By Henry T. Azzam
AMMAN — In business and economics, the biggest threat is the one that we cannot forecast. This is why it is important to think out of the box and identify the wild cards that may play out differently from what the consensus expects.
For 2006, most observers are forecasting a continuation of the strong economic growth conditions in the region. Oil prices are expected to remain firm, while more bank lending and inward looking capital inflows will add to the prevailing excess liquidity conditions and help sustain the current boom in local stock and real estate markets.
However, the expected rise in share prices this year is unlikely to match that of last year. Domestic interest rates will move slightly higher, in line with the 0.25 - 0.50 per cent expected increase in dollar rates.
Most observers believe that despite the recent elections in Iraq and the landside victory of Hamas in the Palestinian elections, the unstable conditions in these countries are likely to prevail.
Here are some of the surprises or wild cards that could form credible threats to the consensus view. Their importance is derived from the fact that they are interrelated. A surprise in one area could trigger events and generate surprises elsewhere leaving their impact on the regional and global scenes.
1. The first wild card could be a sudden surge in oil prices from their current levels of around 60 a barrel to say 90 a barrel, due to supply disruptions from Iran or Venezuela, higher than expected demand for oil mainly from China and India or a combination of other unforeseen factors.
The confrontation over Iran nuclear research programme is turning out to be the biggest risk for the oil market this year. The US and the European countries may opt to impose sanctions on Iran, e.g. forbidding Western companies from investing in the country's oil sector or baring technology transfer to that industry. This could cripple Iran's struggling petroleum sector and reduce oil supply to the world market.
On the demand side, the rise of China and India as economic powers may lead to a much bigger surge in demand for oil than the majority is expecting. A 50 per cent increase in oil prices this year to say 90 a barrel will give another big boost to economic growth not only in the Gulf countries but also in the other countries of the region. Arab stock markets will enjoy another stellar performance this year as well. This together with surging real estate prices will create unprecedented "wealth effect" making people feel richer and encouraging them to spend more and invest more signalling another year of prosperity.
2. Hamas landslide victory in the Palestinian elections and its impact on the future of the Arab-Israeli conflict constitutes a major wild card in the outlook for the region this year.
The majority believes that negotiations between Israel and the Palestinians are off the table for now and Israel is likely to focus on unilateral moves, such as speeding up construction of the separation war.
Economic conditions in the Palestinian territories are expected to deteriorate, at least initially, especially if the US and Europe decide to reduce foreign aid to the Palestinian Authority which is already in a fiscal crisis and could further destabilise the region.
The surprise could be for Hamas to react differently than the majority is expecting. Now that Hamas will be assuming the reins of power and the burden of actually having to govern, the newly- elected leaders may choose to get into the business of making life better for Palestinians and try to negotiate a peaceful solution with Isreal.
While this is less likely to happen, one should not rule it out. For many years Yasser Arafat and the Fateh movement were hunted by Israel, much as Hamas has been in recent years. However, Israel and the US ended up talking to them when the Palestine Liberation Organisation was elected to represent the Palestinian people.
3. Another wild card affecting countries of the region is credit retrenchment. If domestic interest rates rise faster than the consensus expects and monetary authorities change statutory requirements to make it harder for banks to keep expanding credit, this could lead to lower growth with a possible correction in housing and share prices.
Countries of the region may decide to raise interest rates faster than those on the dollar and lower loan to deposit ratio in order to put a halt on surging real asset prices and reduce inflationary pressures.
The exposure of banks to real estate, consumer borrowing and margin lending for share price speculation would drop, and the reverse of the wealth effect would reduce consumer spending and dampen consumer confidence, which will trigger in the process a major correction in stock markets and real estate prices.
4. Most observers expect instability in Iraq to continue in 2006. The turmoil will make it difficult for Iraq to boost its oil production, adding to supply uncertainty in the world oil market and maintaining upward pressure on oil prices.
The wild card here could be that the Shiite majority, emerging strong enough after the recent elections, decides to establish closer ties with their Sunni counterparts and form a strong government. This will help stabilise conditions in Iraq, and allow the US forces to pull out gradually of major population centres.
Such a development could raise expectations of higher crude oil production coming from Iraq and will encourage the markets to discount lower oil prices down the road.
Hedge funds may choose to reverse the long positions they are holding now and start selling oil contracts in the forward market. Cheaper oil, if sustainable, would boost economic growth in the oil consuming countries, acting like a tax break to consumers and companies.
The oil producing Arab countries would suffer, as tighter liquidity, higher interest rates and a reversal of the feel good effect would leave its impact on the region's economic growth and corporate profitability. This could bring forth lower asset prices (stocks and real estate), deflate household wealth, and reduce economic growth rates in the region.
5. The surge in liquidity in the region and the high valuation at which stocks have been trading is encouraging increasingly more privately held Arab companies to list their shares on the region's stock markets. The appetite for initial public offerings (IPOs) will prevail as more new enterprises are established.
Also, existing public shareholding companies will choose to issue more equity than debt to finance their expansion plans given the relatively lower cost of capital in the region's stock markets compared to the rising cost of borrowing. This could reduce liquidity in the markets.
The wild card this year is for the region's stock markets to witness bouts of corrections in the range of 20-30 per cent instigated by the flotation of major IPOs similar to what had happened in Qatar when the new Al Rayan Bank was floated and in Jordan with the doubling of Arab Bank's capital through a rights issue. After surging by an average of 300 per cent in the past three years and with valuations of several listed companies way above generally acceptable level, corrections are bound to happen.
There is likely to be a flight to quality this year, with the professionally managed portfolios rebalanced towards companies with strong earnings derived from their core business, while speculative stocks will take a back seat.
I hope you will make the best of another a good year, but as you enjoy the ride try to heed the lesson of previous years: Expect the unexpected.
Writer is CEO & founder of Amwal Invest