From one financial crisis to the next in the Middle East

07 March 2011

Markets in the region had barely recovered from the financial crisis that started in 2008 before political uprisings dented investor confidence again

As if the political turmoil hitting the region was not destabilising enough, a slow unwinding of the progress made in restoring the financial sector after the economic crisis of 2008 is also occurring.

International and local investors are worried by the Arab uprising, which threatens to leave only a few countries in the region untouched. As unrest spreads, stock markets are crashing, banks are becoming more cautious on project finance and loan deals, and investors are looking for safe havens elsewhere.

Middle East bonds are trading lower and the feeling is they could still drift down further

London-based bond trader

By 2 March, all the Gulf stock markets had retreated significantly from the start of the year. Egypt’s market, already one of the worst performing in the world, has been shut since 27 January. International investors, who are understood to hold about $13bn in Egyptian equities, or about 25 per cent of the market, are expected to withdraw large amounts of their capital when the exchange reopens, depressing it still further.

Capitalisation crashes in the Middle East

Across the GCC, market capitalisation has fallen by 14 per cent from the beginning of the year and Saudi Arabia’s Tadawul All-Share Index was down by 19.6 per cent on 2 March, making it the worst performer in the Gulf. The Dubai Financial Market was down 15.7 per cent.

Eiji Aono, head of research at Saudi Arabia’s National Commercial Bank, says retail investors have driven the sell-off in the kingdom, while institutional investors have been taking the chance to pick up some cheap names. It illustrates how nervous investors are, even local ones, about the protests hitting the Gulf’s largest economy.

Sovereign and quasi-sovereign bonds
IssuerMaturity dateOne-month change in pricing* (%)
Abu DhabiApr-19-1.49
Abu DhabiApr-14-1.05
*=On 2 March 2011 from 2 February 2011. Source: RBS

Credit default swaps (CDS), which measure the cost of insuring debt against a default, have also risen across the region.

Egypt’s CDS rate has increased by more than 50 per cent since the start of the year (although it still remains cheaper than Dubai), and Bahrain’s CDS rate has increased by 70 per cent since the start of the year. The increase in CDS rates is not just a characteristic of financial markets, it has a direct bearing on the cost of borrowing for corporates in those countries. Bahrain has already put on hold plans to sell a sovereign bond to international investors and Egyptian General Petroleum Corporation has abandoned talks with banks to raise $2bn in loans.

It seems whenever the market begins to recover, some event comes to knock it back down

Rajan Malik, Gulf International Bank

Bankers say that after a bumper year of bond issues in 2010, this year looked like having a healthy pipeline of both sovereign and corporate deals. But this is unlikely to be the case in the first half of the year, at least. “For now they will all be hold, no-one wants to issue now, while protests are still spreading,” says a Dubai-based bonds banker.

Panic selling of Middle East credits

Outside the region, investors have been selling off Middle East credits that they had bought over the past two years as the region tried to rebuild its finances after the banking crisis.

“Middle East bonds are trading lower and the feeling is they could still drift down further,” says a London-based bond trader. “Most of those selling are international investors and locals are still holding.”

A sustained sell-off in Middle East names, causing a long drought in new issuance, would be bad news for the region, which had just begun building momentum behind the use of the debt market. Around $30bn of bonds were sold in 2010 and banks had high hopes that the market would finally take off.

Okan Akin, emerging corporate debt strategist at the UK’s Royal Bank of Scotland, says he is expecting $20bn of corporate debt issuance from the Middle East in 2011. “It is most likely that we will not see any corporate issuance from Egypt, Jordan and other North African countries, but I believe GCC corporates will not have any problem in borrowing,” says Akin.

It is a similar story in the project finance sector. That too had just begun to recover after the financial crisis led many banks to pull out of doing 20-year project loans. In 2010, about $33.7bn was raised for projects in the region, a slight increase on 2009. Again, bankers were hopeful that the market was getting back on its feet.

“The momentum was there to build on,” says Rajan Malik, head of syndications at Bahrain’s Gulf International Bank. “But it seems whenever the market begins to recover, some event comes to knock it back down.”

