The future of the Middle East may hinge on the outcome of the Arab Spring. But sectarian divides and the possibility of an imminent conflict with Iran are of equal importance

In December 2010, Tunisian street vendor Mohamed Bouazizi’s act of self-immolation ignited a wave of unrest throughout the Arab world that shows little signs of abating.

The torrent of protests that swept president Zine el Abidine Ben Ali of Tunisia,president Hosni Mubarak of Egypt and Muammar Gaddafi of Libya from power – and could soon add president Bashar al Assad of Syria – has largely been confined to resentment over political and economic abuses.

But it is the prolonged crisis in Syria which may finally unhinge sectarian tensions amid uncertainties of what may follow. Noman Benotman, president of Quilliam, a London-based think-tank, believes unrest in Syria could radically alter the dynamics of the region. “The longer the crisis continues the more likely it is it will become sectarian,” Benotman says.

He says the presence of foreign jihadist groups with an allegiance to extremist causes rather than regime change pursued by Syrian rebels may cause a deepening of the crisis. “Terrorist actions by them,” he says, “could provoke a broader sectarian conflict about which I am very concerned.”

The nightmare scenario portrayed in the media of a regional Sunni versus Shia confrontation looks some way off, but simmering tensions in Lebanon and the risk of drawing Turkey further into conflict are possible trigger points. Then there is Iran: on the brink of an attack by Israel and desperate to prop up its ally, the Syrian regime of Bashar al-Assad.

The convergence of these events suggests a turbulent period, which Benotman says will linger. “This is an earthquake not [just] an Arab uprising, and for the next three to five years we are going to see a period of instability and insecurity.”

Egypt, Libya and Tunisia must resolve deeply rooted issues that could force them to over-promise but ultimately under-deliver. Libya faces an impending battle for control of natural resources, while in Egypt the government is under pressure to take decisive steps towards reform.

The main problem, analysts and observers say, is the youth jobless rate, with figures for unemployment in the 15–24 age groups very high. A recent report by the International Labour Organization estimates youth unemployment in the Middle East at 26.4%, 27.5% in North Africa and predicts the Middle East will rise to 28.4% by 2017. By contrast, global rates of youth unemployment are forecast to reach 12.9% by 2017.

It is a similar story for competitiveness. Egypt and Libya were ranked 107 and 113 respectively by the World Economic Forum in its global competitiveness report 2012–13 of 144 countries.

Nevertheless, there are grounds for optimism. Florence Eid, chief executive officer of Arabia Monitor in London, says the IMF loan to Egypt – with a deal expected in about two months according to comments by Egyptian prime minister Hisham Qandil – represents a step in the right direction.

“The IMF loan for $4.8 billion instead of the initial $3.2 billion is a gauge of Egypt’s ability to secure future credit lines,” Qandil said in September. “This could trigger a further inflow of capital with bilateral and multilateral assistance, especially from the GCC.” Egypt might even request more than $4.8 billion, he said.

Qatar plans to invest as much as $18 billion in industrial and tourism projects, and in June Saudi Arabia provided $1.5 billion in direct budget support.

Still, investors appear to be holding their breath with regional capital markets activity a long way off the peaks of 2010 before the onset of the Arab Spring. According to data provider Dealogic, international bond issuance and syndicated loans to the MENA (Middle East and North Africa) region, excluding Israel, totalled $94.8 billion in 2010 against $43 billion so far this year.

The ushering in of the Muslim Brotherhood in Egypt and Tunisia has unquestionably tilted the region towards conservative Islamist groups. At the moment that seems confined to flashpoints such as Libya and Tunisia where Salafists, ultra-conservative Sunni Muslims, have railed against what they consider as liberal tendencies.

In September events deteriorated when an attack on the US consulate in Benghazi killed the ambassador and three other Americans. The attack followed the broadcast of a US-produced video that insulted Prophet Mohammad and sparked uproar across the Muslim world. However, some Libyan officials have suggested the attack was preplanned to coincide with the anniversary of September 11, 2001 and revenge for the recent assassination of a Libyan linked to Al Qaeda.

In Egypt president Mohamed Morsi walks a political tightrope with the Salafist Al-Nour Party, a point which is worrying many.

So are Islamist groups about to gain the upper hand?

Benotman thinks mounting economic problems will force parties to embrace reform but not without challenge. “When it comes to the reality, [the Muslim Brotherhood] are very pragmatic and put all efforts behind their ideology to survive; that is what separates them from other Islamist groups.”

