Middle East Capital Markets Roundtable: Part I
IFR: I think a good place to start is with the economic situation. There are conflicting signals coming out of the Gulf. The news flow tends to be almost exclusively focused on Dubai’s debt overhang, but the regional economy is growing. Simon and Farouk, could you give us some introductory thoughts about the key issues you see for the regional economy? Where are the stresses
and the strains?
Simon Williams, HSBC: I think it’s been a very difficult 18 months. We had five years of exceptionally rapid growth between 2003 and 2008 - arguably the most rapid and sustained period of economic growth we’ve seen since the 1970s. It came to a very abrupt halt in late 2008 and over the last 18 months I’ve seen many of the regional economies go through a painful deceleration.
Some economies fared better than others but wherever I go, certainly around the Gulf, I see economies that are still struggling to get into recovery mode. I think this year performance has been disappointing. I thought growth would return more strongly and more quickly than it has done. Certainly this year is better than 2009 but I don’t feel that we are back on a level keel yet.
I think the average growth number around the Gulf of 3.5% to 4% is about right. But that’s still three points shy of the kind of number we’re seeing in other emerging markets worldwide. I think growth will strengthen as this year goes on, but we need to ask ourselves why this region is lagging so far behind some of those other emerging markets.
IFR: That’s a good question, Farouk what do you see as the major factors there?
Farouk Soussa, Citi: Well maybe I’ll start on a more positive note. Yes, there is news of restructuring - particularly here in Dubai. But if you look deeper into the story, even though the news flow is negative on restructuring and on the property sector, the underlying economy is, in my opinion, quite sound.
The reason for this is an economy like Dubai is very outward looking; it’s a very externally oriented economy that will fare well or badly depending on how global trade and commerce and the global economy perform. Every dirham spent in Dubai is not a dirham added value to the local economy; it goes out through imports and the like.
There are areas where we see significant growth, particularly on the external side and we see growth picking up over the next couple of years to over 6% in 2012, despite the fact that at the same time we see investment falling quite sharply and consumption remaining relatively subdued.
Now turning to the regional outlook, it’s an open secret that growth will be driven by government expenditure above all. Despite strong government expenditure over the last couple of years, we’ve seen headline growth numbers looking fairly anaemic. I think a lot of that has to do with oil production. You have to look beyond headline growth numbers and look at non-oil growth, which is a little bit more difficult to gauge given the data that we have and how timely it is and so on. But even then I think that Simon’s point is right, it’s been fairly anaemic. I’m more optimistic going forward, given that some of the bottlenecks that have been impeding growth over the last couple of years - particularly with respect to the global environment - should slowly clear.
I think the main risk going forward is really going to be the global economy more than anything else. Regionally, governments have plenty of money to push through some pretty significant expenditure. I’ve seen Saudi Arabia push ahead with its four economic cities (we can talk about the viability of those economic cities) and certainly that seems to be going ahead quite strongly. And other countries in the region such as Kuwait and Qatar are pressing ahead with very significant expenditure programmes. I think that will augur well for growth going forward.
Simon Williams: I think the external demand story is absolutely right. I think Dubai’s export-orientated service sector is world class. I think it does push the growth story forward and without the growth in public spending that Farouk mentions, certainly the slowdown would’ve been much more severe.
I think the impact of that public spending, the impact of that fiscal stimulus, though, is being dimmed by some of the difficulties in the banking sector. We’ve had an 18-month credit squeeze not just in the UAE but across the region. Without growth in credit, we don’t get the multiplier effect for the growth in public spending and private sector companies struggle to gain access to working capital. I think it’s been some of those difficulties in accessing financing that have slowed growth quite so markedly over the last year or so and it’s what makes me still a little anxious about how quick the recovery will be in the coming 12 months.
IFR: Steve, the issues of the banking sector have been well documented. Earlier this year, there were some incipient signs of money coming back into the region from international banks. I guess there are two elements here: the domestic banking sector and the international banks. How would you characterise the international bank position today?
Steve Perry, Standard Chartered Bank: Basically I think the situation up until Greece happening was fairly fluid. The difficulties the local and regional banks have had with taking petrodollars out of their balance sheets and using them on deals has been a fundamental issue for them, as has the price at which they’re borrowing. Robert can probably talk a bit more about NBAD’s position, but the cost of funds for dollars is very high for regional and local banks. This has really pushed them out of the deals that have been done because even when they were up at 2% to 3% some of the regional banks still couldn’t play.
So effectively the GCC market has really been driven by the international banks for the best part of two or three years now. And rather than the locals and regionals four or five years ago complaining that the international banks were driving prices down, unfortunately they’ve indicated that they can’t get into the new deals now because they’ve lost the ability to fund dollars at today’s rates.
IFR: In terms of the international banks’ commitment of funds, has that improved over the last three/four months?
Steve Perry: Most international banks that are playing in this market are generally those that are playing here for good. You haven’t got many banks flitting in and out, so the core business for a lot of these international banks is in the GCC. The European market started to become very vibrant at the start of the year, but has now petered out with the Greek crisis.
The issue now is that the Greek crisis has affected the international banks’ liquidity as much as it has the regionals/locals. So now they’re paying high liquidity premiums. There’s no flow in the interbank market again, which caused the original bubble a year ago. But there’s plenty of cash in the system and that’s probably the only thing that isn’t actually leading to the double dip.
IFR: So just to be clear you’re saying that the banks that are committing funds are the banks that are always going to be here. There were a lot of new banks coming into the region over the last five years who left in the ’08/09 period. Are you saying that that money’s not coming back again?
