Islamic State’s Dam Breaking Currents

ISIS’ march through Iraq and Syria waylaid regional markets as the international community scrambled to mount humanitarian and military responses with fighting for key infrastructure and territory centered on Baghdad and the Turkish border. Mosul with its dam and oil facilities has descended into urban warfare as the military under a new government tries to regain control, with Prime Minister Abadi attempting to unit sectarian factions and militias against a common enemy with the budget already stretched from lower petroleum revenue. Banks have been looted in conflict zones with plans for privatization and financial market development on hold as thinly-traded external bond yields jump. Turkey’s share gains have almost been eliminated as President Erdogan is pressed to join the military coalition against the terror group as Kurds accuse him of neglect while thousands of refugees from the besieged neighbors continue to arrive in overcrowded camps. The budget strain has reduced the primary surplus to 0.5 percent of GDP as growth will come in around 3 percent with the loss of export partners. The current account deficit should improve to 6 percent of GDP on diminished energy costs and consumer borrowing for import demand, but inflation is still at 9 percent mainly from lira depreciation with the central bank ready to intervene at the 2.5/dollar level with monetary tightening off the table for political reasons. Lebanese shares remain up 5 percent on the MSCI Frontier index as soldiers were captured and killed by ISIS and rival parties continue to bicker over the next president. Bank deposit growth of 5 percent has enabled subscription to another recent international debt issue, and the dollar peg has been steady with expatriate infusions. Basel III capital and liquidity standard implementation is on course and minimal Syrian operations have been maintained where feasible. Tunisia has been a main source for Islamic State militants and the stock market is flat with 2-3 percent growth expected this year going into the first post-2011 open elections. The World Bank has produced research on the former Ben Ali regime’s economic stranglehold but also criticized the lack of competitive and skills reforms since which have embedded a low-wage Europe-dependent enclave in its view.

Egyptian equities have kept 25 percent gains as President El-Sisi has been able to justify a hard-line Muslim Brotherhood stance in light of Iraq-Syria events and subsidy cuts demanded by Gulf donors have won investor praise. The IMF will conduct an Article IV review and may also consider a $10-billion range loan when a pledging conference is convened in early 2015. GDP growth rose to 3 percent and the fiscal deficit is near single-digits as a portion of output. Reduced oil import expense should allow faster clearance of foreign supplier arrears and Suez Canal earnings have improved as a parallel waterway project was inaugurated with $8 billion in domestic bond subscriptions as the leadership tries to clean the previously splattered scroll.