How the Corona Virus Will Affect EUs Investment in the Middle East

Abstract

The Corona Virus pandemic has spread rapidly across the world. The COVID-19 pandemic has infected millions across the globe and almost stalled economic activity even as countries restrict movement to stop the spread of the virus (Dabrowski & Dominguez-Jimenez, 2020). As the toll on humans and health continues to grow, the damage afflicted on the economy is evident, representing the world’s largest economic shock to date. The COVID-19 has led to immediate, near-term, and long-term effects on the global economy. The global GDP was forecast to drop by 5.2% in 2020, based on the weights of the exchange rate in the market, making it the deepest recession the world has experienced in decades. This is despite the unique government efforts to counteract the downturn through monetary and fiscal policy support. In the long term, the deep recessions resulting from the pandemic will leave permanent scars through global supply and trade linkages’ fragmentation, human capital reduction through lost schooling and work, and reduced investment.

The pandemic and impending crisis call for immediate action to reverse COVID-19’s effect on health and the economy, providing protection for vulnerable populations and offsetting a lasting recovery (IMF, 2020a). Developing countries and emerging markets already facing serious vulnerabilities need to address informality-triggered challenges, strengthen their public health systems, and deploy reforms to foster strong, sustainable growth after the health crisis. This paper looks into the effect of EU investment in the Middle East.

Running head: HOW THE CORONA VIRUS WILL AFFECT EU’S INVESTMENT IN THE MIDDLE EAST 1

Introduction

The European Union (EU) is an economic and political partnership representing several sovereign countries that have come together to form unique cooperation. It resulted from an integration process that started post World War II, with six initial member states from countries in Western Europe, to promote interdependence and prevent the possibility of another war breaking out in Europe (OECD, 2018). The EU has 27 member states, with the majority being countries in Eastern and Central Europe. It promotes stability, peace, and economic prosperity across the European continent. Traditionally, EU’s trade, foreign, and development aid policies focus on ten Southern and Eastern Mediterranean countries (SEMC) that make up its immediate neighbors. The SEMC countries include Tunisia, Morocco, Jordan, Egypt, Algeria, Israel, Libya, Lebanon, the Palestinian Authority, and Syria.

In recent decades, the EU has been a major development aid provider to the Middle East region. About €84 billion was invested in the region between 2007 and 2019, with major sources being Germany (€21 billion), the European Commission (€22 billion), and France (€15 billion). The European Invest Bank (EIB) has also actively invested in the Middle East, funding regional projects worth €21 billion from 2007 to 2020; about €6 billion was categorized as an aid during the same period (OECD, 2020).

Generally, the EU is a cornerstone of prosperity and stability in Europe. However, it currently faces various internal and external challenges. EU leaders focus their attention and time on managing the COVID-19 pandemic and its economic effects (WTO, 2011). Other issues that the EU is currently facing include backsliding of democracy in some member states such as Hungary and Poland, managing relations with the United Kingdom (UK) after BREXIT in 2020, the presence of anti-EU (to some extent) and populist political parties across the block, challenges posed by China and Russia, and ongoing societal and political pressure related to migration. The EU is also dealing with various effects of the COVID-19 pandemic on its investments in the Middle East and other world regions. Most of these challenges may have implications for the future character and shape of the EU.

More cases of COVID-19 infections are confirmed worldwide as the number of COVID-19 vaccine doses administered also continues to increase. The crisis of COVID-19 extends beyond health to impact education, jobs, the environment, food security, and more. The pandemic began as a health crisis but has rapidly spread to become an economic crisis for many countries and unions worldwide (WTO, 2011). The pandemic continues to impact lives, and more funding is available to respond to ongoing and emerging needs. Development banks, governments, philanthropic organizations, multilateral and bilateral donors, and the private sector continue to contribute equipment, money, and expertise to combat the crisis. This paper focuses on how the coronavirus will affect the EU’s investment in the Middle East.

