June 20, 2013 / 4:53 AM / 4 years ago

MIDEAST WEEKAHEAD-Gulf markets can ride out political risk

* Escalation of Syrian civil war worries Gulf Arab states

* Saudi stocks suffer biggest one-day fall in two years

* But good economic backdrop expected to prevent any downtrend

* Kuwait faces political uncertainty before surprise elections

* But market sees good chance of another cooperative parliament

By Nadia Saleem

DUBAI, June 20 (Reuters) - Gulf Arab stock markets have been knocked back in recent days by a resurgence of political risk, both international and domestic, but economies in the region look strong enough to prevent the markets from suffering any lasting damage.

The escalation of Syria's civil war - with Iran-backed Hezbollah fighters from Lebanon intervening to aid President Bashar al-Assad, and the United States deciding last week to arm Syrian rebels - has worried Arab governments in the Gulf.

Meanwhile, Kuwait faces renewed political uncertainty after its constitutional court unexpectedly dissolved parliament on Sunday and called for fresh elections.

But economies are growing rapidly enough and oil prices are sufficiently high to prevent politics from derailing the markets' uptrends, unless political tensions increase further by a large margin, fund managers said.

"When the sell-off happened on the back of geopolitical moves and after a correction on foreign markets, we were confident the Saudi market would rebound," said Faysal Badran, chief investment officer at NCB Capital in Saudi Arabia.

"Political risk is difficult to price in, but Saudi is a very stable country and we don't see things changing internally."

REGIONAL TENSIONS

Saudi Arabia's main stock index plunged 4.3 percent last Saturday - its biggest one-day drop in over two years - after King Abdullah cut short his summer vacation in Morocco to fly home on Friday. The Saudi state news agency said he returned because of "repercussions of the events that the region is currently witnessing".

Other Gulf stock markets fell by smaller margins. Some investors fear Gulf Arab governments could become further embroiled in an indirect struggle with Iran over the result of the Syrian war, raising tensions throughout the region.

"The morphing of the Syrian conflict into an international proxy war raises regional geopolitical contagion risks and accentuates the sectarian divide" in the Middle East, Bank of America Merrill Lynch said in an economic report.

However, since Saturday the Saudi market has recovered most of its losses, and there are reasons to think the plunge was not the start of any downtrend.

Tensions with Iran do not appear to have neared the point where they could prompt Tehran to try to block oil shipments through the Gulf, the lifeblood of the region's economies. And as the region has discovered in the past, political tensions can to some extent actually benefit Gulf economies if they cause global oil prices, and therefore export earnings, to rise.

Also, many fund managers see room for the Saudi stock market , up 10.7 percent this year, to rise further on the back of solid corporate earnings growth. The kingdom's economy is expected to grow 4.1 percent in 2013, according to a Reuters poll of analysts in April.

While prospects for export-oriented petrochemical shares are murky because of an uncertain global economic outlook, stocks dependent on Saudi consumer demand - such as retailers and health firms - are still attracting strong investor interest.

"The rally will continue till year-end though it might take a break in the summer," when trading volumes traditionally fall because of holidays, said Hesham Tuffaha, a Riyadh-based fund manager. "There is a catalyst in terms of corporate results, especially in local-consumption sectors."

Iran's election last week of a new president seen as a moderate, Hassan Rohani, could conceivably help Gulf markets later this year if it produces a partial thawing of Tehran's relations with the West.

KUWAIT ELECTIONS

Kuwait's stock market faces a different political challenge: a court ruling that is expected to produce parliamentary elections in the next two months.

The court threw out opposition challenges to a new voting system introduced by the emir, but it also found a technical flaw in the process leading up to last December's elections, requiring a new vote to be held.

Kuwait's economy has been hindered for years by bitter feuding between parliament and the cabinet, which has delayed infrastructure plans and economic reforms. The last elections produced a parliament that was relatively cooperative, helping to cause a stock market rally; at the very least, Kuwait is now in for a period of political uncertainty before the next polls.

"Some short-term delay in public investment and economic reform may result from Sunday's ruling by the Kuwaiti constitutional court and the consequent dissolution of the government-friendly parliament," credit rating agency Fitch Ratings said in a report.

Kuwait's stock market, which is up 36.1 percent since the end of 2012, fell in the weeks before the court ruling.

However, it has stabilised since the ruling, and many fund managers do not expect a downtrend even if political noise increases before the elections.

For one thing, the court's decision to uphold the emir's new voting system may well mean the next elections produce another cooperative parliament, especially if, as seems likely, opposition figures again boycott the vote in protest.

"The constitutional court's approval of the one-person, one-vote system means opposition representation will probably be smaller than in early 2012, and the upcoming parliament will therefore probably remain relatively government-friendly," Fitch said.

Also, government-linked funds were seen intervening to support the market in the run-up to the court decision, and they may do so again if political tensions rise. The government's National Portfolio Fund was set up during a 2008 market crash to help stabilise stocks.

"If anything, the ruling might induce the government to play a bigger role in the market - it's not in anyone's advantage to let go of the year-to-date gains," said Fouad Darwish, head of brokerage services at Global Investment House in Kuwait. "The government is aware of this."

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