Dubai: Unsurprisingly, Qatar has been on the investor radar particularly with regard to the banking sector liquidity, higher cost of funds, inflation notching up, capital flight, slowing non-oil GDP growth, dent on current accounts surplus and threat to currency peg. Although there remains a lot of positive vibes around World Cup 2022 projects, the key concerns remain on the funding side, not just the ‘how of it’, but the cost associated with it.

Qatar is running out of dollars?

Though the domestic situation in Qatar has broadly stabilised, with basic essentials being replenished (at higher rates, though) and alternative shipping routes having been identified, the bigger economic threat such as shortage of banking liquidity, lack of availability of dollars, and the sustainability of USD peg, continues to linger in our view.

Our channel checks indicate that the foreign exchange activity has come to an abrupt halt in recent times, and the banks are less willing to part with the dollar. As a result, a bid as high as 100 bps over Libor is ignored by the local banks. A similar picture is visible as the 3-month Qibor interbank market remains elevated at 2.42 per cent, much higher than the pre-crisis levels (1.90 per cent).

According to recent central bank data, capital outflows through the banking system have accounted for as much as $27 billion ($15 billion in June, $7 billion in July and $5 billion in August) in total, since the crisis. Bloomberg also recently quoted that the foreign banks were forced to use offshore currency market to fund imports and other commercial activities for local clients. As suggested, Qatari riyal fell as low as 3.80 versus the dollar early this week, the weakest level in three decades in offshore currency market. While, the central bank’s direct or indirect intervention to defend the peg is inevitable, it remains to be seen if the momentum can be sustained in the medium term, especially with sparse net CB reserves of around $39 billion.

Beyond the balance sheet of the Central Bank, Doha could deploy about $340 billion of reserves resting with QIA, however the extent of the liquid nature of the sovereign funds is questionable. The central bank and the Qatari lenders have more than once reiterated that the currency market is functioning without disruption, although we believe dollar liquidity stress is far from over.

QIA has to pump $55 billion in the medium term to keep banking sector afloat

Qatar now expects infrastructure bill for the 2022 World cup to stand between $8 billion to $10 billion (a 40 per cent reduction from the initial budget). Given that these could possibly flow through the banking systems, we would conservatively expect sector lending growth to be around high single digits for the next few years. The banks need to lure more deposits into their coffers to finance these projects. More importantly, banks have to stop the outflows of non-resident deposits or compensate it with inflows from QIA/public sector deposits.

For the purpose of analysis, if we assume that the non-resident deposit outflows gets successfully curtailed and loans-to-deposit ratio remains stable, then the banking system would need $55 billion of new deposits to fund the projects in the next two years.

While we expect sovereign to provide ‘just enough’ to help the banks out of this situation, the other option is to bridge the funding gap by tapping the international debt market. However, note that Qatari banks already have a significant proportion of foreign liabilities ($100 billion) majority of which we believe to be short-term. More new issuance of external debt raises their vulnerability of leaving a large portion of the funding to finance long-term local projects, resulting in a significant open position in USD, which is not entertained by the central bank.

IMF appears too optimistic, could downgrade GDP numbers in next review meeting

IMF cut Qatar’s GDP outlook by just over 0.9 per cent to 2.5 per cent in 2017E and increased FY18E projections to 3.1 per cent. However, we view that IMF expectations are eternally optimistic. We note that Qatar’s GDP growth expanded just by 0.6 per cent in second quarter, a lowest rate since 2008/2009, driven by weak growth in the oil sector. We see more reasons to believe that non-oil GDP could slow further (such as tourism, financial services), going forward. On that note, we anticipate IMF to revise Qatar’s GDP projection downwards in the next review meeting.

Valuation of Qatari banks heading to new normal?

On valuations, running parallels with emerging market, we see the spread (between Qatari banks and EM banks) has narrowed significantly, as a result of the negative drivers in Qatar, and positive ones on EM. Qatari banks are now trading at a meagre premium of 9 per cent to MSCI-EM banks, as against the historically premium of 35 per cent. Locally, Qatari banks have traded at a significant premium to the UAE banks (both ADX and DFM) and the Saudi banks. However, more recently the sector has lost its shine and the banking index cracked down 15 per cent, thus narrowing the valuation premium to 15 per cent-20 per cent to Saudi and UAE peers. We anticipate this valuation premium to further narrow and fade over time, resulting in a new normal.

The author is a Vice President - Research at SHUAA CAPITAL, and can be reached at im@shuaa.com.