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Chapter II The Impact of the Global Crisis and Policy Responses9

May Khamis, Abdelhak Senhadji, Gabriel Sensenbrenner, Francis Kumah, Maher Hasan, and Ananthakrishnan Prasad
Published Date:
March 2010
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Impact of the Crisis

Declining oil prices and global liquidity shortages

The GCC countries have been hit by the decline in oil prices and production, as well as by liquidity shortages in global financial markets. The direct impact from U.S. subprime assets, however, was limited, given a relatively low direct exposure of GCC commercial banks to these assets. Oil market developments affected government finances and external positions directly, but they also had an indirect impact on banking and corporate liquidity and funding costs as speculative capital inflows reversed and investor confidence in the GCC declined. This, together with global liquidity shortages, triggered a steep fall in asset prices and weakened financial systems’ balance sheets, prompting governments’ intervention in the financial sector.

Plunging asset prices and higher CDS spreads

Similar to other emerging markets, the impact of the crisis on the GCC manifested itself in plunging stock and real estate markets and higher CDS spreads (Figures 1518). The region’s stock market capitalization fell dramatically—by 41 percent ($400 billion) between the collapse of Lehman Brothers in September 2008 and end-2008—and volatility increased.10 As contagion from the global crisis became a dominant factor, the average correlation of GCC markets with global markets turned positive, compared with a negative correlation during January 2007—September 2008 (Table 4).

Figure 15.GCC: Credit Default Swap Spreads on Five-Year Sovereign Debt, Mar. 2008—Jan. 7, 2010

(In basis points)

Source: Markit.

Figure 16.GCC: Equity Market Indices, March 2008–January 7, 2010

(Index, March 1, 2008=100)

Source: Bloomberg.

Figure 17.GCC: Stress Indicators, March 2008–December 2009

(Indices, March 2008=100)

Sources: Mazaya; Bloomberg; and staff estimates of PPP-weighted GCC index for foreign liabilities.

Figure 18.GCC: Current Sovereign Short-Term Ratings and Maximum CDS Spreads, Since Mar. 2008

Sources: Markit; and S&P.

Table 4.Correlation in Stock Markets 1
Average correlation within GCC, before Sept. 10, 20080.86
Average correlation within GCC, after Sept. 10, 20080.90
Average correlation with S&P before Sept. 10, 2008-0.56
Average correlation with S&P after Sept. 10, 20080.85
Sources: Bloomberg; and IMF staff estimates.

Correlations before Sept. 10, 2008 cover the period Jan. 1, 2007–Sept. 10, 2008, and correlations after Sept. 10 cover the period Sept. 10, 2008–Jun. 17, 2009.

Sources: Bloomberg; and IMF staff estimates.

Correlations before Sept. 10, 2008 cover the period Jan. 1, 2007–Sept. 10, 2008, and correlations after Sept. 10 cover the period Sept. 10, 2008–Jun. 17, 2009.

GCC SWFs were also affected by the decline in international asset prices, with losses estimated by market analysts at between 20—30 percent in 2008. Real estate prices fell significantly; the correction was very pronounced in Dubai, where they had risen more sharply. While CDS assessments increased across the board, risk assessments for Dubai, and to some extent Bahrain, were more unfavorable than for other GCC countries.11

Mirroring global developments, equity markets have displayed greater confidence since March 2009, but this trend has reversed more recently. During the first 10 months of 2009, GCC equity market indices gains (except for Bahrain and Kuwait), although stock market levels remained significantly below pre-Lehman collapse levels. CDS spreads have also declined markedly, indicating an improvement in global investor sentiment. More recently, pressures on the highly leveraged Dubai quasi-sovereign entities culminated in the announcement of the Government of Dubai that DW would seek a standstill on debt at the holding level and for its two property subsidiaries (Nakheel and Limitless) until May 2010 (Box 1). These developments have regenerated pressures on the region’s equity markets. CDS spreads on the Dubai government and entities have also increased as a result, but CDS spreads for the rest of the region have been only marginally affected.

Pressures on bank funding and liquidity led to tight credit conditions

The reversal of speculative short-term inflows linked to exchange rate speculation, combined with global deleveraging and widening emerging market spreads, resulted in significant liquidity pressures and increased funding costs. Commercial banks drew down their reserves with central banks, and short-term interest rates spiked sharply, albeit temporarily.12 Timely response by the authorities, including through the infusion of liquidity and deposit guarantees, helped stabilize interest rates and liquidity conditions (Figures 1921). External funding for the banking system was strongly affected, except for Qatar, and is yet to recover (Figure 22).

