Is it calm before the storm? Analysts say it could end up either way
Some countries in the Gulf region have managed to tide over the global financial crisis without much damage, but city state economies such as Dubai have suffered their worst crisis and are still struggling to get out of its stranglehold. Now, with clouds getting darker over the European horizon, there is a chill going down the spine of all those who care. How is the European crisis going to play out in terms of its impact on the Gulf countries? There is a lot at stake in the answer; so everyone is worried; naturally so.
So far, the opinions are divided. Some feel that the GCC countries will emerge out of the phase without much trouble. Some others believe that the indicators are not quite reassuring as the implications are far and wide, and therefore, too early to be pronounced 'over'.
"There were fears that Gulf banks and financial institutions might also be exposed to the debt of these non-performing loans. Fortunately, the amount of Gulf exposure in this regard is limited and could be tackled, as most of the entailing obligations have been covered," said Mohammed al Asumi, a former adviser at the Dubai Executive Office and head of economic research at the state-run Emirates Industrial Bank, in an article.
"Despite the comprehensiveness of the euro crisis, its spillover effects and implications on the world's various countries and economic blocs vary, depending on the location of each economic bloc or country on the one hand, and their economic, financial and trade relations with the EU on the other......regarding the implications of the crisis on GCC countries, there are undoubtedly many possible ramifications that require immediate action in order to check the risks to Gulf economies," al Asumi said.
The Eurozone crisis today constitutes a real challenge for Arab and Gulf economies is view of the critical position Europe holds in today's globalized economy and its vital economic and trade relations with various economic blocs , he warns.
The impact of the crisis has been largely borne by global banks and financial institutions because of their exposure to Europe's faltering loans, particularly of Greece, Portugal and Ireland. There were fears that Gulf banks and financial institutions might also be exposed to the debt of these non-performing loans. Fortunately, the amount of Gulf exposure in this regard is limited and could be tackled, as most of the entailing obligations have been covered, he said.
However, some GCC institutional investors, including sovereign funds and investment banks, have suffered losses resulting from investments in distressed European banks. The EU write-off of Greece's debt will definitely have implications for Gulf institutional investors, who hold stakes in banks that are likely to see their share prices come down.
In terms of their impact on monetary and financial markets, the GCC stock markets have incurred significant losses in the wake of the euro crisis. During the first nine months of this year, GCC markets have dropped by a remarkable 12 per cent, losing about $70 billion dollars in market value, a decline exceeding the European money markets in relative terms, the analysts point out. According to al Asumi, this trend has puzzled financial analysts and market experts, especially as GCC economies are in a stronger position than their European counterparts, and rates of growth in the GCC countries have been high over the past nine months, supported by oil prices and the strong performance of non-oil sectors.
Monica Malik, Chief Economist at EFG-Hermes, has a slightly different perspective on the issue. According to her, developments in the Eurozone remain vital to the GCC, with European banks being the main foreign lenders, accounting for over 70 per cent of total BIS bank lending to the GCC.
"Currently, we see greater risks for GCC countries linked to accessing foreign funding at this stage, with the debt crisis impacting European banks, than at earlier recent crisis points, and then a possible further correction in the oil price. European banks are highly exposed to peripheral Eurozone debt, and the crisis has already spread to funding markets," she says.
So far this year project financing activity and interest have remained on track and solid, but focused towards hydrocarbon and petrochemicals sectors with strong sponsors with a past relationship.
However, Monica points out that there have been some signs of the Eurozone crisis in project funding. She cites the financing of Qatar's Barzan gas/NGL projec, which attracted 30 banks in October, coming in oversubscribed, and the pricing on the deal matching the lowest seen in the Gulf post credit crunch. But she notes the absence of French banks, which have been big lenders to GCC projects, and limited participation from other European banks, as a matter of concern.
"If there is a deterioration in access to financing due to global developments, we believe that the main impact is likely to be delays to project implementation. Foreign borrowing makes up a relatively small proportion of GCC reserves, but it will take time to shift funding sources. We expect government-related projects to remain on track, but there are greater risks to private investment plans. We have already factored this in to a degree, but not to the level of a possible unmanaged Eurozone default," she said.
Gulf central banks are not showing any nervousness, although there are not unmindful of the possible implications of the European crisis. Oman Central Bank executive president Hamood Sangour al-Zadjali, for instance, observed recently that although the Gulf countries would not be immune to a broader global slowdown, investments in European bonds by GCC banks are not so high and therefore the impact is not going to be great.
"However, our economies are dependent on oil; if there were to be any major slowdown in Europe and other parts of the world that would mean the impact on the oil price could affect us," he said on the sidelines of a banking conference in Frankfurt.
