Saudi Arabia has stepped up to the plate for Egypt, announcing a US$4 billion package for Egypt which included transfers, investment, a capital injection for the central bank, purchases of some of T-bills and bonds that Egypt will issue in the coming year, as well as other financial support. This announcement comes just days after […]
Overall, the economic and political outlook has become more clouded for the MENA region, even for the oil exporting nations that should stand to benefit from higher fuel prices, at least until demand destruction kicks in. As the chart below shows, demographic traits and unemployment levels contribute to this uncertainty to different degrees, depending on the country. Across the region, governments have responded with a mixture of reinforcing food subsidies, transfers to the population and, increasingly, more extensive use of force.
Editor’s note: For our most up-to-date coverage of the rapidly changing events in the Middle East and North Africa, see these RGE Critical Issues: “Mubarak Pledges Not to Run Again: Will it Be Enough for the Protestors?” “Will Ripples From Tunisia and Egypt Spread Through Middle East Governments and Markets?”
Events in Egypt are moving quickly, with protests extended today in Cairo, and especially throughout the Delta region despite government attempts to quell them including cutting internet connectivity, stopping mobile telephone service and imposing curfews. After contributing to a 16% slide in Egyptian equities and spike in CDS spreads in recent days, global markets seem to be feeling the effects. In the face of a broader selloff, oil prices have risen, perhaps because of the concerns that unrest in Egypt could destabilize transportation networks (Suez, the main city on the canal of the same name, has been a major center of protests.) It is difficult to predict how things will play out, but we do not expect a major threat to the supply lanes of oil from the GCC to EU. Nor at present do we expect a major shift in the unrest to the oil-rich GCC countries like Saudi Arabia, which have more resources to cushion their populations from economic stress than oil importers like Tunisia, Egypt or Jordan. What is clear, however, is that the political and social institutions have shifted significantly as a result of these developments. Even if the state regains control, the means that they choose will reverberate through Egypt and the Middle East more broadly. President Hosni Mubarak may well have to make some concessions to assuage protesters, but we do not know how significant these will be.
Several elections in the Middle East and North Africa in the latter half of 2010 and succession issues in a number of key countries have been keeping investors guessing. RGE pointed this out in a recent MENA Focus, available exclusively to clients: “Political Cycles Bring More of the Same?” In Egypt, for example, although the National Democratic Party (NDP) has a solid grip on power, the election cycle is adding to policy uncertainty that could worsen prospects for the foreign investment needed to kick-start domestic investment and diversify growth away from consumption. As RGE notes in its 2011 Global Economic Outlook, policy implementation delays in Egypt could add market volatility and restrain inward FDI as investors monitor the country’s political risk.
Egypt’s parliamentary elections took place in late November and early December, and, as expected, the NDP secured the majority of votes. Candidates of the opposition Muslim Brotherhood were again banned from running as a party and lost the seats they contested. Ahead of the second round, two of the biggest opposition groups—the Muslim Brotherhood and the Wafd Party—pulled out of the elections.
At a time when policy makers worldwide are contemplating the proper exit policies after aggressive monetary easing and fiscal expansion in 2009, Kuwait is embarking on its own path, stepping up expansionary fiscal and monetary policy. In 2009, Kuwait’s policy response, especially on the fiscal side was very modest and even a drag on growth. Kuwait’s rather subdued policy intervention, exacerbated by political uncertainties. failed to offset its economic contraction in 2009. Led by the oil sector whose output shrank along with production cuts, RGE forecast that growth contracted by about 1.5-2%, but some financial institutions put as large as 5.5%. As we noted in most recent RGE outlook, Kuwait seems destined to underperform most of the GCC and the Middle East more broadly, growing well below trend, even as oil output gradually increases and government investment provides a boost.
Less than 24 hours after Dubai’s finance chief was demoted, the UAE announced its decision to withdraw from the GCC Monetary Union, putting the broader union at risk. This decision comes two weeks after a major milestone; selection of the location of the GCC Central Bank. UAE officials did not conceal their reservations about the choice of Saudi Arabia to host the institution. UAE newspapers heavily criticized the Saudis in what may have developed into a political rift.
For starters, the GCC Secretariat is already located in Saudi Arabia and other institutions in other GCC countries, and with plans to diversify the government institutions, they believed that the GCC Central Bank should be located in the UAE, given its development as one of the region’s financial hub, possibly with a presiding Saudi National.