Box 1.The Consequences of Dubai World’s Debt Developments

The announcement last November that Dubai World (DW)—a holding company owned by the Government of Dubai (GD)—would seek a debt standstill was a surprise to financial markets. Support provided recently by the Government of Abu Dhabi has helped to calm down markets, but uncertainties remain as the GD is still developing a strategy to put its corporate sector on a viable path. Although the impact of the debt event will depend on the eventual scope and modalities of the debt restructuring, it could have a significant effect on the repricing of sovereign risk throughout the region and beyond.

On November 25, 2009, the GD announced that DW and its two property subsidiaries (Nakheel and Limitless) would seek a debt standstill until May 2010. The standstill was to affect $26 billion worth of loans and bonds, including a Nakheel 09 sukuk maturing on December 14. However, on that date the Government of Abu Dhabi extended a loan to the GD, who stated that it intended to use these resources to: (i) repay in full and on time the Nakheel 09; and (ii) cover payments to contractors, working capital, and interest expenses through end-April 2010, conditional on a standstill agreement being reached between DW and its creditors.

The November announcement came as a surprise to markets. The bursting of Dubai’s real estate bubble in 2008, coupled with the post-Lehman shut-down of international capital markets, had heightened concerns about Dubai’s ability to service its debt, particularly in the case of highly leveraged real estate enterprises. But in the several months leading to November 25, Dubai had been able to roll over market debt falling due, in part with financial support from the central bank. That had reinforced the perception of sovereign support for Dubai-based entities, leading to a substantial tightening of GD credit default swap (CDS) spreads and an increase in the value of Nakheel bonds.

The Federal Structure of the U.A.E.

The U.A.E. is a federation of seven emirates formed in 1971. Core functions of government, such as defense, foreign policy, and central banking, are handled at the Federal level. However, each emirate has autonomy over economic policies, debt issuance, laws, and control over land and natural resources. The richest emirate is Abu Dhabi, which owns 95 percent of the U.A.E.’s hydrocarbon wealth, accounts for half of its GDP, and has accumulated substantial net external financial assets. Dubai is the second largest emirate and accounts for around 35 percent of the U.A.E.’s GDP. Most of the U.A.E.’s external debt is reportedly with Dubai entities.

Dubai Real Estate Sales

Source: Dubai Land Department.

Roots of the Crisis

Dubai’s economy is dominated by Dubai Inc., a web of commercial corporations, financial institutions, and investment arms owned directly by the GD or the ruling family under the umbrella of three major holding companies (Dubai Holding, DW, and the Investment Corporation of Dubai). Each of these holding companies includes several property developers and is involved in assorted property ventures in Dubai and around the world. They also have significant operations in trade and services (such as ports, logistics, transportation, and tourism), which continue to do well.

U.A.E.: Excess Credit, 2004–08

Sources: Country authorities; and IMF staff.

Dubai Inc. borrowed extensively in 2004–08 to fund a major push into commercial and residential property. A significant increase in leverage ensued, followed by a real estate bubble.

Between 2004 and 2008, liabilities to global banks as a ratio to non-oil GDP more than doubled as did domestic credit to nonoil GDP. Credit growth was among the fastest in emerging markets, with U.A.E. banks extending about $100 billion of credit in excess of the historical trend. Banks remained highly rated throughout the period, reflecting government ownership or implicit government backing.

Market Reaction

The debt standstill announcement had a pronounced impact on Dubai’s credit risk as market participants could no longer assume an implicit sovereign guarantee. The Nakheel09 traded at about 50 cents, down from 111 on November 23; CDS spreads on the GD rose to 675 bps from around 320 bps before the announcement; and Dubai government-related entities (GREs) were downgraded by several notches, most to non-investment grade. Although CDS spreads declined after December 14, they still remain elevated. Stock markets in Dubai and Abu Dhabi dropped significantly; those in the rest of the GCC experienced higher volatility, and other countries’ CDS spreads widened marginally in the week after the announcement.

Global stock market reactions to the initial announcement were strong but brief, with bank stocks most affected—especially for banks believed to be exposed to DW or other firms with direct links to Dubai. The decline in stock prices also reflected global market fragilities, low liquidity ahead of holidays in the U.S. and the Middle East, and end-of-year effects.

Implications for the U.A.E.

The ramifications of the Dubai event are still unfolding, as it will take some time for the GD to develop a strategy to restructure its corporate sector. The analysis is complicated by the lack of information on DW’s and many Dubai GREs’ financials. A full-fledged restructuring could involve operational restructuring, asset sales, debt relief, or equity injections. It may also require further financial support from Abu Dhabi or the federal government, on a case-by-case basis, as external funding for Dubai is likely to become more expensive and limited. About $50 billion of bonds and syndicated loans to Dubai-based nonbank entities are expected to fall due over the next three years.

