Meeting early this month, Gulf finance ministers insisted their economies could cope comfortably with the looming global slump. During the world’s last economic crisis, their optimism proved mistaken – but this time, they are on firmer ground.
Big government spending programs, launched for political as well as economic reasons, are likely to support growth. There is less room for asset price bubbles to burst than there was in the last crisis in 2009. And in some ways, financial systems are stronger. “Countries in the region were caught off guard” by the 2008-09 global crisis, said Fabio Scacciavillani, chief economist at Oman Investment Fund. “This time they’re better prepared – crisis management capabilities have improved.”
The 2008-09 slump struck at the heart of the economies of Saudi Arabia, Kuwait, the United Arab Emirates, Qatar, Bahrain and Oman. A 75 percent slide in Brent oil prices over six months, as far as $36 a barrel, pushed growth off a cliff.
Gross domestic product shrank in Kuwait and the UAE during 2009; even Saudi Arabia only narrowly escaped recession, growing just 0.6 percent that year. Stock markets tumbled more than 50 percent, and plunging real estate prices forced Dubai World, one of the Dubai government’s flagship holding companies, into pledging to restructure $25 billion of debt.
Now, some investors are starting to hedge against the risk of a repeat performance in the Gulf as the global economic outlook darkens. The cost of insuring the debt of Gulf states rose last week with credit default swaps for Dubai climbing to their highest level in at least six months.
Economies have clearly started to slow considerably in the Gulf. The SABB HSBC Saudi Arabia Purchasing Managers’ Index, which measures activity in the country’s manufacturing and services sectors, hit an 18-month low in August; the index for the UAE reached a 15-month low. Air freight volume at Dubai International Airport dropped 7.9 percent from a year earlier in August, partly because of economic uncertainty in the U.S. and Europe, the airport operator said Sunday.
This time, however, major Gulf economies are entering the crisis in a different position. Fiscal policy is more expansionary in many states; Saudi Arabia announced in February and March that it would spend an extra $130 billion, presumably over several years, on housing, bonuses for state employees, job creation and other projects.
Such policies were originally adopted to contain the threat of political unrest during Arab Spring protests around the Middle East. But they have turned out to be perfectly timed economically, coming on stream just as global growth slows. Meanwhile, rich Gulf economies have over the past couple of years fashioned an informal fiscal safety net for the region; Saudi Arabia and other wealthy neighbors have pledged billions of dollars to improve housing and social welfare in Bahrain and Oman, and Abu Dhabi has given emergency financing to Dubai.
The safety net is limited in size and depends on political whim. But a principle of mutual assistance has been established that was less clear at the start of the last crisis. Another plunge in the oil price could make it more difficult for Gulf states to spend their way out of trouble – as the price drops, to below $104 at the end of last week, markets are fixated on the minimum levels which countries need to balance their budgets. For Saudi Arabia, analysts estimate that level has risen to around $90 because of the growth in state spending.
But even a temporary oil price slide to the level hit during the last crisis would not necessarily spell disaster. Farouk Soussa, Middle East chief economist for Citi, noted the Saudi government could if it chose maintain spending by drawing on $280 billion of fiscal reserves. A sum that is equivalent to a year of government expenditure. It could also finance part of any budget deficit in domestic capital markets. “If they decided they needed to, they could finance deficits for years. There is plenty of liquidity domestically,” Soussa said.
Since Saudi Arabia effectively controls the supply of oil, a fundamental change in its long-term economic outlook is only likely if there is a big demand shock, Soussa said. Such a shock would probably have to be a technological change, he added – a recession in the developed world would not be serious enough. Fitch Ratings reached a similar conclusion when it affirmed Abu Dhabi’s AA debt ratings last week.
“The 2008-09 global financial crisis was a severe stress test for Abu Dhabi, but one which left its balance sheet largely undented. Any future stress would have to have harsher consequences than this to trigger negative rating action,” said senior Fitch analyst Richard Fox.
A major blow to the Gulf during the last crisis was a plunge of equity and real estate prices, culminating in the discovery of a gaping hole in the balance sheet of corporate Dubai. This triggered capital flight from some economies in the region, putting commercial banks’ liquidity under pressure.
Repairing Dubai companies’ balance sheets is expected to take much of this decade, and a new global crisis would complicate that process, perhaps shutting the firms out of issuing debt in jittery international markets. But analysts think the financial support of Abu Dhabi would help to compensate for any lack of access to market funding, through the medium term at least. And with asset price bubbles in the Gulf already deflated, there is much less risk of damaging capital outflows.
That helps to explain why Dubai and other Gulf stock markets have outperformed many other markets over the last several months as the global picture has worsened. Dubai stocks are down 14 percent from this year’s peak; global stocks, as measured by the MSCI All-Country index, are about 23 percent lower.
Scacciavillani noted that authorities had more tools to protect financial systems than they did at the start of the last crisis. Gulf central banks have developed new facilities to keep money markets liquid, and countries have at least started to develop deposit insurance systems. The regional bond market has become more active and liquid, giving commercial banks a new channel to obtain funds.
In its latest economic, outlook published last week, the International Monetary Fund said the Gulf oil exporters needed to reform and diversify their economies, and predicted slower growth next year for many of them.
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