Political unrest in the Gulf threatens private sector spending and investment but thanks to high oil prices, governments have enough financial firepower to prevent their economies from slowing sharply.
Protests, some of them violent, have touched almost every country in the Gulf over the past two months. Except for Bahrain, the direct economic impact in terms of lost output has been tiny. But the protests have highlighted the potential for more trouble if political issues are not resolved, and this is dampening the mood in the private sector.
However, high global oil prices -- themselves partly due to unrest in the Gulf and North Africa -- are boosting energy sectors in the region and giving governments enough cash to spend their way out of trouble.
"The increase in oil prices will significantly add to growth dynamics both directly and through the wealth effect," said Marios Maratheftis, regional head of research for the Middle East, North Africa and Pakistan at Standard Chartered in Dubai.
The unrest in the Gulf erupted when banks in some countries such as the United Arab Emirates were still hesitant to lend in the wake of the global credit crisis and local debt problems.
As a result, prospects for foreign direct investment in the region "have deteriorated, in the short term even in those countries that have not seen significant levels of protest", said Simon Williams, chief economist at HSBC Bank in Dubai.
"Foreign capital will be more difficult and more costly to access until the market is persuaded that the long-term order has been restored."
After the global crisis, foreign direct investment tumbled by over 70 per cent in Saudi Arabia and the UAE in 2009, and by 86 per cent in Bahrain. More recent data is not available, but political jitters are delaying a recovery of investment in Bahrain and possibly in other countries.
"I have an investment project that I'm working on which has been delayed by these events for a whole month," said a long-term investor in Bahrain, who declined to be named. "I have to wonder whether Bahrain is the best place for it, compared to Dubai for example."
Bahrain, a regional financial centre where the Sunni government used tanks to crack down on mainly Shi'ite-led protesters, has been by far the worst-hit economy. Around 24 people died in a month of unrest which brought in Saudi troops, closed banks and shops and triggered capital flight. Economic losses reached US$1 billion or about 20 per cent of quarterly gross domestic product, NCB Capital estimates.
But not all the capital flight from Bahrain, estimated at tens or possibly hundreds of millions of dollars, left the Gulf; some of it simply moved to more stable countries in the region, benefiting them in the short term at least.
Debt insurance costs for Dubai, viewed as a safe haven in the Gulf, are tighter than they were before the unrest at 389 basis points (bps), down from February's three-month high of 459 bps.
Meanwhile, all of the Gulf economies are benefiting from the rise of U.S. crude oil prices to a two-and-half-year high above $108 a barrel. A $10 increase in the expected average oil price faced by Saudi Arabia to $92 per barrel should contribute $43 billion to the country's nominal GDP this year, Banque Saudi Fransi estimates; that is roughly a tenth of last year's GDP.
In addition, Saudi Arabia and other countries are boosting state spending aggressively to ease social pressures. High oil prices give them more to spend, but in any case they are willing to run down financial reserves if necessary to head off the biggest political threat to their stability in over a decade.
Saudi Arabia announced in February and March that it would spend an additional $130 billion -- presumably over several years -- on housing, bonuses for state employees, job creation and other projects to improve social welfare and the economy.
This is expected to help drive the state sector's output over 5 per cent higher for the third year in a row in 2011, the first time such extended growth in the sector has been seen since the early 1980s.
Taking into account increased oil output to make up for Libya's shortfall, Saudi Arabia's economy is expected to expand 4.5 per cent this year and 4.4 per cent in 2012, an acceleration from 3.8 per cent growth in 2010, a Reuters poll of analysts showed in mid-March.
Saudi stocks have gained 9 per cent since the Saudi king announced the latest fiscal stimulus in March.
"In terms of economic prospects, all these countries are oil exporters and their economic outlook is quite positive if you look over the medium term, particularly Qatar, Saudi Arabia as well," said Dina Ahmad, a strategist at BNP Paribas. "These two countries in the Gulf stand out in terms of economic growth and prospects for foreign direct investment."
In Qatar, where government spending is set to jump by 19 per cent in the fiscal year to March 2012, the economy is expected to power ahead by 15.8 per cent this year, one of the fastest growth rates in the world, the Reuters poll found.
Economists have cut their growth forecast for Bahrain this year to 3.4 per cent from 4.2 per cent predicted in December, and their forecast for Oman to 4.1 per cent from 4.6 per cent, according to the poll. But even here, a slight improvement is expected in 2012.
One supportive factor for Bahrain and Oman is that the richer Gulf countries, eager to prevent political unrest from spilling into their territory, are providing aid to the hardest-hit economies.
Saudi Arabia and other wealthy neighbours have pledged $10 billion in aid to Bahrain and the same amount to Oman over the next 10 years to improve housing and social welfare.
Governments are hoping that such spending will maintain comfortable levels of economic growth until political unrest abates and private sector activity regains momentum, perhaps later this year.
However, a private sector revival may not in some countries be enough to offset a possible slowdown in government stimulus next year -- esepcially if oil prices come down.
"I am expecting next year's (Saudi) GDP growth to decline because I do not think they can sustain such high spending and constantly announce such extraordinary measures," said John Sfakianakis, chief economist at Banque Saudi Fransi.