Five-Year CDS Spreads(In basis points)
Dubai Holding670145078015991346
DP World355740385454414
Abu Dhabi10018383153136
Other GCC Countries
Saudi Arabia74107339579
Other Economies
Source: Bloomberg.

Immediately prior to the Dubai World standstill announcement.


Three days following the Dubai World standstill announcement.


Change in CDS spreads between 27-Nov and 23-Nov.


Immediately after the announcement of the Abu Dhabi assistance package and decision to fully pay the Nakheel09 sukuk.


Most recent.

Source: Bloomberg.

Immediately prior to the Dubai World standstill announcement.


Three days following the Dubai World standstill announcement.


Change in CDS spreads between 27-Nov and 23-Nov.


Immediately after the announcement of the Abu Dhabi assistance package and decision to fully pay the Nakheel09 sukuk.


Most recent.

Dubai: Publicly Held Debt in the Form of Bonds and Syndicated Loans by Maturity Date(In millions of U.S. dollars or U.S. dollar equivalents)
As of: January 2010201020112012Total
Dubai World and subsidiaries5,3696,6477,59319,609
DW standstilled debt5,1694,6471,85011,666
Other DW subsidiaries

(DP World, etc.)
Other Dubai Inc. Debt.10,16117,77411,42439,359
Sources: Dealogic; Zawya; Bloomberg; Datastream;; BIS; and IMF staff.
Sources: Dealogic; Zawya; Bloomberg; Datastream;; BIS; and IMF staff.

The banking sector. Banks have enjoyed full backing of the central bank and federal government during the global financial crisis. More recently, the central bank has introduced an additional liquidity facility, although banks have not seen unusual deposit outflows in the aftermath of the announcement. Banks’ liabilities (deposits and interbank loans) have been under a 3-year federal government guarantee since September 2008. Depending on the terms of the debt restructuring and individual bank exposure to DW, some banks may need further capital injections, possibly from the government. The federal government still has $5.5 billion left for bank capital support under a program of $19 billion introduced post-Lehman.

Economic growth. Given the scale of construction and property-related activity in Dubai (25 percent of Dubai’s GDP), Dubai’s economic activity is likely to be affected, depending on how protracted is the corporate debt restructuring. Ongoing large fiscal spending by Abu Dhabi will help cushion the impact.

The Dubai model. Overall, the event is expected to lead to modifications and a refocusing of Dubai’s development model, and a marked reduction in leverage. Dubai has achieved an impressive degree of diversification and become a major trading and services entrepot. However, the global financial crisis has exposed the vulnerabilities associated with Dubai’s highly leveraged property development and put into question the sustainability of those aspects of the development model.

Implications for the GCC Region and Beyond

The main channel of transmission to the rest of the GCC would be through the balance sheets of banks and other financial institutions. Although developments are still unfolding, available information so far indicates that the impact is likely to be limited, assuming that the debt restructuring remains contained. From a country-specific perspective, the known direct exposures of regional financial institutions seem to be manageable. The impact through real channels is also likely to be limited: Dubai’s economy accounts for less than 10 percent of GCC GDP, and intra-GCC trade is less than 10 percent of total GCC trade.

Implications for Financial Markets

Markets are likely to revisit the assumption of implicit guarantees in pricing quasi-sovereign and private risks, which may result in an increase in the cost of borrowing and reduced access to international capital markets by some GCC entities. The event has also underscored the need for enhanced communication and transparency in both public and private sectors.

Additionally, although the Nakheel sukuk was paid in full, the event underscored existing concerns regarding the legal enforceability of sukuk, which could undermine the sukuk market.

Indirect spillovers from cross-border foreign direct investment and remittance flows could also have an impact on the wider region as well as the Indian subcontinent.

Figure 19.GCC: Commercial Banks’ Reserves with Central Bank, December 2007=100

Sources: Country authorities; and IMF staff estimates.

Figure 20.GCC: Three-Month Interbank Rates, January 2007–November 2009

(In percent)

Sources: Country authorities.

1 Overnight interbank rate.

Figure 21.GCC: One-Year Currency Forward Premiums, January 2008–January 2010

(In percent of spot price)

Source: DataStream.

Figure 22.GCC: Banks’ External Financing,1 December 2003–September 2009

(In billions of dollars)

Source: BIS Consolidated Banking Statistics.

