The boom in the Arab Gulf is well and truly over. The global credit crunch and economic downturn, coupled with falling oil prices, have hit the region with a vengeance. Many observers assumed that it would largely be immune from the turmoil elsewhere, but this has not proved to be the case. Things started to go wrong in November and December last year, and have steadily got worse.
Economic growth in the oil-rich Gulf Co-operation Council (GCC) countries – comprising Saudi Arabia, United Arab Emirates (UAE), Kuwait, Bahrain, Oman and Qatar – will be down sharply this year, and fiscal and current account surpluses are giving way to deficits. Although recession is unlikely if oil prices remain above $45 a barrel, it will feel like a recession because the fall in real gross domestic product growth (GDP) will be from a great height – some countries have achieved double-digit growth in the past few years. And if oil prices fall further, recession is a distinct possibility for the GCC.
UAE-based Simon Williams, an economist at HSBC Middle East, predicts that real GDP growth in the UAE will slow to 1.1% this year, from 7% in 2008. "However, we believe the region is well placed to weather the impact of this abrupt downturn," he says. "The immense surpluses the region has run over the past five years now offer the Gulf room to manoeuvre, which should ensure that stability is maintained, the banking sector is protected and debt obligations continue to be met.
"The region's sovereign wealth funds will be required to change tack as surpluses recede and local financing needs mount. Rather than acquiring assets overseas, we expect outflows to dry, and even reverse, as 2009 progresses."
With oil at $45 a barrel, Mr Williams expects the UAE, along with Kuwait among the other GCC states, to maintain budget surpluses. Qatar will be close to balance. "The impact of declining revenues on spending growth in these three states should be limited, and we expect double-digit gains in spending throughout 2009," Mr Williams adds.
However, the UAE, a federal state, is hugely reliant on the oil wealth of Abu Dhabi. Without transfers from the wealthiest emirate, the fiscal position of the others will be strained. "Dubai in particular is likely to see revenue fall significantly as a drop in earnings from its small oil output is compounded by declining earnings from fees and indirect taxes, as economic growth slows," says Mr Williams.
Developments mothballed
Dubai relies on international trade, finance and tourism for most of its income, and all have been hit by global events. Infrastructure projects and real estate developments – heavily reliant on debt and equity finance raised in the international markets – have been scaled down or mothballed.
The central bank of the UAE, based in Abu Dhabi, bought half of a $20bn five-year bond issued by the Dubai government in February. The bond was proof that Dubai was in trouble and had to do something about its $80bn debt hole; the central bank's investment was proof that the federal government was prepared to help.
The UAE's banking sector is suffering in common with the rest of the world, but so far has not had any notable casualties. How long that will remain the case is anyone's guess, but most banks have lent heavily to the real estate and construction sectors, the sectors that fed the Dubai boom and which are now grinding to a halt.
Conservative approach
Mashreq Bank, based in Dubai and with branches all over the UAE and offices in nine countries abroad, seems better placed than most banks to cope. It is the 15th largest in the Arab world by Tier 1 capital, and the fourth largest in the UAE, according to The Banker's Top 100 Arab Banks rankings published last November.
Mashreq saw its profit fall 13% in 2008 compared with 2007, to Dh1630m ($435m). Chief executive Abdul Aziz Al Ghurair says he is happy with the results, considering that the 2007 profit was a record peak. "Also, our return on equity is about 17%, return on assets is 1.8% and our capital adequacy is 14.1%," he says.
"We are the second oldest bank in the country and have seen all kinds of crises in the past 42 years. We are getting ready for worse times, but we are also getting ready for the upturn when it comes. In good times, banks can get away with anything. Everything is doable. The challenge comes in tough times. Then you see which are the best banks. We are a conservative bank and have a top-notch team, which are factors that will help us navigate through the next year or so.
"We don't have any toxic assets. We run a non-performing loan policy of 90 days, so if an instalment is not paid within 90 days it is classified as non-performing, but none of our customers has fallen into this category." The same is true of its personal and commercial mortgages: Mashreq has no delinquent mortgage customers. Mr Al Ghurair puts this down to the bank's conservative lending policy and selection criteria.
Mashreq's focus this year, in the absence of revenue growth, is on cutting costs. In February it made 4% of its workforce redundant, but this has to be seen against a doubling of headcount in the previous three years. It also plans to tread water and strengthen key aspects of its business. "This slowdown will give us time to breathe, re-examine what we want to do over the next three years, and explore any opportunities that may come along, including acquisitions in the GCC," says Mr Al Ghurair.
