Saving GCC banks is probably the most important challenge policy makers are confronting in today's crisis-ridden world, according to a recent report titled “Shelter in a storm” by Kuwait Financial Centre S.A.K (Markaz) sent to the Saudi Gazette on Monday. The authors of the report M.R. Raghu, senior vice president - Research and Amrith Mukkamala, senior analyst - Research, pointed out that the GCC financial sector is probably reeling under the same aftermath as that of the global mess and hence possible solutions cannot be any different. The report looks at various policy options available to GCC financial leaders and also provides an assessment of the damage this crisis is likely to wreck on the GCC banking and financial sector if these policy options were delayed. The authors argued that currently the global response to the current financial crisis has been predominantly a rescue package initiated, launched and managed directly by the government in order to rescue local banks and financial institutions. These rescue efforts are even spreading to other sectors other than banks and financial institutions. The merits and demerits of such an approach where government will become a dominant player (instead of being a referee) are debated. Government intervention should definitely be questioned under normal circumstances. The authors state that circumstances are hardly normal and therefore instead of wasting time debating, the best course of action would be to follow the global model. The experience in GCC has been very different. The government has been showing marginal interest in initiating and managing a direct rescue program. The only country where such efforts are in progress is Kuwait, where the government is seriously working to hammer an economic stimulus package. The proposal is yet to be approved by the parliament as of the date of this report. However, the package aims to rescue both banks and investment companies. Successful implementation of this bill will set the trend in the region. Other such actions include $20 billion bond issue by Dubai government (subscribed by the Dubai government to the tune of $10 billion) in order to provide support to distressed companies in Dubai. Also, in Qatar, the Qatar Investment Authority has been acquiring between 10 percent to 20 percent in the local Qatari banks. Given the scale of destruction in the GCC, the authors of the report strongly feel that an overt economic stimulus package is no longer a policy option but a necessity. The second policy option prescribed in the report is to enhance the fiscal stimulus plans already announced for 2009 and to announce one if there hasn't been any. The report stated that oil revenues (which form the majority - approximately 80 percent of the GCC government revenues) are expected to witness a significant fall in 2009. Despite this, majority of the GCC governments have already announced an increase in government expenditures to provide fiscal stimulus to their economies. Saudi Arabia has projected a 9 percent decline in revenues for 2009; however, government expenditure has been significantly increased by 16 percent. The Saudi Arabian annual budget expects this to result in a budget deficit of $17 billion as compared to a budget surplus of $11 bollion in 2008. Dubai too has unveiled an 11 percent increase in government spending. The annual budget of Dubai expects this to result in a budget deficit for the first time in Dubai to an extent of 1.3 percent to Dubai's GDP. However, Kuwait posted a contraction in its budget both in revenues and expenditures. The government expenditures as detailed in the annual budget for 2009 are all set to reduce by 36 percent and the revenues are budgeted to reduce by 39 percent. Analyst expectations on Qatar is also on similar lines with expenditures expected to be same as that of 2008. The authors believe that an enhanced fiscal stimulus is a must in the current scenario and should be approached along with monetary easing. The authors believed that there is a lot more room to reduce interest rates. Most of the other GCC countries have cut their interest rates inline with the fed rate cuts. However, the quantum of decline has not been matched. Saudi Arabia started 2008 with its policy rate at 5.5 percent and ended the year with a rate of 2.5 percent. The central bank of Saudi Arabia did not cut its interest rates till October 2008, by which time the Fed had already moved its benchmark rate from 4.25 percent to 1.5 percent. The report noted that deposit rates in the GCC region have already been cut in almost all the countries ex-Kuwait. Kuwait is the only country in the GCC to witness an increase in deposit rate in 2008. The deposit rates have been cut across GCC mainly to deter speculators to take advantage of the differential in interest rates between US and the GCC countries. The authors note that, even though this might be true as most of the currencies in the region are pegged to the US dollar, the more important factor should be the transfer of money from banks to investing in various assets classes. All asset classes are currently quoting at their historic low prices, cuts in interest rates on deposits would deter investors to choose bank deposits as a preferred destination of investment. The authors expected to see some more cuts in deposit rates in the region during the year. The report also noted that a total of $25.4 billion worth of projects have been cancelled or put on hold in 2008 alone in the GCC region. The reason for cancellation of these projects has been mainly due to cost escalations and liquidity issues. However, in the last two quarters the scenario has changed