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Secretary Pompeo’s reassurance tour through the Middle East was largely a flop. His address in Cairo was striking in the low bar it set for earning America’s friendship. American foreign policy toward the Middle East has two interests: countering Iran and terrorism, specifically the Islamic kind. As far as a shared interest in regional growth, economic liberalization and empowerment of a young population, the US is not really that concerned. While Pompeo mentioned that Egypt’s recovery would require the state to relinquish some of its hold on the economy, he devoted more time to praising President Sisi for building a church.
The administration continues to press forward in its nebulous plan for a Middle East Security Alliance, or MESA, touting a last-minute conference in Oman as evidence of its ability to pull together regional leaders in an American-facilitated plan for regional cooperation on energy and economic growth. Confusion over MESA, and if the meeting in Oman constituted a first session, or simply early efforts to organize the alliance, are notable in the read-outs from different attending governments. (Bahrain called it a formal session of MESA; the US called it “ground work.”) Energy cooperation is even less of a group effort; for President Trump, it entails tweeting desired increases in oil production to the Saudis. Economic cooperation means getting someone else to foot the bill for post-conflict reconstruction in Syria, Iraq, and Yemen.
The lens through which most Americans view the Middle East is not complex: oil and war. There is a lost opportunity to advocate for identifying the root causes of instability: where authoritarian governments strangle open economies, where rule of law depends on personal status, and resource dependency distorts fiscal governance and enables repression. The truth is that the US is absent as a beacon or facilitator of a liberal economic vision for the region. So, without a champion of markets governed by rule of law, or an advocate for increasing economic mobility for a young population, markets will sort out the most favorable environments for capital in the region.
How will markets respond in the Middle East, as they are more cognizant of a diminished American role in regional peace and prosperity? There is less optimism for bottom-up economic growth, particularly as state-ownership and intervention continues to dominate, even in the economies that are most successful at attracting foreign investment. And the kinds of capital inflows to the region are less active, less about start-ups or new technology and more likely to be passive investments. Think more trading of government debt and passive inflows into regional stock markets, which are often populated by partially state-owned companies.
This translates to inflows in economies like Kuwait, Qatar, and Egypt, which are dependent on rents, either from natural resources, remittances, or tourism. These states are seeing a greater influx of foreign capital than their regional peers. Kuwait and Qatar topped net foreign inflows to MENA, with Saudi Arabia, the UAE, and Egypt following in 2018, following research by EFG Hermes. Most of the new inflows are passive, tied to the new status of “emerging market” in both global bond and equity indexes.
Second, information flows are increasing. The economic reform movement that began across the Gulf in 2015 included a realization that foreign investment would be essential to diversification aims, but more importantly, to sharing the burden of job creation for a young population with high expectations of economic mobility. In Saudi Arabia, a first step in attracting that investment included opening up to financial media in high profile interviews, but also in welcoming media partnerships and near constant coverage of expected IPOs and new investment opportunities. The government began sharing more information about its fiscal budget plans, while the process of bond offerings with road shows and investor prospectus increased transparency of previously unreported government data.
With that access also came exposure of the corruption purge, the crackdown on civil society and peaceful activists, and the murder of Jamal Khashoggi. Markets responded to this information. Capital flight ensued, and foreign capital flows have gone elsewhere in the region. Saudi Arabia still accesses debt markets with ease, issuing a $7.5 billion bond in January, attracting $27.5 billion in bids, about half of the bids to the offering in April 2018. Yet, investing in sovereign debt is very different than foreign direct investment, which Saudi Arabia continues to struggle to attract.
Capital is flocking to the easy wins, and this will further link the prosperity of the region to oil market volatility and do little to encourage more substantive liberalization supported by strong legal frameworks. Markets will reward and punish, but they will also avoid risk. We will see a deepening divide between Gulf markets that classify as emerging markets, and those in the region that remain frontier (Lebanon, Jordan, Morocco, Oman, etc.) with higher premiums to borrow and more extreme fiscal pressure without resource wealth. This also puts frontier governments in the region in the position of petitioning for Gulf financial support, further disincentivizing economic liberalization. This is the job of effective foreign policy and development finance to mitigate risk, encourage institutional reforms, and give political support to difficult economic decisions. Right now, the United States is out of the business, and in the long term, American investors, citizens, and soldiers might have to pay a price.
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