* Markets calmer than during past bouts of geopolitical
* CDS stay low, no sign of pressure on currency pegs
* Reflects rise in states' financial strength in past 3
* Governments have shown they can spend to maintain social
* Higher oil prices due to Iraq could even benefit Gulf
By Andrew Torchia
DUBAI, June 16 For years, the rich oil states of
the Gulf have struggled to insulate themselves from political
turbulence in the rest of their volatile region. Markets'
reaction to the insurgency in Iraq suggest they may finally have
Saudi Arabia and Kuwait face the potential disintegration of
a country on their borders. At the very least, the turmoil in
Iraq looks set to widen the Sunni-Shi'ite divide which has
poisoned politics across the region.
But in contrast to past episodes of instability in the
Middle East, the Gulf's financial markets are mostly reacting
calmly. Foreign investors have continued to plough hundreds of
millions of dollars into Gulf bonds. There have been no signs of
pressure on Gulf currencies' pegs to the U.S. dollar.
Stock markets have dropped, but traders largely see that as
a natural adjustment after big gains earlier this year, not a
panicked response to geopolitical risk.
The calm reflects the Gulf's progress in building up its
financial resources on the back of high oil prices as a defence
against regional instability, as well as its success in
containing domestic political fallout from the Arab Spring
uprisings over the past three years, economists and fund
"I think people now see the Gulf as well insulated from the
politics around it," said Jason Tuvey, Middle East economist at
Capital Economics, a London-based consultancy.
He added that apart from Saudi Arabia's Eastern Province,
which has seen some low-level unrest among its Shi'ite minority,
it was difficult to see how events in Iraq could have any direct
impact on Gulf states. If there is any impact, governments have
the monetary and security resources to deal with it, he added.
The region has been buffeted by a string of geopolitical
shocks since early 2011, when revolutions in Egypt and other
Arab states briefly raised the possibility of similar unrest
within the Gulf.
Five-year Saudi Arabian credit default swaps
- which insure against the risk of a Saudi sovereign debt
default, and are therefore an indicator of foreign investors'
jitters about the Gulf - shot up to a peak of 140 basis points
in February 2011.
They rocketed back to that level in early 2012, as
international tensions over Iran's nuclear programme rose. A
smaller spike occurred in August 2013, as the United States
threatened to bomb Damascus over the use of chemical weapons.
This month, however, CDS have stayed low, sliding to 37 bps
last week, the lowest level since early 2013. The Saudi riyal
forwards market, which shot up during the Arab Spring to
show expectations for riyal depreciation, has barely moved.
In another vote of confidence in the Gulf, United Arab
Emirates telecommunications operator Etisalat sold
$4.3 billion worth of bonds last Wednesday in the region's
biggest corporate bond issue ever.
The sale, a day after the Iraqi insurgents seized the major
city of Mosul, attracted massive demand from European fund
managers in particular and set a record for the cheapest pricing
of any Gulf bond relative to mid-swaps, bankers said.
Shakeel Sarwar, head of asset management at Bahrain's
Securities & Investment Co, a major fund manager, said the
markets recognised that the six Gulf Cooperation Council
economies could function smoothly next to an unstable Iraq.
"Unless the contagion spreads to the entire region and it
becomes a serious conflict, the probability of which is quite
low at present, I don't think that a contained conflict limited
to Iraq is going to negatively impact the GCC economies," he
One reason for the growing confidence in the Gulf is that
three years of high global oil prices have allowed most
governments to build up their financial reserves, leaving them
in better shape to cope with any political or economic shocks.
Saudi Arabia's net foreign reserves, for example, have
ballooned by over a third since 2011 to $730 billion - enough to
finance several years of state spending at current levels even
if oil revenues plunged tomorrow.
Also, in contrast to Iraq, GCC governments have over the
past three years shown they can spend their oil money
effectively to maintain social peace. Riyadh has directed tens
of billions of dollars towards social benefits, new housing and
new jobs to avert any pro-democracy unrest.
Compared to three years ago, "governments are better
prepared to confront the sectarian threat, the fiscal reserves
they have to do this with are bigger, and macroeconomic
conditions are better," said Raza Agha, chief economist for the
Middle East and Africa at VTB Capital in London.
He noted that since the Arab Spring, the GCC states had also
developed a mutual support mechanism, with the richest
governments - Saudi Arabia, the UAE, Kuwait and Qatar - pledging
$10 billion each to the less wealthy ones to fund economic and
social welfare projects.
If Iraq's sectarian confrontation sucks in Iran on the
Shi'ite side, the Sunni monarchies of the Gulf could conceivably
drift towards a conflict that damages their economies and
endangers their security. This would have a major effect on
Even then, however, the financial position of the Gulf
states could become stronger in some ways, as higher oil prices
boosted their revenues.
Iraq has been producing around 3.5 million barrels of oil
per day; if that were lost because of fighting, much of it would
probably be replaced by Saudi Arabia's almost 3 million bpd of
spare capacity, raising its revenues substantially, Tuvey said.
(Additional reporting by Olzhas Auyezov; Editing by Giles