gcc economic outlook 011209

8/7/2019 GCC Economic Outlook 011209

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Road to Recovery

2009-10 Outlook & Perspective 4

Country-Specifc Outlook

Kuwait: Building Blocks 20

Saudi Arabia: Catching Up 34

United Arab Emirates: Rebuilding Confdence 50

Qatar: Gas Fuelled Economy 62

Bahrain: Surviving the Undercurrents 74

Oman:Slow and Steady 81

ContentsContents


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GCC Economic Outlook

2008 Economic Indicators Forecast

Kuwait Saudi

Arabia

UAE Qatar Bahrain Oman

GDP growth % y-o-y 6.3 4.6 7.4 9.8 6.3 8.5CPI % y-o-y 11.3 9.9 12.0 15.1 3.5 12.4

Current account balance, % of GDP 40.8 37.2 8.0 14.1 10.3 9.13

Fiscal balance, % of GDP 29.3 32.7 23.0 10.6 6.0 1.2

Source: IMF, IIF, Central Banks, KFHR

2009 Economic Indicators Forecast

Kuwait SaudiArabia


GDP growth % y-o-y 1.0 1.5 1.5 9.0 2.5 3.5

CPI % y-o-y 6.0 5.0 2.0 1.5 2.2 3.3

Current account balance, % of GDP 20.9 5.0 1.0 7.8 3.0 -2.0

Fiscal balance, % of GDP 4.8 1.2 2.0 8.0 -1.0 4.0


2010 Economic Indicators ForecastKuwait Saudi

Arabia


GDP growth % y-o-y 2.0 3.0 3.0 10.5 4.0 6.5

CPI % y-o-y 6.5 7.0 3.5 3.5 3.0 3

Current account balance, % of GDP 22.9 10 6.0 12.0 5.7 1.5

Fiscal balance, % of GDP 29.3 32.7 12.3 10.0 3.0 12.0



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GCC Current Account Surplus

-100

102030405060708090

100110120130140150

2007 2008 2009F 2010F

USDb

ln

UAE Qatar Bahrain Kuwait Saudi Oman

Source: IMF, IIF, KFHR

Private sector credit stagnated, reecting both a reduction in the supply and the demand for credit given the uncertain

macroeconomic environment. Private credit growth could decelerate to less than 4% in 2009 from 30%in 2008.The factors

that have likely contributed to the marked deterioration in the bank credit were the sudden drying-up of foreign funds, sharpdecline in the growth of deposits and the decline in domestic asset prices have also put severe strains on the balance

sheets of banks that had both borrowed externally and were heavily exposed to real estate and equity markets. Particularly

notable were the decelerations in deposits in Bahrain, Qatar, and the United Arab Emirates, as well as reduced foreign

nancing in Kuwait. Inationary pressures have fallen largely due to weaker domestic demand, reduced housing rents, and

lower global commodity prices.

Private Sector Credit Growth as % of GDP

0

10

20

30

40

50

60

2007 2008E 2009F 2010F

%

UAE Qatar Bahrain Saudi Kuwait Oman

Source: IMF, IIF, KFHR

Drivers of Change in Credit Growth to Private Sector in GCC

Sources of Funds Alternative uses of Funds

Deposit

& other

liabilities

Credit from

Central bank

Net Foreign

Financing

Capital and

others

Net Claims on

the govt. Bank reserves

Bahrain -

Negligible

impact + + + -

Kuwait +

Negligible

impact -

Negligible

impact

Negligible

impact -

Qatar -

Negligible

impact + - - -

Saudi Arabia - + - - - +

U.A.E. - + - - - -

Source: IIF, IMF, KFHRNote: + sign indicates the given factor has accelerated,-sign indicates the given factor has decelerated


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The impact was manifested by steep falls in stock and real estate markets in addition to the sharp fall in oil prices. The

reversal of speculative wholesale funds linked to exchange rate speculation in mid-2008, combined with global deleveraging

later in the year, resulted in signicant liquidity pressures and higher funding cost. External funding of private sector projects

dried up since late 2008 (except for the gas sector in Qatar). Of an estimated USD2 tln of projects (both public and private)

in different stages of implementation as of end-2008, around 23% have now been placed on hold or cancelled. Weaker

demand for goods and services combined with the credit crunch has also adversely affected corporate sector protability.

