Gulf states ride out worst of the storm

A senior banker considering a business trip in the wake of September 11 is hesitant. “Some of the stories I have heard about the way fellow nationals have been treated make me nervous about travelling there,” he says. It’s not a US banker worried about the risks of venturing outside North America but an Arab chief executive contemplating a US trip.

One of the casualties in the aftermath of the attacks has been global confidence in the Middle East. Immediately after, crude oil prices spiked. But since then the fear has been that a global economic slowdown might drive the oil price down, possibly to as low as $10 a barrel. “These events have brought home to us that we live in a global village and that we cannot be immune to international events,” says Michael Tomalin, chief executive of the National Bank of Abu Dhabi.

Projects will be delayed or cost more to finance. “If oil prices stay low, there will be less liquidity, more bad debts and reduced profitability. There will be fewer projects and fewer bankable deals in contrast to the last couple of years when we have been awash with them,” says a western banker.

Tourism in the Gulf is in trouble. German travel agents took scarcely any winter bookings for Dubai in the three weeks after September 11. Interest has revived only slightly since.

The region’s main flag carriers have been hit hard, particularly by declining business travel. This is a blow to Gulf Air, which had started to cast off its reputation for poor reliability.

Hotels are suffering. “In the UAE, there have been savage cuts in tourism and business,” says an expatriate banker. “Normally at this time of year I would expect to see 10 international investors and 10 times that number would see my colleagues in the bank. That fell to zero and by the start of November had risen to only 40% of the normal total.”

The Gulf states, headed by Dubai, are responding by launching a major advertising campaign on CNN and making a series of spectacular announcements at the recent Dubai International Airshow. Dubai’s flag carrier, Emirates, confirmed that it was spending no less than $15 billion on 51 wide-bodied aircraft and the Dubai airport authority announced that it would build a $2.5 billion third terminal.

And the World Trade Organization summoned up courage in November to meet in neighbouring Qatar, a prelude to the 2003 IMF summit. At least things are not as dire as they were during the Gulf War more than a decade ago. “There has been no sign of the cancellation of credit lines as there was in 1990. There were one or two minor incidents but no real problems,” says Tomalin. And, according to another banker: “There has been no capital flight from the region and no slashing of counterparty limits.”

Nor has there been a rush into dollars. “That did not happen in the UAE because the customer base is very stable – some 75% of deposits are held by UAE nationals and a further 8.6% by other Arab nationals. We don’t expect people to liquidate their holdings,” says Sultan bin Nasser Al-Suwaidi, the UAE’s central bank governor.

So far there has been no sign of bankers leaving the region. In 1990, Japanese bankers were heavily criticized for the way they abandoned the Middle East after the Iraqi invasion of Kuwait. This year, they have remained and made a point of bringing senior executives to the region.

Within the local financial community there is confidence that the regional economy is strong and flexible enough to survive any global slowdown in a way it could not have done 15 years ago. In recent years governments have not repeated the mistake of taking advantage of the higher oil prices in the past two years to go on a spending spree. In Saudi Arabia, for example, the government has kept to its spending targets, while reducing its late-payment bills.

“Conservative banking policies and prudent supervision and regulation in our leading financial centres meant that we have not experienced any significant degree of contagion,” says Abdullah Saif, Bahrain’s minister of finance and national economy. “Meanwhile the capital basis of banks in our region has been strengthened and we are benefiting from endogenous improvements in long-term productivity through economic reform and technology.”

Banks’ profits will undoubtedly be hit this year but the nine months up to September had been highly profitable. “There has been an impact but overall results might not be as badly affected as one might think,” says Al-Suwaidi.

However Saif concedes that there “could be an adverse impact on the region’s international investment portfolios”. Despite the rebound in western stock markets, there has been a reduction in the assets of Arab governments, investment institutions and rich individuals. The Saudi Arabian Monetary Agency (SAMA) estimates that the value of holdings of the Saudi private sector fell by $50 billion as a result of the terrorist attacks.

Repatriated capital boosts markets

The dip of western markets has had one beneficial effect. Money has flown back into the region, providing a much-needed boost for the local stock exchanges. The Kuwait Stock Exchange is up 35% this year and in Bahrain the market has in the past two months made up its losses in the first part of the year.