Background of Trade Flows and Investment in the Middle East

Hydrocarbon exports have driven trade flows for the Middle East region for many years because it is home to the largest natural gas and oil reserves worldwide. Since the GFC, fuel exports share has decreased (The Economist, 2020). Although non-fuel exports in 2007 were below 25%, the figures increased in 2015. Fuel exports also contributed to a large share of exports in 2019. Oil price fluctuations affect the weight of fuel exports in the Middle East the most, with the 2014 oil price collapse contributing to the biggest fall. Due to the COVID-19 pandemic, it is only obvious that the prices declined further, affecting the exports. Fuel exports make up more than two-thirds of exports from the oil-exporting countries in the Middle East.

Non-fuel exports have also grown immensely from $38 billion in 2007 to $316 billion in 2019. 35% of all regional trade in 2019 was with countries in the Middle East (inter-regional trade increased from 30% in 2008). Greater economic integration in the Middle East region is a good sign, given the existing trade barriers and many frozen and hot conflicts (The Economist, 2020). Intra-regional trade and other economic unions have a better chance of growing if trade barriers can be removed and conflicts addressed. The EU is the Middle East’s second-largest trading partner despite a drop in its share of exports from this region post the GFC (the share in 2019 was the only one that rose above the 2008 figure). Most trade between the Middle East and the EU is with Spain and France. China increased its share of Middle East exports from 2% to 6%.

The EU remains a major trading partner of the Middle East region, receiving more than 15% of non-fuel exports. However, the Middle East also trades among its member countries, including North Africa, making it the greatest source of development for the MENA (the Middle East and Northern Africa) countries. The situation is different from an investment view (The Economist, 2020). Investment from other MENA countries to the Middle East is modest and dropped in the 2010s in absolute value and total market share. Even so, the EU is the largest investor in the Middle East. Foreign direct investment (FDI) from the EU to this region increased between 2009 and 2017 before gradually falling due to the COVID-19 effect.

The Impact of COVID-19 on the Middle East Region

The pandemic has caused an extra negative shock to the already fragile and stagnated macroeconomic scenario in the Middle East and Northern Africa (MENA) zone. Some effects include the effects of lockdown measures and the health crisis, dramatic declines in revenues from the tourism industry, temporary supply chains interruption, lower oil prices, and reduction in labor remittances (The Economist, 2020). According to the 2020 IMF forecast in October, GDP will drop in all Middle East countries except Egypt. Additionally, oil producers experienced oil prices collapse in 2020 due to the fall in global demand and the fragmentation of supplier coordination. Reduced GG revenues, the deep recession, and increased expenditure will further worsen debt-to-GDP levels and fiscal balances, which, in turn, may lead to more sovereign defaults.

Capital flight greatly hit the Middle East region between February and March 2020; the IMF estimated capital outflows to range from $6 billion to $8 billion, or even more (IMF, 2020a, 2020b). However, this shock was lower in other emerging markets than in former Soviet Union countries and Latin America (Dabrowski and Dominguez-Jimenez, 2020a, 2020b). Although the virus and its effects widened immensely during the first crisis, market confidence has since recovered, almost to its pre-COVID levels (The Economist, 2020). The enhancement in market sentiment is attributed to the significant fiscal policy and monetary response in developed economies, which has released the tension in financing conditions worldwide. Oil-producing countries with high credit ratings and those with lower credit ratings, such as Egypt, have maintained market access with local currency and dollar-denominated bonds.

Currencies in MENA countries have modestly depreciated except for the Lebanese pound. The currencies have also recovered (with a positive margin) after the first drop in March-April 2020. However, MENA currencies are tied to the dollar, and not all the currencies are fully convertible (The Economist, 2020). The IMF has offered emergency aid to many countries in the Middle East to help address the economic and social effects of COVID-19. For example, Jordan, Egypt, and Tunisia received the Rapid Financing Instrument aid, while Mauritania and Djibouti received the Rapid Credit Facility with concessional servicing terms. The two aids lack ex-post conditionality, meaning they will less likely activate structural reforms from regular IMF aid programs. The Jordan IMF aid program has been changed, Morocco drew from its precautionary credit line, and a new arrangement with Egypt (Stand-By) was approved (IMF, 2020b).

