Liquidity still the issue, projects pending

The focus of government monetary policy will continue to encourage bank lending to support investment programmes. That said, monetary developments have not been static. Central banks have been withdrawing from their recent ultra-loose stance and the liquidity support measures they introduced at the end of 2008.

The most effective measure to increase banking sector liquidity was for governments to substantially increase their net deposit position in the banking system. However, GCC net deposit positions have been falling from the second quarter of last year, as liquidity concerns abated and as governments found they needed to step in and fiscally support growth.

While access to foreign capital has improved, GCC governments have increasingly had to sponsor non-hydrocarbon projects directly. There has also been some suggestion that governments have invested funds in higher-yielding securities abroad. Indeed, at present only Oman has a higher government net deposit position than in December 2008.

We believe that the trend to utilise government deposits in the banking system will continue, although will be carefully monitored to ensure that ample liquidity remains — especially when credit growth picks up.

Kuwait continues to be the most proactive central bank in absorbing excess liquidity from the banking sector. It accelerated the issuance of treasury bonds from mid-2009, and particularly from last December. There has been strong demand for government debt, despite low yields, given limited lending opportunities. Moreover, banks have been increasing their overall deposit position with the central bank, driven by time deposits. Naturally sight deposits have been falling with the low interest rate environment. Kuwait was the last of the GCC countries to reduce interest rates in February this year, but we believe those cuts will have a limited impact until we see more lending opportunities linked to the government's investment programme.

Deposit positions

On the whole, GCC net government deposit positions are still ample and above their pre-crisis levels. However, Qatar and the UAE are exceptions, with the latest data showing that these two governments have turned from net depositors to net creditors to the banking sector.

However, the two countries have very different economic positions. In Qatar, there has been a marked acceleration in government credit growth as it pushes ahead with its domestic infrastructure projects. Government credit has grown by an average of 8.3 per cent month-on-month from last November to February this year. Despite this, private-sector deposit growth remains strong, and the loan-to-deposit ratio remains below its level at the end of 2008 and early 2009. With government spending remaining high and being multiplied in the economy, we continue to see strong deposit growth going forward.

Meanwhile, liquidity in the UAE remains the tightest out of all of the GCC countries, and Eibor has risen to a six-month high. The central bank held discussions with the banks in April in an attempt to reduce it. However, we believe that increasing the government's net deposit position, especially by increasing long-term deposits, will be important to improve the UAE's liquidity position. The difficulty currently is that the banking sector is finding it difficult to access longer maturity deposits, which are consequently becoming increasingly expensive. This, amongst other factors, is also constraining the lending ability of banks.

During the crisis, Saudi Arabia added US dollar liquidity through foreign currency swaps that were used to inject much-needed liquidity into local banks. According to Saudi Arabian banks, in late 2009 and the first quarter of this year, no US dollar swaps were conducted. However, long-term US dollar funding is important for Saudi Arabian, and indeed all GCC, banks as they increasingly get involved in lending to regional investment programmes. A number of banks have indicated that they are considering a bond issue to extend the maturity of their dollar funding bases. Saudi Arabia has particularly high project financing requirements, and the majority of recent projects in the kingdom have been funded by Saudi Arabian banks.

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ECONOMY: GCC COUNTRIES

Saudi Arabia

With the government pushing ahead with its investment programme, we believe policy is to ensure that sufficient liquidity is available, especially if oil prices fall and foreign sources of financing remain constrained. Importantly, the demand for funding will increase this year, given the tendering process. While accumulating net foreign assets can be converted into Saudi riyals as required, demand for US dollars will remain strong.

Aramco has decided to go ahead with plans to boost the country's refining output to 1.5 million barrels per day (bpd), despite difficulties with its joint venture partners. Its projects are vital to the economy, meeting structural needs and expanding the export base. In April ConocoPhillips pulled out of the proposed $10 billion (Dh36.7 billion) Yanbu refinery joint venture, as it looks to reduce its focus on downstream projects.

Saudi Arabia has to expand its refining capacity to meet growing domestic demand and export more high-value oil products as Asian demand increases. Despite being the largest global oil exporter, Saudi Arabia has to import refined products for domestic consumption. Rising domestic demand is also behind Saudi's focus on expanding by 50 per cent its gas production capacity by 2015. As with refined products, current gas production is not sufficient to meet domestic needs.

Nevertheless, the withdrawal of ConocoPhillips is likely to result in some project delay as it affects financing, and some time-sensitive contracts may have to be resubmitted. The financing side, however, benefits from the fact that Saudi banks were going to be heavily involved in the deal, and there remains strong interest by international banks for Aramco's projects.