On May 14th, the Central Bank of Kuwait, the Kuwait Investment Authority (KIA) and a number of private companies entered into discussions to establish a fund, or a “bad bank”, to purchase toxic assets from the country’s investment companies’ balance sheets. This could be the latest new tool in Kuwait’s tool box, and such plans come less than a week after the central bank proposed a third round of stress tests. While details have yet to be released – and there is still reportedly some concern about who and how it might be administered, this could be a step in the process of rescuing Kuwait’s financial sector, though only if it is done transparently.
Following the rescue of Gulf Bank and the default of Global Investment House of one of its bonds last fall, the government has been rolling out new measures in the face of weaker risk appetite in the GCC and globally. On the financial side, it has provided capital to banks, guaranteed deposits etc. It has continued monetary easing and plans to maintain spending though the details of allocation are uncertain. The political stalemate in the Kuwait has not helped these responses and uncertainty about the exposure of corporations and investment companies, as well as the fear of asset ,market losses have kept banks unwilling to lend. The default shed light on the vulnerabilities in other Kuwaiti institutions, underscored by a wave of banking downgrades in the GCC and in Kuwait’s overall banking system, towards the end of 2008 and start of 2009. Moreover, delays in reporting financial results led to trade of many financial and non-financial corporations in spring 2009. Although trading in most resumed after Q4 results were released, reports suggest that the same thing led authorities to stop trading today in 26 companies.
Now that the results of the US Treasury’s stress test of US banks have been released, it seems apt to also turn the attention to other financial systems. Islamic Finance has been touted as an alternative model, less exposed to securitization, with ethical guidelines, and its proponents hoped better insulated from global trends.
However, Islamic banking and finance faces many of the same vulnerabilities as conventional finance (See more on the outlook for Islamic financial institutions in this recent presentation). These financial institutions, both Islamic banks and those issuing Sharia-compliant investment products, are vulnerable to changes in liquidity and growth conditions globally and in the targeted regions. The countries of the Gulf Cooperation Council (GCC) a particular source of growth in demand for Islamic financial products continue also to suffer from tight liquidity.
In this piece we look at some of the vulnerabilities but also the opportunities of Islamic finance, to discuss how one might test this financial model. We focus on the dynamics in the GCC especially in relation to GCC investors, sovereign and private, and to Islamic banks operating in the GCC and MENA region though some of the analysis is also relevant to South East Asia.
Just as Nouriel Roubini has noted frequently with respect to the US stress tests, it is essential to perform such tests based on plausible stress scenarios that could come to pass. As such the relative optimism of the US stress scenarios in terms of unemployment projections could imply that the banks capital needs are even greater than those announced in a worse case scenario. For Islamic financial institutions, a plausible scenario means factoring in possible contractions in several of the economies that have been the centers for Islamic finance. as well as significant asset market corrections which would weaken the balance sheets of Islamic financial institutions. We now look at a few of these factors to lay out how one might test their balance sheets.
Preliminary estimates for the sector (but not individual banks) suggest that most are relatively well capitalized but most still have relatively small market shares. Moreover the rate of growth of Islamic bank assets and of funds placed in Sharia-compliant securities and funds is likely to be significantly slower than many predicted in 2008 as slower growth and tighter liquidity restrict the funds to be invested.
In recent days and weeks, most of the GCC governments have announced plans (or hinted at) issuing sovereign bonds. Kuwait, Abu Dhabi, Dubai (of the UAE), Qatar and Bahrain have all suggested they would issue bonds in coming months, totalling several billion dollars.
In recent years, the issuance of sovereign debt by GCC governments has been quite limited to Bahrain and Oman in light of the enormous surpluses accrued in light of the once-soaring oil prices. In fact a few sovereigns, and sub-sovereigns like Abu Dhabi, did not even have credit ratings. Instead most of the limited bond issuance was by government-linked companies throughout the region. Yet, and as we have explained in a recent piece, with the reversal in hot money, in addition to the the losses and continued losses in the region’s equity markets, the cost of long-term borrowing sky-rocketed, highlighting the vulnerability of relying on external finance even as new revenues began to fall as investment returns and oil revenues fell sharply. Also, with external finance expected to grow at a slower pace in the face of the continued global liquidity crunch, GCC countries are left with no other option but to try to explore other sources of financing to tap the latent funds available in the region and from foreign investors looking for relatively safer credit risks.