High Oil Price Is After All Good!

HIGH OIL PRICE IS AFTER ALL GOOD!

There is a saying, “when it rains it pours”. That is exactly what is happening for the Middle East economies. The doubling of oil prices from 2002 to 2006 has created an abundance of wealth in the Middle Eastern oil-exporting countries. Large sums of money from oil consuming countries to middle eastern oil exporting countries are being redistributed, which has created a wind fall of dollar income of these countries which puts to shy the receipts they saw during the oil crisis of 1970s. This time around, learning from the past mistakes, the oil exporting countries are investing in productive assets, especially in physical and social infrastructure. Despite the investment that is taking place within the oil-exporting countries, a lot of this petrodollar is going overseas. The region’s investment agencies are managing over US$1.5 trillion of foreign assets, this time around, a chunk of that in the emerging world of Asia.

The question now is where is all these money going? Given the amount of liquidity in the region, due to high oil prices and an ever-increasing demand, the answer is hardly surprising-just about everywhere. Just earlier in the year the central bank of UAE declared that they would like to increase the weightage of Euro holdings to 10% or more from the measly 2% at present and all the other central banks in the region expressed their plans to follow suit. In reality this may not affect the US dollar but if the public investment vehicles of these nations with assets estimated at USD1.5 trillion, were to shift their currency, then it will ring the death knoll for most of the central banks of the developed nations which hold their reserves in US dollar. One thing is clear with this movement the middle east is planning to diversify their investments, especially, away from the US, which used to be the largest recipient of the petrodollar for over half a century.

After the test of fire from the last oil boom in 1970, the countries now are not willing to go the opportunity this time. They have started investing in the non-hydrocarbon sector to claim their economies out of the over reliance on the hydrocarbon sector, which is highly speculative. This can be viewed in Dubai International Capital’s purchase of 2% stake in DaimlerChrysler and an investment of US$1.5 billion in Madame Tussauds, the British wax museum. Other examples include Dubai port buying P&O and Mubadala Development Company, and an investment company in Abu Dhabi purchasing 5% in Italian car maker Ferrari. Apart from these big-ticket investments these surplus petrodollar is also flowing to the emerging markets of Asia. This is not without reason.

For the Middle East, Asia is a safe place to park their funds. With the uncomfortable relations with US and the popular negative perception of the west as a whole, the Middle East countries need better investment opportunities outside the western nations and particularly US. Where else is the better place then to look at their Asian peers, whose economies can absorb any amount of money that is poured in, with a good, if not, better return than the western world.

This evident from the fall of US T-bill holdings in the portfolio of the Middle East central banks. Let’s now ask the same question again where else the money is going then? The answer is they are coming to Asia and especially the emerging markets of Asia.

In India we are witnessing one of the economic miracles, perhaps first time in our history all the asset classes –share market, bullion, real estate, debt instruments and even interest rates—are moving north in tandem. The classic economic theory dictates otherwise, and insists some of them have an inverse relationship with each other. The answer to this economic unreality is the petrodollars finding their way into Indian bourses, real estate, companies et al. Let’s not forget this is a hot money going into very liquid asset classes.

Apart from the investment in these asset classes in the emerging markets the middle east banks are investing a lot in hedge funds and investment banks. The petrodollar is ferocious in assimilating the assets through out the globe with accumulation of gold papers sending them north. Where this will all lead to? They are good in one sense and bad really -really bad in another.

Let’s now see how bad it is. This is creating a notional increase in the assets at an outrageous pace. This is exactly what happened in the early 90s with the Asian tigers who became the tamed cats in 1997 with the collapse of their economies like a heap of cards.

It is good in a sense that it circulates the money to other economies, which are in need of them, one being India. The oil price increase of the 1970s created an economic slump of the world economies but today this has created an economic boom for the world economies. The difference is back in 70s the oil sheikhs spend their money wastefully but today they are spending it wisely. The oil price increase has created more petrodollars for the Middle East, which they are investing in building infrastructure of their own country apart from participating in building the infrastructure in countries like India through way of much needed foreign direct investment (FDI).

This can be seen in almost all the infrastructure sectors of the Indian economy. The one recent example is the Oman Oil Company taking stake in the Bina refinery of BPCL. The EMAAR Group of Dubai is coming into India through a joint venture with MGF and is investing over US$4 billion, tipped as the largest FDI in India in real estate, in various projects in Delhi, Andhra Pradesh, Tamil Nadu, Karnataka and Maharashtra. The Middle East money is also coming into India through various FIIs, hedge funds and VCs. This has helped in heating the already boiling asset classes in India.

The trade and investment of middle east economies with US and their western counter parts has also decreased in 2005, thanks to US policy towards the region. The Dubai Port World’s (DPW) recent decision to sell its US ports on the back of the US Congress’ concerns about a UAE government linked company owning ports in US may be sited as an example. The vacuum that is being created in the trade side is being filled in by the emerging economies of Asia, like China and India, swiftly and efficiently. The Indian export to the Middle East has grown 31% last year and is likely to increase further this year.

This is a bare opportunity presented to India to capitalise. If India can capitalise this opportunity, apart from reducing the trade deficit created by the increase in oil price, India can also attract a pie of the US$1.5 trillion floating in the global market to its much needed infrastructure sector, to build a nation in which we all will be proud of.

After all high oil price is good for the Indian economy, if not always, now.