GCC PAIN PRESAGES HEALING HAUL

With global headlines focused on Lebanon’s growing economic crisis and the formalization of Israeli-UAE relations, the oil price- and pandemic-induced economic and market fallout in the greater Gulf region may be no less historic or seismic. In Lebanon, the World Bank estimates the port blast caused over USD 8 billion in damages and losses from the destruction of physical capital, trade disruption, and fiscal revenues for the government. The currency and banking sector have been collapsing for months and Lebanon defaulted on USD 31 billion in Eurobonds in March. IMF talks on a USD 10 billion bailout were stalled before the blast while the Prime Minister and cabinet resigned a week after the explosion, citing “chronic corruption in politics, administration and the state.” A new Prime Minister has been appointed, but government formation is unlikely to be rapid with the usual party and sectarian infighting as the currency continues to fall pushing inflation into triple-digits and causing further economic and humanitarian pain.

Lebanon leads the region and all emerging/frontier benchmarks with +40% stock market performance in USD terms on the MSCI Index through end-November as domestic investors seek relative safety for their savings outside property and gold. Real estate giant Solidere, the biggest and most liquid listing, saw its share price surge more than 150% from the outbreak of demonstrations in October until the explosion that leveled much of Beirut. In contrast, despite strong rebounds over the past few months as oil prices edge up and economies reopen, stock markets in the six-member Gulf Cooperation Council (GCC) are all in negative territory through the first eleven months, despite advances the past few months. Several of the sovereigns have also been able to tap the international capital markets this year to cover soaring budget deficits, with Qatar and Abu Dhabi raising USD 10 billion and USD 7 billion, respectively, in massively oversubscribed offerings. Standard & Poor’s expects total government deficits across the GCC to top USD 180 billion this year while average government debt/GDP is projected to increase by a record USD 100 billion on local and international borrowing to reach 18% of GDP, up from 5% in 2019. They are a major weighting in the sovereign JP Morgan EMBI index after it altered criteria to admit high-income countries.

In Kuwait parliament debated tapping the international markets for the second time ever in advance of late year elections. Government debt/GDP leads the region at 39%, according to Standard & Poor’s. While the IMF is predicting the economy will only contract a little over 1% this year, the government warned it lacks sufficient liquidity to pay public sector wages. The Finance Ministry is preparing to transfer funds from the world’s oldest Sovereign Wealth Fund, the Future Generations Fund, to the General Reserve Fund for budget financing after it reported that total revenue was down 16% in the fiscal year that ended in March. As the economic downturn takes its toll, parliament responded with changing a 40-year-old corporate bankruptcy law designed to save solvent companies suffering oil price and pandemic stress. In the past, failure to make debt payments was a criminal offense and meant automatic bankruptcy, and now creditor settlements or restructuring are permitted.

In regional giant Saudi Arabia, the IMF expects the economy to contract 6.8% while 2019’s 5.9% of GDP current account surplus sharply reverses to a deficit of 4.9%. Early in the pandemic the Kingdom transferred some USD 40 billion from the central bank to its USD 325 billion sovereign wealth fund, Public Investment Fund, to boost buying capacity for its global portfolio as blue-chip equities around the world sold-off. Monetary authority foreign reserves are near a 10-year low with the price swing in oil accounting for 40% of output. Officials slashed expenditures, suspended cost of living allowances for state employees and even cut USD 8 billion from the Crown Prince’s Vision 2030 program designed to diversify the economy away from oil. In addition, the Kingdom tripled value-added tax to 15%, sending annual inflation near 6% as food prices spiked.

The Saudi stock exchange, Tadawul, with USD 2.2 trillion in market capitalization, dominates regional bourses and despite advancing more than 5% the past three months is still trading down 2.8% year-to-date on the MSCI Index. Opened to foreign investors with a minimum of USD 5 billion in assets under management in 2015, it was added to the FTSE and MSCI EM indices last year and now boasts over 2,000 foreign investors, up 78% over a year ago, although trading is still dominated by locals. Late last year Saudi Aramco, the world’s largest crude producer, went public, raising USD 25.6 billion, and despite the broader economic downturn another 4 companies have come to market this year with other IPOs waiting approval. At the same time the bourse, which plans to go public, launched its first exchange traded derivative, the Saudi Futures 30 Index Futures Contract based on the MSCI Tadawul 30, and plans to start trading single stock futures next year. Development of Tadawul into a regional market to further attract foreign investors is part of Vision 2030. On the debt side, FTSE Russell just launched a local currency Saudi government bond index covering both Islamic sukuk and traditional interest-bearing instruments with maturities of over a year.

Finally, in the United Arab Emirates, stocks have recovered more than 10% in dollar terms on the MSCI Index the past three months but are still off 6.5% year-to-date. The past two decades the Emirates, led by Dubai, have diversified away from oil, with the commodity accounting for only 25% of its GDP last year. However, the shift to reliance on tourism, transportation, and retail resulted in a significant downturn during the pandemic, with Standard & Poor’s projecting the economy will contract 11% this year following anemic expansion of 1.7% in 2019. Dubai’s Eurobond prospectus offering both Sharia complaint Islamic and standard debt surprised investors. It disclosed direct government debt of only 28% of GDP, far lower than private estimates. However, that figure does not include “government-related entities” which Standard & Poor’s last year estimated had debt outstanding totaling more than 50% of GDP. Dubai has not raised funds in the public markets since 2014 and analysts remain wary of data that does not incorporate overall on- and off-balance sheet sovereign obligations and guarantees, recalling that Abu Dhabi had to bail out its neighbor during the GFC under the crushing load of contingent liabilities.

Overall, the IMF expects the combined drop in economic output across the GCC markets this year to be 7.6%. Banks in the region entered the current crisis far stronger than in 2008 and monetary authorities have provided liquidity and cut rates in line with the US Federal Reserve to support the broader economy. However, as in markets worldwide the end of 6-month loan standstills will hit balance sheets. While oil prices are unlikely to rebound to the USD 80/barrel estimated “break-even” level to cover budgets, the markets undertaking concerted efforts to liberalize, diversify and attract international capital – both portfolio as in Saudi Arabia and foreign direct investment in tax free zones as in the UAE – are likely to rebound more quickly and shake up longstanding industrial/financial sector competitiveness lag and investor access/product lethargy for more upbeat area headlines.