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The credit crunch and the Gulf

  • Story Highlights
  • A turbulent week for world markets and the Gulf wasn't immune
  • Investors are watching the U.S.'s problems to see if they will affect the region
  • From Riyadh to Doha petrodollars are cushioning the area from the credit crunch
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By Mairi Mackay
CNN
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LONDON, England (CNN) -- It has been a turbulent week for global stock markets. On Monday U.S. stocks fell sharply -- the seventh down day in eight sessions -- and markets in the rest of the world including those in the Middle East felt the reverberations. The Dubai Financial Market followed Dow Jones' downward tumble.

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Petrodollars are keeping Gulf economies afloat but the dollar peg is causing inflation

Just 24 hours later -- undoubtedly aided by the U.S. Federal Reserve's announcement that it would inject $200bn into the U.S. banking system -- stocks rallied. Shortly after the Federal Reserve and the European Central Bank announced their decision to pump $15bn into banks in Europe to meet their demand for dollars.

The markets rallied and a collective sigh of relief could be heard echoing through Wall Street and other financial centres in the world. Dow Jones Industrials surged nearly 250 points in morning trading and Wall Street ended the day more than 400 points higher. The Gulf with its dollar-pegged currencies followed suit and stocks rebounded.

The Federal Reserve's cash may have shored up big institutions in the U.S. for the moment but it looks to be a short-term solution as the markets continue to be hammered.

The world is looking at the first generalized transatlantic liquidity shortage for decades. A crisis which is threatening to push the U.S. economy into its first recession since 2001.

All this is making investors in the region very nervous. They are watching developments closely for any sign that the beleaguered U.S. economy's problems will spill over into their arena.

"I don't think this downturn in the U.S. is over and there is a serious risk that the recession will affect all of us," said Marios Maratheftis, Regional Economist for Standard Chartered Bank in Dubai.

But Maratheftis admits that the Gulf is better insulated financially to deal with these challenges. The region is sitting on a mountain of surplus petrodollars and the ever weaker dollar and soaring oil prices means that from Riyadh to Doha, the windfall is replacing liquidity lost from global credit markets.

In fact, the weakening dollar is pushing oil prices higher, according to Dr Mahdi H. Mattar, Chief Economist and Strategist at the Dubai based investment bank, Shuaa Capital. All this is guaranteeing a good flow of capital from local investors into the Gulf markets.

The Gulf economy is mainly sustained by local demand. Right now there is an investment boom driven by private sector -- and to a lesser degree -- government spending. High oil prices create a financial cushion from the credit crunch in the wider world allowing both parties to continue huge investment programs which has a positive knock on effect on the whole region.

So the Gulf's resilient economy is fuelled by petrodollars and protected from the worst of the credit cruch because oil is the predominant export. That's good news for investors.

"Local investors and the local economy are not affected by the global slowdown or the meltdown in the financial markets because we really don't export much except oil," agrees Mattar.

But the Gulf's dollar pegged currencies could become a victim of their own success. Skyrocketing prices over the past few years are already making life tough for the regions's workforce whose salaries haven't risen as fast as inflation.

Meanwhile the U.S. -- reeling from the sub-prime shocks and credit problems -- is lowering interest rates which directly affects the dollar-pegged Gulf economies desperate for higher interest rates.

"We are booming. But we need to make sure that the economics do not overheat. The problem here in the region is that we need tightening. We need higher interest rates ... because we are not facing the risk of a recession here," Maratheftis told CNN.

The question is being asked: is it time to de-peg from the dollar? Maratheftis certainly thinks so. "One percent interest rates might be good for the United States economy, but they're certainly not what we need here in the Gulf right now especially if you combine low interest rates with an extremely weak currency," he told CNN.

Going forward, the challenge for the region is not how to cope with the slowdown, but how to manage its own growth. But can the Gulf learn from the United States' mistakes, and design a monetary policy that will keep prices stable and make sure growth is sustained in the long term? E-mail to a friend E-mail to a friend

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