Lending growth fuels inflation in Qatar

09 October 2008
The rapid expansion of the banking sector is a major contributor to Qatar’s high inflation, which is now the greatest economic challenge facing the authorities.

Doha’s economic diversification programme is delivering impressive results, with the rapid expansion of the state’s construction, services, petro-chemicals and other downstream activities on the back of the global boom in energy prices.

Real economic growth in Qatar will average 13.5 per cent in 2008, with gross domestic product (GDP) per capita set to reach an impressive $75,792, compared with $45,800 in the US and $5,300 in China.

But such a rapid pace of growth in the Qatari economy has been creating real headaches for the government. Inflation is the greatest short-term economic challenge for the authorities.

Qatar’s consumer price index rose to a record high of 16.6 per cent in the second quarter of this year, the highest level in the GCC. Soaring rents, construction and food prices are considered the biggest contributors. But the stellar growth of the state’s banking sector is also a significant contributor.

“Probably about 70 per cent of inflation is generated domestically,” Qatar’s Finance Minister Yousef Hussein Kamal said in May.

Tackling inflation

In response, the government has introduced a series of measures to dampen inflation. A two-year freeze on property rents became effective on 15 February, and Kamal announced in January that the government was providing Barwa Real Estate, an affiliate of state-owned property developer Qatari Diar, with land at “nominal prices” to build 2,000 low-cost housing units this year and 6,000 in 2009.

The government has also fixed the prices of some raw materials that are generated in Qatar to lower construction costs, as well as creating state-owned Qatar Raw Materials to supply contractors.

Yet Doha’s efforts to tame inflation remain constrained by its currency peg to the dollar, forcing it to shadow the US Federal Reserve in cutting interest rates.

For the time being, talk of ditching the peg has subsided because of the recent appreciation in the greenback and falling international commodity prices, but is likely to reappear if high inflation persists.

“Other key drivers of inflation remain in place, namely loose monetary and fiscal policies and rapid credit growth,” says Tristan Cooper, senior analyst at ratings agency Moody’s Investors Service.

“Without tackling these powerful stimulants, it will be difficult to quash the problem. We are concerned that the sheer rate of expansion in credit facilities is exacerbating inflation, which is already excessive.”

Money supply growth reached a high of 33 per cent at the end of 2007, further intensifying inflationary pressures.

A key challenge alongside taking the steam out of Qatar’s overheating economy is managing its rapid asset growth.

“We are mindful that periods of rapid credit growth can store up problems in the future as banks’ asset quality is compromised,” says Cooper.

As the wealthiest nation in the world, in terms of GDP per capita, and with a recently reduced corporate tax rate of 12 per cent, it is no surprise that Qatar has the fastest-growing banking sector in the GCC.

Although Qatar’s population remains small, at about 1.1 million, rapid banking and finance sector expansion is being driven in part by the fact that Qatar has long been under-banked.

Today, there are 17 commercial banks, made up of nine local banks, seven branches of foreign banks and one specialist, government-owned bank, Qatar Development Bank.

Modest credit

The combined total assets of Qatar’s banks stands at nearly $60bn, while the ratio of domestic credit to GDP is still about 50 per cent, a modest level given that the benchmark percentage for high-income economies is about 160 per cent, according to the World Bank.

The system is highly concentrated, with the three largest banks - Qatar National Bank (QNB), Commercial Bank of Qatar (CBQ) and Doha Bank - controlling about two-thirds of total assets.

The state’s impressive economic growth has been key to the development of the wider banking community, with most banks exhibiting solid capitalisation, good asset quality and ample liquidity.

“High hydrocarbon prices and volumes, together with planned government projects and the rapid growth of the retail segment, have resulted in high credit growth over the past few years in Qatar,” says Mohamed Damak, credit analyst at ratings agency Standard & Poor’s.

Indeed, retail banking grew by more than 50 per cent and 40 per cent for QNB, CBQ and Doha Bank combined in 2006 and 2007 respectively.

With this growing demand has come increased competition. The entrance of newly licensed banks into the market has increased price competition over the past year, squeezing profit margins.

Net interest income compared with average earning assets for the three leading banks started falling in 2006.

In particular, competition has been increasing in the loans market. “Loan growth has consistently exceeded 40 per cent a year over the past three years,” says Damak.

“This has been mainly driven by the huge demand for consumer and real estate loans, the latter exceeding 13.6 per cent of total loans by mid-2007.”

Given the concurrent sharp increase in real estate prices over the past three years, Qatari banks’ vulnerability to a correction in the real estate market has been drastically increased.

With inflation peaking at a record high of 16.6 per cent in the second quarter of this year, there is concern that such vulnerability could put even greater pressure on households’ income, and ultimately their credit quality.

However, the impact of inflation on the credit quality of retail loans in Qatar has been limited because of several factors.