drastically, wherein prices of commodities for projects and other input costs have declined drastically. The authors believed that financial institutions should take advantage of such a scenario by kick starting lending to long-term projects. Due to the decline in interest rates in banks, attracting retail and institutional investors toward bank deposits has become a challenge. The reports states that, anecdotal evidence pointing towards a decline in lending activities by banks resulting in reluctance of banks to take in time deposits. (Higher cost than demand deposits). The authors felt that this situation would require the governments to increase their participation in the banking sector by increasing deposits in banks. Some GCC governments have historically been active participants in a few banks, e.g., Qatar National Bank, wherein, the bulk of the deposits are from the government of Qatar. The authors of the report believe that such an increase in deposits by the government would also provide greater room for banks to increase their exposure to risky assets. The report also detailed the impact of the four main forces - Size, Intermediation, Cross Border Activity & Capital Market representation on the GCC financial services sector in the present context. The authors stated that central to this role is the level of liquidity which in turn is determined by the level of oil prices. The region experienced high levels of economic activity (real GDP growing at 6.5 percent annualized) due to high oil prices. This had triggered a wave of liquidity that positively impacted all the four forces as mentioned earlier. However, in light of the current financial sector crisis accentuated by low oil prices, the authors evaluate the health of the four variables and their impact on the performance of GCC financial sector. 1. Cross Border Activity: Cross border activity indicates the trend in outward investments from the GCC countries. Due to high oil prices, the quantum of investments reaching foreign shores from the region grew at a CAGR rate of 23 percent between 2000 - 2008. The bulk of this growth has come in between 2006 - 2008 coinciding with the strong up tick in oil prices during that period. Majority of these net foreign assets in the GCC are from Saudi Arabia forming 84 percent of the total GCC foreign assets. The authors feel that cross border activity as a percentage of the size of the economy provides a better perspective on relative quantum of assets which are held outside the home country. The report notes that the net foreign investments for the first time in history of GCC crossed the 50 percent mark in 2008. Among the GCC countries, the net foreign assets of Saudi Arabia is almost 92 percent to the size of its GDP. In Bahrain and UAE, the assets have witnessed a contraction of 24 percent and 70 percent, respectively, in 2008. The authors expect average for GCC to remain stable at 51 percent in 2009 due to an expected 15 percent fall in the nominal GDP. 2. Size: The size of the financial sector as measured by broad money/GDP was at an average of 54 percent till 2004. After this period broad money mainly consisting of bank deposits witnessed a steep growth and reached 60 percent of the GDP at $606 billion in 2008. The authors attribute the growth in broad money to high liquidity mainly supported by an increasing trend in the current account surpluses in the region. However, with the fall in oil prices, the authors expect broad money also to witness a decline from its peaks in 2008. Qatar has been witnessing the highest growth rate in broad money at a CAGR of 28 percent between 2000 - 2008. Broad money as a percentage of GDP shot up to a high of 61 percent in 2007 as compared to only 48 percent in 2000. After clocking a near 20 percent growth during the last several years, the authors expected money supply growth to be at zero percent for 2009 given the steep decline in oil prices. 3. Asset Intermediation: Asset intermediation is represented as claims on private sector divided by nominal GDP. Claims on the private sector represent loans provided to the private sector. Its proportion to GDP indicates the extent of heating up in the economy due to leverage in the private sector. The report noted that leverage levels were low in the GCC economies till 2004 at 40 percent and were bearable till 2006 at 46 percent. In 2007 and 2008, the intermediation levels spiked up to historically high levels of 54 percent. The value of claims on the private sector grew by 34 percent and 29 percent in 2007 & 2008 to $447 billion and $578 billion, respectively. The high intermediation levels of 2008, the authors believe, will lead to significant cooling off in claims against the private sector in 2009. The general macro scenario also favors such a situation as asset prices have been witnessing a steep decline, which is a major deterrent for banks to lend for real estate and investment banks. 4. Capital Market Representation: The report further noted that capital market representation (Market cap/GDP) has cooled off since its peak in 2005. This can be mainly attributed to the significant crash in markets both in 2006 and in 2008. The GCC market capitalization has been by reduced by 52 percent from $1.1 trillion in 2005 to $546 billion as at the end of 2008. This reduction has reduced the capital market representation from 184 percent in 2005 to 51 percent in 2008. The report pointed out that net profit growth in banks peaked in 2005 when it touched 73 percent. After this period, it has been a phase of steady decline in growth rates to an estimated 4 percent growth in net profits in 2008. The efficiency ratios also looked robust. __
