US-GCC ties should be Obama's top priority

The ascent of GCC countries as the financial and economic powerhouse of the Middle East poses both opportunities and challenges for the United States.

According to a study by a Dubai-based think-tank, this means preserving the US's relations with the GCC should be one of the top issues that the Obama administration has to address.

According to Gulf Research Centre's (GRC) "US-Arab Economic Relations and the Obama Administration" report, the US needs the region more than ever since the region would not only be instrumental to finance its deficit, but it also has a large stake in the American economy on account of its investments in dollar-denominated assets.

In addition, the current economic crisis is forcing the US to introduce a deficit-financed economic stimulus plan, which will require even more investment by GCC countries and China in US government treasury bills and bonds.

Nevertheless, the region is also obliged to assist the US economy as most of the Gulf's currencies – except Kuwait's – are pegged to the dollar.

"The US's high deficit, which allows it to maintain its large volume of imports, can put added downward pressure on the dollar, which is a matter of concern for GCC countries, who hold more than 60 per cent of their foreign assets in dollars," the report said.

The value of these foreign assets has decreased by an estimated 25 per cent during the recent turmoil in global financial markets. Consequently, GCC governments have no alternative but to prevent a dollar collapse in the short run because of their existing dollar assets. But a gradual divestment towards European and Asian assets may occur in the long run if they fear further weakness in the dollar.

And since the Obama administration has already announced that it plans to finance a large economic stimulus plan in the next few months, it must engage in close consultations with its GCC and Asian creditors, who will be asked to purchase a portion of this additional debt, it added.

Although stimulating the US economy will remain the top economic priority of the new administration, it must also demonstrate a strong commitment to long-term price stability and to the strength of the dollar in order to reassure its international creditors and restore confidence in the US economy.

"Given the magnitude of debt involved this will be a very difficult task, but it is absolutely essential," said the report, written by Nader Habibi and Henry L Leir, Professors at the Brandeis University, and Eckart Woertz, Programme Manager, Economics, at GRC.

"The US economy will face new hardships in the long run if the GCC countries and other international creditors lose faith in the stability of the dollar and reduce their investments in the US assets," it added.

Another issue to be tackled is the US policy towards foreign equity investments. As part of their long-term investment strategy, the GCC Sovereign Wealth Funds (SWFs) are allocating a larger share of their assets in equity investments but some political and media circles in the US have recently opposed large-scale investments that would offer a foreign investor substantive management power in large American firms. In 2005, for example, the US prevented the China National Offshore Oil Company (Cnooc) from acquiring Unocal, although its bid was better than Chevron's and this was followed by the strong political opposition to a Dubai-based firm's interest in acquiring six port authorities in the United States in 2006.

Notably, the sensitivity has diminished since 2007. Saudi petrochemical giant Sabic bought GE Plastics for $11.6 billion (Dh42.6bn), the Abu Dhabi Investment Authority (Adia) bought 4.9 per cent of Citigroup, and the Abu Dhabi Investment Council (Adic) bought the Chrysler building.

"As more and more American firms face financial difficulties in the current economic crisis, foreign investment is often an attractive alternative to bankruptcy and government bailouts," it said.

Some concerns, however, remain that SWFs could be used to serve political objectives and harm the national interests of the host countries.

To address this, the IMF formed a 26 member International Working Group (IWG) of Sovereign Wealth Funds to come up with a set of recommendations and guidelines for SWFs, leading to "24 Generally Accepted Principles and Practices" (Gapp) known as the "Santiago Principles".

It is important that the Obama administration support this process, says the GRC report, as such a step will facilitate larger GCC investments in US firms and provide more liquidity to the US economy.

And while the GCC tends to co-operate with the US as regards its economic sanctions against Iran, Washington needs to look at the issue more closely as Iran has established close trade and economic linkages to the region.

Figures from IMF show that the GCC countries enjoy a considerable trade surplus vis-à-vis Iran. Co-operating with US economic sanctions, therefore, will impose an economic cost on these countries.

GRC said the GCC would be the most impacted region by US pressures against trade with Iran. After China (14.3 per cent) and Germany (9.7 per cent), the GCC is the third largest exporter to Iran.

