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The Saudi/GCC Financial Positions.

Saudi Arabian Monetary Agency (SAMA) Governor Hamad al-Sayari says the world financial turmoil will have minimal effects on the kingdom's economy, citing the country's conservative fiscal stance, overseas assets and plentiful oil revenue (expected in 2008 to exceed $285 bn, up from $233 bn in 207) which will provide insulation. He says: "The current crisis will have no impact on Saudi banks because of our cautious loan regulations. Saudi banks are mainly interested in the local economy and do not depend on foreign activities, which is why they are in a very good position today". But the Saudi riyal is pegged to the US dollar. If the dollar weakens so does the riyal - and inflation is imported. And the Tadawul All-Shares Index has dropped sharply on fears of the impact of the Sept. 15 collapse of Lehman Brothers.

Beshr Bakheet, head of Bakheet Investment Group in Saudi Arabia, says: "Nothing justifies the market decline except people frightened by the news. We do not have direct links to the US market and exposure in the banking system is limited". Although the index has dropped by a third this year, the performance does not reflect fundamentals, but rather the fact that retail investors make more than 90% of the market and often respond irrationally to news flow. In a move intended to support the index, the Capital Market Authority (CMA) in August decided to open the market to non-resident foreigners by authorising Saudi brokers to sell stock swaps.

International investment funds had long sought access to the Saudi market, particularly amid the regional economic boom triggered by oil's dramatic rise. Tim Gray, CEO of HSBC investment Bank in Riyadh, says: "I do not think there is a close correlation between the [Saudi] economy and the market. Local investors are increasingly focusing on corporate fundamentals and this will be encouraged by the CMA's recent moves to open the market to direct foreign participation". But analysts suggest the retail traders create market volatility which might be alleviated by more funds and institutional investors.

Such speculative investment is widely attributed to causing a dramatic drop in 2006, when the Saudi market lost $500 bn in value and dropped from its $834 bn peak. But Gray says: "There is adequate liquidity in the market, it is completely different from 2006. Back in early 2006, we had dramatic circumstances, with no liquidity - many offers but no bidders. The situation is nothing like this today".

Saudi Arabia has traditionally been less disposed to foreign investment than other GCC states. But since 2002, the kingdom has moved to liberalise its capital markets as it prepared for accession to the WTO, a process completed in 2005. Among its other recent reforms, the CMA has insisted on public disclosure of shareholder stakes in listed Saudi firms which exceed 5%. IMF chief Dominique Strauss-Kahn recently told a meeting with the GCC central bank governors in Jeddah that the region's banking and financial sectors had proven "quite resilient" to the crisis.

The UAE Central Bank on Sept. 22 said: "The Central Bank has decided to set up a facility amounting to Dh50 bn for banks operating in the UAE, to be used by these banks if so needed" - without elaborating further. As lines of credit to global banks recently dried up, UAE and other GCC institutions have found it harder to raise funds internationally.

As a result local funding costs have risen, leading to concerns of a domestic liquidity drought. Sharp lending growth, which was up as much as 57% in the 12 months to the end-June 2008, has not been matched by growth in deposits. There is also increasing concern about banks' exposure to an over-inflated real estate market.

Intervention has not been confined to the UAE. Kuwait's KIA recently interceded to stem sharp falls in that emirate's equity market. The Kuwaiti Central Bank on Sept. 22 said it was willing to pump money into its banking system if that was needed, but added that overall the banking system was sound.

UAE Central bank officials said its actions could be copied elsewhere in the GCC area, especially given the long-term uncertainty around credit markets. The FT on Sept. 23 quoted a UAE Central Bank official as saying: "Money is going around in a circle and if the problem is here it will move elsewhere. What is worse is that we won't know the extent of the problem until a few months' time". Marios Maratheftis, head of research at Standard Chartered in Dubai, says: The UAE Central Bank "is basically telling the markets they won't let the liquidity situation deteriorate too much". While the UAE Central Bank wants to restrict credit growth to curb inflation, it does not want the economy to grind to a halt, imperilling growth. Maratheftis says: "It is a Goldilocks story: they don't want it too hot, and not too cold either".

