Oil earnings to help UAE ride out crisis

The massive mid-year surge in oil prices has created a fiscal buffer for the UAE in 2009, while a quick Central Bank response to the credit freeze has placed the country's banking sector in a strong position.

These are some of the views expressed by top finance professionals – Frederic Sicre, Executive Director, Abraaj Capital; Ziad Makkawi, Chief Executive, Algebra Capital; and Hani A Kablawi, Managing Director and Head of Middle East & Africa, The Bank of New York Mellon – in an Emirates Business Round Table on how the UAE economy has performed in 2008 and the challenges that lie ahead.


2008 has been a tough a year for the global economy, with the US, the UK, Japan and much of Europe officially in recession. What is your global outlook for 2009?

Sicre: Everyone is realising that 2009 will be a year of uncharted waters. From the end of 2008 and into the start of 2009, the global financial sector is being hit hard. The real economy is next, as can be seen in the US car industry… We're starting to see the consequences of the financial meltdown.

Next year will provide smart players with the opportunity to continue to prosper. There will be a cleaning up of the system, with inefficient and over-leveraged companies ripe for takeover. There will be consolidation plays, and there will be winners and losers.

The smart companies that have the right skills and governance systems in place will be able to view the forthcoming year with a good degree of optimism. It's time for all corporates to do a thorough review of their strategies, taking into account the changed global situation. The severity of the financial crisis can be shown by the fact the total investment in alternative products, some of which are known and some unknown, now stands at $1.4 quadrillion (Dh5 quadrillion), which is over 22 times global GNP of around $50 trillion.

This quantum is on such a scale that we have never had to measure investments in terms of quadrillions before in our history. It goes to show the severity of the situation and could signal that more surprises might be unveiled along the way.

We tend to agree with most of the people we speak to who believe the global economy is facing two difficult years and that this period has only just started.

Makkawi: Predictions on what will happen over the next six months are pointless. Events are unfolding at such speed that month-on-month we are witnessing sea changes in the global economic landscape. This same speed also means that companies and businesses that are financially weak or over-leveraged will not survive for very long and the dust should start settling by the third quarter of 2009. Only then will we be able to regain some degree of visibility. We are, in other words, right now in the fog of war.

Kablawi: The current situation can be divided into a financial crisis and an economic crisis. We believe that much of the former is behind us. The central banks and ministries of finance have co-ordinated their actions to stem the crisis that struck many financial institutions around the world. That's not to say there won't be more consolidation.

This phase of the crisis may be ending, but we're only at the beginning of its impact on the real economy and globally the outlook is difficult, with a tough operating environment for institutions. They will have to give up a lot of their gains of the past couple of years in the form of provisions or lower loss reserves. Institutions that didn't have much balance sheet exposure are facing lower growth.

In the recession, spending will decline and saving will increase. Deleveraging is continuing at the corporate and institutional level and is now moving down to the individual level. House prices are falling and so people are feeling poorer, which means they will spend less and instead focus on paying off their debts. This deleveraging has been long overdue; it just required the US sub-prime crisis to act as the catalyst.

The crisis in developed markets has also hit the Gulf, with oil plunging from a high of $147 per barrel in early July to less than $40 today. What will the effect of this be on government infrastructure spending and how will this affect the economy?

Sicre: Government spending in our region will slow down to a certain extent. Credit and leverage is not so easy to come by and is more expensive. In times of uncertainty, it would be absurd to follow a strategy of denial and so we're likely to see state spending revised downwards, but not massively. The surpluses with the oil-producing nations are such that spending can continue.

If governments were to continue infrastructure spending at the rates at which they have been doing, they would need to find $3.6trn between 2008 and 2020. And if oil was to stay at $50 a barrel during this period and production remained at current levels, this would create revenues of $4.7trn.

The consensus view is that oil will average $75 a barrel for the next two to three years. So it's clear that there's cause for optimism as far as growth fundamentals are concerned – these being oil generated liquidity, continued economic reform and demographic growth.

