Financial Fire Fighting
The disastrous results from RBS illustrate how challenging it is to mark the bottom of the market. Between the write down of the pricey purchase of ABN Amro and marking down toxic assets, the once highly successful bank tallied up a record loss of $34 billion. That is a sea of red ink which is forcing the British government to up its stake to nearly 80 percent.
I used the RBS example because everyone in government and business alike is trying to douse the flames of financial turmoil. The most dramatic example of this approach in the Middle East came from the United Arab Emirates -- which in the spirit of the term “united” took federal action to support Brand Dubai by taking 50 percent of a $20 billion bond offering.
A few days later, we heard from Nasser Al Shaikh, Director General of Dubai’s Department of Finance, who said that the government was looking at a possible stimulus plan over the next few weeks to jump start small and medium size enterprises. “The times are challenging throughout the world. Now it is up to us,” he declared at a news conference.
The re-defining of “us” in the context of the UAE is what the $10 billion bond purchase is all about. The UAE central bank pumped more than $30 billion into the banking system during the fourth quarter of 2008, but that money was not earmarked for Dubai. This latest round was.
The strategy changed back in mid-November at the top levels of government. During an interview on Marketplace Middle East back then, the Speaker of the House of the Federal National Council, Abdul Aziz Al Ghurair pointed in that direction.
“The UAE has over $600 billion in foreign currency reserves and sovereign fund investment abroad. Now, this money will have to be put into use,” said Al Ghurair. “So I think the commitment is there to support the economy of the entire country.”
Al Ghurair, who is also CEO of MashreqBank, had a message to those who were not managing their bottom line, “If the cash flow is there, and if the track record is there, people will still lend you money.”
That will mark the biggest shift going forward, the effort to evaluate companies on their merits and future growth. As one well-known banker noted over coffee this past week, “Dubai cannot fail.” He believes that it would be a defeat not only for Brand Dubai but for the entire UAE. He, by the way, is putting money behind his words, seeing the near completed infrastructure of the emirate and the financial services sector as key reasons to go into the market now.
Another leading financier who also preferred not to be named said the support from the UAE Central Bank sent the right message. This is “not a charity.” The $10 billion purchase was done on commercial terms of 4 percent a year. It was being viewed as a lot of money (about one-fifth Dubai’s GDP) but “not too much money.”
In fact, Dubai finance officials say there is no rush to go to the market to raise the other half of the funds. With no strings attached, the government can allocate funds where needed in the short-term. At the same time, bankers say this will reduce the risk premium on future borrowing this autumn when additional payments come due.
Florence Eid of London-based Passport Capital was in Dubai when the new strategy was announced. “It is certain that the vote of confidence through the bailout package, the debt package is a very strong vote,” noted the economist. “But there is going to be a lag between this and the real economy.”
Eid is referring to the 25 percent drop in real estate prices already on the books. The head of the Dubai Real Estate Authority said that rents could drop by 40 percent by the end of 2009. Eid also noted that we should wait to see what happens at the end of the school year. If expatriates vote with their feet and leave, that will undermine the real economy.
Brand Dubai has been built on confidence and a dream. This applies to financial services, the airline sector, the giant Jebel Ali airport and most importantly the property market. Step by step UAE finance officials are trying to put fires out by providing liquidity to the federal system and so far to one key emirate. Everyone is keen to see if there will be future flare ups as the region and the globe attempt to navigate extremely rugged terrain.
The right conservative
A broad cabinet reshuffle, some surgical appointments, and a younger voice at the helm of the central bank mark some pretty sizable changes in the Kingdom of Saudi Arabia.
There has been a great deal said already about the message King Abdullah was trying to send with his biggest cabinet move since taking power in 2005. What may have been overlooked is how the pieces of the puzzle come together.
We know that a woman, specifically Nora Al-Fayez, will become deputy education minister. That would not mark huge changes in Brussels, the United Arab Emirates or Qatar, but it certainly does in Riyadh. Overlooked recently in this process is that plans to build a $10 billion co-education university under the management of Saudi Aramco (not the Education Ministry) is going full steam ahead.
At the same time, four senior cabinet ministers have been removed, and the long serving deputy of the Saudi Arabian Monetary Authority takes over as Governor. Muhammad Al Jasser is a western educated economist who has obtained his bachelors, masters and PhD in California.
“We now have somebody who is U.S. educated, and of a younger generation”, said Jane Kinninmont of the Economist Intelligence Unit, “He will be very good at putting forward the Saudi message internationally, in and beyond the region.”
The timing is not accidental. Beyond the demands of falling revenues from declining oil prices, Saudi Arabia is being called upon to play a larger role in the region and within the global economic community as it prepares for a single currency.
Back in November there were calls -- quickly rejected by the Kingdom -- to increase its contributions into the International Monetary Fund. The new Governor’s stance at the G20 meeting in London on April 2 this year will make for intriguing analysis. The position to date has been that Riyadh has done more than its fair share, but that may be in a drive to formally expand the G7 to the G20, with the Kingdom representing the Middle East.