Saudi Arabia has reached its goal of increasing output capacity to 12.5 million bpd by end-2009, with ample spare capacity of circa 4.3 million bpd currently. While it still plans to develop its fields to ensure that future demand is met and secure spare capacity of around 2.0 million bpd, the speed of development will depend upon global economic recovery.

We expect to see some tentative pick-up in credit growth from the current quarter, and that rental prices will continue to drive domestic inflation this year, given the current housing shortage.

UAE 

The Dubai government announced a debt restructuring proposal for Dubai World (DW) and Nakheel on March 25 this year. We believe the proposal was positive from an economic perspective and will substantially reduce systemic risks. Under the plan, a further $9.5 billion (Dh34.9 billion) of fresh cash was to be injected ($5.7 billion from an undrawn loan from Abu Dhabi, $3.8 billion from Dubai), with $8 billion destined for Nakheel.

The successful issuance of a $1 billion five-year note by Dubai Electricity and Water Authority (Dewa) in mid-April also was a positive development for the gradual revival of the UAE's corporate bond market. However, central to the strong demand was pricing, viewed by the market as generous, given Dewa's strong cashflow position and virtual market monopoly. The bond carried an 8.50 per cent coupon, with a spread of 592 basis points over US Treasuries. The note was oversubscribed, with an order book totalling $11 billion, and most of the paper placed outside the region. Nevertheless, this is the first US dollar benchmark offering completed by a Dubai corporate since 2008, and since the DW debt restructuring announcement. It is vital that this door was opened, given that Dubai corporates need to access international capital markets to roll over debt.

We believe that the further resolution of the restructuring plans for DW and Nakheel will be central in reducing bond pricing, although ultimately the track record and financial position of each individual corporate will differentiate the companies. Positively, Nakheel has started signing settlement agreements with its trade creditors, offering banks and trade creditors up to 40 per cent in cash (payments starting in June) and 60 per cent in a publicly-traded security with a 10 per cent annual return. However, the rate offered by Dewa and Nakheel on their recent bond issues has become a strong bargaining chip for banks in finalising an agreement with DW.

In a further positive move, Dubai is expanding the role of the government's Financial Audit Department. A new decree enables the monitoring of companies less than 25 per cent government-owned, and the free zone authorities. That increases fiscal visibility and consolidation of all government-owned companies and bodies.

KUWAIT 

Recently-released official data show that the current account surplus fell by 50 per cent in 2009 to $28 billion (Dh102.8 billion). The decline was the result of a sharp fall in oil revenue (42.4 per cent), although the overall decline in the trade balance was halted by the fall in imports (25.8 per cent), as domestic demand slowed, and by the fall in global prices.

Although the trend of lower import values was seen across the GCC, the fall in Kuwait was particularly notable, with a weak domestic environment as a result of a deceleration in government spending and the fallout from the difficulties being faced by investment companies.

We forecast a widening of the current account surplus to over 30 per cent of estimated GDP in 2010, on the back of higher oil revenue. However, we see imports again accelerating, as a result of February's approval by parliament of an $104-billion development plan and investment programme for the next four years, starting April 1.

In March information minister Shaikh Ahmad Al Abdullah Al Sabah, also oil minister, survived a close no-confidence vote, after being questioned for allegedly failing to uphold media laws and protect national unity.

There have been some tentatively positive signs that the government is making progress with the implementation of its programme. These include the number of projects being tendered, along with the rise in steel prices (partly reflecting increasing demand as well as the rise in global commodity prices). However, with projects just starting to be tendered, the demand for credit still remains low. Consequently, the government accelerated the pace of issuance of treasury bonds in April.

Meanwhile, a privatisation bill that allows the sale of some state assets was passed by parliament in mid-May in its first round of voting. The bill needs another round of voting, after study of amendments submitted by MPs. The draft law excludes the privatisation of companies operating in the upstream oil, health and education industries.

The government has been trying to pass a privatisation bill for over ten years. Even should it be passed, we do not expect an immediate pick-up in privatisation activity. But it would be likely to be very positive for sentiment.

QATAR 

Qatar announced the start-up of RasGas Train 7 in February, taking overall LNG export capacity to 51.8 million tonnes. This leaves two more trains (Qatargas Trains 6 and 7), which we expect will come online between the fourth quarter this year and first quarter next. The existing gas moratorium and limited spare oil production capacity means that Qatar's growth outlook beyond 2012.

Non-hydrocarbon will also continue to remain strong, with the planned expansion in Qatar's aluminium, petrochemical and fertiliser capacities coming on stream between 2010 and 2012. The recent announcement that Al Khaleej Gas Project Phase II (AKGII) is complete will be positive for Qatar's industrial expansion, as (along with the planned Barzan project) it will provide the required feedstock at much lower prices.

