Gulf's recovery a little slower, but still on track

While other countries recover, the particular differences of the Gulf's economies seem to be slowing the region's return to rising GDPs.

Despite falling by more than two thirds in price the past year, oil has still been providing a steady stream of income to regional governments.

First, Asia emerged from the global recession, propelled by recovering growth in China. Now it appears that even Europe has managed to slog its way back to economic growth. Yet even with oil prices back at about US$70 a barrel, the Gulf still suffers from the equivalent of a low-grade dose of flu, neither falling as ill as Asia and the West, nor seemingly able to spring back as quickly. A year after the collapse of the US investment bank Lehman Brothers touched off a global financial firestorm, the region that many thought would sail through the crisis unscathed is instead mired in a building slump that has crippled its banks and exposed shortcomings in corporate governance, regulatory transparency, legal institutions and capital flows. It is unclear what this might mean for the region if, as some economists warn, the global economy slips back into recession in a "double dip". But assuming the world is on track for a genuine recovery, economists say the Gulf's delayed response is merely a symptom of how rapidly growth has reversed and of the region having less experience managing through debt crises, such as the collapse that hit the savings and loan sector in the US 20 years ago or the financial crisis that swept Asia a decade later. The Gulf may not soon see a return to the heady days that preceded Lehman Brothers's collapse, they say, but its own recovery is just a matter of time. "When you've been growing that fast for a long period of time and you suddenly come to a halt, it hurts," says Simon Williams, the chief economist for Gulf markets at HSBC in Dubai. "We still have excesses to digest. We are in the process of working through those excesses." The Gulf was blessed with several bulwarks against the crisis. The first and most obvious was its oil, which despite falling by more than two thirds in price has still been providing a steady stream of income to regional governments. Over the past five years, moreover, Gulf nations stored surplus oil revenues in central bank reserves and sovereign wealth funds, providing them with a massive rainy-day fund to help cope with the deluge that came last autumn. But the crisis also exposed the region's vulnerabilities. Oil may have provided a cushion, but property, and more importantly the massive loans issued to buy it, had become a critical source of weakness. At the peak, the amount of borrowing was rising at 35 per cent a year in Saudi Arabia, and almost twice that in Qatar and the UAE. The explosion in credit worked only as long as asset prices were rising. When they fell, the result was disastrous. "The fall in asset prices has put balance sheets under tremendous pressure and impaired the viability of whole sectors of the economy," says Farouk Soussa, the head of Middle East government ratings at Standard & Poor's in Dubai. The downturn has not discriminated: from family-run conglomerates such as Saad Group and Al Gosaibi to government-owned giants such as Nakheel, to brokerages such as Kuwait Investment to small investors in Britain, anyone with heavy debts was laid low by the sudden collapse in asset prices. If there was a flaw in the Gulf's growth model during the boom, therefore, it was not its enduring reliance on oil, nor the fact that for many, economic diversification has largely meant the growth of property and construction. While examples of hubris abound, economists say building the infrastructure to support growth was essential to helping the region absorb new investment. On the contrary, the glaring vulnerability, economists say, was in the region's inability to moderate the pace and direction of its own growth. Keeping their currencies pegged to the US dollar, for example, has deprived the Gulf's central banks of a key policy tool, and meant that they had to keep interest rates largely in line with those set by the US Federal Reserve, even when the directions of the Gulf and the US diverged. The perils of the peg became most apparent last year, when the Fed was cutting rates in a vain effort to stave off recession, even as the Gulf battled with accelerating inflation. Instead of being able to raise rates to curb inflation, Gulf central banks largely had to cut in line with the Fed, making local inflation even worse. Lehman's collapse triggered a global liquidity crunch, but the implosion began in the Gulf as early as July last year, as international investors began pulling money out of the region. Many had put money in to profit from what they thought was an inevitable revaluation upwards of Gulf currencies. Others acted simply to take advantage of the region's boom. By mid-summer, however, with officials making clear the dollar peg would remain, and with the property market looking increasingly overheated, investors began heading for the exits. "It's the lost access to credit, rather than the reduced value of oil earnings, that to me has had the most marked impact," Mr Williams says. The credit crunch has left banks and companies alike dangerously short of cash. Economists credit central banks and governments with taking swift measures to shore up the banking sector. In the UAE, for example, the Central Bank provided Dh50 billion (US$13.61bn) in low-cost financing to banks, guaranteeing loans, and then injected another Dh70bn into the banks themselves. If there has been a focus for the crisis in the Gulf, it has undoubtedly been Dubai, the region's financial capital. After announcing that it had $80bn in outstanding debt, Dubai borrowed $10bn from the Central Bank so that its stable of developers and other businesses could keep paying contractors and lenders, removing a big source of investor uncertainty. Now Dubai looks set to borrow another $10bn and the Central Bank has said it is standing by with funds. The fact that Gulf governments have used their savings to counter the impact of the recession has been equally important, economists say. In past recessions lower oil prices forced governments to cut back, worsening the downturn. This time around, governments in Saudi Arabia and the UAE announced they would go into the red to raise their budgets. Policymakers have been frustrated by the economy's sluggish response, however, particularly the fact that lending has yet to resume, so that property borrowers can refinance rather than default. But with property prices still in a tailspin and banks saddled with more loans than deposits, few lenders are willing or able to finance more property purchases. Many are bracing for a wave of defaults. With banks thus impaired, the effect of government stimulus is muted: normally a dirham spent would be re-lent again and again. Now, it tends to be deposited and go no further. Bankers and economists say this logjam at the banks could be circumvented if only the region had a more vibrant market for corporate bonds, so that companies could borrow directly from investors. Legal and policy uncertainty are also big brakes on recovery, economists say. Too much mystery surrounds government decision making, they say. Uncertainty also swirls around the legal environment, particularly insolvency regimes. In the UAE, the law covering bankruptcy remains largely untested, and the World Bank estimates that it takes on average five years to wind up an insolvent company in the country. In Saudi Arabia, by contrast, it takes roughly 18 months. This could be preventing capital and the people attached to it from moving on to more productive ventures, a situation that is likely to get worse if defaults rise. Personal insolvency also remains a touchy issue. Many loans require that borrowers issue post-dated cheques to cover payment. Bouncing a cheque in the UAE is a criminal offence. Hayden Smith, an associate at Trowers and Hamlins in Abu Dhabi. said: "Some would say that this has resulted in many individuals fleeing the country rather than trying to manage their debts." Issues like these are responsible for retarding the region's recovery, economist say, but are not preventing it. Mr Williams, who has ranked among the most bearish of regional economists through the crisis, says: "I think there are very good times coming to the Gulf." Recovery may come more slowly than many predict, he says, but "the region's medium-term story is still a very strong one and a very clear one". [e-mail]