1 Includes foreign currency interbank lending extended by foreign bank branches in GCC countries.

After September 2008, in response to tighter liquidity conditions, higher asset losses, and perceptions of higher credit risk, banks became more reluctant to lend and some were forced to deleverage. Although liquidity conditions have improved significantly since then, credit expansion has continued to slow, largely reflecting weaker economic activity coupled with banks’ reluctance to lend (Figure 23).13 External funding for the nonbank private sector also tightened in late 2008 (Figure 24), although it has shown some recovery in 2009. Nonbank external financing for Qatar remained robust throughout.

Figure 23.GCC: Credit to the Private Sector January 2008–December 2009

(Annual percentage change)

Source: Country authorities.

Figure 24.GCC: External Financing of Nonbanks,1 December 2003—September 2009

(In billions of U.S. dollars)

Source: BIS Consolidated Banking Statistics.

1 Includes foreign currency credit extended by foreign bank branches in the GCC to local nonbank financial institutions and corporates.

A negative feedback loop between tight credit markets and economic activity emerged. Of an estimated $2.5 trillion of projects in different stages of implementation and/or planning as of end-2008, around 23 percent ($575 billion) had been placed on hold by end-2009 (Figure 25).14 Also, weaker domestic and external demand adversely affected corporate sector profitability, with net profits of 409 locally listed companies in the GCC declining by about 30 percent in 2008, and by 48 percent year-on-year in the second quarter of 2009.15 Profitability in the third quarter of 2009 showed some improvement, with an overall decline of 25 percent year-on-year. Real non-oil GDP growth is now estimated to average just below 2.8 percent in 2009, down from an estimated 6.7 percent in 2008.

Figure 25.GCC: Projects On Hold, End-2009

(In billions of U.s. dollars)

Source: MEED.

Weakening import prices and deflating house prices in the wake of the economic slowdown helped reverse inflationary trends starting in the first half of 2009. GCC inflation declined to 2 percent by the third quarter of 2009 from 10½ percent at end-2008 (Figure 26).

Figure 26.GCC: Recent Inflation Dynamics

(Annual percentage change)

Source: Country authorities.

1The latest observation was at September 2009 for Qatar; October 2009 for Oman; November 2009 for Bahrain, Saudi Arabia, and the U.A.E.; and February 2009 for Kuwait.

A Forceful Response Contained the Impact of the Crisis

Forceful response by the GCC authorities

Following the tightening of liquidity conditions in the last quarter of 2008, the authorities took measures to stabilize the financial system and mitigate the impact on credit expansion (Table 5, and Annex I). Central banks infused liquidity into the financial system through repos, and governments provided direct liquidity injections via the placement of long-term deposits. All central banks—except in Qatar, where inflation remained high until end-2008—reduced policy interest rates, and some lowered or modified reserve requirements (Bahrain, Oman, and Saudi Arabia). To shore up investor confidence, some governments provided deposit guarantees (Kuwait, Saudi Arabia, and the U.A.E.), and certain SWFs were asked to support domestic asset prices (Kuwait and Oman) and provide capital injections to banks (Qatar). The government also provided capital injections in Kuwait and the U.A.E. Additionally, in Qatar, the government purchased banks’ holdings of equity and real estate assets. These measures had a favorable effect on market conditions, helped preserve stability in the financial system, and limited the impact on banks’ long-term ratings.16

Table 5.GCC Policy Response to the Global Crisis
Central BankLong-termBankStock
Saudi Arabia
Source: Data provided by country authorities.

Includes expansion of retail deposit insurance and guarantee of wholesale liabilities.

Source: Data provided by country authorities.

Includes expansion of retail deposit insurance and guarantee of wholesale liabilities.

Despite lower fiscal and external surpluses, GCC countries largely maintained their previous levels of spending to counter the impact of the crisis on economic activity (Figure 27). Saudi Arabia passed a stimulus package—the highest among the G-20 in terms of share to GDP—that forms part of a five-year $400 billion investment plan that will contribute to the global effort to revive demand, given its high share of imported goods (around 55 percent). The GCC’s supportive policies also had an important stabilizing impact on the other economies of the MENAP (Middle East, North Africa, Afghanistan, and Pakistan) region by contributing to workers’ remittances, foreign direct investment (FDI), and to a lesser extent, imports (Box 2). The slowdown in GCC growth in 2009 has weakened financial flows from the region, but these are expected to rebound partially in 2010.

Figure 27.GCC: Non-oil Fiscal Balance

(In percent of non-oil GDP)

Sources: Country authorities; and IMF staff estimates.