It is a trend that bankers and politicians expect to continue. Saif says: “We have seen some signs of an increased propensity to repatriate private capital to the region in order to take advantage of the private-sector investment opportunities.”

Albert Kittaneh, chief executive of Bahrain-based investment bank BMB, says: “One consequence of September 11 is that local stock exchanges in the region will continue to do well as a lot of wealthy individuals have brought some of their money back to the region. In the next few years things will continue on an even keel as long as oil prices stay between $15 and $20 a barrel.”

An even more positive view is taken by Ziad Makkawi, executive managing director of Shuaa Capital, which specializes in bringing international capital into the Middle East. “People are repatriating funds to the region, realizing that it offers investment opportunities across the assets classes. The region is a major exporter of capital and if even a small portion comes back, the impact will be profound and positive for the region,” he says.

The challenge, though, remains the lack of properly regulated, efficiently run, large stock exchanges with a variety of securities to attract investors. “It is one of the oddities of the Middle East that, when most parts of the world are closing down airlines, it is acquiring more. Moreover, as stock exchanges merge globally, each state is desperate to hold on to its own and some are reluctant to have foreign investment,” says one banker.

The local markets also suffer because, with the exception of Kuwait, where the Kuwait Investment Authority is active, very few of the large local institutions, such as pension funds, invest in them.

The slow pace of privatization and the reluctance to sell to foreign investors – most recently Saudi Telecoms abandoned plans to sell a minority stake to foreigners – have also made it harder for equity markets to develop.

Elsewhere, however, there is greater readiness to allow foreign investment – the latest country to do so is Kuwait, which has joined Oman and Bahrain in allowing 100% foreign investment. Makkawi’s confidence is demonstrated by Shuaa’s decision to launch a UAE equity fund early next year, followed by a regional fixed-income fund and regional structured notes. “As these products are developed, the regional environment will become more structured and less money will find its way out of the region. These are positive factors from the capital market point of view,” says Makkawi.

Many argue that the region’s exchanges should consolidate into a single venture with several different floors. While this may be unrealistic in the short term, there is at least a greater readiness to cross-list. Encouragingly, shares in Qatar’s part-privatized telecommunications company, Qatar Telecommunications (Q-Tel), are to be quoted on the Bahrain Stock Exchange (BSE).

This decision, made possible by the recent settlement of the long-running territorial dispute over an island, is likely to be followed by further cross-listings.

The BSE’s acting director, Ali Al Thaner, says that he expects more companies from other regional exchanges to be listed in Bahrain early next year. “We are looking forward to making Bahrain a regional hub and to activate the local capital market in line with the developments taking place in the global market.”

Q-Tel is also likely to be quoted on the Abu Dhabi Securities Market (ADSM), bringing protracted negotiations to a successful end. “The listing of Q-Tel at the ADSM is in its final stage and we believe this will affect the share pricing positively,” says Shaikh Mohammed bin Sahim Al Thani, vice chairman of Q-Tel.

The UAE market is also likely to benefit as links between the ADSM and the Dubai Financial Market (DFM) move towards becoming the single market with two floors as was originally planned. Progress has been extremely slow in the 18 months since these exchanges were established to replace the old unregulated over-the-counter market, which still exists. “At times it looked as if the UAE had replaced one market with three,” says one western banker.

Brokers in Abu Dhabi and Dubai now for the first time have direct access to shares on each other’s market. This will make it possible for Etisalat, the national telecommunications company, to be quoted on these exchanges – political sensitivities about the company, which is a federal institution, only being accessible from one of the exchanges mean that it continued to be traded only on the OTC market.

“The link [with Abu Dhabi] is now complete. Brokers now have direct access. However, I believe that we have to consolidate the order book in the future, meaning that trading and clearing and settlement have to merge in order to create one market,” says Essa Kazim, chief executive of the DFM.

The DFM is also completing negotiations with Jordan and Bahrain exchanges to set up an exchange for high-technology stocks. Brokers hope this will help diversify the region’s markets, which are heavily dominated by banks and other financial institutions.

