War Will Restructure Investment in the Middle East
Dec 19, 2002 stratfor.com

Summary

The U.S. wars against Iraq and al Qaeda will devastate the already troubled economies of the Middle East. Investment into non-petroleum industries will fall in most countries -- with Iran a possible exception -- and increased security risks and mounting political instability will plague traditional FDI destinations.

Analysis

A U.S. war against Iraq will devastate economies in the Middle East. Although investment in the region's hydrocarbon sector likely will continue unabated, most of the region -- apart from a few countries with stable and financially attractive environments -- will suffer a severe downturn in coming months.

Already near the bottom of the global economic scale, the Middle East will fall even further behind the rest of the world during and after a war. Meanwhile, the political and security upheaval caused by the U.S.-led operations against Iraq -- and the uncertainty created by al Qaeda -- will deter investors.

In sharp contrast, the U.S. economy might be about to rebound from a period of slow growth that was induced by the dot-com bust and greatly aggravated by the Sept. 11 attacks. But a U.S. rebound won't necessarily translate into similar surges in other regions, and particularly not in the Middle East.

Washington is expected to spend about $50 billion in direct military costs for a short campaign against Iraq and as much as $140 billion for a prolonged operation. This does not include the money needed for nation-building and reconstruction in Iraq should military strikes succeed in toppling President Saddam Hussein. During the Gulf War, Arab allies like Saudi Arabia and Kuwait provided substantial financial assistance to U.S. war efforts; that is not likely to be the case this time.

The financial strain of the war will mean that the United States has less dough to distribute to its Arab and Middle Eastern allies. Washington will continue to back International Monetary Fund and World Bank loans to Turkey, and to provide nearly $2 billion in annual financial and military assistance to Egypt. But extra spending to bolster allies' troubled economies will be puny, if it comes at all.

The Middle East already is nearly level with sub-Saharan Africa in terms of contributions to the global economy. The Arab League estimates that the gross national product of Arab countries -- $712 billion -- accounted for only 2 percent of world GNP in 2001, whereas sub-Saharan Africa makes up about 1 percent of the world economy. Contributions from the Middle East will diminish further when the political instability created by a war in Iraq sends fleeing the few foreign investors who have remained loyal to the region.

Arab countries -- especially those closely allied with the United States -- will be the biggest losers in the event of a U.S. war on Iraq.

Egyptian Foreign Affairs Minister Fayza Abul Naga said Dec. 18 that his country could lose an estimated $6 billion to $8 billion in revenues from tourism, exports and other channels. These losses would stoke political dissent within Egypt, where unemployment already is estimated at 8 percent. According to the World Bank, Egypt needs GDP growth rates of at least 6 percent annually to counter rising unemployment. The financial impact of a war would create a cruel cycle: Lost industry revenues would create social instability that frightens away investors.

Saudi Arabia also is likely to take a direct hit. Although investments in the oil and gas industry will remain high, the kingdom likely would experience an internal backlash for any cooperation with Washington during the war and lose investor interest as fears of political instability climb. Moreover, with unemployment officially recorded at 8.1 percent -- and unofficially estimated at 15 percent to 20 percent -- energy investments won't ease the country's economic troubles entirely.

With the most developed and modernized economy in the region, Israel is typically attractive to investors. But a recession caused by the 27-month-old Palestinian intifada and the global slowdown now is expected to enter a third year.

Global FDI flows reached $1.3 trillion in 2000, but the U.N. Conference on Trade and Development expects world FDI flows to drop by 40 percent in 2003, back to 1998 levels.

Saudi Arabia and Egypt still receive the lion's share of foreign investment -- taking in about $1 billion and $1.2 billion respectively in 2000. But Iran is gaining ground quickly: That year, it lured $400 million in FDI, according to the Middle East Review World of Information.

Considering that it has been closed to investment for nearly two decades, Iran is closing in on both its Arab rivals. The republic is expected to garner 0.7 percent of global foreign investment, totaling $650 million, between 2001 and 2005, according to estimates from the Economist Intelligence Unit.

Iran is not likely to see an investment surge during a war against Iraq, but in the post-bellum period it could become much more attractive to financial markets than its Arab neighbors, for several reasons.

First, the top destinations for foreign investment will be countries unlikely to suffer a backlash from Islamist extremists and terror groups. Iran has not been targeted by Islamist militants nor by al Qaeda -- and with its growing ties to Europe, it could experience a surge in non-oil investment as foreigners steer clear of more troubled states like Saudi Arabia, Jordan and Egypt.

Second, Europe is eager to counter U.S. dominance in the Gulf and is looking to Iran as a strategic partner. Although Tehran won't receive more than the rest of the Middle East combined -- or even as much as economic powerhouses like Egypt or Saudi Arabia -- it initially will be perceived as more stable and more attractive, especially as it liberalizes its investment laws over the next year.

European and Asian car manufacturers already are scrambling to tap the Iranian market and replace the Revolution-era Paykan, now that the government is breaking up its monopoly. France's Peugeot, Italy's Fiat, South Korea's Kia and Japan's Nissan all hope to seize market share, Middle East Online reports.

The biggest winners in the impending conflict will be the investors who are willing and able to scoop up cheap assets. Foreigners familiar with the region and its business practices, who have contacts there and an ability to tolerate risk, will find a host of investment opportunities in everything from telecommunications to manufacturing. Herd investors will graze elsewhere, and the lack of capital will make locals eager to do business with those brave enough to enter the region.

War creates inherent uncertainties that will be reflected in both the markets and in FDI flows. Because al Qaeda continues to lurk in the region, the Middle East is the theater of battle for the U.S. wars against both terrorism and Iraq. As a result, few will make investing in the region a top priority in coming months; what is already a trickle of FDI into non-oil sectors will all but dry up. For governments and citizens, the consequences will be disastrous -- but for savvy investors who can take a risk, the opportunities will be sublime.

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