First, a large proportion of personal loans are guaranteed by salary assignments so the debt service is immediately honoured once the salary is transferred to the bank.

Second, the government has announced an increase in salaries for civil servants following the rapid inflation over the past couple of years.

To date, loans to expatriates have been limited and, in most cases, granted to the white-collar workers who benefit from high salaries.

Islamic finance

In seeking to diversify, Qatari banks are also capitalising on the growth of Islamic finance.

Sharia-compliant assets offered by Qatari Islamic banks and subsidiaries of conventional banks experienced 48 per cent growth in 2007.

“Islamic banking is now one of the most -rapidly growing parts of the financial sector in Qatar,” says Cooper.

“With competition increasing in the banking sector, Qatari banks see Islamic finance as a good way to differentiate themselves and attract new customers.”

The 2005 change in Qatar Central Bank’s regulation has led to an increase in the number of conventional banks creating Islamic subsidiaries or branches, bringing the total to four banks: Qatar National Bank, Commercial Bank of Qatar, Doha Bank and Ahli Bank.

With the inception of Masraf al-Rayan bank in 2006, along with the long-established Qatar Islamic Bank (QIB) and Qatar International Islamic Bank, there are now three fully-fledged Islamic banks in Qatar.

Founded 25 years ago, QIB was the first Sharia-compliant bank in Qatar and today enjoys the leadership position in the Islamic banking sector, holding a 57 per cent share, as well as ranking as one of the world’s five largest Islamic banks.

QIB’s net income increased by 70 per cent between June 2007 and June 2008, from $137.8m to $234.6m.

At the start of this year, it was granted a licence by the UK regulator, the Financial Services Authority (FSA), to operate an Islamic bank in the UK.

As part of their diversification strategy, leading Qatari banks are setting up operations abroad to gain scale and reduce margin pressure.

But while this geographic expansion is providing an additional source of credit, it is increasing operational risk.

Negating risk

“As growth opportunities diminish compared with the situation a few years ago, Qatari banks may be tempted to enter riskier segments such as SMEs [small and medium-sized enterprises] or conduct business with clients with average or below-average credit quality,” says Damak.

“The challenge is therefore to continue growing without being lenient on risks and/or risk management.”

To date, any operational risks have been mitigated by high financial flexibility in the form of capital injections to finance acquisitions - for example, CBQ’s successful turn-around of National Bank of Oman in a relatively short period of time.

For the foreseeable future, Damak says, Qatari banks’ strong efficiency (low ratio of total operating expenses to total revenues) and low cost of risk (the ratio of new loan loss provisions to total revenues) will continue to underpin their profitability.

In addition to Qatari banks expanding beyond their domestic markets, in recent years there has been an influx of foreign players into the Qatari banking system, facilitated largely by the launch of the Qatar Financial Centre in 2005.

Set up with the main objective of attracting top firms in finance, energy, tourism, transport, health and education to aid the integration of Qatar into the global economy, the QFC has become an invaluable vehicle through which new entrants can get close to investment opportunities across the GCC, principally the $2.6 trillion Gulf project finance market.

The general consensus is that the entrance of these foreign players will not endanger the competitive position of leading native banks because of the huge room for growth given the ongoing projects and resultant high financing needs in Qatar.

The value of projects planned or under way in Qatar today stands at $208.1bn.

“Banks entering the market are targeting primarily big corporates’ business and syndications where margins are already low compared with retail banking,” says Damak.

A few dissenting voices argue that the continuous arrival of foreign multinationals registered at the QFC and the dominant position large foreign banks have assumed in megaproject financing deals means native banks face a huge task in gaining an equal footing in this market.

What is certain is that over the long term, project finance, whether sharia-compliant or not, will be a key engine of growth for Qatari banks.

However, the crisis in the global banking markets has stalled the sector in the short term.

“The balance sheet composition of Qatari banks is still reflective of the narrowness of the economy,” says Damak.

On the positive side, Qatari banks do not appear to have any significant exposure to the sub-prime debt crisis and are not dependent on international wholesale funding, which helps insulate them from the ongoing turmoil in global financial markets.

However, the rapid growth of the loans market is straining funding, prompting Qatari banks to consider long-term sources.

“We think the access to wholesale funding would be done in a first stage using bond/sukuk issuance,” says Damak.

“And we have seen some syndications and issuances by the leading banks over the past three years.

“Also, we see some potential for securitisation backed by real estate loans as the latter grew substantially in the past.

“However, the legal environment for this in the GCC region remains untested.”

With many of the key indicators showing an economy in rude health, if the Qatari government can tackle rising inflation in the short term, the future of Qatar’s economy, and its banking sector, is bright.

Key fact

The government introduced a two-year freeze on property rents at the beginning of 2008 to try to tackle inflation

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