Hasan Jamali/AP
An oil pump seen in the desert area of Sakhir, Bahrain, in the Persian Gulf.

Persian Gulf Feeling Pinch of Credit Crunch, Falling Oil Prices

October 30, 2008 06:32 AM
by Anne Szustek
The Gulf states’ oil wealth is being sapped by falling prices, and the region’s real estate boom is being crimped by tightened lending. What’s next for these suddenly soft economies?

Gulf States Drill Further Into Oil-Funded Coffers

From an all-time high $147.27 per barrel, oil prices have tumbled some 50 percent since July. The price of a barrel of U.S. light sweet crude for December delivery hit an 18-month low on Monday of $61.30.

“Demand for physical commodities is tanking in many parts of the world, with U.S. oil consumption contracting at the sharpest rate since 1980,” wrote Merrill Lynch in its fourth quarter-2008 oil price forecast, according to CNBC. “More importantly we are starting to see signs of oil demand slowing in emerging markets.”

Oil prices were edging up slightly during Wednesday morning trading in New York. But in any event, in emerging markets based heavily on oil wealth like those of the Arab states of the Gulf, slowing demand and a strengthening U.S. dollar, which often lures traders away from buying into oil futures, would appear to pack a one-two punch.

 “Were oil to fall toward the $15-a-barrel low last seen at the start of the decade, the most indebted Gulf sheiks might default on their loans,” writes Andrew Critchlow in The Wall Street Journal. “Foreign direct investment would shrink. The $2.2 trillion capital spending binge that has underpinned the region’s real-estate boom would end.”

Real Estate, Financial Markets Struggling

The member nations of the Gulf Cooperation Council, unlike their economically wheezing emerging market brethren Russia and Iceland, are at no risk of going bankrupt, however. According to statistics cited by The Wall Street Journal, the Gulf states have projected 2008 budget surpluses of some $150 billion.

Partial freeing up of those countries’ financial markets and the region’s glut of ostentatious real estate have been two conduits of economic diversification and foreign funds into the area. But at the same time, the financial and real estate sectors have left the Gulf states susceptible to the credit crunch flu sickening other economies around the world.

“The UAE’s openness has also brought exposure to global economic turmoil and changes in global credit markets are affecting both the Emirates and the Gulf more broadly,” Arabian Business quoted U.S. Deputy Treasury Secretary Robert M. Kimmitt as saying during a visit to Dubai Tuesday.

Much of the region’s oil wealth is holed up in countries’ sovereign wealth funds and by the ruling families, rather than banks. Banks in the U.A.E. constituent emirate of real-estate heavy Dubai, for one, offer borrowers negative real, or below inflation, interest rates. “And,” as The Economist writes, “since some think the official inflation rate seriously underestimates price increases in Dubai, there is a big incentive to borrow from banks and invest somewhere else.”

Dubai’s international cachet arguably is centered on iconic buildings such as the Burj Dubai, which, still under construction, is already the world’s tallest structure. With liquidity pouring out of the region’s financial institutions, questions have emerged over funding for future “mega-projects,” the long-term viability of the plush lifestyle enjoyed by the region’s Western expatriates and the availability of work for the millions of poor laborers that make developers’ Dubai plans come to fruition.

Last month, the UAE Central Bank launched an emergency lending facility of 50 billion dirhams (about $11.6 billion) to the nation’s banks. The UAE’s Finance Ministry announced a separate 25 billion dirham fund injection into the banking system last week, meant to free up credit markets.

In fellow Gulf state Kuwait, which removed its currency’s dollar peg in May 2007, the country’s main financial market—the second-largest in the Arab world—has lost 37 percent in value. The steep losses have prompted the Kuwait government to tap into its sovereign wealth fund to buy into flailing stocks. On Wednesday, Kuwait passed a bill to guarantee bank deposits in the country, following its rescue of Gulf Bank, the country’s fifth-largest lender.

Saudi Arabia’s main financial market has dropped 49 percent this year, according to Reuters. The Saudi Arabia Monetary Agency has put $3 billion into bank deposits and cut benchmark interest rates, a rare move for the oil nation.

On top of credit crunch concerns, real estate investors predicted the Gulf states would depeg their currencies from the dollar as the greenback’s tumbling value versus other reserve currencies was translating into double-digit inflation in the region. As the dollar rebounded in value, the investors pulled their money out of the U.A.E. The sell-offs came around the same time as a report from Morgan Stanley that speculated Dubai real estate prices would drop 10 percent by 2010.

That is the same date that the GCC has slated as its deadline for a single currency for the six-nation bloc. Arabian Business says this goal is “unlikely” to come to pass within the next two years. Yet the need for coordination among the Gulf states is immediate, say some financial authorities in the region.

“The crisis proves how much we need a single currency and that a single central bank should be a supervisory body,” Qatari Financial Minister Youssef Kamal said after an emergency GCC meeting on Saturday called to discuss ways to mitigate the effects of flagging economic conditions in America and Europe, where the Gulf economies have invested much of their sovereign wealth funds.

Related Topic: Credit crunch, oil prices crimp Iceland, Russia

Iceland, whose emerging economy is centered largely on a financial sector reliant on foreign currency deposits, is on the brink of bankruptcy.

On Oct 9, Kaupthing, Iceland’s largest bank, became the third of the country’s top three banks to be taken over by Iceland’s Financial Services Authority in the past two weeks, following number two Landsbanki on Tuesday, and the third-largest Icelandic bank, Glitnir. The latter was nationalized on Sept. 29, and taken under receivership on Wednesday, granting the bank a temporary reprieve from paying its debts.

Glitnir also got 5 billion Norwegian krona ($820,000) in liquidity from the Norwegian Banks’ Guarantee Fund. The bank announced the same day that it had begun to sell off its Norwegian operations.

Between July 2007 and October 2008, the Icelandic krona has dropped more than 46 percent versus the euro, prompting the country to peg its currency to the predominant EU monetary unit and seek a €4 billion (about $5.7 billion) loan from Russia to shore up its reserves and help bolster its currency.

The International Monetary Fund has allotted $2 billion in loans for Iceland. But Russia’s own economic travails have brought the $5.7 billion in aid into question.

This spring, Russia seemed to be hitting its economic stride. High oil and gas prices kept government reserve funds—the third-largest in the world—flush with cash. The ruble was doing so well against the U.S. dollar that the Kremlin was considering making the local currency a regional reserve currency, putting it in a class closer to hard currencies such as the dollar and the euro.

According to the Associated Press, the Kremlin’s “official line” is that the “Russian economy remains healthy, vibrant and largely insulated from the impact of any global recession.”

Russia’s numbers, however, tell a different story. Between May and last week, Russia’s stock markets have lost some 60 percent in value. On Oct. 15, the Kremlin suspended trading on the RTS and MICEX markets in light of massive losses. Russian national banking council member Pavel Medvedev was quoted by McClatchy newspapers as saying that, “Many banks lost their capital on the market. The government and the central bank were afraid of panic and … tried to find buyers.”

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