamics of the region, as well as foreboding challenges given the continued importance of oil as a key global commodity. A region with a young demographic population, the need for change in the Gulf is arguably stronger than it has been in the recent past.

A recovery in oil prices and revenue and regulatory reforms is of great importance to reverse current trends. As the global economy begins to show signs of recovery, the risk of a sharp surge in oil prices is likely as growth driven by developing nations will signal the onset of greater consumption of oil beyond today's stagnated levels. A spike in the price of oil appears to be a matter of time. The upward push in crude oil prices is intimately linked to the depth and timing of the economic recovery process. The price of oil may ultimately not rise to the levels that fueled the Gulf's extravagant building boom, but it will put things back on track. The scope of the policy reforms, structural adjustments and any government response to the current socioeconomic challenges borne of the financial recession that take place between now and then will determine how strong the Gulf region will be when it eventually emerges from the crisis.