Projects on Hold/Cancelled in GCC

Bahrain

15%

Oman

14%

Qatar

7%

Kuwait

15%Saudi Arabia

10%

UAE

39%

Source: Meed, KFHR

Government Measures Mitigated Crisis Impact

The impact of the crisis on the regional economies has been greatly mitigated by countercyclical government spending.

Drawing on substantial reserves built up prior to the crisis, governments responded with strong countercyclical policies,

which have helped contain the impact on the non-oil sectors of their economies: non-oil GDP has slowed, but still is

projected to grow at 3.5% in 2009. Looking ahead, higher oil prices, a revival of global demand and continued government

spending will provide the basis for stronger growth in 2010.

The GCC authorities have adopted extraordinary measures to ensure the normal functioning of nancial markets. These

have included deposit guarantees (Kuwait, Saudi Arabia, UAE), liquidity support to ensure orderly money markets, capital

injections (Kuwait, Qatar, UAE), equity purchases (Kuwait, Oman, Qatar),monetary easing, and scal stimulus to shore up

demand. Despite much lower revenues from oil, GCC countries maintained their expansionary scal policies. Saudi Arabia

passed a USD400bln scal stimulus package to be implemented over ve years. The increased spending on social sectors

and infrastructure is cushioning the downturn.

Policy Response to Global Financial Crisis

Financial Sector Macro Economics

Deposit

Guarantees

Liquidity

Support

Capital

Injections

Equity

Purchases

Monetary

Easing

Fiscal

StimulusBahrain Yes Yes

Kuwait Yes Yes Yes Yes Yes

Qatar Yes Yes Yes

Saudi Arabia Yes Yes Yes

U.A.E. Yes Yes Yes

Oman Yes Yes Yes

Source: IIF.IMF, KFHR

While policymakers in the region have taken a number of steps to boost government spending and liquidity in the economy,

these initiatives have helped only in limiting the impact of the downturn so far and not in driving economic growth. There

is a limit to the support that monetary and scal measures can provide to the GCC economies given the sharpdecline in both hydrocarbon and non-hydrocarbon output. Therefore the need of the hour is to push ahead with

liberalisation and reforms to kick start a sustainable growth process. In our view, to help realize these economies


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potential, public spending on infrastructure and social development will remain a key feature of economic policy.

Looking ahead, governments will need to begin designing strategies to unwind the exceptional liquidity support

provided to mitigate the impact of the crisis.

Key Policy Challenges

Near-term challenges

The ability to sustain the expansionary scal policy through 2010 and balancing the expected growth slowdown and

addressing nancial stress, while attending to the GCCs development needs

On the monetary side, the authorities need to remain alert to the possible need to support credit to the private sector

through unconventional measures, given that policy rates are now close to zero.

A thorough assessment of banks exposures to family-afliated conglomerates, together with establishing norms for

greater transparency, is needed.

To ensure level playing eld for all investors and creditors.

Policy challenges of a medium-term nature requiring priority attention include:

Further improvement in the regulatory and supervisory frameworks of banks, nonbank nancial institutions and

wholesale banks. Enhancement of transparency and governance of the nonnancial corporate sector.

Raise the productivity of the non-hydrocarbons sector by implementing additional structural reforms to improve

competitiveness and boost the regions resilience to shocks. This is particularly important given the vulnerability to

uctuating oil prices.

