LONDON, 7 March 2005 — Gulf banks are at risk of being exposed, either directly or indirectly, to the region’s booming equity and real estate markets, warns a report published recently by Standard & Poor’s, the international credit rating agency.
Asset price inflation in the two classes, says the report, are partially due to high oil prices; repatriation of some funds invested abroad; improved regional stability; some structural economic and financial reforms; renewed confidence and investment opportunities in the region.
However, more disturbingly, “it is also partially an artificial bubble that can deflate or burst — an unlikely, worst-case scenario that could nevertheless result from a regional political crisis or major oil price collapse, for example.”
Saudi Arabia, Kuwait and the UAE are the markets most at risk. While the larger Gulf banks would be in a better position to absorb a major correction, the impact on the wider banking sector could be devastating especially if both asset classes were to see a collapse. The limited size of the market, the high concentration, unsophisticated local investors, and the lack of public information on the real estate market in particular, stresses Standard & Poor’s, add to the risks.
How realistic is this assessment? There is a general consensus that Gulf banks and investors are disproportionately over-exposed to the real estate and equity markets.
Lack of information and quality data is a major problem in the region. This applies equally to government statistics and the corporate private sector. While there are signs that things are starting to improve, disclosure and transparency is still perceived as an unnecessary intrusion as opposed to an essential market requirement.
Many analysts and bankers dismiss talk of an outright collapse of these two markets. At worst they talk about a market correction of about 20 percent in the real estate sector. They reject any notion of a repetition of the Souk Al-Manakh crisis in Kuwait in the 1980s, in which investors lost millions in the unofficial stock market and in real estate investments.
With all these structural deficiencies, it is worth questioning the very ratings which international rating agencies such as Standard & Poor’s (S&P); Fitch; and Moody’s assign to some of the Gulf countries countries. Perhaps the rating criteria are too narrow concentrating largely on oil prices, revenues, ability to pay, and some economic reforms.
Normally, the development of the capital and the real estate markets in any economy would be welcomed especially in helping in the economic transformation of the country or region. The Gulf states in this respect are no exception. Stock markets in the GCC states, for instance, have surged between 70 percent to 190 percent in 2004, the fastest in the world.
However, they are in many respects abnormal markets where booming prices and a free-for-all valuation culture are an increased concern. Property ownership regulations also are more skewed to national considerations rather than market principles. Quality research and data on the sector is still nascent; and the absence of a benchmark property index makes it difficult to assess the extent of real estate market inflation in the region.
High liquidity can be both a boon or a curse to an economy, depending on the circumstances. The filtering of this liquidity in massive proportions into the property markets has caused high price and financial inflation, especially in an environment of low real inflation averaging about 2 percent in the GCC countries.
This says, S&P, for instance, is exacerbated by the fact that, because of a less sophisticated banking sector, there is a serious lack of avenues to recycle liquidity. The corporate issuance and both primary and secondary markets in the Middle East, including securitization, are almost non-existent. Many of the capital markets have been set up recently or are still in the process of being established. This warns the international rating agency “is a sign that a correction or crash could have a serious monetary impact.”
On the plus side, the GCC real estate boom is also driven by strong economic growth; low interest rates; rapid population growth; evolving property ownership legislation; and increasing government spending on infrastructure projects. In this respect the construction boom also benefits contractors, sub-contractors, developers and banks as financiers.
Although the ratio of bank lending to the real estate sector is still relatively low at between 7 percent to 16 percent, S&P believes this is big enough to impact seriously on the banks in the case of a severe downturn. In any case, the property and equities boom shows no sign of abating, judging by the oversubscription to real estate private placements by institutional investors and to IPOs including in property and property finance companies such as Emaar, Nakheel, Riyadh Real Estate, and Amlak Finance. Similarly, property finance and mortgage finance is also starting to take off in a big way in the GCC markets. At the same time real estate is a common form of collateral in the region. As such in a major shock, the value of collateral would also drop.