GCC economies feeling the pinch of global financial turmoil, says GFH economic report

The steep fall in crude oil prices from their peak last summer, output contraction across other key economic sectors, tight liquidity conditions and the fall in asset prices will make 2009 a challenging year for the GCC region.

However, the current environment is also creating attractive buy opportunities for cash-rich investors looking for gains over the medium to long term, says the latest issue of the GCC Economics and Strategy report.

Oil prices remain key to GCC governments' ability to spend their way out of a severe slowdown, says the report, which also raises the possibility of Kuwait reverting to the dollar peg to unclog its domestic money markets and to rejoin the GCC exchange rate mechanism.

"As we anticipated in our previous report, the GCC has now firmly joined the last group of countries to be impacted by the global financial crisis," said Dr Ala'a Al-Yousuf, Chief Economist at GFH, in comments to coincide with the release of the report.

The GCC Economics and Strategy report, which is produced quarterly by the Economic Research Department of GFH, provides an in-depth analysis of the most important global and regional economic developments and their implications for the GCC region.

"While the GCC would be able to manage the challenges of lower oil prices, the region cannot stave off the effects of a protracted, global financial turmoil. Nevertheless, in a worse case scenario, the GCC's substantial public and private wealth will enable it to cope better than many large economies," said Dr Al-Yousuf.

The fallout from the global financial crisis, coupled with the plunge in oil prices, has effectively ended the six-year economic boom which began in 2003 on the back of high oil prices that allowed strong government and private spending.

"Against the backdrop of distressed global financial markets and an extremely weak outlook for the global economy, the GCC macro picture for 2009 is going to be disappointing compared to recent years," said Dr Al-Yousuf.

Mr. Hany Genena, Senior Economist at GFH, said the average aggregate GCC crude oil production levels are expected to post their largest annual percentage decline in at least a decade, while hydrocarbons export revenues are likely to fall by about 60% to $200bn. Nominal GDP will shrink by about 30%, with the possibility of an even bigger fall in aggregate GCC national income in case of a severe cut in government expenditures.

Thus, after several years of posting massive surpluses, the combined current accounts of the GCC states will nearly balance in 2009.

"The ability of GCC states to spend their way out of a severe slowdown depends on the cushion of reserves accumulated during the boom years," said Mr. Genena.

"We believe Qatar will outperform other GCC states in terms of structural resilience and growth momentum in 2009, due in large part to a doubling of its liquefied natural gas (LNG) export capacity during this year," said Mr. Genena.

Any prospect of GCC states opting out of the fixed peg to the US dollar has firmly receded. If anything, the volatility in foreign exchange (FX) markets raises the possibility of Kuwait reverting to the dollar peg not only to rejoin the GCC exchange rate mechanism but, more importantly, to unfreeze its domestic money market, which has suffered as a result of the higher FX risk premium.

"The recent experiment of changing a dollar-pegged FX regime has neither helped support the policy bias towards fighting inflation nor is it demonstrating support for the policy shift towards promoting growth," said Mr. Genena.

The report also outlines a sector allocation strategy for the 2009 investment environment, which will be marked by bottom line contractions across a wide range of key GCC sectors/industries.

Banking:

Most GCC banks will see profit contractions as a result of slower growth in business volumes. Some banks will need to recapitalize or merge, and, in the process, cut back on credit expansion to improve capital adequacy metrics.

Petrochemicals:

Downside risks remain high in the petrochemicals sector due to the build up of excess global production capacity, declining global demand, lower prices and higher financing costs. Also several projects will be delayed or cancelled, as foreign partners exit and project economics deteriorate.

Real estate:

The real estate sector is directly exposed to tight financing conditions and the near-freeze in secondary markets for off-plan property. Anecdotal evidence suggests that speculators are unable to exit long positions except after a long period and at significant discounts. In this environment, property flippers will be obliged to hold on to property and meet payment obligations, raising the likelihood of an increase in default rates in 2009.

Construction:

The weakness in the GCC construction sector is a natural outcome of the weakness in the real estate sector, which will suffer from delays or cancellations of projects and tighter access to credit. However, falling prices of building materials and infrastructure projects contracted by GCC governments may provide some respite to construction firms during 2009.

Telecoms:

Although profitability growth of telecom companies in the GCC will likely decelerate in 2009 due to already-high penetration rates, slower growth in subscription and intensifying competition relatively strong profitability and cash flow metrics present an adequate buffer.

"Although deteriorating profitability metrics will likely continue to depress corporate valuations during the first half of this year, this period presents attractive acquisition opportunities for investors with adequate cash reserves, high risk tolerance and long-term investment horizons,"

said Mr. Genena.