The Other Liquidity Crisis

Overlooked in the past month in all of the horrible news coming out of the US and Europe is the liquidity crisis hitting the emerging markets of the Gulf. Dubai, in particular, has seen private credit dry up almost overnight as local markets have tanked in line with global markets and currency speculators have withdrawn funds en masse after the strengthening of the US dollar made it unlikely that any of the Gulf governments would adjust their currency pegs. In the month of September alone, the GCC markets lost $153 billion off their collective market cap. In response, the UAE central bank created a pool of $13 billion to inject into the banking system to ease the tightness of local credit markets. Other GCC governments have promised similar moves if credit markets in those countries become too tight.

Compared to the situation in the US, the credit crisis in the Gulf looks somewhat paltry. But when you consider that the Gulf markets, along with China, were supposed to remain one of the few places globally left unscathed by the US financial crisis, the situation takes on a somewhat different perspective. Granted, the credit crisis in the Gulf, particularly in the UAE, is largely of its own making. In its latest report, issued on 16 October, Standard Charter points out that much like the situation in the US in the late 1990s and early 2000s, the combination of low interest rates and high liquidity led to rampant speculation in property markets. Prospective investors took on highly leveraged positions in order to flip properties, which in turn led to asset inflation. This should sound very familiar to US readers. And, like the current situation in the US, we should expect to see heavy government intervention to bail out local markets. Most national governments in the Gulf continue to enjoy very deep pockets thanks to a seven year bull run in commodity markets. Standard Charter estimates that despite OPEC's worry over the current trajectory of oil prices, the break even price for the Gulf oil producers is in the $45-$55/barrel range.

Still, any slowdown in the Gulf adds additional wrinkles that should be considered: first, the Gulf economies have been fueling growth in the construction industry with their vast development projects. A slowdown there, particularly if coupled with a slowdown in Asia, will mean even more widespread pain for construction and infrastructure developers. Second, Gulf growth has fueled expansion in the Middle East and parts of Africa through robust foreign investment flows. Even Egypt, considered to be among the most promising emerging markets in North Africa, is largely beholden to Gulf investors. Lastly, what becomes of sovereign wealth funds in the face of a Gulf slowdown? The Gulf Research Center, a UAE-based think tank, estimated on 15 October that Gulf sovereign wealth funds have been more exposed to the financial turmoil in US markets than local banks despite SAMA's recent denial of having suffered any loses as a result of the US downturn. This may mean an even further tightening of liquidity globally if one considers that the Gulf funds have been of one the last bastions of easy money.

All in all, not a pretty picture.