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Chapter I Impact of the Global Crisis and Policy Response

May Khamis, and Abdelhak Senhadji
Published Date:
July 2010
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The GCC countries performed well during the 2003–08 oil boom, but the boom also presented challenges. Buoyant economic activity, rising consumer and investor confidence, and abundant liquidity spurred excessive credit growth, inflation, and asset price increases. In addition, in some countries, banks’ growing dependence on foreign financing and exposure to real estate, construction lending, and—to a lesser extent—the equity market, contributed to balance sheet vulnerability in the event of a slowdown in economic growth and a decline in asset prices. In the corporate sector, the boom was associated with higher leverage, which increased the sector’s vulnerability to the availablitity and cost of financing.

As the global economic crisis took hold, the GCC countries were affected through trade and financial channels. By the second half of 2008, GCC government finances and external positions were directly affected by the decline in oil prices and demand. At the same time, GCC countries underwent reversals of speculative capital inflows experienced in 2007 and early 2008. These developments tightened liquidity conditions and affected investor confidence, and were further exacerbated by Lehman’s collapse in September 2008 and the ensuing global liquidity shortages and deleveraging. GCC financial sector imbalances came to the fore, especially in the United Arab Emirates (U.A.E.), Kuwait, and Bahrain, given these countries’ close linkages with global equity and credit markets.

A forceful response by the authorities contained the impact of the crisis. To offset the fallout from the crisis, GCC governments maintained or even increased spending levels despite a sharp decline in oil revenues. In particular, Saudi Arabia adopted the largest fiscal stimulus (as a share of GDP) among the G-20. They also introduced exceptional financial measures, including capital and liquidity injections (Table 1 and Figure 1). In line with monetary easing in the United States in late 2008, and to ease domestic credit conditions, GCC countries (except Qatar) lowered interest rates, and eased liquidity through direct injections in the money market and through statutory changes, including reductions in reserve requirements and relaxation of prudential loan-to-deposit ratios.

Table 1.GCC: Policy Response to the Global Crisis
Saudi Arabia
1Includes expansion of retail deposit insurance and guarantee of wholesale liabilities.
Source: Country authorities.
1Includes expansion of retail deposit insurance and guarantee of wholesale liabilities.

Figure 1.GCC: Bank Support Packages, 2008-09

Source: Country authorities.

1 Pre/post-crisis change in government deposits and use of central bank facilities.

2 Includes purchases of bank assets, stock market interventions, etc.

3 Includes some double counting of capital liquidity support.

The global crisis triggered a steep fall in asset prices, and credit default swap (CDS) spreads on sovereign debt widened. Tighter global liquidity conditions and the subsequent slowdown in credit growth and economic activity deflated real estate prices in most countries in the GCC. As regards equities, despite some recovery in 2009, equity prices remained at much lower levels compared to the pre-Lehman collapse (Figure 2). After their initial rise in late 2008 and early 2009, CDS spreads declined markedly, indicating an improvement in global investor sentiment. Nevertheless, CDS spreads on Dubai government debt remained elevated, reflecting developments associated with highly leveraged Dubai government-related entities, notably Dubai World (DW): the announcement in November 2009 of a debt standstill by DW resulted in a sharp increase in market perceptions of the default risk for Dubai-related entities and negative—but rapidly dissipating—spillovers throughout the region (Box 1).

Figure 2.GCC: Equity Prices

(Percentage change)

Sources: Bloomberg; and IMF staff estimates.

The global crisis had an adverse impact on financial institutions, but there were no systemic consequences. The crisis had a moderate impact on financial institutions’ profitability and led to defaults by a few, isolated GCC nonbank financial institutions.2 Despite a significant decline in bank profitability, banks remained profitable overall (Table 2 and Figure 3). Nonperforming loans (NPLs) increased in most countries, with a notable increase in Kuwait due to loan concentration in real estate, equities, and the battered investment companies’ (ICs) sector, in addition to significant losses by Gulf Bank in 2008.3 Profitability declined in 2009 across the board, reflecting higher provisioning needs.4 Nonfinancial corporate sector profitability also declined in many GCC countries (Figure 4).

Box 1.Update on Dubai World Debt Restructuring

Tightened global liquidity conditions and a slowdown in economic activity led to the deflation of real estate prices in most GCC countries. The correction was most pronounced in Dubai, where some government related entities (GREs) had engaged in highly leveraged property development projects. In light of the scale of funding needs compared to domestic banking system assets, GREs relied on foreign borrowing, which, in the wake of the global financial crisis and a slowdown in international credit flows, turned out to be the Achilles’ heel of the development model.

On November 25, 2009, the Government of Dubai announced that Dubai World (DW) and its two real estate subsidiaries, Nakheel Properties and Limitless World, would seek a standstill until May 2010 on property-related debt to allow time for an orderly restructuring. The announcement effectively abolished the perceived implicit sovereign guarantee for GREs and brought to light the effect of the perceived guarantee on borrowing costs. The initial negative market reaction was strong and spread beyond Dubai. Prior to the collapse of Lehman Brothers, five-year CDS spreads for Dubai had averaged about 70 basis points, well below those of countries with similar or lower indebtedness ratios. Following the post Lehman spike, CDS spreads fell significantly, but soared from about 300 basis points to 654 basis points in response to the standstill announcement. The initial impact of the DW debt standstill spread to other emirates and to countries throughout the region, although these spillovers had largely dissipated by end-2009.

