GCC 'better placed' to deal with global crisis, oil fall

Given the increasing GCC financial integration with the rest of the world, the region may not be escaping the fallout from the global financial turmoil.

However, the GCC countries are better prepared to deal with the current global financial crisis and the decline in oil prices than in the past three decades, the Institute of International Finance (IIF) said in a new study on the impact of the worldwide financial crisis on the Gulf.

The main message of the report is that risks have risen, but remain localised and manageable given ample resources and improved macroeconomic fundamentals.

The GCC economies will experience a sharp drop in oil revenues and slower, albeit still solid growth in 2009.

The banking system is generally sound but there are specific risks that need to be monitored closely, particularly in wholesale banks and in connection with a possible reversal of the property boom.

The current financial crisis has partly spilled over into Gulf oil producers but their massive petrodollar assets will enable them to absorb possible severe shocks, said the Washington-based IIF, which groups many major banks from the United States and other countries.

The six Gulf Cooperation Council (GCC) countries, which control nearly 45 per cent of the world's extractable oil deposits, have entered the current crisis armed with an enormous overseas investment empire, large fiscal surpluses, high growth rates and a strong banking sector that has largely benefited from several year of economic boom, it said in the study.

Besides weathering the financial crisis, the six members will also be able to maintain reasonable macroeconomic stability despite a plunge in oil prices, said the 21-page study.

"Given the increasing financial integration of the GCC countries with the rest of the world, the region is unlikely to escape the fallout from the global financial turmoil… however, the GCC countries are better prepared to deal with the current global financial turmoil and the decline in oil prices than in the past three decades," IIF said.

"The region's transformation in recent years, especially greater diversification and the cushion built up in the form of large official reserves and foreign assets, should help it to absorb severe shocks."

IMPACT ON BANKS

IIF said it believes the impact of the financial crisis on GCC banks would be generally manageable.

But it acknowledged that some smaller banking institutions with a large proportion of lending directed towards the consumer and real estate sector, and with less rigorous risk management practices might be "put under stress".

The report said banks in the region with higher government participation are expected to be supported by the ample public resources available.

"While specific vulnerabilities have been revealed, the overall impact of the crisis so far has been limited, as these economies are underpinned by solid fundamentals and strengthened financial buffers," IIF said.

"This partly reflects banks' healthy balance sheets following a period of solid performance. A good portion of bank lending is to government-backed infrastructure projects (mainly in Dubai and Qatar), which tend to be well conceived and executed, and fully underwritten.

"The significant share of public ownership in local banks also provides some assurance to markets. By all indicators, the banking system is sound but there are specific risks that need to be monitored closely."

It noted that in 2007 and the first three quarters of 2008, profits of most GCC banks remained strong with average returns on equity of 21 per cent, supported until recently by a low-cost deposit base.

Capital adequacy stood at 13-20 per cent, far exceeding the minimum regulatory requirements, the report said.

It said good progress has been made in strengthening banking sector supervision and regulation while nonperforming loans as a share of total loans have declined in recent years.

"With the exception of few banks, the region's banks have been relatively less impacted by the global financial turmoil as compared with other emerging economies. The ample financial resources of the region, combined with the support measures taken by the authorities, should help to mitigate the adverse impact of the current global financial crisis," it said.

According to IIF, with the exception of few wholesale banks in Bahrain and a

couple of local banks in Dubai, the regional banking systems had less than 20 per cent of their total liabilities funded by

non-residents at the end of June 2008, compared, for example, with nearly 50 per cent in some Eastern European and Central Asian economies.

"As indicated by the relatively low ratios of loans to deposits, banks in the GCC countries (with the exception of banks in Dubai and Qatar) have relied more on domestic deposit growth to finance private credit, rather than increase in foreign liabilities, limiting their vulnerability to deteriorating global financial conditions … another source of strength comes from the limited role that structured financial products play in the region's financial activity and low direct exposure to subprime-related structured credit products," it said.