Like Bahrain, Oman, Qatar and Saudi Arabia, the UAE pegs its currency to the US dollar, which obliges the Central Bank to follow interest rates set by the US Federal Reserve (Fed). The injection did not affect money market rates immediately because of market inefficiencies. But the significant sum being made available, the equivalent of about 5.6% of the UAE credit market, ran the risk of stoking inflation.

A lack of liquidity had been detected in August as major deposits of international money abandoned the UAE. Investors in August had moved into the UAE dirham, betting that the Central Bank would de-peg from a weakening dollar or revalue the currency to damp inflation. Many traders reversed those bets once the dollar began to strengthen, while financial contagion prompted many others to liquidate their holdings in the UAE and other GCC states.

Facing domestic pressure over its stakes in troubled US banks, the KIA on Sept. 23 took the unusual step of acknowledging losses in Citigroup (Citi), one of its most high profile investments. The SWF's Managing Director Badr al-Sa'd told al-Arabiya TV the KIA had lost $270m in Citi but had made no losses on its investment in Merrill Lynch, the WS investment bank which was recently bought by Bank of America for $50 bn. In January, KIA invested $5 bn in the two US banks. Sa'd said the global turmoil was creating investment opportunities abroad - including in the US, Europe and Asia - but said the KIA was not in the business of bailing out ailing banks.

GCC SWFs were seen as rushing to the aid of distressed US financials earlier this year but recently there have been questions about their losses and calls in some quarters for sovereign entities to invest locally. In the previous week, KIA began investing in the Kuwaiti stock market to support that exchange which, like other GCC markets, had plummeted in recent weeks.

Unlike other GCC states, Kuwait - an ally of the US - has active media and parliament renowned for grilling state officials. The FT on Sept. 24 quoted an un-named "Kuwait-based analyst" as saying: "There is concern in the market about how sovereign wealth funds may have suffered, there are also questions from [Kuwait's] parliament about their losses...[the statement] is a way of advising the people and a political message. What they were trying to say is our investment strategy is not politically motivated".

Although other GCC SWFs have no parliament to account to, their foray into ailing US financials in 2007 and early this year has put them on the defensive. Some GCC bankers say it is likely that more capital will stay in the region as governments and private investors look to invest in EEs closer to home, such as Algeria and Libya. A Dubai-based banker says: "The global crisis reinforced perceptions that it's better to keep your money at home". This is not to say SWFs will stop looking at Western bargains - although they are keen not to be seen to be taking advantage of the West's problems.

Mubadala Development Co. (MDC), one of the Abu Dhabi government's main investment arms, on Sept. 23 said it had bought 50% in Kor Hotel Groups, a Los Angeles-based company. There are several Abu Dhabi-government entities like MDC buying stakes in Western companies and firms in Asian EEs. They are all backed by ADIA which is the largest SWF in the Middle East.

The FT on Sept. 24 quoted Philipp Lotter, an analyst at Moody's, as saying: "I think sovereign wealth funds with lots of liquidity and lots of cash and the consequential backing of a cash-rich government are going to remain active. Certainly you are not going to see Mubadala or any other sovereign entity go out and make a bid for a strategic asset just because they happen to be cheap. They are conscious of the political sensitivities. But that notwithstanding, these entities remain very liquid, highly government supported and will identify investment opportunities as they arise".

Oman's inflation fell to 13.35% in July, from 13.73% in June. Although the headline inflation figure eased, food and rent costs continued to rise by double digit amounts. Food, beverage and tobacco costs were up 22.9% on June, while rent costs rose 16.99%. Hamood Sangour al-Zadali, executive president of Oman's Central Bank, expects inflation in Oman to fall below 10% by end-2008 or in early 2009.

