Cost of debt rising in GCC

With Western banks reluctant to lend, firms will now have to turn to local sources of cash.

Housing will be the first to be hit should the Gulf be struck by the credit crunch.

A GCC credit crunch may be on the cards with housing in the firing line, after the international banking crisis sparked soaring lending rates. Some analysts believe this may boost local stock exchanges, which may emerge as a relatively more attractive way to raise money.

Attention since Sunday has focused on the stock markets, both internationally and across the GCC, but the sharp falls could be seen as merely symptoms of the wider issue: because of Lehman Brothers' bankruptcy and Bank of America swallowing up Merrill Lynch, banks will have a reduced appetite for lending, whether to each other or the public. The GCC stock markets are seen as not large or diverse enough to severely impact the economy when they drop sharply in value, particularly as so many firms are family or state-owned and not listed, and because the economy rapidly recovered from the 2006 crash to last year's boom.

Debt, therefore, takes centre stage, with all indicators showing its cost rising. The London interbank offered rate, or Libor, which sets the rate at which banks lend to each other, shot up on Monday, rising a quarter of one per cent. That put the 2.75 per cent rate at its highest level since April, and was the sharpest one-day rise in nearly a year. The local Emirates equivalent, Eibor, has been climbing since June, when the markets began to slump, and now stands at 3.18 per cent.

In addition, the overnight Libor rate shot up on Monday from 2.15 per cent to 6.43 per cent, the highest since 2001. Since Western banks will now be increasingly reluctant to lend, thus curbing the cheaper rates GCC companies and governments could expect, banks will be forced to turn to local sources or reduce lending. Mohammed Salih al Hashemi, the executive director of asset management at the Abu Dhabi Investment Company, said: "Local banks may not have enough deposits to expand lending, and will have to go to the markets. It may limit their ability to extend credit to corporate customers. Deposits are the cheapest way to raise money for loans."

This could particularly have an effect on the housing markets, in particular the Dubai sector, which has been a main driver of growth for the UAE because low bank deposit levels force borrowing. Udo Schaeberle, director of clients at the Abu Dhabi branch of BHF Bank, said: "You have a large lack of trust between banks internationally and the cost of debt has gone up in the last few days. There may be a negative impact of falling deposit levels at banks, which increases costs and becomes a new burden for them."

Mr Schaeberle said although GCC banks were not nursing heavy losses right now, as the crisis spread to the likes of the insurance giant AIG "even local conservative banks" would start to discover they had exposure to the global financial crisis. The impact of lower debt available to homebuyers could hit the housing market, especially if expected regulations aimed at curbing speculators are implemented.

Mr Schaeberle said he was advising his clients to increase their investments in the GCC, but he was reducing the risk profile of the investment portfolios. There may be an upside to the situation, as Imran Ahmed, managing director of asset management at Mashreq, explained: when the debt markets become expensive, companies may have to re-evaluate local stock markets, and in turn re-energise and develop them.

"The lack of credit may force financial officers to look at the debt and equity markets again in a new light, when borrowing the capital required becomes harder," he said. He added that firms could also start to look at their capital structure to ensure they were operating efficiently, and newly listed firms would be expected to improve their corporate governance and procedures. Local markets fell yesterday in response to the continuing turmoil in the West, but the drop was muted compared with the previous day's rout, with some bourses gradually rising. The Dubai Financial Market was one of the biggest decliners, closing down 2.22 per cent, in contrast to its neighbour the Abu Dhabi Securities Exchange, which gained 0,4 per cent. Even the Saudi Tadawul pared back its previous morning losses to end down just 0.53 per cent.

The London Stock Exchange, however, at one point had dropped 4.3 per cent, led by the banking group HBOS, which was down as much as 35 per cent, raising doubts about its solidity. [e-mail]