As a result, many local banks are instead concentrating on short-term contractor loans, rather than more complex and longer-term project funding, he says. In Saudi Arabia, many of the local banks are devoting large amounts to funding the kingdom’s biggest contractors on government-led projects.

Project pipeline

By the end of the first quarter, two major project finance deals should have closed, providing a fillip to the market. They are both Abu Dhabi projects, Shuweihat S3 independent power and water project and the Shams 1 solar project. These are unlikely to be representative of the ability to raise finance elsewhere in the region. The Muharraq wastewater project should be close behind them, so far unaffected by the protests in Bahrain. Later this year, Qatar plans to raise funding for its Barzan gas project. The country has so far been stable and shows no signs of expecting protests.

Most international banks say they would be unable to take an Egyptian deal to their credit committees at the moment. Given the nervousness in markets such as Saudi Arabia, that too could be a tough deal for European or US banks to get internal approvals.

Fortunately, local banks in the kingdom have been shouldering the bulk of the financing burden for Saudi projects, meaning international bank presence is of reduced importance.

The political unrest is also likely to hit pricing on loans. Pricing had been falling since the impact of the global financial crisis peaked in late 2009, with the announcement that state-owned Dubai World would have to restructure $25bn of debt. For example, the Shuweihat S3 deal is expected to close at pricing starting at 175 basis points above the London interbank offered rate, about 100 basis points less than the last Abu Dhabi power project, Shuweihat S2, closed at in late 2009.

But, pricing is now expected to start to creep back up. “A combination of new banking regulations, the sudden potential for governments in the region to change and periods of political unrest, and the rising cost of bank funding, mean that pricing will have to go up,” says a project finance banker based in Dubai.

Whether pricing does rise will be dependent on banks being able to go out and convince sponsors that the market is now different, says Steve Perry, regional head of syndications at the UK’s Standard Chartered. He says that unless banks start to negotiate better pricing, sponsors will continue to think they can drive pricing down further.

As activity in the financial markets slows, it will have a knock-on effect on economic growth. So far, most analysts have not started revising their forecasts for the region, saying it is still too unclear how long this period of turmoil will last, but growth is expected to slow.

“Capital flows, notably foreign direct investment, is likely to slow considerably as investors within and outside the region put their investment plans on hold temporarily,” says Alia Moubayed, senior economist for Middle East and North Africa at the UK’s Barclays Capital. “At least until the medium-term political outlook becomes more visible. As governments react, we believe investors will differentiate between countries.”

Long-term benefits

Credible signals that governments are engaging with the region’s deep-seated economic and governance problems will help investors come back to the region, but this will take some time, says Moubayed. “The risks of continued turmoil and seeing significant protests unpredictably occurring in the streets of the Middle East seem to be becoming a constant way of expression,” she says.

The impact on economic growth, given where protests have occurred so far, will be very different across the region. Currently, stable oil producers, such as Saudi Arabia and the UAE, stand to benefit from higher oil prices. Countries hit by protests will face more constrained finances.

Already rating agencies have started to downgrade sovereign ratings for Bahrain, Egypt, Jordan, Libya and Tunisia. As a result, many corporates in those countries are also being downgraded, a further blow to the perception of the region.

The political crisis engulfing the Middle East and North Africa could not have come at a worse time for the financial sector. A recovery from the bursting of the equity bubble in 2006 had hardly taken root before the financial crisis of 2008 once again wiped out regional stock markets. Despite its strong fundamentals, a high oil price and strong government balance sheets, the Middle East failed to live up to the expectations of investors over the past 12 months.

At the beginning of 2011, optimism was returning. More international banks were returning to project finance, the bonds market had been through a rosy period in 2010, and traders were talking excitedly of Saudi Arabia opening to foreign investors and opportunities in key regional markets, such as Egypt.

That now all seems far away as the political crisis takes it toll on investor confidence. Many may be left wondering if this latest crisis has just been one too many for them.


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