Makkawi: We don't believe that government infrastructure spending should or will be impacted. The need to upgrade the infrastructure in the GCC, to create jobs and allow for the diversification of the economies away from oil and gas means that these projects are strategic. The impact will, however, be felt in the broader private sector, in particular with small and medium size companies that will not have easy access to credit. Infrastructure by definition is long term and there is no doubt in our mind that the long-term price of oil will be above $50 per barrel, which means that fiscal spending will not be curtailed.

Kablawi: Government infrastructure spending will clearly slow down. A lot of announced projects in both infrastructure and real estate were planned and based on much higher oil prices than today's, so much will depend on where oil prices move to and they're obviously very difficult to predict at present.

The consensus forecast is for between $50 and $70 a barrel in the medium term, with the regional governments needing prices at the upper end of this scale to meet budgetary requirements and have enough for infrastructure spending as well as adding to sovereign reserves. This will result in the halting of some of the more ambitious projects that have been announced over the past 12 months.

The crisis has been a double whammy for the Gulf, with lower oil revenues combining with more expensive borrowing costs. Dubai has sent a positive message to the markets by paying off some of its debt in recent weeks and the focus will be on the size and location of debt maturing in the next 12 months. Many companies may opt to deleverage rather than refinance at higher costs.

When the credit crunch was in its infancy, many commentators believed the cash-rich UAE would be unaffected, but the abrupt exit of foreign funds left local banks struggling for liquidity. How do you see this unravelling?

Sicre: The UAE Central Bank was one of the first globally to react positively and inject money into the banking system. Most of the banks in the region are not over-leveraged and their liquidity ratios are good. If you look at loans-to-deposit ratios, the GCC average is 87 per cent, while in the US this figure is 358 per cent. American banks are in a far more precarious position, as we have seen. Gulf banks are solid and well capitalised and fairly liquid.

Makkawi: Like banks everywhere, the credit crunch has hurt the financial system and through it the real economy. There is no systemic risk to the banking system in the GCC because their degree of leverage is nowhere near the levels of many of their international counterparts. The problem has to a great extent been identified and there are solutions being put into place. Regulatory review will be a global phenomenon and we will go through a phase of increased regulation in general.

Kablawi: The UAE Central Bank has been doing a good job in providing banks with liquidity. Most banks have opted to slow down their lending and have taken up the central bank's credit facility, which is a key difference between this region and developed markets. This region has no shortage of liquidity, but the banks have become more conservative, with tougher requirements for both corporate and individual borrowers. Maybe they will never lend to the same relative extent as they did in late 2007 and early 2008.

By central bank standards, loan-to-deposit ratios reached a very high level in the UAE, while overseas funds were pumping money into the country in the hope of a revaluation of the dirham against the US dollar before being withdrawn as the financial crisis struck. In the long term, the contraction in credit can be a good move, with a healthy slowdown and deleveraging of the economy.

What additional measures can be taken to get banks to lend again? What effect will this have on the UAE economy in 2009?

Sicre: Bank lending is a factor of trust. Borrowers and lenders are sitting on the fence until the end of the year at least. That's because there's a lack of clarity and people aren't very confident about the economy. According to the IMF, the UAE economy will grow 5.9 to 6.1 per cent in 2009. This is plausible, but the turbulent times we are living through makes forecasting very difficult.

The region needs leadership and the Gulf governments should be very forceful in continuing to show their confidence in their economies and act together.

The Gulf can provide one of the few bright spots in the global economy. The region is sitting on 60 per cent of the world's proven oil reserves and this can be leveraged for further growth in the wider region. Healthcare, education, energy, petrochemicals, transport and logistics are all UAE sectors in which private sector players are expecting double-digit growth next year. It's not a question of living in La-La Land and thinking we are immune from the global downturn, but the fundamentals of the region remain strong.

In terms of real estate, transparency in the UAE is improving and recently introduced regulations have cooled the sector down, which is helping to get short-term speculators out of the market and creating a correction which was unanimously expected to occur.

