Worrisome Economic Consequences from the Unrest in Egypt

February 4, 2011 9:30 AM

The demonstrations and the more recent violent clashes between the pro and anti-Mubarak factions in Tahrir Square continue unabated despite President Mubarak's announcement on February 1 that he would not seek reelection in September. (It is also presumed that his son Gamal Mubarak will not run for the presidency.) The Mubarak concession may well have worked if it had come in the first week of the protests, but the dynamics of the movement to remove him have moved beyond that possibility.

What will the instability in Egypt mean for the Middle East economies, and more generally for the world economy?

It is always difficult to predict such matters with certainty. But on the face of it, the direct costs of even a sharp decline in the Egyptian economy would not amount to much. Egyptian GDP is about $215 billion, a mere decimal point in the world GDP of $58 trillion. While Egypt is certainly a large country in the Middle East, at least in terms of the size of the population of 85 million, its GDP is less than 10 percent of the combined GDP of the Middle East and North African countries. Based on these numbers, one would be hard pressed to make the case that even a complete collapse of the Egyptian economy, which is highly unlikely, would have serious ramifications for the region, let alone the world economy.

On the financial side the effects are also small. Western banks' exposure to Egypt is quite limited. The data from the Bank for International Settlements (BIS) show that international loans to Egyptian corporations and the government are around $50 billion, with the bulk held by European banks. US banks' exposure to Egypt is only $5 billion. Even a complete loss on these loans will make hardly any difference to the underlying balance sheets of the big banks, although one has seen a small drop in the share prices of French banks, such as Societe Generale and Credit Agricole, which have the largest exposure to Egypt. The Cairo Stock Market lost 16 percent of its value in two days before it was closed on Sunday, January 30. There were some adverse effects to regional stock markets, mainly in the Gulf countries, which were down about 5 percent. But in the last two days these markets have stabilized. There was little if any direct effect on the major stock markets of the world.

The price of oil is the real issue. Many observers believe that a possible shutdown of the Suez Canal would seriously disrupt oil supplies, causing a sharp jump in world oil prices. But only about 2–3 million barrels a day transit through the Suez Canal, a drop in the ocean of global supplies. Total world supply of oil is 88 million barrels a day, so the temporary loss of 2–3 million barrels daily is not particularly worrisome. Besides, the oil coming through the Suez Canal would not really be lost. It would simply need to be rerouted via the Horn of Africa adding a little to the price because of the higher shipping costs. Despite these facts, oil prices have jumped significantly in the last few days, with Brent crude on the ICE Futures Europe Exchange rising from $95 a barrel on January 26 to $103 a barrel on February 3.

If Suez is not the cause, then what is pushing up oil prices? The simple answer is fear of contagion—the fear is that the protests in Egypt will spread across the region and into the major oil producing countries. Algeria, for example, has already experienced protests and demonstrations in the wake of the Tunisian uprising. Libya, also in North Africa, could well be a candidate for similar political unrest. Both countries have closed political systems and large scale unemployment, particularly among the young. But the main worry is that this type of instability could spread to the Gulf countries, which together supply 15 million barrels a day, about 17 percent of world oil production. Egyptian- or Tunisian-style political unrest does obviously have the potential to create oil supply disruptions in Saudi Arabia, Kuwait, and the United Arab Emirates. Even though the Egyptian turmoil may be a black swan event, it appears the markets have started to reprice the risk of a disruption, and therefore both spot and futures prices have been moving up.

An oil price spike of the kind seen a few years ago, when the oil price hit a record high of $147 a barrel in July 2008 would have very serious consequences for the world-wide economic recovery. (At that time, there were heightened concerns over oil consumption going up in Asia, fears of supply problems in some parts of the world, all of which gave rise to speculation in the markets.) However, the probability of a supply disruption, with significant amounts of oil being taken off the market, seems small in the near term.

Oil prices could still rise further, on the other hand. It should be recalled that in 2008 oil prices rose from $92 a barrel in January to $140 a barrel at the end of June when the oil market was well supplied. In fact, the fundamentals of demand and supply would have suggested that oil prices should have fallen in the first half of 2008 rather than rise. Speculation, and particularly momentum trading, can push up prices even though the fundamentals would point otherwise. This is the real danger now. It is doubtful that the fragile world economy could take the hit of such a large spike in oil prices. In that sense, what is happening in Egypt has to be of concern to the world.