Iran Nuclear NewsCapital markets in Iran nuclear row firing line

Capital markets in Iran nuclear row firing line

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ImageReuters: Global markets already live in fear of an escalation of the dispute over Iran's nuclear ambitions which could shake an already fragile world economy.

By Sebastian Tong

ImageLONDON (Reuters) – Global markets already live in fear of an escalation of the dispute over Iran's nuclear ambitions which could shake an already fragile world economy.

But the Gulf states' growing integration with the world economy poses an additional threat, as well as the obvious one to oil prices and supplies.

The emergence of the Gulf Cooperation Council as a major source of global funding means any disruption to the flow of oil revenues would jolt already beleaguered capital markets.

"Today the Gulf countries are so intertwined with the rest of the world that anything that happens to their economies will have some influence on the rest of the world," said Farid Abolfathi, managing director risk service at Global Insight.

This financial clout has never been more apparent than in recent months when the credit crisis roiled global markets.

Gulf states and companies spent some $60 billion (30 billion pounds) on foreign assets last year, almost double the previous two years combined, with major Western financial institutions such as Citigroup and Merrill Lynch selling stakes to regional sovereign wealth vehicles such as Kuwait Investment Authority and Abu Dhabi Investment Authority.

These investments are part of a larger international capital flow from the oil-rich bloc whose cumulative current account surplus is estimated to have hit nearly $1 trillion since 2002.

"External account surpluses in the GCC are generally directed abroad, providing an automatic sterilisation of monetary flows to prevent inflationary pressures from building up," said Standard & Poor (S&P) analyst Luc Marchand.

SHORT-TERM FLIGHT

The ability of the GCC to generate these surpluses could be threatened if tensions flare up over Iran's nuclear programme, which the Islamic republic insists is for power generation but the West says is a cover for making bombs.

Negotiations between Iran and six major powers to rein in its nuclear programme have ended in stalemate and Iran, the world's fourth largest oil producer, faces tougher international sanctions after test launching missiles earlier this month.

Israel, widely believed to have the Middle East's only atomic arsenal, has described Tehran's nuclear programme as a threat to its existence and has hinted of possible military strikes against Iranian nuclear facilities.

A military attack on Iranian facilities could spark off a short-term capital flight from the region, spurring the Gulf's decades-long drive to acquire assets overseas and more deposits into Western banks.

"It will be bad news for local stock markets but the Gulf's overseas drive is about diversifying risk. A diversified portfolio is a less vulnerable portfolio," said Keith Crane, senior economist at U.S. think-tank Rand Corp.

ASSET VALUE CRASH?

Iran has threatened to retaliate if attacked, by destroying Israel and U.S. military bases in the Middle East.

Although most analysts cast doubt on Iran's military reach, the threat puts Qatar, Bahrain and Kuwait — which host U.S. military bases — at risk.

If the United States — a key Israeli ally — is drawn into a wider conflict with Iran, the protracted instability could also have devastating economic consequences should oil production be disrupted.

Oil prices would predictably spike up if a conflict were to flare up, putting further strain on a world economy already grappling with high food and fuel costs.

Any Iranian naval blockade preventing producer countries from transporting oil out of the Strait of Hormuz would hurt the region's oil revenues, in turn hitting world markets accustomed to capital flows from the region.

"We could see a crash in asset values if a serious conflict were to break out as the increase in asset prices in recent years has been driven by the (oil) liquidity boom," said S&P's Marchand.

Crucially, the GCC remains a net importer of foreign direct investment despite being a net exporter of capital, with Qatar, Bahrain and the United Arab Emirates being significant beneficiaries of overseas investment.

Such inflows would fall if risk premiums rose on regional insecurity, damaging the global ambitions of Gulf states such as Dubai and Bahrain, which have sought to position themselves as regional financial centres.

"Investment in the Gulf is dependent on the willingness of international corporations to send their employees there," said Rand Corp's Crane.

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