Inflation in Qatar rose to 16.6% in the second quarter of 2008, according to the Qatar Statistics Authority (QSA), up from the first-quarter's 14.8%. The biggest increase in the consumer price index was in the miscellaneous goods and services category, which rose 4.78% and was attributed to rises in gold prices and hotel rates. The second-biggest price rise was in the food index, which was up 4.48% compared with the first quarter. The QSA says the rent, energy and fuel aspects of the consumer price index rose 3.68% compared with the first quarter, mainly because of rental price rises. But that was a slower pace than in previous months. Qatar's GDP rose 60.8% from QR59.8 bn in the first quarter of 2008 to nearly QR96.2 bn in the second quarter.

After the Sept. 17 Jeddah meeting of the GCC finance ministers, Qatari Finance and Economy Minister Youssef Kamal said of the measures then adopted: "We are beginning to see that if we don't agree on these issues [of monetary union and a single central bank], future storms may be more difficult to deal with", adding that the financial crisis in the US illustrated the need for a regional structure.

GCC states have been struggling to protect their dollar-pegged currencies from dramatic monetary fluctuations. Kuwait in May 2007 devalued its dinar and moved to a basket of currencies rather than maintaining its dollar peg. The Saudi National Commercial Bank (NCB) Chief Economist Sayed al-Shaikh said of the Jeddah agreement: "This is meant to reassure [GCC] markets, banks and financial institutions that the central banks are committed to the unified currency. There were doubts in the market as to their ability to implement the plan. They wanted to reconfirm their commitment".

The six GCC states agreed in 2001 to form a monetary union by 2010 to boost regional trade. But Oman later pulled out of the plan. With Kuwait unilaterally withdrawing its peg to the dollar, many believe the GCC region to be at risk. Governors of GCC central banks have approved the Sept. 17 proposal, which will be referred to heads of state for endorsement at their summit in Oman in November, after which it will become effective when ratified by the legislatures of the six member-states.

In 2002, the GCC committed to integration by voting to set up a customs union in 2003, a monetary union in 2005, and a single currency in 2010. The Sept. 17 decision meant movement towards a unified currency will continue. Shaikh said: "This is of a great value for the...of the GCC region. The monetary policy of the GCC will follow the GCC business cycle independently from the US economy, which is a mature economy with a totally different cycle with which they were otherwise forced to synchronise".

GCC states have struggled in the past two years to defend their currencies' pegs to the declining US dollar, but recent increases in the value of the dollar may have provided re-assurance. Yet rising GCC inflation has fuelled expectations of revaluation, encouraging speculative inflows. These, added to huge oil revenues for most states, have fed domestic liquidity. GCC central bank governors said more efforts were needed to curb soaring inflation, which threatens to undermine the initiative.

Many commentators attribute GCC inflationary pressure to a combination of a big rise paper WTI since 2002 and surging demand for real estate for the region's growing population. Shaikh said: "Unifying the exchange rates will facilitate policy co-ordination. It will enable financial institutions to provide funds across the GCC area and facilitate the flow of capital, pricing of goods, commodities and stocks".

The Jeddah meeting was attended by IMF chief Strauss-Kahn. The GCC officials did not disclose details of the agreement, the proposed location for a common central bank, or any timeline for adopting the proposed new GCC currency.

When paper WTI fell below $100/b recently, Dubai-based economist Muhammad al-Asoomi said GCC transport costs and the price of goods and services will come down as well, adding: "Inflation will fall in GCC countries on weaker oil prices and a stronger dollar. Since the GCC countries have factored a $40/b oil price in their budgets, lower oil income won't hurt growth". Abu Dhabi-based economist Muhammad Amerah agreed: "The local economy should be able to continue its growth momentum. Locally manufactured products can compete better in terms of prices, especially which use oil as feedstock" - citing examples of processed food industries and clothing and leather industries which will gain a competitive edge. But Dalton Garis, associate professor of economics at the Petroleum Institute in Abu Dhabi, said it will be premature to make any forecasts at this stage, adding: Oil prices may pick up again. About 90% of Abu Dhabi's revenues come from oil and gas exports. "Whether lower oil prices will affect UAE economic growth or not remains to be seen".
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Title Annotation:Gulf Cooperation Council
Publication:APS Diplomat News Service
Geographic Code:7SAUD
Date:Sep 29, 2008
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