Default swaps support recovery evidence in the Gulf

Improved sentiment has been evident in the Gulf over the past month as increasing belief that the worst of the financial crisis has aided the more positive environment. Regional equity markets have soared as the outlook has become a little clearer. Stock markets are nearly always a leading indicator of economic activity and corporate earnings, usually looking twelve months ahead. Much of the confidence for the Gulf has been generated by the stronger oil price, which flows directly to the domestic economies. The improved risk profile for the Gulf is also reflected in falling credit default rates for Gulf sovereigns, which have seen an improvement since the nadir was reached in early January 2009. Credit default swap rates, an insurance against losses on a security in the event of default and hence the market's perceived risk of the exposure, have fallen over the past few months from record highs seen in the early part of 2009. Back then, Dubai's credit default swaps for five-year sovereign US dollar debt was above a staggering 1,000 basis points, reflecting the market's very high nervousness about Dubai's debt level and capacity to service its obligations. The subsequent $20 billion (Dh73.4bn) bond launch with $10bn underwritten by the UAE Government, saw Dubai's spreads fall to the 750 basis point level, still very high by any standards. Since them, Dubai's spreads have narrowed to around 515bp. This is still the highest among the GCC states but the important point is sentiment is improving although challenges remain. Other current spreads for GCC countries include 370bp for Bahrain, 250bp for Abu Dhabi, 177bp for Qatar and 162bp for Saudi. All have narrowed over the past couple of weeks but of course remain considerably above pre-crisis levels. Although perceived risk through falling yields at the sovereign level has improved, and funding markets have opened up slightly for banks and corporates in the region, there remains many challenges for the banking and corporate sectors in the Gulf. Although the door has opened up marginally, liquidity and funding opportunities for financial institutions and banks remain very difficult. The interbank funding market remains tight as all institutions have reigned in exposures and loans, and reduced leverage. Most foreign banks have reduced their exposure to the region significantly and have cut credit lines, and regional banks are still extremely cautious. The big challenge is that many loans and facilities for both financial institutions and corporates are becoming due over the next six months, with some quite lumpy amounts. Many will need to rollover these loans. Some are trying to convert short-term facilities into longer term facilities, including bonds. Again, this will be challenging. Recent regional defaults such as those at The International Banking Corporation, the Saad and Al Gosaibi Groups, and their associated debt restructuring has created more uncertainty and nervousness, in part because it was largely unseen and there still remains much opaqueness and lack of transparency to the issues and actual financial positions of the groups. Falling sovereign credit default spreads accurately reflects the improving risk profile of regional sovereigns. However, spreads for corporates have not fallen. This, appropriately, reflects the continuing challenging conditions, particularly in respect to funding and liquidity.