FOLLOW THE MONEY AS GULF TENSIONS RATCHETS UP / THE FINANCIAL TIMES COMMENT & ANALYSIS

Follow the money as Gulf tension ratchets up

Expect very large capital flows after geopolitical realignment in the region

John Dizard


© Stocktrek Images/Alamy


“The Shanamah has a happy ending”. Iranian proverb about how good outcomes are only found in fiction.

Elite American chatter about Iran or conflict in the Gulf mostly concerns courtiers rising or falling at the White House, or Washington think-tanker moans over past or present American policy. Perhaps that is less useful than considering the sentiments of people in the region, and what they are doing with their money.

That is not a simple task, because most of the states on the Gulf have fixed currency pegs, and all of them have opaque governance and obedient media. Insider trading is not the exception but the rule. For decades, Gulf financial markets and exchange rates have been tranquil, right up to the moments when they are not.

The most openly contentious society in the region is Iran, which is riven by political feuds and increasingly volatile official and “unofficial” currency markets. One of its sworn enemies, Israel, was at one time considered a natural, even biblical, ally. The other principal enemy and former ally, the US, has the largest number of Iranians outside the country.

Other states in the region have kept these historical contradictions in mind as they consider how they align themselves in the world. Alliances can change, and I think they will do so rather quickly now. Quiet flows of money will precede the coming geopolitical realignment in the Gulf, and very large flows will follow.

At the moment the most rapid financial shifts are happening within Iran. Last week the unofficial exchange rate of the Iranian rial to the dollar crashed through the 50,800 level, widening rapidly from the official rate, which is just below 37,000 rials to the dollar. That black market price is down about a quarter over the past six months, despite the rising oil prices that have driven up the region’s other risky-asset markets.

There are other indications of political and financial uncertainty in Iran that are not rooted in White House intrigue. Predata, the data analytics firm, says its “Iran Economic Risk Prediction Signal” has been trending up since early March. The signal is based on algorithmic trawls of Iranian social media, and usually predicts major internal events such as strikes and protests about two weeks in advance.

Inward flows from non-US companies have been glacially slow. The regime’s enforcement of laws from dress codes to clerical heresy has become more hesitant and uncertain.

So if blocks of hundred dollar bills are harder to find in Iran, where did they all go? After all, Iranians have a difficult time opening dollar-denominated bank accounts. Step forward the currency pegs of the Gulf Cooperation Council states. The UAE, Oman, Bahrain have had stable currency pegs with the dollar since the 1980s. Oman had the last devaluation back in 1986.

Afghans and Iranians with unexplained wealth find some of the GCC’s local banks are very convenient and understanding. The banks know the Americans are not going to turn away the traffic in US currency.

The UAE leadership may nod vigorously when the Americans talk about isolating Iran, but know their neighbour has seven times the UAE’s population. And 80 per cent of the UAE’s population is foreign. Iranians do commercial business in Dubai, develop gasfields with Qatar, use the central bank of Oman as an intermediary, and fight alongside Iraqi militias. Kuwait is a bit more standoffish with Iran, but it is conservatively financed and not looking for another war.

That is less true for Saudi Arabia. The Saudi engagement in the proxy war in Yemen with Iran has had very mixed results. Even so, the Kingdom seems open to more direct action against Iran.

The Iranian regime has more ground combat experience than the Saudis, but the Saudis have air and missile forces that they believe could do a lot of damage, quickly, to the Iranian oil and gas industry and electricity system. Both populations are thinking this through. Predata has a “Saudi-Iran Tension” indicator based on both Persian and Arabic social media. It increases with bits of incendiary war news or “Yemini” missile attacks, and began to rapidly spike up again after March 24.

Saudi Arabia has also recently been aggressive in loosening its “macro-prudential” banking regulation. For example, loan to value ratios for housing and local businesses have been raised, with a gentle tisk-tisk from the IMF. The UAE and other Gulf states, more burnt by past booms and crashes, are keeping animal spirits somewhat in check.

The placid to non-existent forward markets tell us the Gulf states’ currency pegs to the dollar look pretty stable for at least the next couple of years. Floating exchange rates or otherwise more active monetary policies are probably beyond the administrative capabilities of the governments and central banks.

Devaluations would not do much good anyway, with the high dependence on oil income, imported goods, foreign workers, and foreign currency debt. The risks of regional war or social upheaval are more likely to be dealt with through formal and informal capital controls. Korea is chilling, but the Gulf is heating up.