The Impact of COVID-19 on EU FDI Investment in the Middle East

This year, global foreign direct investment (FDI) will be under great pressure due to the pandemic. The resources will drop sharply below the $1.5 trillion figure in 2019. It will also fall below the global financial crisis trough and reverse the lackluster international investment growth amassed over the last few decades. Flows to countries in the developing world, such as the Middle East region, will be hit hard due to commodity-linked and export-oriented investments being the most affected (The Economist, 2020). The effects may last beyond the immediate effect on investment flows. The crisis could drive the structural transformation of the current global production, atop creating an opportunity for enhanced sustainability. However, this will depend on exploiting the new industrial revolution and overcoming increasing economic nationalism.

The COVID-19 pandemic will result in a dramatic FDI drop. The global FDI flows have been projected to reduce by about 40% in 2020 from a value of $1.54 trillion in 2019. Since 2005, the FDI figure will drop below $1 trillion for the first time. In 2021, FDI is estimated to drop further by 5% to 10%, with recovery expected to begin in 2022; this rebound is projected to revert FDI to its pre-pandemic state if all positive expectations come to pass. However, a lower forecast bound would further cause stagnation in 2022, reducing the global FDI value below 2019. Although the effect of the pandemic is severe worldwide, the level of impact varies from one region to another (The Economist, 2020). The biggest drop in FDI is expected to occur in developing economies such as countries in the Middle East because they depend on investment in extractive and global value chain (GVC)-intensive industries severely affected by the crisis. The economies are also bound to experience a larger drop in FDI because they cannot afford the same economic support measures as developed economies.

The immediate effect of the pandemic on EU investment in the Middle East will be dramatic. There will be a supply chain resilience push in the long term, and more autonomy in production capacity may result in lasting effects. Apart from the pandemic, other FDI game-changers include the shift of policy towards more economic nationalism, the new industrial revolution, and sustainability trends (The Economist, 2020). They will have lasting effects on global production into 2030. International production will experience an increasing focus on value addition, shorter value chains, and declining international EU investment in productive physical assets in the Middle East. As a result, MENA countries will experience several challenges because they founded their strategies for industrialization and development on increasing participation and capture of GVCs value, attracting FDI, and gradually improving technology in global production networks.

Anticipated changes in global production may create opportunities for development, such as the development of regional value chains, promotion of investment focused on resilience, and entry into new markets through digital platforms. However, there will be a need for a change in development strategies to exploit these opportunities. Investment oriented towards export and exploitation of resources, production, and low-cost labor will be critical. However, the number of such investments continues to reduce, meaning development progress will be harder to attain. Consequently, there will be a need to balance regional and domestic demand with promoting domestic and infrastructure services. Therefore, there will be a need to promote SDG sector investment. Existing EU investments in the Middle East focus on renewable energy, infrastructural value-creating projects, food and agriculture, water and sanitation, and healthcare, but not manufacturing (The Economist, 2020).

The sudden, simultaneous demand- and supply-side shocks together with reactions of policy towards the crisis worldwide continue to impact FDI. The immediate impact of the pandemic on EU investment in the Middle East is that it got stuck in lockdown. Due to the physical closure of manufacturing plants, business places, and construction sites to stop the virus from spreading, investment projects deployment experienced immediate delays. Although investment expenditures, such as the fixed costs of running projects, persist, other outlays were blocked entirely (World Bank, 2020). There is also a delay in announcing Greenfield projects. Mergers and acquisitions (M&As) have been suspended temporarily. Ongoing M & M&A transactions have also been delayed and thus risk cancellations; M&As and Greenfield’s projects are the EU’s long-term investment commitments to the Middle East. Similarly, financial markets have been reducing the stock prices of companies that have been affected by merger delays or takeover plans.

