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The Future of Gulf Capital Markets

Matein Khalid (Money Maze) / 20 July 2009

THE sheer scale, swiftness and trauma of the global tsunami has exposed the deep flaws in the banking systems, money markets, risk metrics regulatory regimes and governance protocols in the GCC.

Even though media and official cheerleaders predictably insisted that the Gulf was “immune” from the woes of Wall Street’s credit meltdown, the region was not spared a nightmare of corporate defaults, property and stock exchange crashes, bank funding crises, money market nervous breakdowns, economic recession, sovereign debt time bombs, regional contagion, a consumer credit shock and an exodus of both flight capital and expat populations. In fact, not only was the GCC not decoupled from Wall Street, the credit crunch demonstrated that the small, open economies of the GCC (other than Saudi Arabia) were dangerously leveraged to the global business cycle. Why? All GCC states rely on petrocurrency revenues and oil prices plunge in a recession. GCC economies are also reliant on such notoriously cyclical industries as petrochemicals, aluminum, luxury tourism, property, shipping, aviation, logistics and finance. GCC states also borrowed on a prodigious scale to finance their economic development in the Eurobond and international bank syndication markets. However, with $1.5 trillion in money centre bank writedown and counting, the Gulf can no longer depend on offshore money to finance its projects and industries, let alone its extravagant consumerist culture and go go property speculation. It is mission critical that bankers, borrowers, governments, savers, investors and homeowners understand the embryonic new rules of the GCC capital markets.

One, as long as the GCC maintains its dollar peg, its banking systems, property and stock markets will import both inflation and deflation from Wall Street and regional central banks will be powerless to use monetary policy as a shock absorber in the local business cycle. The result? The wild booms and ruinous busts endured by the Gulf in the past decade will continue.

Two, credit powered property and stock market bubbles will simply not happen. Property priced soared because bank credit growth in Qatar, Kuwait and the UAE ran to as high as 50 per cent per annum. This was only possible because banks used cheap offshore funding to finance white hot local property speculation loan books. This is impossible now. Western money centre banks will no longer lend untold billions in cheap money to the Gulf because their own balance sheets must shrink. Loan growth rates triple deposit growth, so common in UAE banking during the boom, is mathematically impossible. The GCC banking systems (ex Saudi) are overleveraged, with loan deposit ratios in excess of 100 per cent in most countries. Bank credit growth will shrink, not soar, making it impossible to finance future asset bubbles.

Three, the default of Kuwait’s Global Investment House (the largest independent investment bank in the GCC), the devastating currency losses at Gulf Bank and CDO writedowns in banks such as GIB, ABC, ADCB will retard the willingness of local banks to lend surplus cash to each other or engage in high octane derivatives trading. Back to basics means banking is now a utility business, with low ROE and the Gulf’s financial buccaneers can no longer rely on the interbank market to underwrite their wheeling and dealing.

Four, after the $15 billion Saad Group and Al Gosaibi debt shocks in Saudi Arabia and its immediate impact on the crème de la crème of Gulf banking, name lending has proven to be as lethal as Wall Street’s CDO daisy chains. Name lending will plummet and hundreds of zombie corporates on the brink of default across the region will be forced to restructure their debts or go out of business. Creative accounting and eyes wide shut bankers can no longer postpone the inevitable for so many borrowers who have lost untold billions in wild property and stock exchange speculation.

Five, the regional business culture of no transparency, rubber stamp boards, CEO’s unaccountable to minority shareholders and Japanese Zaibatsu style conglomerates. Revolutionary change in Gulf business will stem from the shock waves of the banking, government, consumer credit and corporate debt shocks that will reverberate across the region in the next decade. Saad Group and Gosaibi are only the tip of the iceberg and credit rating agencies will prove impotent to protect investors. Note that many Gulf banks and corporates will have their credit ratings suspended or withdrawn if agencies do not receive even basic financial disclosure.

Six, GCC sovereign wealth funds have lost more than $100 billion in highly leveraged, aggressive dealmaking on Wall Street, the City of London, the European and Asian stock exchanges. Several funds competed to take leveraged stakes in international banks at the peak of the worst credit bubble in the history of the Euromarkets. They amplified the financial risks faced by petro-economies leveraged to the global business cycle, not diversified them. Sovereign wealth funds do not exist to roll the dice with borrowed money in offshore bidding wars or bail out busted local stock exchanges, as happened in Kuwait after both the Souk Al Manakh and Gulf War shocks.

Seven, Islamic finance is no oasis of stability in the Gulf. Islamic banks willingly financed property bubbles across the region. Nor does Islamic finance finance its own balance sheet growth. When the Eurobond new issue market froze, so did the sukuk market. When the property bubble crashed, Islamic mortgage financiers were wiped out. Funding costs spiked for both Islamic and Commercial banks. There is no lender of the last resort for Islamic banks, no deep and liquid money markets that can help raise liquidity as their balance sheets are burdened by colossal nonperforming property loans. We also just witnessed the default of a Kuwaiti investment bank’s public sukuk issue.

Eight, the Gulf’s professional money managers were exposed as beta chasers, not alpha generators. Why did almost all GCC funds get wiped out in the stock market crash? Diversification was a cruel illusion when the markets cratered in unison. When the grizzlies run amok, the Gulf’s co-efficient of correlation soars to one.

Nine, the GCC insurance companies never learnt the lessons of the late 1990’s bear market, when so much capital was wiped out. George Santayana was right. Those who refuse to learn the lessons of history are doomed to repeat them.

Banks will hoard cash, slash facilities, compete for deposits, shrink balance sheet growth. Independent money managers and investment banks in the GCC are a doomed specie, as they will be unable to issue debt or equity. Gulf banks will be unable to sell property linked assets to the Euro-mortgage securitization markets. Debt markets will be open to only the most highly rate sovereign or quasi sovereign borrowers. Western rating agencies, asset managers, hedge funds and brokers will withdraw from the region now that Kuwait, Oman and UAE will not be included in the Morgan Stanley emerging market index. Name lending is going share the destiny of brontosaurus.

Decoupling from Wall Street has been exposed as a dangerous, if self serving myth. We desperately need new paradigms of banking, capital markets and market regulation, to restore confidence that has vanished as eerily as a desert mirage.

Views expressed by the author are his own and do not reflect the newspaper’s policy.

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