It is a view echoed by Eid. “We cannot see further into the future for the Morsi Cabinet, but they are likely to make efforts to provide an environment conducive to inclusive growth that is investor-friendly.”

However, the 100-day target Morsi has set himself to address fuel problems, subsidy reform, security, traffic and garbage seems ambitious, says Eid. His Freedom and Justice Party suddenly finds itself in the driver’s seat and appears to be struggling to deflect criticism over the rate of progress.

The leaders of the six-member Gulf Cooperation Council, dynastic monarchies for the most part, are nervously watching events unfold – suspicious of the intent of the Brotherhood.

Nevertheless, with oil prices hovering close to historic highs, they can stem unrest by effectively buying off dissent.

Saudi Arabia, the world’s largest oil exporter, is following a massive $133 billion plan equivalent to nearly $10,000 for every citizen, to boost welfare spending and build 500,000 homes and create jobs. Despite calls for a constitutional monarchy, it has granted only modest political reforms.

The United Arab Emirates also took similar steps by doubling the wages of some state employees and established a $2.7 billion fund to pay off the loans of low-income citizens, but has detained around 60 activists it accuses of having links to the Muslim Brotherhood. The Brotherhood is philosophically at odds with much of the hereditary style of government in most parts of the Gulf.

Bahrain remains a centre of unrest in the Gulf as protesters from the Shia majority clash with security forces of the Sunni-dominated government of King Hamad bin Isa al Khalifa. Though contained, local protests in Bahrain have reverberated in the largely Shia Eastern Province of Saudi Arabia and heightened sectarian tensions in Kuwait.

Regardless of their financial strength, many Gulf countries suffer similar problems of the wider region including youth unemployment and allegations of corruption. Nevertheless, spending power and a common enemy in the form of Iran will maintain popular support for these regimes in the short term.

Michael Stephens, a researcher at the Royal United Services Institute in Doha, says it is too early for radical change. “Gulf monarchies are simply not ready – nor are their respective populations – to move to democratic systems,” he says. “The desire must come from both sides, and it isn’t there on either side, but when the money runs out it will be.”

There are economic consequences, says Said Hirsh, a Middle East analyst at Capital Economics in London. “There is no doubt record levels of public spending in the Gulf have increased the risk of a fiscal squeeze,” he says. “But this needs to be balanced against very low debt and large foreign currency savings.”

According to Hirsh, Brent crude prices have averaged $60 per barrel since 2000, and following the recent fiscal packages, a price around $80 is required to balance budgets. “I would say an average of $75 will still be a comfortable price for the GCC, especially if the recent boost to production is maintained.”

IRAN, ISRAEL AND US ELECTIONS

The ebbs and flows over the seriousness of the threat posed by Iran’s alleged nuclear ambitions have become almost theatrical, but an attack by Israel remains the single event that could polarize the Middle East – and potentially the most disruptive event for the global economy.

Benotman says US elections in November loom large. “[Israeli prime minister Benjamin] Netanyahu sees this time as a golden opportunity. There is around a 50/50 chance of an attack.” But it is the aftermath and response from Iran that is a concern, says Benotman. “There will be a huge rise in state-sponsored terrorism.”

The mutual enmity between the Gulf monarchies and Iran is also a factor, says Stephens. “Lack of trust is perhaps the key here: the Iranians don’t trust the GCC states to be anything other than lackeys of the US and the forward posts for an attack on its nuclear facilities.”

Eid says Egypt will be less conciliatory towards Israel, but a change in foreign policy is unlikely. “The FJP (Freedom and Justice Party) and Morsi regime are likely to maintain closer ties with Hamas; we do not expect them to do so at the expense of US interests in the region, and attach a minimal probability to a severe deterioration of the relationship with Israel.”

The Arab Spring has fuelled a resurgence in Arab nationalism which may ultimately redefine the shape and form in the Middle East. Yet, it appears more likely to be nationalism within borders rather than a wholesale collapse in geographic boundaries. The former Yugoslavia’s redefinition along ethnic lines provides ample evidence of what happens when an old treaty becomes unsustainable.

The current turmoil is also about broader geopolitics. Syria and Iran represent Russia’s last meaningful relationships in the Middle East – the culmination of a largely unsuccessful foreign policy adventure. It is also not going to be an easy ride for the West, which would much prefer to deal with the Gulf monarchies, but they appear too busy looking East emboldened by their intrinsic economic power and overtures from China.

After all, some Arab nationalists have long wanted revenge for the Sykes-Picot agreement, the secretive agreement made between the UK and France with the acceptance of Russia in 1916 that controlled spheres of influence in the region. They may yet have their day.