In addition, the UAE in recent years has emerged as Iran's window to the world, serving as a re-export centre for many types of machinery and spare parts that Iran needs.

GCC countries also look to Iran to overcome their looming natural gas shortage – and co-operation with US sanctions would make it more difficult for them to develop their natural gas trade with Iran.

GRC suggests if the United States insists on broad GCC participation in the sanctions, it will have to offer some political and economic concessions to offset the above-mentioned costs that GCC countries will have to incur.

"From the GCC's point of view, an even better alternative would be an attempt by the United States to resolve its dispute with Iran through direct negotiations, allowing the GCC countries to remain neutral," it added.

There are also a host of other factors that the Obama administration needs to consider in pursuing US-Middle East economic relations.

The growing competition for Middle East oil, for one, remains of prime importance.

The penetration of Chinese and Indian companies in the Mena energy markets not only takes away business opportunities that might otherwise have been awarded to American firms, but also diverts a larger share of Middle East oil exports to Asia.

This is because the service contracts awarded to Chinese and Indian firms are often part of larger long-term oil and gas export contracts, which sometimes involve reciprocal investment agreements.

State-backed Chinese oil companies are in a better position than the Western ones to overlook short-term commercial profitability in favour of long-term strategic considerations.

China poses another challenge to the US States' energy interests in the Middle East by investing in countries that are off-limits to Western energy firms because of international sanctions and political considerations.

Whereas the US has imposed sanctions on Sudan and Iran, for example, Chinese oil firms have aggressively penetrated these countries. Both China and India are expected to expand their energy co-operation with the Sudanese government despite international criticism.

More significantly, China and India have both invested in Iran's oil and natural gas. China is also involved in the construction of a 240-mile oil pipeline for transport of crude from the Caspian Sea port of Neka to a refinery near Tehran.

Overall, the policies that China and India are currently pursuing with respect to securing long-term energy supplies from the Middle East pose a challenge to the US oil and security interests in the region.

Then there is the issue of free trade agreements. The George W Bush administration tried to strengthen trade and investment ties with Mena countries by negotiating bilateral free trade agreements (FTA). It has already signed FTAs with Morocco, Israel, Jordan, Bahrain, and Oman. Currently negotiations are under way with several other Mena countries, including Egypt, Qatar, and the UAE.

The current US trade agenda in the Middle East was formulated by the Bush administration in 2003 as a graduated path toward a comprehensive US-Middle East FTA.

According to this plan, the United States would first negotiate bilateral FTA agreements with individual Middle Eastern countries and over time consolidate these individual FTAs into an integrated regional FTA.

Critics argue, however, that the separate FTAs that the United States is interested in undermine existing regional trade agreements among Arab countries.

Tensions with Bahrain rose, for example, when concern arose that the US-Bahrain FTA (which went into effect in August 2006) violated the GCC customs union, which called for a five per cent tariff on imports from non-GCC countries.

In contrast, the European Union and China are negotiating regional FTAs with groups of Middle Eastern countries and encouraging inter-Arab economic integration.

The Arab countries, says the report, seem to prefer collective free trade agreements with their major trade partners. As the Obama administration reviews the state of US economic relations with the Middle East, it must decide whether to continue the current policy of independent trade negotiations or to switch to a collective FTA option with multi-country blocs, similar to the approach taken by the European Union and China.

"By modifying its FTA programme along these lines, the United States would demonstrate its goodwill toward the region and would in all likelihood, be able to sign trade agreements with larger groups of Arab countries," it said.

The promotion of growth and economic development in Mena countries needs to be in Obama's list as well.

In light of the sizable economic and geopolitical interests of the United States in the Middle East, it is in the American national interest to promote economic growth and development in the less developed areas of Middle East for several reasons, GRC said.

First, poverty and underdevelopment create a breeding ground for the promotion of militancy and political violence, which is frequently directed toward the United States.

Second, if properly channelled, the region's oil revenues are large enough to finance its much-needed sustainable development. If the US can help address this, US businesses will benefit from the economic growth and development of Mena countries, it added.

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