"We are sending more people for training. We are spending $120m on technology upgrades. Now we have time to do all of these things. This is investing for the future. If I can't develop my business outside because the market is not growing, I have to look internally to ensure I have quality people who are well trained and quality infrastructure to help us become even more efficient and customer friendly."
Stock market survivors
Naser Nabulsi, executive chairman of Al Mal Capital, a Dubai investment bank set up in 2005 with shareholders from 82 UAE and regional families and institutions, admits it has been hit hard by economic events and the plunge in regional stock markets and asset values. The firm provides brokerage and asset management as well as investment banking services.
"We didn't see the crisis coming," says Mr Nabulsi. "We trade on the Dubai Financial Market, Abu Dhabi Securities Exchange, Nasdaq Dubai and the Saudi Stock Exchange. We were doing so much business. All of a sudden it stopped. It was a shock. The turning point came in November."
All banks and companies are having a hard time. "If some of the big companies go under, they will take a lot of investors with them and there will be a high degree of personal insolvencies," he says. "Individual investors are not as diversified here as they are in North America and Europe.
"We had 80 staff, but had to lay off 20% at the end of last year. But we are in it for the long term." Al Mal did the initial public offering (IPO) for Drake & Scull, a large construction contractor, last July, but because the market collapsed the listing on Dubai Financial Market was delayed until March this year. It is likely to be the last IPO Al Mal does for some time.
Minimum leverage
Al Mal Capital's future is secure, says Mr Nabulsi, because it uses conservative investment methods compared with the rest of the investment banking sector. "We have hardly any leverage and invested our own capital. Like everyone else we have been hurt by the crisis, but we are not leveraged as much as others."
He also believes Dubai's future is secure. "There will be lower growth this year and next, but Dubai is coming down from a high and it has built a strong infrastructure. Low growth or recession may last two or three years, but people still want to come here. When the world economy recovers, Dubai will be one of the first to benefit."
Islamic banks, of which there are nearly 40 in the UAE according to The Banker's Top 500 Islamic Financial Institutions published last November, appear to have been less hard hit than conventional banks. This is partly because they have not invested in toxic assets or speculated, which is against their principles. Even so, they still belong to the banking eco-system and are suffering like others from lack of liquidity and the economic slowdown.
Many new Islamic institutions sprang up last year. Noor Islamic Bank in Dubai was one such, created in January 2008. The owners are two Dubai government entities (50%), the federal government (5%) and 15 individual shareholders (45%).
Hussain Al Qemzi, Noor Islamic's chief executive, says the shareholders' ambition is "to be the largest Islamic bank globally". This will be a tough goal to achieve in the current environment, but Mr Al Qemzi believes that Noor's approach is more dynamic than most competitors. "We are a modern, forward-thinking Islamic bank that is not confined to traditional environments and we are going cross-border," he says.
Noor Islamic has only 15 branches in the UAE, with plans to increase that to 20 this year. It has one overseas office, in Tunisia. "With the financial crisis we have put all plans on hold for now. We are in a situation of 'wait and see' because of the uncertainty out there. Our five-year plan remains – to expand into Asia, Africa and Europe."
What makes Noor so different that Mr Al Qemzi believes it will rise to the top of Islamic banking globally is its strategy to sell to non-Muslims. "Muslims around the world want Islamic products when they are given the option," he says. "They prefer Islamic banks if they give them value. There is natural demand in that domain. The challenge is to sell outside that domain and sell to non-Muslims.
"We view ourselves as a non-religious institution. This means we are a good bank, and are compliant with sharia. But we are also here to create value for customers and shareholders, so we aim to serve the needs of customers whether they are Muslim or non-Muslim – 50% of our UAE customers are non-Muslims. There is nothing to stop us from dealing with the whole world."
Abu Dhabi's new entrant
Another new entrant is Al Hilal Bank, Abu Dhabi's second Islamic bank, set up last June with $272m of capital by the Abu Dhabi Investment Council, a sovereign wealth fund. Al Hilal too is bidding to act, and look, different. Its eight branches, all in the UAE, are decorated in a bright orange and designed like ultra-modern retail units in a Western shopping mall. Its main branch is a mall in its own right, with individual 'shops' catering to the financial needs of different customer segments – children, youths, home-buyers, car-buyers and so on.
Chief executive Mohamed Berro explains that the rapid economic growth experienced by the UAE demanded another bank to support that growth. Wasn't that bad timing, in the light of how the economy is now floundering? "We are one of the lucky ones," he says. "If we had launched a year before we did, maybe we would have been more affected. But if we had planned to launch after we did, maybe we would not have launched at all. We are one of most liquid banks in the country. We are investing our assets in the most risk averse way, aligned to Abu Dhabi's 2030 vision." The 'vision' he is referring to is the government's $160bn urban development plan.
