Dawn of a new age of austerity

Investment bankers in the Gulf keep waiting for a definitive upturn, but one globally significant financial shock after another keeps postponing the return of normality.

Ikbal Daredia is waiting. Like many other investment bankers in the region, Mr Daredia has watched in frustration as one economic challenge after the other has washed over the Gulf. First it was the global financial crisis, triggered by the failure of the US investment bank Lehman Brothers in September 2008. Then came Dubai World's well-publicised debt restructuring, announced about a year later.

And just when Dubai World seemed close to a final US$23.5 billion (Dh86.31bn) debt pact in March that would extend loans made to the government conglomerate over five and eight years, trouble started to crop up in Europe. Shaky finances in Greece, Italy, Spain, Portugal and Ireland left few companies in the Gulf confident about borrowing from investors, the type of activity that is Mr Daredia's bread and butter.

The markets for all kinds of debt, from bank loans to Islamic bonds, or sukuk, did not look very friendly. "Unless the market comes back, it doesn't matter whether it's a conventional bond or a sukuk; nothing will be issued," says Mr Daredia, the head of capital markets and institutional banking at Unicorn Investment Bank in Bahrain. "I think there are a number of issuers just waiting for the right time."

The persistent lack of appetite for debt is one of the main effects Europe's financial problems are having on the Gulf. And as Ramadan approaches, Mr Daredia is not too optimistic about a summer surge. Several planned bonds have already been postponed this year because skittish investors were asking for interest rates that companies deemed too high. Sabic Capital, a division of the industrial giant Saudi Basic Industries Corporation, and BBK, a Bahraini lender, have been among the victims. While Gulf bond prices have risen in recent weeks and pushed yields down, few observers are ready to call it a comeback.

"You still have pressures from Europe and the Dubai World stuff that still has to be worked out," Ziad Shaaban, the head of fixed income at EFG-Hermes in Dubai, said last week. Europe's highly leveraged countries received $1 trillion of aid from the EU and IMF in May, a bout of spending that has since prompted the region's leaders to weigh budget cuts. At meetings last weekend in Toronto, leaders of the world's 20 biggest economies pledged to halve government deficits by 2013 and make further efforts to reduce debt-to-GDP ratios by 2016.

Austerity measures have already been announced in Greece, Spain, France, the UK and elsewhere. Even the US, which previously had been at loggerheads with Europeans over their moves to restrain government spending, agreed over the weekend to pull up its bootstraps. Precisely how austerity in Europe will affect the Gulf remains to be seen, but few economists are reassured by the measures. European investors and banks, for one thing, account for a large slice of the foreign investment that once helped give life to local property, banking, stock and bond markets.

A quartet of British banks - Royal Bank of Scotland, HSBC, Lloyds and Standard Chartered - were revealed to be some of Dubai World's biggest creditors after it announced its debt restructuring last year. Europeans are also major investors in the UAE's property market, not to mention big buyers of regional bonds and sukuk. Those sources of capital could diminish if lower government spending back home caused more risk-aversion.

The bigger impact for the Gulf, though, could be on oil prices. While they have stayed high despite the European crisis and austerity measures - crude for delivery in August now trades at about $76 per barrel - any austerity-induced slowdown in Europe could threaten Gulf governments' main source of revenue. "The painful measures these European economies are going to have to endure could have an impact on oil demand as their economies slow down," said Paul Gamble, an economist at Jadwa Investment in Saudi Arabia.

"That's how I see it in terms of oil. Equally you could see more caution from European banks in lending to this region. Obviously it is [now] nowhere near the pre-crisis level, but it could dampen appetite to lend to this region." Yet while risks exist for oil prices and foreign investment, the world's changing fiscal dynamics may also come as a blessing. Although recent weakness in the euro has hit the Gulf's tourism industry, it also means the region's dollar-pegged currencies are stronger. A dirham goes about 15 per cent further in Europe than it did at the beginning of the year, a fact the UAE's summer holidaymakers and consumers of French cheese will cheer.

And most governments in the Gulf have pledged to raise spending this year, a factor that may help keep business humming despite austerity elsewhere. Saudi Arabia, for example, revealed a budget last December that forecast an $18.7bn deficit meant to fund infrastructure projects and stimulate economic activity. Revenue was projected at $125.3bn, while spending was estimated at $144bn, the kingdom's highest level ever.

In March, Qatar also put forth its biggest budget ever for its 2010-2011 fiscal year, outlining $32.4bn of spending while maintaining a surplus. Kuwait and Oman are also projecting budget surpluses this year, and the UAE Federal Government decided to raise spending by more than 3 per cent when it announced its 2010 budget last October. Dubai is perhaps unique in the Gulf in that it is both running a deficit and cutting spending: in January, the emirate projected a Dh6bn deficit, and in March it said government departments had been instructed to cut costs by 15 per cent.

With spending still high in the Gulf as Europe tightens its belt, analysts are expecting a shift in trade and investment activity towards rapidly growing Asian economies. They also expect governments to occupy a higher rung on the region's financial ladder. Even Mr Daredia takes comfort from that. He predicts that several Islamic bonds will be issued by GCC companies this year, most of which will be government-backed.

"We see in the pipeline a number of transactions being talked about, but having said that, my feeling is that these will be either sovereign sukuks or sovereign-backed sukuks," he says. "That is where the appetite is. Corporates can't come to the market unless they are very good, highly rated companies. Investors want to put their money in safe transactions, and they feel comfortable with sovereigns."