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Special Report
October 8, 2008

 

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Economic Developments: A View from Riyadh
Brad Bourland

   

Editor's Note:

Today we are providing a snapshot of economic developments with the perspective on implications for the Gulf, provided by Mr. Brad Bourland, Chief Economist at Jadwa Investment in Riyadh. SUSRIS readers have long benefited from his perspectives on Saudi economic developments and we thank him for continuing to share his insights here.
 

Update on Global and Local Financial Conditions - Oct 8
Brad Bourland, Chief Economist, Jadwa Research 

U.S. stock markets slumped again yesterday, prompting large declines in Asia, Europe and the GCC this morning. The first annual decline in US consumer credit for over a decade heightened concerns about the impact of the financial crisis on the broader global economy sending markets into a frenzied sell off. This was despite new measures from the US Federal Reserve designed to provide additional liquidity and clear indications that further interest rate cuts would be forthcoming. 

The U.S. S&P 500 dropped 5.7 percent yesterday to close below 1,000 for the first time since August 2003; it is now down by 15 percent in the last five trading days. Financial shares again led the way, with the S&P financials index hitting its lowest level in 11 years. In response, Asian markets plunged, with Japan falling by 9.4 percent (its largest one-day decline since 1987) and Hong Kong dropping by 8.2 percent. European markets were down by upwards of 5 percent in early trading after closing relatively unchanged yesterday (the stock markets in the UK and France both ended up slight and the German market was down by just over 1 percent). GCC markets have also fallen sharply again, with the TASI down by another 8.5 percent and Dubai dropping by over 10 percent.

The central concern among investors over the last few days has been the freezing of the interbank market. Lending between banks has virtually stopped as bank’s confidence in their counterparties has drained as more and more financial institutions have got into trouble. Three-month euro interbank rates are now at an all-time high and three-month dollar interbank rates are currently 4.32 percent, up from 2.82 percent in mid-September. Interbank rates are a key determinant of lending rates, so higher interbank rates combined with an aversion to lending will have a clear impact on the broader economy. Interbank markets are also a vital tool for banks to manage their liquidity. In this climate, the huge injections of liquidity from central banks are vital. 

The markets are falling despite additional government efforts designed to improve financial conditions, including the following announcements over the past 24 hours:

  • The U.S. Federal Reserve has said it will buy commercial paper (short-term debt issued by corporations and banks). Many companies rely on commercial paper to finance their day-to-day operations, effectively using it as a credit line. The extreme aversion to risk in the markets means that investors have significantly scaled back their purchases of commercial paper and interest rates have jumped. The intervention in the commercial paper market is separate to the $700 billion that has been allocated to buy up distressed financial assets in a plan approved by the U.S. government on Friday and marks the first time that the Fed has assets that not backed by collateral. 
  • Fed Chairman Ben Bernanke signaled a shift in policy at a speech yesterday commenting that the outlook for economic growth has deteriorated and that inflationary pressures have eased. This gives a strong indication that there will be further interest rate cuts. The futures market had already priced in lower rates, but previous Fed comments had been careful to balance concerns about the economy (which call for lower interest rates) with concerns about inflation (which call for higher interest rates). 
  • This morning the UK government announced a financial support package for domestic banks. GBP50 billion of government money has been made available to eight of the country’s largest financial institutions, who in return for access to this funding will give the government shares that guaranteed a fixed rate of interest but do not have voting rights. A further GBP200 billion of short term financing has been made available to provide liquidity. Share prices of commercial banks plunged on Tuesday; HBOS was down by 40 percent and Royal Bank of Scotland down by 39 percent. Share prices of the companies with access to the support package are currently registering double-digit gains. 
  • A summit of EU finance ministers yesterday agreed to a set of principles for government action in rescuing financial institutions. These principles were reasonably broad and did not amount to a formal EU-wide action pan. Instead the region will deal with banks on a case-by-case basis. In addition, deposit insurance in the EU was increased yesterday from Euros20,000 to Euros50,000 ($68,000). This move was designed to reassure savers and prevent potentially destabilizing withdrawals from the banking sector and follows Ireland and Greece guaranteeing all depositors’ savings in the last few days. 

Implications:

Global and regional stock markets are overwhelmed by panic. While the plunging share prices are creating some strong investment opportunities, investor confidence is exceptionally fragile and a sustainable recovery is not likely in the near term. The declines of this week are putting more pressure on political leaders and discussions of G7 leaders on Friday and global financial leaders at the IMF/World Bank meetings on Saturday and Sunday should be closely watched. The chances of a large-scale coordinated rescue package across the leading global economies are growing day by day. Jadwa will be reporting from these meetings.

Interbank rates have been pushed up throughout the GCC, as interbank lending has dried up. This process began well before the extreme stresses in global interbank markets of the past few weeks (though this has heightened the interbank strains, particularly in the UAE), but is related to the global financial turmoil. Three main factors account for this. 

  • The exit of foreign funds that have entered the regional banking system in anticipation of exchange rate adjustments as investors became more risk averse and GCC government’s reaffirmed their commitment to the exchange rate pegs. 
  • Central banks clamping down on credit growth in order to contain inflation by withdrawing liquidity (for example, by raising commercial bank reserve requirements). 
  • Some banks raising large amounts of local currency to buy up the assets underlying instruments they hold that were affected by the financial crisis. 

Higher local and global interbank rates raise the cost of financing for local companies who are also finding it more expensive to borrow on international markets. This is hampering implementation of the project boom in the region and has prompted action from GCC central banks. This morning, the Central Bank of Kuwait slashed its discount rate to 4.5 percent from 5.75 percent and its repo rate to 2.5 percent from 3.5 percent. SAMA has again stated that there are no liquidity problems in Saudi Arabia and that it would provide addition liquidity if needed (the three-month interbank rate is currently 4.59 percent compared to 2.16 percent in early May). 

SAMA has also stated that bank deposits are safe. There is no formal deposit insurance in Saudi Arabia, but we believe there is a strong implicit government guarantee and the government has stepped in in the past when banks have been in trouble. We do not see any circumstances in which a Saudi bank would be unable to fully honor customer deposits.

Third quarter results released so far by Saudi banks do not point to any serious problems. Saudi Hollandi Bank, Bank Al Bilad and Banque Saudi Fransi all reported double digit profits growth, though profits fell by 8 percent at Samba and by 28 percent at Riyad Bank. 

 

Brad Bourland

Mr. Brad BourlandBrad Bourland is head of research at Jadwa Investment, Riyadh. From 1999 through 2007 Brad was the Chief Economist at Samba Financial Group, formerly Saudi American Bank, in Riyadh, where he published regularly on issues related to the Saudi and global economies and the world oil market. He appears frequently in the domestic and international media and is a regular public speaker. Before joining Samba, Brad spent an 18-year career as diplomat, economist, and manager with the U.S. Department of State. During the last three years of his diplomatic career he was in Riyadh as the American Embassy's First Secretary responsible for financial affairs, where he analyzed the Saudi economy for the U.S. Government and conducted financial aspects of US-Saudi relations. Brad has his BA and MA magna cum laude from the University of Utah, and is a CFA (Chartered Financial Analyst) charterholder.

For comments and queries please contact: 
Brad Bourland 
Chief Economist and Head of Research 
jadwaresearch@jadwa.com  
Head office: 
Phone +966 1 279-1111 
Fax +966 1 279-1571 
P.O. Box 60677, Riyadh 11555 
Kingdom of Saudi Arabia 
http://www.jadwa.com  

 

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