This euro crisis has legs in the Middle East

Regional bourses would be vulnerable to a euro collapse because it will drive interest rates higher, the dollar up and oil down.

Last Friday turned out to be a mental-health day for investors in Middle East stock markets. Geography and tradition combined to ensure that they were closed when Wall Street and Europe were undergoing plunges that, by some ways of figuring, were the worst ever. Trading had stopped by the time the US market opened on Thursday, the day the Dow Jones industrial average was down nearly 1,000 points, albeit for only a minute or so. The next day, when panic continued almost everywhere else, Middle East exchanges were closed for the weekend.

When they reopened last Sunday, traders were aware that a European Union plan to rescue, well, itself was in the works, so declines were far more muted than elsewhere. Losses in Abu Dhabi and Dubai were 1.4 per cent and 1.2 per cent, respectively. Markets soared around the world the next day when the extent of the EU support package - nearly US$1 trillion (Dh3.67tr) in potential assistance to weaker member states - became apparent. UAE indices rose about 1.5 per cent (compared with gains of 8 per cent in Europe), missing out on the manic part of the manic-depressive episode as well as the depressive part.

That remarkably placid trading could turn out to be the calm before the storm. There's no guarantee that the EU rescue programme will succeed over the long haul. If it doesn't and there is a further run on European markets or the euro, many other markets are bound to suffer, too. Some more than others. Middle East bourses, especially in the UAE, would be among the most vulnerable because failure to restore faith in Europe is likely to coincide with three developments that have been banes of Gulf economies and markets: rising interest rates on risky debt, weaker oil prices and a stronger dollar.

It may be unnecessarily gloomy to suggest that the EU plan might fail. Member states, with help from the International Monetary Fund, have pledged a massive amount of cash to save the euro and weak economies like Greece's, Spain's and Portugal's. The problem is it's not their cash to pledge. EU governments are already running deficits, so this batch will just be piled on top of it. They'll be borrowing money to reduce borrowing. Press reports last Monday quoted the governor of the UAE Central Bank, Sultan bin Nasser al Suwaidi, saying that events in Greece were having no effect on the UAE or the region and that he expects no further corporate debt restructuring's.

Perhaps, but Dubai is still working through its own debt troubles. A renewed aversion to risk among global investors could push up interest rates on all debt, not just paper issued west of the Aegean Sea. Declining oil prices reflect an aversion to risk, too, adorned by a veneer of macroeconomic analysis. The logic goes like this: A cheaper euro makes oil, which is priced in dollars, more expensive in Europe, reducing demand. It also lowers demand for anything produced outside the region - in Asia or the United States, for example - for the same reason, putting a damper on economic growth and again cutting demand for oil.

Whether or not investors were acting on logic, they managed to knock about $13 a barrel off the price of crude, or 15 per cent, in just three days during the plunge in stocks this month. The stronger dollar, still a haven for nervous investors, could be an even more ominous development because it represents one of the biggest threats that Middle East shares can face: an alternative. Bank deposits and money-market accounts aren't the stuff that dreams are made on, but interest rates are comparatively high in the region - a bit more than 2 per cent a year in the UAE if you lock your money away for long enough - and pegs of Gulf currencies to the dollar have enabled European expatriates to add substantially to returns when translated into their home currencies (although the same doesn't hold for Asians, whose currencies have been more resilient).

Deposits have gained nearly 10 per cent since the start of the year when measured in euros or pounds. That's far more than has been available on almost any stock exchange. The effort to stabilise the euro and European financial markets may yet be successful, but it seems risky to bet on it. Meanwhile, European savers in the Gulf who chose not to take the bet are sitting on decent returns and reaping an additional dividend: staying sane during a crazy time.

Conrad de Aenlle writes from Los Angeles about investment and personal finance issues. His blog on contrarian investing for MoneyWatch.com, "Against the Grain", can be found at http://bit.ly/NjaBa