Lessons Learned from Ratings Agencies

The ratings agencies have been busy these days in the Gulf. Perhaps out of real concern or perhaps out of a need to be perceived as doing their jobs after failing to so spectacularly in rating US financial products, the agencies have re-opened their books on the Gulf and don't really like what they see. Standard and Poors recently downgraded Emaar Properties, perhaps the standard bearer of the "new economy" in the UAE, to a BBB+, down from an A- and gives the company a negative outlook. In its analysis, S&P cites the continued weak real estate markets in Dubai and the lingering uncertainty over the length and severity of the downturn.

Likewise, Moodys has taken a new look at Kuwait and has publicly announced the country's sovereign rating is in review for a downgrade. Among the reasons Moodys cites in its call for a review are the recent resignation of the cabinet and the dissolution of the National Assembly. To quote directly from the press release issued today, "In Moody's opinion, these events reflect an erosion of institutional strength which is of particular concern given the current challenges presented to Kuwait by the global economic and financial crisis."

Although neither the downgrade of Emaar nor the potential downgrade of Kuwait's sovereign rating should be surprising, one hopes that each country and market take away some lessons learned from the downgrade. In UAE, development needs to move away from a single track focus. Stretching yourself so thin, both from a borrowing and a profit perspective, in real estate alone has led to a host of problems for the Emirates. Besides subjecting your domestic market to inflationary pressures (cost of labor and construction materials have been accelerating) and speculation due to easy and cheap credit which in turn exacerbates the inflationary pressures, you leave your economy vulnerable to any number of possible downturns. It's a lesson that the UAE well understands now that Abu Dhabi has bailed Dubai out and may have to again. Still, I am not entirely sure it's a lesson that will prompt them to do things differently. Looking at the UAE press, there isn't a tremendous amount of self-reflection going on. No calls for tougher regulations to prevent bubbles from developing. No talk of diversifying away from real estate. Maybe it's too early to see those signs. But I hope the lesson doesn't go unheeded.

Likewise, I think Moody's has hit the nail on the head when it talks about institutional erosion in Kuwait. I would argue that it's not only because of the National Assembly, although that certainly is playing a role. But the lack of oversight and the inability of the government to anticipate troubles in its own domestic financial industry suggests that many things aren't working in Kuwait these days. Kuwait could use the opportunity of the crisis and the dissolution of Parliament to get its governing house in order but one senses that it's inertia that has and will rule the day in that country.

All in all, it's a shame that both countries don't seem to be flexible enough to learn from these painful lessons. The UAE is particularly disappointing because of all places in the Gulf, and the the Middle East quite frankly, the UAE was proving to be innovative and new. Granted, the country never left the statist model behind (in fact you could argue that with groups like Dubai World, they reinvented it), but with a dash of flash, credit, and private-public partnerships, it would seem that country in fact could become the next Singapore. It's too bad that Emirati decision makers may only be innovative on the up side and not on the down. As a result, the next time a crisis hits, they might not be so well positioned to withstand it.