These efforts have been generally well received by markets, although further coordination on country measures could have been helpful, particularly in the early stages of the crisis (for example, on deposit guarantees). Weaknesses in coordination have also been a challenge at the global level as countries underestimated the extent and momentum of the crisis and tended to address emerging issues, first and foremost, at the national level because of the fiscal dimension of bank support policies. The lack of clarity regarding the severity of the impact of Lehman Brothers’ collapse also undermined coordination and resulted in ad hoc measures.

Adverse impact on financial institutions, but no systemic risk

The sharp downturn in global asset prices and tight liquidity conditions led to defaults by a few GCC nonbank financial institutions, but these were isolated, owing partly to swift actions taken by countries to ensure stability.

Box 2.GCC Financial Flows: Regional and Global Spillovers

Remittances from GCC countries remained resilient in 2008, as migrants’ employment was largely maintained at previous levels. During 2001–08, outward remittances from the GCC region—a major source of financial inflows for some partners—grew by 7 percent on average per year, totaling $250 billion. The main receiving countries were Bangladesh, Egypt, India, Jordan, Lebanon, Pakistan, Philippines, Sudan, Syria, and Yemen. In view of the impact of the crisis on global growth, global remittances are expected to decline by 7-10 percent in 2009 (Global Development Finance, World Bank, July 2009). For the GCC, staff estimates outward remittances to decline by 4 percent in 2009, to $46 billion, before recovering partially in 2010.

GCC: Cumulative Outward Remittances(2001-08)

U.S. $ Billion
Share to Total

Saudi Arabia125.150.1

GCC: Contribution of Remittances by Recipient Country, 2008

(In percent of GDP)

Sources: World Bank; and IMF staff estimates.

Global FDI flows have also been affected strongly by the current crisis. UNCTAD (January 2009) estimates world FDI flows to have declined by 21 percent in 2008, mainly due to a sharp drop in the fourth quarter. The World Bank (2009) estimates that in the fourth quarter of 2008, flows to 25 middle-income countries—including Egypt, Jordan, and Pakistan—declined to their lowest level since the fourth quarter of 2006. It projects world FDI inflows to drop by 30 percent in 2009. While outward FDI flows from the GCC and FDI inflows to the region remained strong in 2008, they are expected to fall sharply in 2009 in the context of lower growth and global uncertainty.

Foreign Direct Investment

(In billions of U.S. dollars)

Sources: Country authorities; and IMF staff estimates.

The strong fiscal spending in the GCC, including the large fiscal stimulus in Saudi Arabia, will continue to support global demand, with the GCC’s share of global imports expected to increase from 2.6 percent in 2008 to close to 3.4 percent in 2009 and 2010. GCC non-oil imports play a small role in the MENAP (Middle East, North Africa, Afghanistan, and Pakistan) region, as they represented only 12 percent of the region’s exports in 2008.

The strong fiscal spending

(In billions of U.S. dollars)

Sources: Country authorities; and IMF staff estimates.

Investment companies (ICs) in Kuwait and wholesale banks in Bahrain were most affected, given their direct exposure to global markets. Two Bahrain-based wholesale banks—the International Banking Corporation and Awal Bank—owned by Saudi conglomerates, were placed into administration by the Bahraini authorities, after falling into default in May and June 2009, respectively. Two Bahrain-based wholesale banks, Gulf International Bank (GIB) and the Arab Banking Corporation (ABC), have incurred large cumulative impairment charges (GIB: $1.3 billion, ABC: $1.2 billion) over the past two years, but they continue to be well capitalized.

In Kuwait, by January 2009, Global Investment House, the largest IC, was in default on the majority of its debt, estimated at $3 billion, but reached a debt restructuring agreement with its creditors in October 2009. In May 2009, Investment Dar, another of Kuwait’s large ICs, defaulted on a $100 million sukuk. The company reached a restructuring agreement with its creditors in December 2009. Some of these institutions have important linkages to the banking sector (Box 3).

The impact was also felt in the U.A.E., largely as a result of falling real estate prices and liquidity pressures. The U.A.E. federal government took over two Dubai-based Islamic real estate finance companies (Amlak Finance and Tamweel) that faced financing difficulties. In addition, Abu Dhabi’s Real Estate Bank and Emirates Industrial Bank were merged. Credit rating agencies have taken several negative rating actions on GCC banks.

Moderate impact on overall GCC bank profitability

So far, the GCC banking sector has been relatively resilient, with the most recent available FSIs remaining generally strong (Table 6). These indicators show that banks had CARs above the required regulatory norms and low nonperforming loan (NPL) levels.17

Table 6.Banking Sector Performance and Soundness(In percent)
Nonperforming LoansCapital AdequacyProvisioning RateReturn on AssetsReturn on Equity
2007Latest2007Latest2007Latest2007Latest2007 Latest
Source: Country authorities.