LITTLE DAMAGE

The report said the effects of the financial crisis has been felt in the GCC mostly in equity markets, dollar liquidity strains, higher funding costs, and widened CDS spreads for both Dubai debt and corporates.

"Nonetheless, the GCC countries are relatively well positioned to withstand the effects of the current global credit crisis with little enduring damage. Overall the risks are containable given the ample resources of the region and strong macroeconomic fundamentals," it said.

It referred to what it described as an ambitious investment programme being undertaken by the GCC nations to expand capacity in real estate, tourism, transportation, manufacturing, and hydrocarbon sectors.

These investments exceed $1 trillion (Dh3.6trn) for the next five years (about the combined size of the GCC economies) even after assuming that half of the planned projects will be cancelled or postponed due to the current global credit crunch, according to the study. "When fully implemented as planned and inflationary pressures ease, they could set the stage for structurally higher productivity growth and output potential," it said.

"While external corporate financing has become difficult and more expensive, the anticipated slowdown in investment by the private sector could be supported by ongoing government funded projects."

GDP SLOWDOWN

But the report said it expected a slowdown in the GCC economies because of the global financial turmoil and the sharp decline in crude prices.

Its figures showed real GDP growth would slow down to around 4.2 per cent in 2009 from 5.7 per cent in 2008 due to reduced oil production, tighter credit conditions, and substantially lower oil prices.

Non-hydrocarbon real GDP growth for the region is projected to fall to 5.4 per cent in 2009 as compared with 6.5 per cent in 2008.

The report noted that the extent of the slowdown varies considerably across the GCC region, depending on the speed of the earlier expansion and the stance of macroeconomic policies.

Growth in the region will continue to be driven by private construction, retail trade, and transportation, spurred by the oil-financed fiscal stimulus and by improved business environment, it said.

INFLATION

As for inflation, which hit double digit rates in most GCC members this year, the IIF said it had started to climb down and could plunge in 2009.

"If managed skillfully, the slowdown in growth could carry a silver lining as the GCC economies have been overheating with GDP growth above potential and inflation rising rapidly. In a non-financial crisis environment, a moderate slowdown in the GCC would have been welcome," it said.

"Until mid-2008, the main concern was overheating, with headline inflation running as high as 15 per cent in Qatar and the UAE. We expect a notable slowdown in credit growth, from levels that were clearly excessive, during the second half of 2008 and into 2009.

"This, combined with the recent modest strengthening of the dollar and some further decline in commodity prices, should lower the average inflation from a peak of 12 percent in 2008 to 8.5 per cent in 2009."

FISCAL SURPLUS

With regard to the oil market, the report expected crude prices to tumble to an average $75 a barrel in 2009 from an expected $105 this year.

It said the decline would depress the GCC fiscal surpluses but they would remain high.

"The fiscal position will remain in large surplus of around $140 billion in 2009 (13 per cent of GDP) as compared with $291bn in 2008, despite a continued rise in government spending… An increase in government spending may offset the modest slowdown in spending by the private sector as a result of tighter credit conditions," it said.

"We believe that the GCC countries could maintain macroeconomic stability even in a situation of a sharp fall in oil prices." Its estimates of the export price of crude oil that will balance budgets for 2009 are: Qatar and the UAE below $40 per barrel; Kuwait and Saudi Arabia around $50 per barrel; Bahrain and Oman around $70 per barrel.

It said that if oil prices stay in the $60-65 range through 2009, then both the account and fiscal balances will be in significant surplus, of $70-90bn.

"The region has entered the current period of global financial turmoil from a position of relative macroeconomic strength," the study concluded.

"Pubic domestic debt is insignificant and all GCC countries are net external creditors. Net foreign assets exceed 150 per cent of GDP in Kuwait, Qatar, Saudi Arabia and the UAE, and international reserves of Bahrain and Oman have increased to comfortable levels, far exceeding short-term debt.

"Available indicators of financial soundness show that the region's banks are in a generally strong position.

"Data through June 2008 showed high levels of profitability, low nonperforming loans, and high capitalisation levels."

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