Perhaps, the area that should cause the biggest worry for the Gulf countries is the impact on oil prices, which have so far not shown any major sign of dropping below the psychologically significant $100-a-barrel mark.
According to Mohammed al Asumi, oil is at the forefront of the issues that may likely be affected by the developments as the euro crisis has led to a slowdown in domestic economies and growth rates have been revised down. "This in turn has led to reduced expectations regarding global demand for oil, which has been relatively balanced, thanks to growing demand in Asia. As is known, oil remains an important priority for GCC states because it lends stability to economic conditions and for financing their annual budgets that still derive 70 to 80 per cent of their revenues from oil," he said.
"The impact of the euro crisis on oil prices has been limited especially as OPEC has adopted flexible policies that have strengthened oil prices in general, thus limiting the adverse impact of the euro crisis on GCC economies," he pointed out.
Across the region, however, the picture is at least partly obscured by the spending plans that many governments have launched in response to the events of the Arab Spring, Jarmo T Kotilaine, chief economist at the National Commercial Bank points out. Keen to keep their populations peaceful, many have announced significant spending plans, amounting to 4.5 per cent of GDP in the case of Oman and as much as 25 per cent of GDP in both Algeria and Saudi Arabia.
The extent of these spending plans is one of the principal reasons why the World Bank in September raised its economic growth forecasts for the region to 4.1 per cent for the year, up from its previous estimate of 3.6 per cent. A further key factor was the high oil price, which will allow many Gulf governments to maintain high levels of spending, although it will also add to the pressure on the region's oil-importing nations.
But Kotilaine argues that all predictions of growth will have to be revised if the euro zone economy deteriorates more than is currently expected. "Should Europe and the US fall back into recession it will dampen demand for oil in those economies, leading to further price falls on international markets," says the NCB chief economist.
"Perhaps more worrying is the potential for the crisis in Europe to tip over into another credit crunch where banks become extremely reluctant to lend and financing seizes up again. This will be an issue for Dubai because it still has to refinance large amounts of debt," he adds.
Dubai, as with many Gulf governments, may also be affected by the falling value of investments it has made in Europe. There is thought to be relatively limited direct exposure to European sovereign debt by Gulf states, but many investors have built up shareholdings in European banks, he points out.
Monica Malik agrees that there are risks for Dubai if there is a marked deterioration in access to foreign funding for a sustained period, given the emirate's significant refinancing obligations. Access to capital markets and at improved rates also have been central to the improving the debt profile.
But she points out that Dubai's debt risks have fallen significantly, with the majority of 'Dubai Inc.' debt being restructured and an improvement in the economy. "We estimate that Dubai will have relatively small debt repayments in the fourth quarter of 2011 of around $600 million. The emirate is in a position to meet its short-term debt servicing obligations, but the challenges will increase in 2012. With the progress made with restructuring Dubai Inc debt, we believe that any difficulties would be a result probably of external shocks rather than domestic, and would be supported by further assistance from Abu Dhabi," she wrote.
An announcement by DIFC Investments that it has repaid in full an amount of $200 million to Deutsche Bank under the terms of a loan facility seems to strengthen her argument. "The repayment is positive news, and is evidence of our commitment to meet our debt obligations as and when they fall due. We remain focused on progressing our plans regarding the Sukuk commitment and we are confident of achieving a successful conclusion,' Shahli Akram Juma, Managing Director of DIFCI, was quoted as saying in a DIFC statement. The repayment related to a Multicurrency Term and Revolving Facility Agreement between DIFC Investment and Deutsche Bank, Luxemburg.
Another related development of significance is Standard & Poor's (S&P) announcement that it is reviewing credit ratings on 50 banks in the Middle East and North Africa under a new set of criteria, a move that could result in higher funding costs for lenders already hit by the euro zone crisis and the Arab Spring revolts.
The agency, which classified Bahrain's banks as the riskiest in the GCC and saw a weak credit profile for UAE lenders, expects more activity in debt capital markets as bank lending struggles, a senior S&P executive indicated.
The executive said that S&P expected European banks to be less active in lending in the GCC area given the euro zone crisis and higher capital requirements under Basel III. Given the funding and liquidity metrics of the GCC banks, excluding Saudi Arabia, S&P felt that the banking systems may lack the capacity to fill the potential funding gap, he added.
S&P points out that there were many companies planning to grow and needed to fund this growth. "Many companies in this region could do with additional capital. That probably will not be forthcoming. So it makes sense for them to consider more stable and longer maturity bond options," the S&P executive said.
© Banking & Business Review 2011