Latest data is for end-2008. Indicators are only for conventional retail banks.


Latest data is for end-September 2008.


Latest data is for end-2008. For Oman, return on assets and return on equity for 2008 are staff estimates.


Latest data is for end-June 2008, except for CAR, which reflects end-June 2009.

Source: Country authorities.

Latest data is for end-2008. Indicators are only for conventional retail banks.


Latest data is for end-September 2008.


Latest data is for end-2008. For Oman, return on assets and return on equity for 2008 are staff estimates.


Latest data is for end-June 2008, except for CAR, which reflects end-June 2009.

While some banks showed losses in the fourth quarter of 2008—reflecting higher loan provisioning and mark-to-market valuations in investment portfolios—banks continued to be profitable in 2008 and the first half of 2009, albeit at lower levels than in previous years (Table 7 and Figure 28).18

Box 3.Cross-Sectoral and Cross-Border Linkages in the GCC

Cross-sectoral linkages are most pronounced in Bahrain, Kuwait, and the U.A.E. in view of the presence of some systemic financial institutions (see Annex II for a description of the structure of the GCC financial system). In Kuwait, investment companies’ (ICs) on- and off-balance sheet assets comprise more than 100 percent of GDP, with about 40 percent of GDP (around half of banking sector assets) in proprietary trading (on-balance sheet). Kuwaiti banks are highly exposed to this sector: bank loans to ICs amount to 11 percent of total bank lending, and to close to 56 percent of banking sector equity. While ICs are generally not highly leveraged (the capital-to-assets ratio is around 35 percent), they are dependent on foreign funding, which amounts to about 25 percent of their liabilities. Furthermore, their profitability is linked to the performance of capital markets, both domestically and abroad. As this sector suffered significant losses on its investments between July 2008 and May 2009, and also had difficulties refinancing maturing obligations,1 the impact threatened to spill over to the banking sector, given its exposure to ICs.

Wholesale banks in Bahrain are also linked to the global economy and have exposures to the region, a cross-border channel that is important, given the nature and size of Bahrain’s financial center. The exposure of the retail banks to the rest of the financial sector is low, but since wholesale banks contribute heavily to the country’s GDP, shocks affecting this sector inevitably spill over to the retail banking sector through their effect on the real economy via job losses.

In the U.A.E., the two major mortgage finance institutions have been merged and placed under restructuring. The combined mortgage lending of the two companies is about 16 percent of banks’ real estate lending and 3 percent of banks’ private sector credit.2 This sector has been hit by the decline in domestic real estate prices and liquidity shortages. If the restructuring of these institutions is not managed effectively, it could have an impact on the availability of housing finance in the U.A.E. However, the impact would be of limited scale, in light of the relatively small size of this sector.

There are also some cross-border linkages that arise from the operations of GCC conglomerates. These were highlighted by the failure of two wholesale banks in Bahrain that are part of the Algosaibi and Al-Saad groups, two prominent Saudi business groups. A number of GCC and global banks have announced that they had significant exposures to the two groups.

On the real side, while intra-GCC exports were not affected during the third and fourth quarters of 2008, most recent data for 2009 show some signs of a slowdown. However, intra-GCC exports are relatively small, accounting for less than 3 percent of the GCC’s GDP.

1 In the ten months after its peak at end-July 2008, the stock of foreign financing for conventional ICs dropped by around 24 percent. In contrast, foreign financing for Islamic ICs have increased by about 11 percent in the first five months of 2009 (see “Kuwaiti Banks: Annual Review and Outlook,” Fitch Ratings, July 2009 available at As Islamic institutions, the companies’ mortgage book is a combination of rental and lease instruments, not directly comparable to housing mortgages provided by conventional banks.
Table 7.GCC: Banking System Profitability (Listed Banks)(In billions of U.S. dollars)
Change (%)

of Banks
20072008Q3 2008Q3 20092008–2007Q3 2009–Q3 2008
Saudi Arabia117.
Source: Compiled from banks’ balance sheets reported in Zawya.
Source: Compiled from banks’ balance sheets reported in Zawya.

Figure 28.GCC: Banking Sector Profitability

(Annual percentage change)

Source: Compiled from banks’ balance sheets reported in Zawya.

Islamic banks were less affected than conventional banks by the initial impact of the global crisis, but mid-year 2009 results indicate slightly larger declines in profitability for Islamic banks in some countries, which could be attributed to the second-round effects of the crisis on the real economy and real estate (Annex III). The full impact of the crisis on GCC banks, however, is still unfolding, including expected additional provisions against the two Saudi groups and, potentially, Dubai-related debt.