Sources: JEDH; Dealogic; and IMF staff estimates.

On May 20, 2010, DW reached an agreement in principle with its core bank creditors on restructuring $23.5 billion in liabilities for itself and Nakheel (Limitless did not need restructuring). This agreement, which built upon a proposal dated March 25, 2010 by the government, clarifies the nature and extent of government support and limits DW-related uncertainty. The agreement has been put to the full group of bank creditors and has three components:

(1) $8.9 billion of debt owed to the government will be converted into equity, as announced on March 25;

(2) full repayment of principal through the issuance to two tranches of new debt: (i) $4.4 billion with an interest rate of 1 percent and a five-year maturity; and (ii) $10 billion with an eight-year maturity and a menu of interest rate options that combine interest of 1 percent, deferred interest payments between 2½ to 3½ percent, and a limited guarantee from the Government of Dubai in the event that DW is unable to meet these obligations; and

(3) upon creditor agreement, the Government of Dubai will provide up to $9.5 billion in new funds, mainly to continue work on Nakheel’s projects. Separate proposals have been made for Nakheel’s liabilities to customers, contractors, and suppliers.

With negotiations on the DW debt restructuring proceeding well and the economy beginning to recover, the immediate focus should be on successfully completing the debt restructuring, determining the full breadth of potential debt problems in other GREs, and maintaining the stability of the banking system. Although Dubai’s sovereign and GRE CDS spreads have narrowed from their early 2010 peaks, they remain elevated compared to other countries and to their historical levels.

Sovereign and GRE CDS Spreads

Table 2.GCC: Banking Sector Performance and Soundness1(In percent)
NonperformingCapitalProvisioningReturn onReturn on
LoansAdequacyRateAssets Equity
Saudi Arabia2.13.320.616.5142.989.
1Latest data is as of end-2009 for Bahrain, Kuwait, Qatar, and Saudi Arabia; Nov. 2009 for the U.A.E., except for CAR, which is Mar. 2010; and June 2009 for Oman.
Source: Country authorities.
1Latest data is as of end-2009 for Bahrain, Kuwait, Qatar, and Saudi Arabia; Nov. 2009 for the U.A.E., except for CAR, which is Mar. 2010; and June 2009 for Oman.

Figure 3.GCC: Listed Banks’ Profits

(Annual percent change)

Sources: Zawya; and IMF staff estimates.

Figure 4.GCC: Nonfinancial Sector Profitability, 2006-09

(In billions of U.S. dollars)

Sources: Country authorities; and IMF staff estimates.

While external financing for GCC banks declined substantially, the impact on nonbank financing was less severe (Figures 58). Banks’ external financing declined significantly post-Lehman, both in levels and as a share of total liabilities, and is yet to recover. External financing of nonbanks was less affected. Furthermore, despite heightened risk aversion among global investors, Qatar and the U.A.E. were able to raise significant funding on international bond markets in 2009, largely through sovereign debt issuance. Nevertheless, by end-2009, over 20 percent of an estimated $2½ trillion in projects at different stages of planning and implementation at end-2008 had been placed on hold due to financing constraints.

Figure 5.GCC: Banks’ External Financing1 December 2006-December 2009

(In billions of U.S. dollars)

Source: BIS Consolidated Banking Statistics.

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

Figure 6.GCC: Commercial Bank Foreign Liabilities to Total Liabilities, January 2007-May 2010

(In percent)

Sources: Country authorities; and IMF staff estimates.

Figure 7.GCC: External Financing of Nonbanks1 December 2006-December 2009

(In billions of U.S. dollars)

Source: BIS Consolidated Banking Statistics.

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

Figure 8.GCC: Bond and Sukuk Issuances1

(In billions of U.S. dollars)

Sources: BEL; Zawya; and IMF staff estimates.

1 Through May 2010.

Private sector credit growth stagnated in 2009. Higher risk aversion by banks and weaker investor and consumer confidence stifled credit growth (Figure 9). In Qatar, however, although credit growth declined sharply compared to during the boom years, credit growth registered higher levels than in the rest of the GCC in light of continued strong growth. In Saudi Arabia, credit extended by the state-owned specialized credit institutions mitigated the impact of the decline in bank credit growth on non-oil activity.

Figure 9.GCC: Growth of Credit to the Private Sector, 2007-091

(Annual percentage change)

Sources: Country authorities; and IMF staff estimates.

1 Includes credit to public enterprises in Qatar and Saudi Arabia.

Fiscal and financial measures helped support non-oil activity in 2009. Real growth in the GCC’s non-oil sector declined by about half in 2009, to 3.2 percent, but surpassed growth in advanced economies by a large margin and outperformed other emerging markets (Figure 10). The decline in global oil demand had a significant impact on oil GDP output and, combined with lower oil prices, led to weaker fiscal and external balances. The fall in imported food prices and slowing aggregate demand—with its particular impact on rents—caused annual inflation to decline from double digits in 2008 to 3.3 percent in 2009.5

Figure 10.Real GDP Regional Comparisons

(Annual percentage change)

Sources: Country authorities; and IMF staff estimates.

1 Non-oil GDP.

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