Despite projections in late 2008 that the Persian Gulf states had the cash and the incentive to cushion the regional impact of the financial crisis, evidence is mounting that the region is far from being immune to the global economic recession. Regional economies will be more hard-hit than initially thought. Oil-rich Gulf states invest revenues from exports back into the global economy, and have almost relatively little production capacity in non-energy sectors to speak of. With oil prices tumbling and investor caution from the Gulf more common, how much of a toll the crisis will take remains to be seen.

The region's industrial sector has been lagging and the Gulf monarchies depend heavily on the United States for their security infrastructure. Most rely almost exclusively on energy resources as the backbone of their economic system. The 2009 Energy Information Administration (EIA) report raised the warning flag on falling global petroleum production, by close to 6% annually. The report's longer term projection is that global oil production may dry up all together in 15 years. The Gulf nations have taken note, gearing up to take preemptive measures against signs of economic downturn and the end of era of ‘low-hanging fruit'. Attention has turned to new investment opportunities, employment generation in the tourism and financial sectors, and programs to meet domestic demand for food products.

The global economic slowdown has impacted the region under three distinct headings. These are: erosion in the value of existing funds; surplus of Gulf crude oil and production costs; and sharp declines in revenue with the declining global demand for petroleum.

Erosion of existing funds and liquidity shortages

Initially, the Gulf states were relatively sheltered from the financial crisis that grew out of excessive and irresponsible borrowing, mostly because the government debt to GDP ratio is very low across the region. As opposed to states that rely on foreign borrowing, oil-exporting countries in the Arabian Peninsula and the Gulf benefited until recently from surplus funds-or ‘Petro Dollars'. Years of economic sanctions have meant that Iran and Syria have been virtually untouched by the financial downturn because they only produce as much petroleum as is needed to meet their domestic demand. Surplus production cannot be injected into global markets because of the economic isolation of these countries.

In comparison, the processes of modernization and globalization Gulf states, and especially OPEC members, vulnerable to the impact of the current economic slump. So much so that 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 market. Dubai is one of seven members of the UAE federation, and the first one to have ever been strapped for cash in this amount 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.

Kuwait has been hit especially hard and the parliament has been dissolved following the government's resignation in mid-March. It was the second resignation of the cabinet in six months. An announcement by Kuwait's Finance Minister Sheikh Mohammad Sabah Al-Salem Al-Sabah in January that Arab states lost almost $2.5 trillion in the past 4 months and that around 60% of development projects in the 6 Gulf Cooperation Council countries were either postponed or cancelled underlined that the region's oil-rich nations were not invincible after all. It also meant that funds managed by the Arab League would no longer be available, thus triggering a government crisis in Kuwait and the eventual resignation that came 2 months later.

Similarly, the tumbling global economic crisis has had a ripple effect in other Arab states. Saudi Arabia announced losses of almost $ 600 billion, and that 60% of development projects in neighboring countries have been suspended. 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. Regional funds said to amount to $3 trillion have had losses of $ 2.5 trillion in just four months. 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 regional economies by building tourism, real estate, financial services, transportation and other non-oil sectors were designed to help cushion the sharp decline in fiscal surpluses caused by a fall in demand for oil. But these sectors also took a hit with the global downtown.
The U.S. looked to Gulf investment to tide over the financial crisis and had stressed the role of foreign investment in boosting confidence to the markets. Gulf sovereign wealth funds have invested billions of dollars in U.S. financial institutions. The likelihood of investing Gulf funds abroad is now extremely low, especially now that at least some of the funds are coming under pressure to funnel their assets to domestic purposes rather than foreign investment. Pulling out of investments would be an even bigger miracle. Rampant liquidity concerns in economies of developed countries, formally poles of attraction for Gulf investment, are for now 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.