The impact on growth was moderated by supportive policies

The impact of the crisis on GCC growth was moderated by supportive financial, monetary, and fiscal policies of the GCC countries. The medium-term economic outlook remains broadly positive. In the short term, lower oil production is estimated to have led to a contraction of 3.8 percent in real oil GDP in 2009, but real non-oil GDP growth is estimated to have remained positive at 2.8 percent, leading to overall real GDP growth of 0.8 percent (Figure 29). A rebound is expected for 2010, mirroring recovery in advanced countries albeit at a stronger pace. The short-term outlook, however, may be clouded by recent developments in Dubai.

Figure 29.GCC: Selected Macroeconomic Indicators, 2008–10

Sources: Country authorities; and IMF staff estimates.

Due to lower oil revenues, the fiscal and external balances of GCC countries have weakened in 2009 and are expected to have a partial recovery in 2010, in line with the expected oil price increase. Despite the impact of the crisis, all countries have observed the GCC monetary union convergence criteria in 2009.19

Taking Stock: What Has the Crisis Revealed?

As discussed above, the impact of the crisis on the GCC was mitigated by forceful government intervention and strong banking sector supervision and regulation. However, the crisis exposed a number of areas that should be addressed to limit future disruptions.

The banking sector. Overall, the GCC banking sector has been resilient to the crisis, indicating adequate risk management practices and strong regulation and supervision. Accordingly, banking sector prospects remain positive. However, NPLs—which are still low—are expected to rise as the full impact of the crisis on banks’ portfolios works through banks’ balance sheets. Fortunately, CARs in most countries were high to start with, and some countries have provided capital injections for additional cushions. Stress tests conducted by staff suggest that GCC banking systems can absorb relatively strong credit and market events, and that it would take a substantial increase in NPLs before the need arises for significant additional bank recapitalization.20

However, the crisis revealed some vulnerabilities related to banks’ exposures to asset markets, their increasing dependence on foreign financing, and a general weakness in their liquidity management frameworks. It also exposed instances of weak supervisory enforcement. For example, the severe liquidity shortages that banks faced in 2008 were due, to a large extent, to the use of short-term speculative capital inflows to finance rapid credit growth. In many cases, banks violated—by a large margin—regulatory loan-to-deposit ratios. Additionally, the manner in which some banks managed the speculative short-term liquidity inflows of 2007 seems to point to moral hazard issues, where banks appear to expect to be “bailed out” when needed.

The nonbank financial sector. The crisis also revealed weaknesses in the regulatory and supervisory frameworks of nonbanks. The systemic importance of nonbank financial institutions in many GCC countries has increased in recent years with the rise in their number, activities, and market share. However, similar to the international experience, the development of regulatory and supervisory frameworks for nonbanks has lagged behind, resulting in a buildup of vulnerabilities in some cases. Examples include asset/liability maturity mismatches and high loan-to-value ratios in mortgage finance companies in the U.A.E.; and maturity mismatches, high exposure to market risk, and weak disclosure in ICs in Kuwait. Tight liquidity conditions and asset price deflation have exposed these institutions’ vulnerabilities, resulting in high losses and some defaults.

Offshore financial centers. Given the nature of their operations and their high exposure to global markets, OFCs can transmit global shocks to domestic markets through their impact on the economy or the interbank market. In the current crisis, the largest losses were incurred by banks operating as wholesale (offshore) institutions in Bahrain. In addition, the default of two Bahrain-based wholesale banks affected the region’s retail banking system through interbank exposures.21 However, overall, OFCs have shown resilience to the crisis and the impact of losses has been limited.

Resolution frameworks. All GCC countries have explicit legal powers to intervene in, or liquidate, problem banks. However, regulators may need greater flexibility in the resolution approaches for banks, particularly in complex cases. As regards nonbanks, this issue is most important in Kuwait and the U.A.E., given the systemic relevance of ICs in the former and mortgage finance companies in the latter. Both countries have already initiated measures in this area. Kuwait’s Financial Stability Law addresses weaknesses in the resolution framework for ICs (Box 4), and the U.A.E.

Box 4.Financial Stability Laws

The use of temporary financial stability laws has been extensive in emerging Europe in the current crisis. Some countries opted for this approach to address gaps and deficiencies in the existing legal framework for bank resolution and provide temporary powers to the government and/or supervisory authorities to address the current crisis efficiently. These laws are typically used to set aside fiscal resources to deal with potential banking issues and to establish the needed legal power and ex-ante government approval to recapitalize or nationalize banks quickly, provide bank guarantees, buy banks’ “toxic” assets, and conduct a variety of bank restructuring/resolution operations that would not have been possible under existing laws.