Steve Perry: You’ve got your 10 to 15 core banks that are playing in the region. Five or 10 additional banks were here because they saw reasonable yields and good solid credits (GREs and sovereign names) but when the credit crunch came along, they retrenched.
IFR: This issue of the funding costs of local banks is not a new issue. Robert: as a regional bank, to what extent is the high cost of funds impacting your ability to commit funds to lending?
Robert Mohamed, National Bank of Abu Dhabi: I think in all honesty the UAE banking system is still going through a process of deleveraging. Clearly, that is going to have an impact in terms of availability of funds, but what that is doing is forcing indigenous clients to look at a wider brief, to look at markets in a much more constructive and positive way. Don’t just look at the bank market, look beyond the bank market. Look at the debt capital markets, look at improved transparency. Look at enhanced corporate governance and explore the optionality in terms accessing capital markets as well. Because that’s where you will get the size, that’s where you get the tenor. You’re leaving your [bank] lines unutilised to some extent, but you’ve got the optionality to look outside.
IFR: When you go and talk to borrowers about alternative funding channels, what kind of reaction are you getting?
I ask that because to access the bond market, you typically need ratings, there’s much more of a public process and it can be a lengthy process. Are borrowers prepared to go that route?
Robert Mohamed: Yes. The rating agencies deserve a lot of credit despite the knock-backs. I think that the market’s slightly thrown because they do have private letter rulings; they will retain confidentiality. I think the next phase of development of the capital markets within this region encompasses probably the creation of a domestic bond market, because that in itself will deliver wholesale liquidity to the region, which currently doesn’t exist.
The UAE banks as a whole are extremely strong if you look at their capital adequacy ratios. And they’ve been able to withstand some fairly hefty knocks with no impairment on the capital adequacy side. Yes the ratings processes can be quite long, but the value-added in terms of pricing benefits and diversification with the investor base outside the region are two clear benefits, which would certainly warrant a process of closer scrutiny from a lot of the GRE entities in particular and the private family companies as well.
IFR: Jonathan, will we see renewed appetite for new issues going into the second half of this year and into next year?
Jonathan Segal, Barclays Capital: I believe Gulf issuers have very good market access for the most part and indeed they’ve had that since around February this year. It took no more than two or three months for the market to separate the issues that are present with certain entities in Dubai from the rest of the Gulf in the first instance, and in the second instance certain other issuers which are deemed to be sound credits in Dubai of which DEWA (Dubai Electricity and Water Authority) was one example.
DEWA priced a US$1bn five-year Reg S/144a Eurobond in late April through joint leads Citigroup, NBAD, RBS and Standard Chartered at the tight end of revised 8.50%-8.625% guidance, which had already narrowed from the 8.75% area. The bonds priced with a 592.4bp pick-up over US Treasuries.
I think the reason for the very slow issuance into the market and low volumes in the first half of the year has been more on the issuer side. Entities and governments in the region have taken some time to recover psychologically from the impact of the Dubai World announcement. Added to which, at the point at which we were starting to see more interest, more roadshows and more reports of deals coming, the volatility started up related to Greece and the other European sovereigns.
So my outlook for issuance volumes and interest from investors is very positive post-summer and post-Ramadan because I think issuers will start coming out of their shells. For the most part, Middle Eastern bonds are trading very positively, having widened out much less than other emerging markets and certainly much less than many of the developed markets as a result of the recent volatility. I still see a significant drive for infrastructure in all sorts of forms: ports, airports, railways, energy infrastructure in most of the jurisdictions around the Gulf. And I think that’ll drive a lot of financing going forward.
IFR: So quite a positive view about financing. But there’s a very heavy GCC redemption schedule of around US$28bn coming in 2012, mainly from Abu Dhabi and Dubai investment holding companies and real estate companies. How much of an issue is this going to be? Will this get financed?
Farouk Soussa: Well that’s where the greatest risks lie in Dubai. I think that’s well understood by the markets because of the quantum of the debt relative to GDP and also because the resources available to the government are lower than in other oil-rich countries in the region.
We expect that there will be further restructurings and I think that’s also understood by markets. The restructuring is going to be predominantly on the loan side through private negotiations, i.e., we’re not seeing a strong likelihood of significant restructuring on the public debt side. This is something that makes economic sense in the current environment where Dubai’s maturities are very short term and its cash flows are long term. You need to try and match those up somehow.
Negotiating with the banks and trying to arrive at something that’s more sustainable is in everyone’s interest, including the banks. Of course the terms are something that have been widely debated and subject of some controversy. We’ve got the Dubai World restructuring to look at as an example. But I think overall this is going to be something that has to be done.
I think the main risk in terms of dealing with the restructuring of the public debt is the piecemeal approach that we’re seeing. We’re going from one maturity to the other and each one is being tackled on its own merits. I think that makes sense from an administrative point of view, but it has the potential of prolonging the negative flow of headlines and the like that come out of the region. It would be more constructive if there were a broader strategy to tackle all the debt issues that lie within the public sector across the board in Dubai and the region.
That said, even with this significant debt overhang story and even with the associated downturn in investment and uncertainty in the balance sheets of the domestic banking system and stagnation in credit, we do see growth returning to Dubai. And to speak to Simon’s earlier point, the reason for that is that we’re shifting into a different phase of growth where we’re no longer going to be depending on factor accumulation for growth.
In Dubai we’re going to be looking at greater factor productivity. Effectively we have an overcapacity situation in Dubai. There is spare housing, there is spare commercial office space and there is spare infrastructure. The output gap is significant and the economy will be able to grow into that overcapacity without having to invest large amounts of money. That’s a key advantage that Dubai has and that’s why to my mind the issue of the debt overhang is quite separate from the one of economic growth.
Click here for Part two of the Roundtable.