"Recession hits all banks, no matter how you are structured," says Mr Berro. "But Islamic banking can weather the storm better. If we had had more Islamic banks globally, it would have mitigated what has happened because Islamic banking is based on the real economy, not on the derivatives and imaginary instruments that triggered the global crisis. My guess is that regionally there will be more convergence into Islamic banking, which has been able to create the necessary products and services in a sophisticated manner to compete with conventional banking."
HSBC Amanah is the world's 10th largest Islamic bank, with $15.2bn of sharia-compliant assets, according to the Top 500 Islamic Financial Institutions, and is based in the UAE. "Managing costs, streamlining resources and growing organically through cross-selling are some of the initiatives that are currently being undertaken to deal with the downturn," says HSBC Amanah's deputy chief executive, David Dew.
"Needless to say, we also need to be ready for the market upturn when it happens. Our recently approved strategy review includes certain expansion initiatives into new markets as well as growing our existing markets by expanding our products and services offerings."
Global financial centre
Since the Dubai International Financial Centre (DIFC) free-zone opened in 2004 it has become the world's fastest growing financial centre. It is home to hundreds of banks, insurance companies, asset managers and support services companies from around the world and the region who pay no tax on profits and face no restrictions on foreign exchange or repatriation of capital.
"There has been quite a bit of belt-tightening among the business community in the UAE, and within the DIFC as well," admits DIFC chief executive Nasser Alshaali. "Generally, the DIFC is going to see roughly only half the growth in 2009 that we saw in 2008. We ended last year with more than 750 companies located here, having started the year with 550. In 2009 we are expecting to add about 100 more companies.
"The international community knows that the fundamentals that were here before the crisis are still here. We have the demographics – 50% of the population is under 21. We have the resources – not just oil and gas, but other minerals. And we have the assets, built up over the past couple of decades. Those three fundamentals remain relevant."
Sunday opening
Nasdaq Dubai, which changed its name from the Dubai International Financial Exchange last November, and which is located in the DIFC, stopped trading on Fridays from the end of March, but still trades Sunday to Thursday and has just extended its Sunday hours.
Nasdaq Dubai's chief executive Jeff Singer says equities trading volume in 2008 was 2.39 billion shares, 117% higher than the 1.1 billion shares traded in 2007. "It would have been higher if we had reported all volumes that were being traded," he adds. "It wasn't until September that we announced that all over-the-counter (OTC) trades needed to be reported to the exchange – before they weren't being reported. From then on, our trading volumes have doubled." The recent addition of large blocks of OTC trades explains why, in the first two months of 2009, trading volumes have risen compared with the same period last year.
"The highlights of 2008 were two additional primary listings and five secondary listings," says Mr Singer. "We also had four local members join us to do brokerage and trading on the exchange. We launched the derivatives platform in November, and re-branded the same month."
The best news so far this year was the March listing of Dubai Gold Securities, the region's first sharia-compliant gold exchange traded fund. It is a joint initiative of the World Gold Council and the Dubai Multi Commodities Centre. "If you buy a share in this security, it is equivalent to buying a tenth of an ounce of gold," says Mr Singer.
Abu Dhabi heavyweight
The Abu Dhabi Department of Planning and Economy and the Abu Dhabi Chamber of Commerce and Industry hosted an economic forum in March, which included an exchange of views on the UAE's response to the financial crisis. Giyas Gokkent, chief economist and co-head of asset management at the National Bank of Abu Dhabi, said the best course of action was for the government to keep spending.
"The UAE economy is suffering because there is reduced spending by consumers who are afraid of losing their jobs," he said. "Companies are not investing because they are seeing sales go down. Banks are lending less and their loan-to-value ratios are down. Governments are trying their best, with expansionary fiscal policies and accommodative monetary policies. But so far these policies have had little traction."
One reason for these policy failures is that "we need to live through demand destruction before things improve", said Mr Gokkent. "A good thing about recession is that the seeds of recovery are always built in. The economy has to involve some level of adjustment, and over time things will improve again." In the meantime, UAE governments must keep their nerve and continue to support projects already started or planned. "They need to spend, spend, spend," says Mr Gokkent.
The ability to keep spending will depend in large part on the oil price not falling too much. But even if it does fall lower, Abu Dhabi's colossal accumulated wealth, the fact that it has the world's biggest sovereign wealth fund, and its commitment to continue with its relatively new domestic development plans, indicate that if anyone can spend their way out of recession, the Emirates can.
