The Gulf is for the most part insulated from the Greek crisis, but the UAE does exhibit some vulnerability due to the debt troubles facing the emirate of Dubai, contending with debt exceeding $100 billion, including $25 billion under negotiation for restructuring, Credit Agricole Corporate & Investment Bank said on Friday. In its “Emerging Market Focus” report, it noted that an escalation of troubles in Europe will only raise the burden on Dubai, which - like Greece - relies heavily on the support of its wealthier neighbor, Abu Dhabi, to bail it out of tight spots in exchange for adopting greater austerity measures. In the short term, Gulf Arab states are more insulated from the impact of the European sovereign crisis than other MENA countries, such as those in North Africa. Should European bank deleveraging pick up pace, the Gulf will be compelled to continue relying on domestic funding sources. European banks could perpetuate their risk aversion towards the region, except where the borrower affords explicit sovereign or quasi-sovereign status. The Dubai debacle has compounded risk aversion in the UAE. European bank deleveraging would also hit the book value investments of Gulf sovereign wealth funds. A deepening crisis in Europe could weigh on wider Gulf SWF investments, particularly in property. While European policymakers and the IMF have hammered out a loan package of almost $1 trillion designed to dodge a potentially scathing and wide-reaching sovereign debt crisis, the ripple effect of debt troubles in Europe is unlikely to disappear in the coming months. In the short term Gulf Arab states are more insulated from any European deleveraging than other Middle East countries, such as those in North Africa. Gulf banks' exposure to Europe is contained and provides little systemic risk. Still, any precipitous and sustained price drop in commodities such as oil or global equities would not bypass the Gulf. Saudi Arabia stands out as a particularly compelling investment case compared with some of its neighbors, owing to its large indigenous population fuelling domestic demand, foreign assets of $415 billion supporting twin surpluses, and noticeable lack of asset price bubbles. The cost of insuring Saudi debt against default remains low relative to regional peers. This week, 5Y credit default swaps (CDS) for Saudi sovereign debt stood at 72.1, about 12bp lower than Qatar and 31bp less than Abu Dhabi. Dubai and Bahrain are perceived as most-likely to default - Dubai CDS stands at 435 while Bahrain's is at 160. Should European contagion spread, Gulf credit spreads would widen. Inter-regional differentiation is clearly happening, however, with Saudi Arabia, followed by Qatar and Abu Dhabi, perceived as least risky. While Gulf issuers had faced challenges in tapping the debt market after Dubai World delayed debt repayment in November, the pessimism has shifted to some extent since then. Bahrain raised $1.25 billion from sovereign issues, against a $1 billion target, while bonds issued by National Bank of Abu Dhabi and Banque Saudi Fransi were well oversubscribed. Gulf equities are coupled on the downside with global markets. Petrochemical stocks, seen as a proxy to world trade and oil prices, were the main drag on the Saudi index recently. Even if oil offers very auspicious returns for petrochemical companies, a drop in prices has cultivated caution among investors. In terms of bank risk, we are not particularly concerned about absolute banking exposures of Gulf lenders to Europe and most of the acquisitions of regional sovereign wealth funds have largely taken place based on mostly equity. On the other side, BIS data as at Q409 shows European lenders have around $174 billion of Gulf exposure, US banks a small $34 billion and UK banks $83 billion. Out of the total exposure of European, UK and US cross-border banking exposure in the Gulf, half is with the UAE, 16 percent with Saudi Arabia and 17 percent Qatar. If a further liquidity squeeze materializes, important counter-cyclical measures can be taken by Gulf banks, based on high FX reserves and non-hesitation by central banks to provide emergency liquidity facilities to its banks. Certain banks in the Gulf are differentiated due to better asset quality and capitalization but overall there are no systemic bank-wide risks. Non-oil-sector growth is also likely to be muted across the region this year as banks continue to adopt risk-aversion policies that have reined in credit growth and forced the states to take the upper hand in financing projects, sometimes crowding out the private sector. Saudi Arabia and Abu Dhabi are moving ahead with key energy projects even after ConocoPhillips pulled out of plans for a $12 billion refinery in Saudi Arabia and a $10 billion Shah gas field project in Abu Dhabi this quarter. Downward pressure on regional FDI flows from Europe are inevitable should conditions worsen. Credit Agricole believes though the impact on trade is manageable. The region relies heavily on imports, particularly of foodstuffs, a large part of which comes from Europe. A quarter of imports to the UAE and Bahrain arrive from Europe, while more than 30 percent of imports to Saudi Arabia, Kuwait and Qatar are sourced from the euro zone, according to official data. Declines in the value of European exports to the Gulf could enable exporters to gain greater market share countering Asia's ever-growing role. Gulf states are also a major source of oil and non-oil exports to Europe and, as exports become more expensive and European economies slow down, these could doubly hit Gulf exports. Still, with trade links in Asia gaining greater prominence, only 10.5 percent of Saudi exports are destined for Europe while only 5.8 percent of Qatar's are, paling in comparison to Asia's 55 percent and 80 percent share of each country's exports, respectively. With forecasts of higher energy demand from Asia this year, “we expect it will be relatively easy for Gulf states to post current account surpluses, particularly as import costs fall. Saudi Arabia made a current account surplus of $26.5 billion last year despite subdued world trade conditions, and we expect the surplus to rise to $46 billion this year.” Moreover, inflationary pressures will not be a cause of worry for the Gulf this year. Saudi inflation rose to 4.7 percent in March, although we anticipate that, in the event of a slowdown in global commodity prices and lower pressure on rents at home, the overall rate for the year would be 4.3 percent, down from 5.1 percent in 2009. Only Qatar is expected to experience a second year of deflation in 2010 albeit a mild drop, considering that as recently as 2008 inflation averaged a high 15 percent for the year. In the UAE, the recent liberalization of fuel prices is going to exert some upward momentum on inflation, forecast at 2.5 percent for 2010.