The Financial Stability Law in Kuwait establishes support measures for banks, including guarantees for shortfalls in banks’ loan provisions. It also provides for guarantees for bank lending to investment companies (ICs) and productive economic sectors. The law supports the restructuring of viable and solvent ICs that are under stress and facilitates the exit of insolvent institutions. The law was issued by an Emiree Decree and is currently in effect, unless rejected by Parliament. So far, other countries in the GCC have not seen the need for similar laws.

Ministerial Committee has recently obtained cabinet approval to revise the bankruptcy law. Furthermore, the Ruler of Dubai issued a decree effective December 13, 2009 to establish a special insolvency regime to facilitate the reorganization and restructuring of DW and its subsidiaries.

Excess liquidity and asset price bubbles. Despite a wide-ranging set of prudential regulations adopted by GCC central banks to contain the expansionary impact of the oil boom (Box 5), the GCC economies experienced a prolonged period of excess liquidity conditions in 2003—08, during which asset markets appreciated significantly, only to deflate again as oil prices declined. Asset price cycles have traditionally affected the real economy via the wealth effect and consumer and investor confidence. With the increasing role of the financial sector, the recent collapse of the asset price bubble was also transmitted through its impact on the financial system and credit growth.

Box 5.GCC: Banking Sector Prudential Measures1

Prior to the crisis, several countries (Kuwait, Oman, Qatar, Saudi Arabia, and the U.A.E.) had in place loan-to-deposit prudential ratios to encourage banks to seek stable sources of funds and limit credit growth. In addition, some countries attempted to slow the growth of credit to the real estate sector (Qatar and the U.A.E.) through caps on real estate lending, and caps on personal loans sought to slow consumer lending (Oman and Saudi Arabia). Maximum limits on debt/income or debt service ratios for individuals were also used to control the buildup of debt in household balance sheets (Kuwait, Qatar, and Saudi Arabia). GCC countries also moved to the Basel II framework, which included more rigorous capital standards.

1Annex II provides a summary of the institutional structure for financial sector regulation and supervision, and key banking sector prudential regulations.

Dubai World event. This event has underscored risks related to high leverage (especially to finance property developments), increased the focus on the legal enforceability of sukuk, and brought to the forefront issues related to transparency and disclosure in the GCC. Most importantly, the market’s assumption of implicit guarantees on government-owned entities, commonly associated with the GCC, has been called into question. This is likely to have a prolonged impact on the U.A.E.’s (particularly Dubai’s) access to capital markets, and may affect the pricing of quasi-sovereign risks more widely. It might also result in a general reassessment of real estate risk in the GCC.

Corporate governance and transparency. Improving corporate sector transparency has become a priority. The corporate sector in the GCC is largely owned by family business groups or GCC governments.22 This has tended to decrease overall disclosure, internal controls, and corporate governance, particularly in view of the limited disclosure requirements for unlisted companies. While these groups had comfortable access to credit prior to the crisis, both domestically and externally, lenders are now putting pressure on them to enhance disclosure, particularly in view of the default of the two Saudi conglomerates and DW developments.

Communication. Communication during the crisis showed some weaknesses. For instance, the experience with liquidity support in the U.A.E. early in the crisis was mixed because banks were not provided with clear guidelines on extraordinary liquidity access, which delayed their ability to make use of these facilities. In addition, some countries’ decisions on bank recapitalization measures were provided in a piecemeal fashion, without clear information about the authorities’ intentions or target banks. More recently, a more prompt release of information on bank exposures to the two Saudi Conglomerates could have avoided market uncertainties. Finally, weak communication has exacerbated the negative market reaction to DW developments. The initial announcement on the debt standstill did not include key details, there was no effective follow-up with market participants, and official statements came with some delay.

Fiscal policies and diversification. The crisis has re-emphasized the risk of high dependence on oil revenues and the importance of revenue diversification and rationalization of fiscal spending. Notwithstanding progress made by the GCC in diversifying economic activity in the past two decades, the oil sector continues to contribute heavily to total GDP and is the main source of fiscal revenue (Figures 30 and 31). The volatility of oil revenue and production also underscores the importance of accumulating fiscal savings during economic upturns to allow for countercyclical fiscal policies during downturns.

Figure 30.GCC: Oil GDP, 2000–08

(In percent of GDP)

Sources: Country authorities; and IMF staff estimates.

Figure 31.GCC: Oil Revenue

(In percent of total revenue)

Source: Country authorities.

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