UAE and the Gulf Cooperation Council – An Economic Update

by Monica Malik, Chief Economist and Shailesh Jha, Economist, ADCB

Data for the first half of this year showed that although the liquidity of the UAE’s banking sector was continuing to tighten, this was at a slower pace than in the second half of 2015. Along with Kuwait, the UAE‘s overall liquidity position was better than that of the four other countries in the Gulf Cooperation Council - Saudi Arabia, Qatar, Bahrain and Oman. Upside pressure was limited by the differential in pace between credit and deposit growth narrowing in the first half of the year: deposit growth was generally stronger as banks focused on raising deposits following last year’s squeeze. Non-resident deposit growth was stronger than resident, although it accounted for just 11.9% of total deposits in the banking system. Domestically, the rise in government deposits was noticeable in the first quarter of 2016, possibly supported by the USD 5bn sovereign bond raised by the Abu Dhabi government in April. The government has thus returned to being a net depositor to the banking sector this year, having been a net borrower in 2015. Credit growth, on the other hand, decelerated in the year to June 2016, which we believe reflects three things: the general softening of the economic backdrop and demand for credit; higher market rates accompanying the tightening banking sector liquidity; and a more cautious approach towards lending by banks (see figure 1).

Another factor which helped to reduce upside pressure was greater external borrowing in the form of bonds, syndicated loan and deposits. Private sector loan growth, including both corporate and retail segments, has slowed down, and government borrowing remained broadly stable from its mid-2015 levels, after strong growth in the first half of last year, possibly in an attempt at tightening liquidity.

Access to capital

The GCC’s access to capital is being supported by the stronger oil price, the fact that the US Federal Reserve is keeping rates on hold and a general improvement in sentiment towards emerging markets (EMs). Low global interest rates are helping to keep foreign debt raising attractive for GCC governments and corporates, and we believe that the more gradual tightening in monetary conditions (which have led to higher market rates than in the second half of last year) is positive for the growth outlook, though it continues to be a headwind for economic activity in 2016.

Oman, Saudi Arabia and Qatar are the countries in the region which are continuing to experience the strongest tightening pressures – the larger fiscal deficits, relative to their GDP, of Saudi Arabia and Oman resulted in their governments drawing down their banking sector deposits and borrowing from domestic banks. Government deposits in Oman, for example, contracted sharply in May, despite the fact that Oman has issued bonds this year and both countries taking international syndicated loans. Saudi Arabia and Kuwait are looking to issue sovereign bonds this year to help cover their fiscal deficits. These tightening liquidity conditions in other GCC countries, and the consequent higher interbank rates, are a potential risk to UAE market rates and banks in that region may have to raise their deposit rates in order to compete (see figure 2).[[[PAGE]]]

Saudi Arabia

The net foreign assets of the Saudi Arabia Monetary Authority (SAMA, the country’s central bank) fell by an average of -USD 7.8bn per month in the first half of this year. The government issued a USD10bn syndicated loan at the end of April but government deposits in the banking sector were still down -13.6% year on year in June despite having risen USD6.7bn in May. Total banking sector deposits have contracted year on year each month since February. Credit growth however has continued to expand solidly in all areas: private sector credit growth was supported partly by the need for short- to medium-term working capital. Unless the SAMA increases its regulatory L-to-D (loan to deposit) ceiling, currently 90%, the ability of banks to lend will be curtailed. The regulatory ceiling has already been raised once this year from 85% in February. We also see the potential for other regulatory reforms in order to support liquidity, such as reducing the reserve requirement ratio (RRR) as tighter conditions are likely to persist in the medium term. In the short term, liquidity could be boosted by the expected sovereign bond issuance, as this in turn may increase government deposits (as with the syndicated loan). Bloomberg recently reported that the SAMA had offered SAR15bn (c.SAR1.5bn per bank) worth of short-term loans to banks in June to ease liquidity constraints; however, we see this as only a temporary solution.

Qatar

Qatar’s demand for loans continued to grow strongly in the first half of this year, supported by the country’s ongoing investment programme. Total credit growth expanded strongly by 13.2% year on year in June, with the public sector seeing growth of 17.7%. Despite having a strong foreign exchange reserve position and a smaller fiscal deficit forecast for 2016, public sector deposits continued to fall since end-2014. However, public sector deposits increased moderately in 2Q, probably supported by the sovereign bond issuance in May.

We estimate that the USD9bn that Qatar raised is more than sufficient to cover its 2016 fiscal deficit. The country should therefore theoretically have seen less banking sector liquidity pressure, but, reflecting the tight conditions, the system-wide L-to-D ratio stood at 114.6 in June. Non-resident deposits were critical for Qatari banks to boost their deposit bases ( see figure 3). Despite the liquidity squeeze, the Qatar Central Bank has continued to issue Treasury bills this year, albeit at reduced volumes.