The bottom line, in business terms, is that we should not expect a great deal of economic change from Saudi Arabia. I am calling it the right kind of conservative.
The Kingdom has remained loyal to the dollar, conservative on banking regulation and a conservative investor in relation to its foreign assets. Boring U.S. Treasury bonds were in -- taking a large stake in U.S. banks was not an option. As Kinninmont says, “Right at the moment they feel they have been vindicated with all these things.”
On the ground in Riyadh, long serving Chief Economist of SABB John Sfakianakis reaffirms that belief, "To the credit of the authorities, particularly the central bank, money has stayed and accumulated, it has not been lost unlike other countries in the region and outside."
According to one of the key architects of Saudi Arabia’s build out, Governor Amr Al Dabbagh of the Saudi Arabia General Investment Authority (SAGIA), the Kingdom will forge ahead with $400 billion dollars of spending over the next five years. That is a sizable sum considering a population of 28 million. When you land in the Kingdom you can see where it is being spent -- roads, airports, seaports, schools and four new economic cities, maybe growing to seven if the demand is there.
While there is a lot of discussion in the region and globally about retrenching during this downturn, Saudi Arabia (as well as Qatar) is using the wreckage to leverage lower prices for everything from cement to silicon. If you build while everyone else is not, the negotiating power is even greater.
Speaking of power, King Abdullah seems to be using his to streamline government operations and reduce bureaucracy. In the World Bank’s latest “Doing Business” survey the Kingdom ranked 16 out of 181 countries last year, however in the enforcing contracts category it was all the way down to 137.
“He (King Abdullah) is upping the ante as he sacks most of the key judicial leaders to get in new faces”, says Kinninmont, “This means there is pressure on the new guys to do something.” The courts and schools according to local and international observers have traditionally been the spheres of influence of the religious clerics.
This King seems to be a leader in a hurry. It explains the recent bi-lateral meetings with China to expand trade ties, record spending during a global recession and yes his biggest cabinet reshuffle to date.
Destruction in demand
"It is too easy to be pessimistic," is how one senior financial executive from the Gulf put it over dinner in London. My accountant from New York is taking negativity to the extreme, saying he has only invested in land, having no faith in financial instruments.
It is challenging at best to see the glass half full at this juncture. Even with stimulus packages being cobbled together, two key ingredients -- confidence and capital -- are clearly missing. As a result, this slowdown is spreading far and wide.
During an exclusive interview with Marketplace Middle East this week in London, the Secretary General of OPEC Abdalla Salem El-Badri pointed to the challenge ahead, "There is destruction in demand; there is no doubt about it."
The Secretary General says the worst case scenario is that demand drops by up to a half million barrels a day this year. The International Energy Agency is projecting consumption will drop by double that amount -- or a million barrels a day. If that is the case, daily demand will be below 85 million barrels a day, and holding onto $40 a barrel will be difficult.
El-Badri, as the great equalizer in the organization, is trying to prod producers inside the 12-member group and outside, amongst the key Non-OPEC players, to trim their sails. "We really need more from our member countries," says El-Badri, noting that 800,000-900,000 barrels still need to come off the market to hit the promised cuts of 4.2 million barrels a day, announced back in December.
Once those cuts are delivered, "if the market did not react, I think we have to balance the market,” said El-Badri. He pointed to the amount of stock, which today is floating on the sea or sitting in bunkers. "The stock at this time is about 57 days. This is five days above the 52 day average; if we want to take the five days out of the stock, then we have to cut more." That is as clear as it gets, whether the group that controls 40 percent of the world’s supplies is prepared to do more.
At this juncture, they are the only players doing so. The IEA still believes that non-OPEC production will go up by 400,000 barrels a day this year. OPEC is not keen to play the role of swing producer all the time or in this case of "swing reducer."
"I am taking this opportunity to ask Norway and Mexico to join us, because if the market collapses, it is not to the benefit of anybody," said El-Badri. This follows consultations with Russia’s President, Dmitry Medvedev, to do the same. This is a case where market share may override near term revenue shortfalls.
The International Monetary Fund, in a special regional report, notes that Middle East producers could see their revenues drop by $400 billion in 2009 due to demand destruction. The IMF urged oil producers to spend their way through the downturn so that the infrastructure build-out continues and confidence remains. The Fund sees regional growth at 3.6 percent this year, down from 6.3 percent in 2008. That is certainly not bad, and is a dream-like scenario compared to Europe or the United States right now.
The Secretary General, like many others, is hoping that the emergency actions taken today will mark the bottom of the cycle by mid-year, with the first hints of recovery by the close of 2009. I believe that is the best case scenario.
Lower interest rates, stimulus plans and tax cuts don’t do a whole lot if businesses cannot get access to capital. That is the quandary today. In the meantime, medium and long term planning and investments are being shelved.
"Because of demand destruction, and also because of financial problems, we are postponing about 35 of our projects from 150 projects, and I think that if this price continues, more projects will be delayed," said El-Badri. The reality is that no one seems willing to pony up more money if they don’t see revenues bouncing back to justify it. That is why there seems to be a building consensus to find what we have talked about on our programme, "The Goldilocks Scenario."
