The GCC is witnessing a period of rapid
transformation as oil prices, which were once at a cushy $100 per barrel, has
fallen below $50 over the past 18 months. The stable oil prices between 2012
and 2014 enabled GCC to earn more than $3 trillion in export revenues. Thanks
to that, GCC governments are now sitting on strong cash reserves.
However, that is only a short-term comfort.
Given the extremely high dependence on oil revenues of GCC governments and
their lack of economic diversification, the depletion rate of those precious
reserves has been highlighted as a major cause for concern. GCC countries now
require the oil price to be much higher than $50 in order to balance their
budgets. Since prices are still significantly lower than that rate, the
region’s governments will face successive years of fiscal and current account
deficits; which they will have to plug through additional reserve depletion or
through borrowings. Given this context, I would like to specifically look at
the financial challenges this period of low oil prices will pose to four
specific stakeholders: Government, Banks, Corporates and Individuals.
Government
The biggest pressure is on governments, who face
a bloated bureaucratic structure and increasing levels of expenditure largely
comprising of salaries and subsidies. Therefore, there is little flexibility
for them due to the current social welfare model and the strong social contract
with nationals. While rationalising subsidies and reducing wasteful expenditure
can be prioritised, this may not reduce deficits within the urgent time frame
that is required. Hence, the biggest financial challenge for GCC governments
will be funding growing deficits. The IMF estimates GCC countries to pose a
fiscal deficit of about 12% of GDP or $150 billion in 2016. I expect this to be
met through a judicious combination of reserves, local debt and foreign debt. Research
estimates by Marmore point to the cumulative debt increasing from $250 billion
to $390 billion by 2020, a significant jump from $72 billion raised
cumulatively between 2008-2014. Such a massive growth in debt raising is bound
to have an impact on the overall economy in multiple ways. Saudi Arabia, for
the first time in eight, had to secure a loan of approximately $26 billion from
domestic banks in 2015. It is also in talks to raise $10 billion from a
consortium of international banks in an effort to address their growing budget
deficit. Most notably the credit rating will be lowered as a consequence of the
increasing Debt to GDP ratio. Sovereign ratings of Bahrain, Oman and Saudi
Arabia have already been downgraded recently with further downgrades expected
in the future. Another point of impact will be the Credit Default Swap (CDS)
spreads. In the last six months, CDS spreads of Abu Dhabi, Qatar and Bahrain
have doubled while Saudi Arabia’s has tripled. The current macroeconomic
conditions will also increase the cost of capital for governments.
Banks
The financial challenge for banks will come in
the form of lower levels of liquidity. Banks, to a great extent, largely depend
on government deposits for their liquidity; which have experienced significant
decreases. With stagnating growth in deposits, banks will have lesser amounts
to lend at a lower spread; which will have a negative impact on their
profitability. On the other hand, the sovereign bond issuances will see high levels
of subscription by banks because of the attractive yields and their risk free
nature; this will crowd out lending to the private sector. The pressure this
will introduce to the margins of banks will result in lower profitability. Additionally,
the financial challenges for corporates will mean deteriorating asset quality
and a rise in Non-Performing Assets. As a result, the credit rating for banks
will remain on the downward trajectory.
Corporates
Banks being crowded out will directly impact
the private sector, since fund raising will be increasingly difficult and
expensive. Many companies have solely depended on government spending for
projects. In this climate, project delays are inevitable and may affect working
capital. Advance payments for projects have been slashed from 20% to 5% of
contract value. Since corporates access banks for most of their short-to-medium
funding requirements, access to funding may become difficult and expensive
given the pressures banks face resulting from lower liquidity and tighter
margins. Debt markets may be an attractive source of funding for governments
but not for the corporate sector due to wider spreads demanded by lenders. We
have already noticed a weak corporate issuance of debt due to the drying up of
liquidity. Where funding is absolutely necessary, it will come at higher cost
of capital which adds additional pressurise on margins and profits. Introduction
of VAT may also impact corporate profitability. These developments will have a
substantial impact on Small and Medium Enterprises (SME’s); who will be crowded
out the most.
Individuals
Financial challenges for individuals will come
in different forms. Firstly, the generous government policies in the form of
subsidies will see cuts; especially for the three most highly subsidised
amenities which are petrol, water and electricity. As subsidies are reduced,
the cost of services will increase and lead to higher inflation. Individuals
will also have less access to financing options from Banks as lending procedures
are tightened. Simultaneously, borrowing costs will also increase. Such market
conditions may lead to increased debt defaults. Also, governments employ a majority
of citizens in the public sector more as a social contract rather than genuine
need. The absorption rate will come down as a consequence of growing federal deficits.
Opportunities
As many experts say, challenges can also be
viewed as opportunities. Increasing government debt will induce financial discipline,
better management of fiscal expenditure and more importantly, the much needed
development of debt markets and improvement of the yield curve. Efforts to
reduce wasteful expenditure will improve productivity levels across sectors and
banks will look for overseas expansion opportunities to improve profitability. The
current economic conditions will also encourage the adoption of advanced technological
products and services to reduce the cost of service offerings. Corporates will focus
heavily on efficiency and productivity gains and align corporate planning with thoroughly
researched market needs. Mergers and Acquisitions will be on the rise along
with alternative financing avenues such as private equity, crowd funding and
sukuks. It will be a period of financial reform to navigate through this
challenging period for both the government and private sector!
