Does the turmoil in Egypt threaten the global recovery?

  • Share
  • Read Later

At first glance, the upheaval on the Nile might seem far removed from the world of Wall Street and Main Street. Egypt is not a major participant in global manufacturing networks, nor is Cairo a significant financial hub. But Egypt’s political crisis could have implications for the global economy nevertheless. That’s because the economic and political role Egypt plays in the Middle East gives it economic power beyond the easy-to-measure statistics. The turmoil in Egypt is putting a glaring spotlight on the fragility of political stability in the entire Arab world. That, in turn, is giving already-nervous investors yet another reason to worry about the questionable strength of the global recovery. Here’s how Mohamed A. El-Erian, chief executive officer of Pimco, explained it recently:

How Egypt evolves in the next few days and weeks matters a great deal — and not just for Egyptians but also for the world economy. It matters in ways that are unusual and, for many, unfamiliar. Unlike China, Egypt is not a major source of global demand nor is it a major exporter. Unlike commodity-rich countries, Egypt does not directly influence world prices. But Egypt is a critical enabler and, as such, indirectly touches many other nations. With its control over the Suez Canal, Egypt is a major gatekeeper of global trade. Even more important, its role and standing in the Middle East makes it a critical participant in promoting geo-political stability in an area prone to volatility. Where the country goes from here will have an impact on the wellbeing of the global economy and stability of the world’s financial markets.

Here’s why:

The main way Egypt can impact the global economy is through oil. Though Egypt does produce oil, it is not a major exporter, and the country isn’t a member of OPEC. But the Suez Canal, which runs through Egypt, is a crucial waterway for transporting oil from the oil-rich Persian Gulf to Europe and elsewhere, and any disruption in the operation of the canal due to Egypt’s political crisis could quickly produce bottlenecks in oil markets that might cause prices to spike. And as the protests in Egypt spread to Jordan, Yemen and other parts of the Middle East, they raise the alarm that super oil exporters like Saudi Arabia could eventually find themselves facing similar unrest, which could have major implications for oil production and prices. Just those fears alone pushed oil prices upward as Egypt unraveled, with Brent even reaching $100 a barrel.

Further increases in oil prices could become a serious problem for the global economy. Higher oil prices fuel inflationary pressures in emerging markets like China and India that are already fighting rapidly rising prices, forcing them to take measures to slow down their economies. They can also sap the spending power of consumers and companies in the developed world, just when such demand is badly needed to sustain the recovery from the Great Recession. Even before the Egypt crisis, the International Energy Agency warned that oil prices were reaching a “dangerous zone” for the global economy. Economist Nouriel “Dr. Doom” Roubini said in The Financial Times that the result of Egypt’s political crisis could end up being a double-dip recession for oil-importing countries in the developed world:

The upheaval in Tunisia and now Egypt has important economic and financial implications. About two-thirds of the world’s proven oil reserves and almost half of its gas reserves are in the Middle East; geopolitical risk in the region is thus a source of spikes in oil prices that have global consequences. Three out of the past five global recessions have followed a Middle East geopolitical shock that led to a spike in oil prices…This rise – and the related increase in other commodity prices, especially food – pushes up inflation in already overheating emerging market economies where oil and food prices represent up to two-thirds of the consumption basket; it is also a negative terms of trade and disposable income shock for advanced economies that are barely out of the recent recession and experiencing an anemic recovery…If oil prices were to rise much further, these economies would slow down sharply and some might even experience a double-dip recession.

The political upheaval in Egypt is also having an amplified impact on world economic sentiment simply because investors are already in a jittery mood. Sure, the global economy is in better shape than many had expected, with some strong data coming out of important economies like the U.S. and Germany. The International Monetary Fund upgraded its forecasts for global growth recently. But a long list of threats to the recovery remain, from the European debt crisis to the weak U.S. housing market to persistent unemployment. The last thing the world needs is a new, unforeseen shock from an unexpected source. Egypt could prove to be just such an unwelcome surprise.

However, my personal view on this issue is that the fears over the economic fallout from Egypt’s political crisis on the global economy have been way overblown. Oil markets are functioning normally and the upward pressure on prices from the crisis appears to be easing up already. The rest of the world is simply not exposed to the Egyptian economy in ways that could send severe ripple effects through global financial markets. So I tend to agree with Said Hirsh at Capital Economics, who noted this in a recent report:

For now the main impact on global markets comes from the increase in regional geopolitical uncertainty rather than any specific economic or financial factors. In particular, there is no sign of any disruption to traffic through the Suez Canal and OPEC has plenty of room to increase supply to offset any shortfall in Egypt’s oil exports. European and especially French banks have a fair amount of exposure to Egypt but this is relatively small compared to their total lending or that to the periphery of the euro-zone. Provided the political crisis eases soon, the global fall-out should be limited.

The real economic pain from the Egyptian political crisis will be felt primarily by the Egyptians themselves. Tourism is a major source of jobs and revenue, and with foreigners fleeing the turmoil, Egypt can kiss those dollars goodbye for a while. Though the government isn’t facing a serious financial problem, it does post large deficits and could very well find its borrowing costs going up, further straining the budget. Though the country has enjoyed a good few years of growth, the average Egyptian can ill-afford the sort of severe economic shock that the political unrest could very well cause. Unemployment remains high and a hefty chunk of the population still lives under the poverty line,

For me, the real threat to the global economy from the Egyptian crisis will depend on how widely and deeply the anti-government sentiment in Egypt spreads to the rest of the region. We’ve already seen a switch of government in Jordan and the collapse of the regime in Tunisia. What happens if Saudi Arabia, Syria or others get dragged into the mix? Though such a development would be a world-changing event that could bring freedom to millions of oppressed, it could also prove much more traumatic for the global economy.