Home By Invitation Cheer up – the Arabian real economy steams ahead


Cheer up – the Arabian real economy steams ahead

Reasons to be optimistic during a global recession

by Imad Ghandour

As I am writing these words, stock markets around the world are witnessing one of the most dramatic free falls in their history. The subprime problem is now snowballing to become a global recession. Banks are hesitant to even lend to each other. Central bankers are panicking. The Federal Reserve dropped its benchmark discount rate by 0.75% — the largest single drop in seven years.

Despite the talk of gloom and doom, I am cheerful. 

The markets back in 2000 were hit by the burst of the technology bubble, and then in 2001, they were slammed again by the 9/11 attacks. Thereafter, economic growth slowed considerably. But for private equity, investments made after 2001 yielded excellent returns. As valuations plummeted from their 2000 highs, private equity players in US and Europe were able to close deals post-2001 at bargain prices. The graph below shows CalPers (the largest investor in private equity funds) returns on its private equity portfolio by fund closing year (also known as “Vintage Year”).

Arabia will not be insulated from the black clouds that will be downing on the world financial markets over the next months and years. The reaction from the regional stock markets on Monday, January 21, confirms that Arabia is not as decoupled from the global economy as some people like to think. Even the super-insulated Saudi stock market, Tadawul, dropped by more than 20% over the course of several days.

Yet the Arabian real economy will continue to steam ahead despite hiccups in some sectors. The financial sector will be affected by the global turmoil, but less so than other regions in the world. Real estate may also be affected as global, and even regional, financing sources dry up. Transportation and logistics growth will also slow down as growth of transit shipments and passengers from east to west will be influenced by the probable recession in the US and Europe.

The biggest question will be to what extent oil prices will drop in the wake of a global recession, and consequently, whether oil may drop below $50 a barrel. Oil prices are the biggest determinant of Arabia’s economic growth. Psychologically, they form a leading indicator of GCC economic outlook. They are the main source for financing governments, which are still the main economic drivers for the economy as a whole. Fortunately, GCC governments have accumulated huge reserves, and they will be able to easily weather any short-term drop in oil revenues.

Going back to private equity, the next few months will be difficult for all financial players. But as private equiteers come to grips with the consequences of the downturn, and as new realities settle in, the playground for private equity players in the region will be even greener. On one hand, as a result of dropping oil prices, stock markets’ downturn, and gloomy global economic prospects, valuations will be beaten down to reasonable levels. The market will shift to become more balanced, after being under the mercy of the sellers. Secondly, liquidity, although not easily accessible, will not evaporate. Whatever the severity of the global recession, the region still exports daily $700 million to $1 billion worth of oil. Furthermore, governments’ reserves will continue to trickle down to the rest of the economy — sustaining corporate profits and public investments. Last but not least, global funds will realize that growth in Arabia is more robust than in other regions, and hence, the theory of “Arabia is negatively correlated with the rest of the world” will translate into a shift towards further investment by global institutional investors in Arabia’s stock markets and funds. But this will probably happen after the recession settles in.

Be ready for a tumultuous 2008. Remember: Luck favors the prepared and the courageous.

Imad Ghandour is the chairman of the Information & Statistics Committee Gulf Venture Capital Association.

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