Developments in the Eurozone remain vital to the Mena region, especially to the GCC, with European banks being the main foreign lenders. The Eurozone has been an important source of foreign financing, 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.
There has been an increase in bank lending to the GCC since 2009, especially to Qatar and Saudi Arabia for project financing, and greater confidence regarding lending to Dubai after the restructuring of its debt. The non-GCC countries [in Mena] have been substantially less reliant on external funding for investment. For the non-GCC countries FDI has been a more significant driver of investment growth. It will be far more difficult for the non-oil exporting countries to compensate for the fall in FDI, which has continued to decline from 2007 levels, with weaker fiscal and reserve positions and thus generally a slower growth outlook regionally.
So far this year project financing activity and interest have remained on track and solid, but focused towards specific sectors (hydrocarbon and petrochemicals) with strong sponsors with a past relationship.
Governments, notably Saudi Arabia and Qatar, are continuing with major projects, including with foreign joint venture partners. Indications suggest that this is also the case for ‘Dubai Inc.' debt refinancing, with European banks continuing to participate at their usual level.
However, there have been some signs of the Eurozone crisis in project funding. Qatar's 1.4 billion cfd capacity Barzan gas/NGL project attracted 30 banks to its financing in October, coming in oversubscribed, and the pricing on the deal matches the lowest seen in the Gulf post credit crunch. However, there was a notable absence of French banks, which have been big lenders to GCC projects, and limited participation from other European banks.
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.
Our current scenario also expects a general increase in foreign pricing and an increase in interest ECA (export credit agency) loans, bond issues, and maybe even multi-currency loans, in order to raise the capital need by corporates. We note that there are already signs of greater domestic funding support for project implementation.
Saudi Finance Minister Ibrahim Al Assaf has indicated that Dow Chemical asked the Public Investment Fund (PIF) for a USD2 billion loan until it borrows from the markets to finance its project, one of the world's largest chemicals plants to be built in the Eastern Province. The PIF also approved a SAR4.0 billion facility to property developer Dar Al Arkan in October, to finance the Qasr Khozam development project in Jeddah. Moreover, we believe that government direct project sponsorship will remain high.
We note that GCC banks are in a better position to step in to meet any growth in credit demand than in 2008/2009. Indeed, half the banks involved in the Barzan project funding deal were regional, and made up for the more limited European participation. Regional lenders have booked higher provisions to cover non-performing loans, and liquidity levels remain ample. Recently, the loan-to-deposit rate has risen in Saudi Arabia as credit growth has picked up, but we believe that banks will reduce their non-statutory deposits at the central bank, and the government will add deposits if necessary.
Interbank rates have remained low, and there has not been an increase in the cost of funding. In the case of Dubai, domestic vulnerabilities are substantially lower after the restructuring.
Individual country risksWe see the greatest risk of a sharp external deterioration or shock for Egypt, Dubai and to a lesser degree Bahrain, especially in relation to access to foreign funding support. These risks would be largely mitigated by the fact that support is expected from regional governments (Bahrain and Egypt), the IMF (Egypt) and further federal support (Dubai) if needed.
Nevertheless, it is important to highlight the risks. We continue to see Qatar and Saudi Arabia having the strongest growth forecasts in the region, based on the strength of their domestic demand environment and the ability to continue with them in the event of another external crisis, supported by external reserves.
We continue to note that Qatar and Saudi Arabia have the most active investment activity in the GCC. In both these countries we do not expect to see a derailment in project activity.
In Qatar, the Barzan gas development is the last major gas development before the moratorium. We had already expected to see a greater focus on domestic funding with the investment programme shifting away from gas development, and view the 10.0 per cent increase in the share capital into a number of DSM-listed banks by the Qatar Investment Authority (QIA) in January 2011 as central to ensuring that they are in a position to fund the investment programme.
We see slightly greater risks of delays in funding to Saudi Arabia, although strong government support is likely to mean that project activity will remain solid. We have recently increased both our private sector credit growth rates for Qatar and Saudi Arabia for 2011 and 2012.
For Dubai the risks are related to the continued vulnerabilities of the debt profile. Debt risks have fallen significantly, with the majority of ‘Dubai Inc.' debt being restructured and an improvement in the economy. However, risks remain if there is a marked deterioration in access to foreign funding for a sustained period, given Dubai's significant refinancing obligations. Access to capital markets and at improved rates also have been central to the improving the debt profile.
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.
For Bahrain the tighter fiscal position means greater reliance on foreign funding and FDI for projects. We see most of the government projects aimed at reviving the economy kicking in during 2012. Bahrain is also looking to tap the sukuk market for $1.0 billion to help cover the 2011 fiscal deficit.
Bahrain initially looked to raise this amount by a conventional bond in February this year, but decided to hold off as a result of the political unrest. Credit rating agencies have downgraded Bahrain's rating thereafter, likely to push up Bahrain's borrowing costs upon returning to the market. However, we expect to see greater regional support for the country if required. Bahrain has indicated that it has already received a significant portion of the GCC fund, referring to the first elements of a $1bn tranche expected this year of the $10 billion total package.
The dollar and monetary union
The downgrade of the US's sovereign debt rating by one notch to AA+ in August by Standard & Poor's has led to questions being raised about the sustainability of US dollar pegs in the region. We believe that the downgrade will have only limited impact on currency policy in Mena in the short term, or on wider economic policy. We do not see it as a catalyst for GCC countries to move away from their currency pegs to the dollar, and we expect those to remain in place into the medium term.
Nevertheless, the rating downgrade highlights the challenges faced by the US economy. Moreover, the measures required to reduce the debt levels are likely to lead to a weak medium-term growth outlook. This, along with the rebalancing of the global economy, means that the dollar looks structurally weak in the medium term, and raises questions about its position as a reserve currency.
GCC countries are not now seeing the challenges as they were in 2007 and the first half of 2008 linked to dollar weakness and strong speculative inflows driven by currency reform expectations. Moreover, monetary policy in the GCC is in line with the US's policy at this time, with both looking for a weak policy environment. The weakening global growth horizon and a supported dollar will help reduce imported inflationary pressure in the short term. The currency reform debate could once again re-emerge in the GCC, but we believe that this would require a sustained weakness in the dollar and a sharp pick-up in inflation (which is not our core scenario). Even if there is some increase in market expectations of currency reform in the GCC, we do not expect this to reach the levels seen before the crisis.
Any currency reform, although not likely in the near term, would probably be in the form of an undisclosed trade- and investment-weighted currency basket, as is the case with the Kuwaiti dinar. We believe that at this point the GCC (excluding Oman and the UAE, which have pulled out of monetary union talks) remains committed to the formation of the GCC Monetary Union, which will be a first step towards any possible change in currency policy.
However, after the difficulties of the Eurozone, the GCC countries will look at the fiscal and monetary integration issues more closely. There has been limited progress on the fiscal and monetary harmonisation required for a monetary union. Thus, we believe that Gulf monetary union and a common currency are still some time away.
The writer is chief economist, EFG-Hermes