We believe that the deceleration in private-sector lending has bottomed out, and we will continue to see credit growth to the private sector gradually inching up (year-on-year) to a forecast level of 15 per cent year-on-year by end-2010, mostly directed towards government-linked projects.

We estimate that government spending as a per cent of non-oil GDP is the highest in Qatar among GCC countries, just above 70 per cent, providing strong economic stimulus. Investment spending constitutes 37 per cent of total planned expenditure, with around $9.8 billion (Dh36.0 billion, 30 per cent of total spending) allocated to infrastructure projects. Note that we believe that not all of Qatar's gas revenues are reflected in the official budget figures, which our estimates are based on; the actual fiscal position is likely to be substantially stronger.

With excess residential and commercial housing unit supply, we expect the rent, fuel and power component of the CPI to continue to contract on a year-on-year basis throughout the first ten months of this year before turning positive in November. However, Qatar will not see deflation becoming entrenched in its economy. Qatar's macroeconomic fundamentals are strong. Higher government spending in 2010, along with the forecasted strengthening in population growth, will continue to boost domestic demand and non-oil real economic growth.

OMAN

Despite the contraction in fourth-quarter 2009 growth, investment spending has been growing at double-digit levels, and we believe that this will continue throughout 2010, with government spending being the key to Oman's real non-oil GDP outlook. The expansionary budget that was approved earlier this year, with overall spending slated for a 12 per cent year-on-year increase to 7.18 billion Omani riyals (Dh68.5 billion), further underlines our view. Additionally, banks' risk appetite is improving, and more working capital and other financing needs are being directed to the private corporate sector.

Oman boosted its crude output in 2009, largely due to its implementation of enhanced oil recovery techniques over the past few years. The government plans to expand its output further, and reach a target production level of 900,000 barrels per day (bpd) over the coming two years (+10.8 per cent over 2009 levels). The ability to reach this level will depend on the government's commitment and fiscal ability to increase spending.

We are, however, confident on that prospect, and a number of official statements have reiterated the Sultanate's support towards increasing capital spending. Moreover, with oil prices currently at a comfortable level, we are even more confident. With a higher oil price estimate for 2010 ($80 per barrel for Brent crude), we are forecasting that Oman's fiscal balance will swing back to a surplus of $3.3 billion (5.3 per cent of 2010 GDP) after posting a small deficit in 2009.

Meanwhile, central bank governor Hamud Bin Sangur Al Zadjali has indicated that Oman plans to raise 122 million riyals in two Government Development Bonds (GDB) in 2010. The Omani riyal-denominated GDB issues have over the past two decades been closely linked with financing the government's five-year development plans and covering fiscal shortfalls. However, the build-up in fiscal surpluses since 2003 and strengthening of Oman's reserve position have limited the need for new bonds. Such issuances are, in our view, largely aimed at refinancing maturing bonds, while providing local banks (who are the largest subscribers of GDBs) with alternative investment opportunities.

BAHRAIN

Bahrain issued a ten-year US dollar-denominated bond in March, which was heavily oversubscribed, leading to an increase in the issue size to $1.25 billion (Dh4.59 billion) from $1 billion. Owing to its attractive pricing, offering a higher coupon (5.5 per cent) than the recent ten-year issuance of neighbouring Qatar (5.25 per cent), the bond managed to attract international interest. While this issue will help create a benchmark yield curve for future corporate and financial institutions' US dollar issuances, more importantly we believe that the Bahraini government is utilising improved sentiment levels and investor interest to diversify its financing sources. The increased borrowing levels will enable it to expand its planned expenditure and press ahead with projects it had previously put on hold or cancelled — especially as oil prices are now at a more comfortable level.

We are forecasting that Bahrain's fiscal deficit will narrow to a manageable $164 million (0.7 per cent of 2010 GDP) from an estimated $1 billion in 2009 (-5.3 per cent of GDP).

GCC-wide rising food prices will be a key driver of 2010 inflation. In fact, along with transport costs, food prices contributed most to the rise in March consumer prices to 1.8 per cent year-on-year. Prices for housing and utilities in Bahrain on the other hand contracted, from weak positive growth year-on-year in February. Rental price growth has been decelerating since the beginning of 2009, owing to oversupply, which is also leading to weak real estate activity.

Quarterly real GDP data (released in April for the first time) show that the construction and real estate sectors for the fourth consecutive quarter continued to contract in the last quarter of 2009. For the full year they saw severe contractions of 15 per cent and 9 per cent respectively in real terms, after positive growth over the past five years.

We believe that the more externally-facing sectors such as manufacturing and financial services (excluding offshore financial services) are currently seeing stronger activity, and are making up for the slowdown of domestically-facing sectors. Bahrain is benefiting from the regional economic recovery, particularly strong demand from Saudi Arabia.