Makkawi: Once the central bank has made available lines to the banking system and guaranteed the interbank lending as is the case in the UAE, it is mostly up to the banks whom to lend to and on what terms. Certain measures can be introduced, namely to lower capital adequacy requirements on lending to specific types of businesses or making the liquidity contingent on the banks lending to strategic sectors.

The UAE economy will continue to weaken for the next six months as the impact of the credit crunch takes its toll on the real economy. However, most asset prices already reflect a worse-case scenario which we do not subscribe to, hence we see interesting opportunities for investors with a two or three-year time horizon. There has been a disconnect between asset prices and what we consider to be fair market value. During the course of the second half of 2009, we should start seeing some bottom-picking and at least a greater degree of clarity.

Kablawi: The energy sector is driven by oil and gas prices and we expect the Qatar and UAE economies to fare better than the rest of the GCC. Both Qatar and the UAE will be protected by the fall in oil prices because they have successfully monetised their gas reserves. The good news is that the Gulf has done a pretty good job over the past few years in building up reserves, both in foreign currencies and through the respective central banks and sovereign wealth funds. They have been saving for a rainy day, which is now upon us.

In terms of the UAE real estate market, the current correction is positive. The market must be supported by end users, whether they are permanent residents or people buying holiday homes. This will create a real supply and demand dynamic, rather than one distorted by speculators.

When will lending resume and the crisis recede?

Sicre: At Abraaj Capital, we're not so dependent on bank lending, contrary to private equity firms in the West. In our business, the returns we have been achieving have not been based on a huge amount of debt. Our returns have been based on the growth story which the Middle East, North Africa and South Asia region has to offer. It's about taking national champions and growing them into regional players. It's about operational enhancements in the companies we acquire. It's about platforming strategies.

Basically, it's about building regional brands which in turn can play on the global stage. And when it comes to debt, well, capital will still be attracted to good deals and the best deals in our business are probably just starting to appear over the horizon.

Makkawi: At this point, it is difficult to determine or predict when the crisis will recede. What we need, and should focus on, is having a real understanding of the scale and magnitude of the current crisis, in order to come up with suitable and effective solutions. However, considering the quick pace by which the economic conditions are deteriorating currently, we might get a clearer vision of the crisis over the next six to 12 months, and only then will we be able to predict an approximate time for recovery, based on the extent of damage cause by the crisis.

Kablawi: It will take a while, but again this can be seen as positive, with the loans-to-deposit ratio coming down. Lending will return to former levels in absolute terms, but will it return to the same loans-to-deposit ratios? Maybe not. Banks should let deposit growth dictate loan growth, not the other way around.


Real estate sector to emerge stronger

Ziad Makkawi, Chief Executive of Algebra Capital, believes that once it gets past short-term adjustments, the UAE real estate sector will adopt effective policies that will help it emerge stronger than before. His view on some sectors of the UAE economy:

-Real estate: Short term there will be pain with many overleveraged buyers unable to make their payments. Also the lack of available mortgage financing in the short term means that this will preclude new buyers to come in to the market. In the medium term we expect the real estate sector in the UAE to go through healthy reform measurements, and I believe that the current crisis will force real estate companies to adopt more effective policies that will help them get out of the situation stronger than before. Smaller players in the sector are expected to have financing problems.

-Banking: The banking sector is struggling with the shortage in liquidity and a gap between deposits and loans. The involvement of central banks will eliminate any systemic risk to the sector, and help rectify the situation.

-Energy: Considering the limitation in oil resources on the global level, compared to the continuously growing demand, I believe the current decline in oil prices is temporary, and that average oil prices will on average be substantially above $50 per barrel over the next 10 years. However, GCC countries need to focus on diversifying and expanding their economic basis, which will help create more job opportunities.

-Insurance: There is a tremendous opportunity for consolidation in many sectors and insurance is one of them. We will see strong growth in the insurance sector as the regulatory environment continues to evolve.

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