Short-term effects of the pandemic on EU investment in the Middle East include tightening margins for reinvestment and restrictions on new investment. The FDI is experiencing restrictions on market, operational and financial conditions, with plummeting profits in 2020. Most multinational EU enterprises with investments in the Middle East revised their expected earnings between February and May 2020 by 35%. The effect of reduced foreign affiliate profits on FDI could worsen because over 50% of FDI flows worldwide are linked to earnings from reinvestment. Governments introduced new requirements for screening and investment restrictions to prevent a shortage of critical medical supplies during the pandemic due to temporary restrictions on trade (World Bank, 2020). The EU gave out investment guidance for non-member states to protect the strategic assets of its member states.

On the other hand, medium-term effects of the pandemic on EU investment in the Middle East include navigating a worldwide economic recession. 2020 macroeconomic forecasts during the pandemic’s early stages were revised down into a negative trough. If economic activity picks up in 2021 due to policy changes, the recovery of GDP is expected to be highly uncertain and modest (IMF, 2020a). A steep reduction of demand in the EU will strongly reduce production in the Middle East region. New investment plans have been dampened due to uncertain economic prospects. Most businesses diverted their investment funds to working capital due to liquidity issues and financial distress. There is the likelihood of previously delayed projects (announced or ongoing) during lockdown measures to be aborted indefinitely.

Demand shock in 2020 and 2021 will affect FDI on a downward trend. The long-term impact of the pandemic on FDI (EU) in the Middle East will cause secure access to essential supplies and resilience of the supply chain. There will be a drive to boost strategic industrial capacity and increase regional or national self-sufficiency in essential supplies production. Other long-term effects of the pandemic on the EU’s investment in the Middle East include global operations rationalization, tighter global investment and trade restrictions, regionalization, near-shoring, and re-shoring (World Bank, 2020). Although the pandemic continues to impact the EU’s investment in the Middle East, measures have been put in place to help address the imminent consequences.

A Way Forward

The immediate and most critical challenge for the Middle East is dealing with the health emergency of the COVID-19. Some countries lack sufficiency in medical capacity and experience shortcomings in sanitation. With about 3 million refugees and almost 17 million internally displaced persons, the most fragile MENA nations are in a more critical situation (IMF, 2020a). Uncertainty looms in the coming months. A major obstacle to recovery is the subsequent pandemic waves and related measures of containment. Increasing poverty and hardship may trigger social unrest in Middle East nations that are already fragile politically. Therefore, the EU must update and upgrade its existing FTAs with partners in the Middle East region prepared for such a step. It should also strengthen inter-regional cooperation frameworks (within the UfM) in green energy, environment protection, research, education (providing scholarships, for example, to students in the Middle East), legal migration, and culture.

The COVID-19 pandemic may lead to a larger role for states and a move from market policies. If this happens, the EU will experience a hurdle in accommodating this change because it is currently focused on the single currency, the single market framework adopted during the economic liberalization (World Bank, 2020). Moreover, clashes within the EU could ensue from member state’s attempts to adopt more interventionist techniques, more so around taxation and fiscal policy, industrial policy, and labor markets and redistribution. The EU could easily drive collective change in such areas due to sufficiency in the consensus among its member states. However, the impending asymmetric impact of the economic crisis and political differences in Europe may lead to an uneven change in economic policy across the EU in response to the pandemic. The EU may be trapped in a suboptimal status quo with no way to change it, in turn, being unable to change towards a political economy focused on its member states that citizens may now demand. The EU may have to undergo reforms to accommodate an economic model based on a more interventionist strategy. Therefore, European leaders must cease to view the EU as a linear integration with irreversible policies or one that cannot change its course.

Strategic Policy Responses for Recovery

Investment recovery remains uncertain. However, the environment post-COVID pandemic will affect investor behaviors and investment policies. Governments adopt more protectionist policies and strategies to substitute imports and depend less on international value chains, such as Lebanon and Algeria (OECD, 2018). Barriers to entry and screening measures of importance in particular sectors may increase due to national security concerns. Even so, countries in the Middle East may experience an increase in emerging opportunities in sectors such as automotive other than oil and gas (OECD, 2020).