"I think that $40 will not permit us to invest to have a reasonable price where you can invest, where you can have another source of energy then from $70-$80 a barrel, is fair," said El-Badri.
There was a hint of disagreement within the Organization on this point. The President of the group Chakib Khelil thought that $40 was a "good price for the moment." Privately others said it is too painful for those desperate for revenues and probably counting on $60 or more.
As El-Badri noted we should be thinking a few years down the road, "There will be no additional capacity when the economy will pick up. Then you will not find additional capacity."
Crises have a tendency to force the hand of those who would otherwise ignore the positioning of the global economic jet stream which is blowing strong winds of change.
I had, what was intended to be, a slight detour on my way back from Davos via Geneva to London. Mother Nature extended my journey for a day, and as a result, I bumped into bankers and transport officials who saw our coverage from the World Economic Forum.
They asked bluntly, “What came out of Davos 2009?” The answer can be summed up as -- a high profile dust up between Turkey and Israel over Gaza, thanks to Prime Minister Recep Tayyip Erdogan walking out -- a couple of tough speeches from Vladimir Putin and Wen Jiabao who opened the meeting -- and towards the end of the gathering, some fresh oxygen that was pumped into the Group of 20, as leaders and delegates began to pack their bags high up in the Swiss Alps.
Before British Prime Minister Gordon Brown took the stage Friday, there seemed to be a lack of clarity in the efforts to bring 85 per cent of the global economy under one umbrella.
As one senior finance official – who asked to remain unnamed – put it on the sidelines of Davos, this decision to move forward is “well above the pay grade of the Ministers of Finance. This, John, is at the Heads of State level and requires clarity.” He asked me to take my own reality check, hinting that things cannot move that fast.
Shortly thereafter, I sounded out that discussion with Ricardo Hausmann, a leading economist from the John F. Kennedy School of Government at Harvard, who confirms there are active consultations taking place across the board.
U.S. President Barack Obama did not show up at Davos, nor did his two top finance officials, as planned, but no one was eager to jump before Washington signalled it was safe to do so. In sum, old habits, like getting U.S. support, die hard.
Hausmann made a solid point, while we flushed out the topic in the midst of hundreds of government officials and businessmen, “The G-20 jives well with the message of President Obama”. This is true. It is collective, equitable and disperses the burden of future challenges and decision making. At the same time, by its very nature of broader membership, it also dilutes power amongst those who are used to having it. Therein lays the problem.
The G-20 already exists. The fact that it does not need to be created from scratch makes the debate over membership less onerous. The gap between the haves and the have-nots, not the rich and poor, but rather the surplus and debtor countries has never been greater. So co-dependency is at its peak.
During a panel that specifically addressed global imbalances, Azman Mokhtar, Managing Director of Malaysia’s sovereign wealth fund Khazanah Nasional said, there is a danger that the world moves to the “lowest level of equilibrium”, meaning that we gravitate to lower standards of legislation, rush to print money, widen budget deficits and regret later that it could have been done differently.
Victor Halberstadt of Leiden University in the Netherlands said, the “sense of urgency to address global imbalances is not there.” Hausmann then made an illustrative point comparing the airline sector to the rolling crises every seven to ten years in the global economy. Anytime that there is a crash, the airline business dissects every bit of evidence to try and take the risk out of travel and rebuild confidence. In the financial sector it is literally every man for himself.
This is a bit worrying because of the trends that emerge during global downturns. For one, highly coveted foreign direct investment, that keeps the wheels of cross border transactions and trade well oiled, is expected to drop by up to 15 percent this year according to WAIPA, the World Association of Investment Promotion Agencies. That follows a record year for FDI of 1.8 trillion dollars. The Middle East saw its share of the pie grow to 43 billion dollars last year, a six fold increase from the year before. The last thing the region needs is for investment to dry up.
In the United Kingdom, we see workers protesting that British workers should get British jobs, and finally President Obama is rightly trying to strike “Buy American” legislation out of the bailout package.
The tendency to become protective of ones home turf is instinctual, but mistaken. In Davos, World Trade Organization Director General Pascal Lamy urged countries to pass the Doha Round to encourage more investment and lower trade barriers. I did not hear a lot of enthusiasm for that to be candid.
The reality is, no one wants to see the U.S. or other G7 countries stumble and fall. If they do, demand for hard goods from China and Japan and for oil from the Gulf and Russia will stumble as well. So, the surplus holders from the Gulf and China are likely to continue buying the debt to finance budget deficits from Washington to London.
But G7 countries should not bank on it. We know that countries from the Middle East to China have their own set of employment challenges to deal with. It is for this reason that Gordon Brown called for a “shared revolution” to bring countries under one roof in London in April. Let the power sharing begin, and hope that protectionism is put behind us.
ABOUT THIS BLOGJohn Defterios’ blog accompanies the weekly business program, Marketplace Middle East (MME) that is dedicated to the latest financial news from the Middle East. As MME anchor, John Defterios talks to the people in the know, finding out their opinions on the big business moves in the region, he provides his views via this weekly blog. We hope you will join the discussion around the issues raised.
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