Despite intensive marketing campaigns by the stock exchanges of several Gulf states, most of the leading merchant families have resisted every attempt to persuade them to float their shares on local stock markets. There has, for example, been no IPO on the BSE for the past four years.

Despite problems with merging the two floors, the Dubai financial markets have earned a reputation for innovation. In July Emirates Airline raised Dh1.5 billion ($408.3 million) through a five-year floating-rate note, issued at 70 basis points over the six-month Emirates Inter Bank Offered Rate (EIBOR). This followed two earlier dirham issues for international borrowers, BMW and Abbey National, which wanted to diversify their investor base.

The issue for Emirates was the first for a UAE company, the largest to be issued in dirhams and the first to be quoted on the DFM. It is also the only quoted instrument – apart from 20% of the shares in Emaar Properties – that can be bought by foreign investors.

Generous pricing, the award of a zero-risk rating by the central bank and Emirates’ international reputation meant that the airline could have raised Dh2 billion and the bond has traded extremely well in the secondary market. Two of the underwriters, HSBC and Emirates Bank International (EBI), have sold down their holdings to retail clients.

The stable currency, which is effectively fixed to the dollar, means that it will be attractive for local institutions to follow this example. However, EBI, which is still planning to raise a dirham bond next year, decided this autumn to raise $230 million on the syndicated loan market. “Despite the events of September 11, EBI was able to raise the money at rates lower than we achieved in the past and for a longer term,” says Charles Neil, the bank’s general manager.

The syndicated loan market has remained very active since September after a short pause.

As the market regains momentum, bankers believe that borrowers will have to pay slightly wider margins for their money, though the absolute cost of financing, aided by lower interest rates, will be less. Investors will also insist on maintaining material adverse change clauses, which normally lapse after a loan has been signed.

Some deals have been postponed or abandoned. But, say bankers, the events of September 11 are being used as an excuse to pull deals that were already in trouble.

A project finance wonderland

Despite these short-term difficulties, Mark Yassim, head of global and structured finance at the Bahrain-based Arab Banking Corporation, says that “the Middle East is the most active and probably the largest project finance market in the world, particularly as the US is in recession”.

Bahrain, alone, for example, will need to raise up to $3 billion to finance a major expansion of its aluminium plant run by Aluminium Bahrain (ALBA), to upgrade one of Bahrain Petroleum Company’s (Babco) refineries and to expand the Shaikh bin Sulman al Khalifa superport.

Bahrain has asked Standard&Poor’s to provide a sovereign rating, fuelling speculation that ALBA will raise some $200 million of its $1.7 billion financing through a Eurobond, a method of financing that has had limited use in the Gulf. Qatar has used Eurobonds to finance its gas expansion and to raise two sovereign bonds and Egypt this year raised its first sovereign Eurobond.

Elsewhere in the Gulf, deals include a $1.6 billion financing that is being completed for the Shuweihat power project. Lead managers include Tokyo Mitsubishi and Abu Dhabi Investment Company. A $600 million deal for Ras Laffan power station in Qatar is also being finalized. A deal for Oman LNG, which was pulled in the aftermath of September 11, is now going ahead. Abu Dhabi is replacing its Umm Al Nar refinery and electricity generation plant ande Fujeirah is building a $1.2 billion water and electricity plant, underwritten by Abu Dhabi.

“We believe conservatively that there are up to $30 billion of projects coming up in the GCC over the next five years, a large percentage being under UAE initiative,” says Terence Allen, head of treasury and investment banking at the National Bank of Abu Dhabi.

Saudi Arabia remains the key to the region, with banks preparing to get involved in the massive financing required for oil, gas, electricity and desalination projects. With the overall cost estimated at $250 billion, bankers estimate that some $175 billion will have to be raised in debt from international markets.

The National Petroleum Industries Corporation is presently raising $260 million and Saudi Arabian Basic Industries (Sabic) is planning a $2 billion petrochemical project, but most attention is now focused on the $20 billion to $25 billion required by the international oil companies awarded the contract to develop Saudi Arabia’s gas industry. Bankers believe it will require funding through syndicated loans and bonds.

Though recent events have made business more difficult in the Middle East, they have not dented the fundamentals of a region rich in oil and with capital to export.