Surplus crude oil and production costs

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 barrel in the U.S., $60 in Canada, $40 in Russia and as low as $25 in the Middle East. Costs of production in the Middle East are very low, mainly because of low investment costs. But despite booming prices in 2008, with an average high of $99 per barrel, prices have not pushed beyond the $40-$50 marker this year. The tightening of the global demand for oil by as much as 3 million barrels a day has meant that the Arab region is left with surplus crude oil. With global trade also on a downturn, the surplus oil is held in tankers that cross waterways, a cheaper solution to land storage. Looking at global tanker movements, there is approximately 1 billion barrels of oil stored in tankers at sea, which equates to about 3-4 months of surplus production. The security needs of oil tankers against piracy have grown, with military forces being deployed to the region. At the same time, there is an oversupply of supertankers competing to collect consignments of Gulf oil. According to a recent survey by Bloomberg, there were 25% more very large crude carriers for hire than cargoes needing to be collected in early March.

Current levels of surplus oil are enough to meet global demand for the next four months, even without any additional production. Conversely, available surplus fiscal funds will not adequately meet the demands of the Arab world for even the next few months given the risk of liquidity shortages facing the region. 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 international economic 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 because of 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, 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 investments in Middle Eastern financially strapped nations 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 debilitating drop in oil revenues and the reasons behind why the U.S. based economic crisis is being felt severely in the region.

Given the current state of crude oil inventory and production costs, the Arab world looks like it will be consuming funds rather than shoring them up for a minimum of the next six months. 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 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 extravagant oil wealth which had fueled an explosive building boom in recent years, cash strapped Gulf nations will find 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 are 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.

Decline in petroleum demand and dropping revenue

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. Movement in market prices has meant that previous production levels with profit margins near 400% are now barely hitting 100%. This, topped with the 3 million barrel a day tightening of global demand and enough surplus crude oil for the next four months, means that demand and production will be on a decline in 2009. This in turn will mean turbulence ahead for the Gulf. Without an upward shift in demand, pricing and profit margins will not rise. Having been caught by the international financial recession while in speedy investment mode, OPEC members and oil exporting nations will be forced to turn to global financial institutions for loans. Kuwait is likely to follow Dubai's example. The UAE may soon follow suit.

Inflation has been receding to negative rates in the Gulf region, while losses of around %35-45 in the housing sector have been reported over the past two months. 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. The boom in the automobile sector relying on the steady inflow of foreign workers has now also gone into decline. The parking lot of the Dubai International Airport is strewn with abandoned vehicles. The government is negotiating a way to encourage the resale of these vehicles abroad. In a parallel development demonstrating the national economic downslide, rent and housing prices have dropped.

The effect that falling oil demand has had on earnings in the Arab world has been far reaching. Since February 2008, the 3 million barrel per day drop in global demand has cost the region $ 300 million daily. Feeling the pinch of an income deficit, with assets eroding, liquidity shortages, and access to credit tightening, regional governments are coming under greater pressure to provide financing services to local investors at home and continue subsidies to the public. The economic and political implications of government cut-backs on subsidized fuel, food and other commodities will be significant. U.S. based think tanks and analysts following regional trends project that the end result of economic woes in 2009 will unleash mass public dissent and calls for government reform. In a similar move, the EU has also been paying greater attention to the possible political scenarios that will emerge in the Gulf monarchies after the worst of the crisis is over. One such scenario is that public revelation that the region's leaders have been building their personal wealth in foreign accounts, while racking up budget deficits will add fuel to the internal political turmoil. The government response will be to resort to increasingly repressive tactics to keep a tight lid on public unrest. The notable rise in Saudi Arabia of death sentences over the past 2 months is an indication of what may lie ahead. Authoritarian regimes will either resort to more extremist measures to prevent simmering protest from below, or risk facing destabilizing public protests and riots.

In terms of the implications of the economic crisis on the Gulf's foreign relations, Gulf states will become increasingly frustrated by the inability to pull out of fiscal investments made to developed states, notably the UK, owing to devaluation and problems of liquidity. Gulf monarchies are likely to turn to Russia and China for military assistance. This is significant. Such a shift could potentially alter global socio-economic and military dynamics governing the region.

Despite having large account surpluses, the Arab region and Persian Gulf will be short of at least $500 billion in 2009. These oil-rich states, bolstered by the individual wealth of their leaders, will nonetheless prove to be vulnerable to the economic storm. In the medium to long term, the Gulf region will witness political and economic tremors as a result of diminishing reserves and financial capacity. 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. This may signal a change in the status quo-in the domestic political climate as well as military-security dynamics.