Gcc Economic Recovery Taking Hold

The world economy now appears to be entering into a new phase, moving from a period of containing the crisis to one of

economic recovery. Over the course of this year, nancial markets have stabilized and the outlook for the world economy

has greatly improved. As a result of the improving economic conditions IMF has recently revised its global economic

outlook and expects the recovery of the global economy in 2010 to remain sluggish, particularly in advanced economies,

as nancial systems remain impaired and households will rebuild savings. Tight lending standards are likely to last through

mid-2010. Despite recent signs of the onset of recovery in many parts of the world, the IMF expects the global economy to

contract by -1.1% in 2009. By later this year, the combination of easing monetary and expansionary scal policies should

begin to yield some results, and the forecast remains for a return to modest global growth of 3.1%in 2010.

GCC vs. World GDP Growth Rates (2007-2010F)

%

0

-2

2

4

6

8

10

2007

GCC World

2008E 2009F 2010F

Source: IMF, KFHR


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Oil Price Recovery

The economic and business outlook in the GCC has improved considerably since the second quarter. Despite the troubles

of 4Q08 and 1Q09, fortunes seem to be reviving for GCC economies as the renewed sentiment that the global economy is

stabilizing, rather than returning to strong growth has helped reinforce the oil market in recent months. The oil prices have

rebounded from their USD35-40p.b rst quarter lows to hold at around USD65-70p.b in Oct09 driven mainly by improved

market perceptions of the state of the global economy and sustained OPEC compliance with production cuts. Market

sentiment improved signicantly in early October following an upward revision by the IMF to world economic growth for

2010 and projected increase in demand for the latter part of 2009 and 2010. A sharp depreciation of the US dollar against

other major currencies and crude stock draws also underpinned persisting market sentiment and lifted crude prices.

Stronger oil prices and an easing of the global nancial crisis, have improved economic prospects in the GCC for the second

half of the year. Although production levels remain constrained by OPEC quotas, higher oil prices will provide a welcome

boost to GCC nances. This will help fund government scal stimulus efforts, nancial support to banks and state owned-

corporate sectors, while bolstering scal and external balances. Increasing oil revenues have also boosted condence, and

helped buoy external market perceptions of the GCC which has facilitated improved - albeit still restricted - access to capital

markets. In addition, decisive and broadly effective government support to businesses boosted condence and removed

some of the gloom in debt markets. However, 2009 will still be a year of retrenchment and contraction.

Real GDP growth will be stagnant, as credit growth slows sharply, private investment slumps, and oil production declines.

We, thus maintain our cautious stance to medium-term growth prospects in the GCC region. Despite the announced

scal stimulus packages in some GCC countries, in our view growth in the Gulf economies are expected to slow

in 2009 to 3% (IMF Est: 0.7% in 2009), shrinking by approximately 15% in nominal terms. However, our baseline

projection for 2010 for the GCC assumes modest global recovery or a growth of 4.5%, backed by an average oil

price of USD75p.b, and that the impact of the troubled family-afliated conglomerates on banks is contained.

Although, active central bank intervention has bolstered money market liquidity which in turn has fuelled a renewed equity

market rally, however our outlook towards real estate sector still remains grim and state spending will continue to support

the non-oil sector, but economic activity will be held back by the weakness in the world economy and trade. The economic

recovery in the GCC region also depends a great deal on the revival of economic activity in the industrialized and emergingnations, not least because of the impact their prospects will have on the all-important oil price.

GCC Real GDP Growth Rate

0

5

10

15

2007 2008 2009F 2010F

%


Source: Central Banks, IIF, IMF, KFHR

There are downside risks to the baseline scenario. The sustainability of a global economic recovery remains the key risk to

the oil price outlook despite a pronounced recovery from the lows in 4Q08. In September 2009 sharp movements in energy

prices have taken place in response to revised assumptions about market fundamentals as well as uctuations in the value

of US Dollar. Improving global economic conditions in 2Q09 have not been sufcient to assuage concerns regarding the

durability of this revival. Indeed, deteriorating government balance sheets in the US, UK and Japan call into question the

sustainability of government stimulus against the background of still fragile fundamentals. Moreover, consumption, the

mainstay of Western economies, is also likely to experience a period of cyclical and structural weakness with uncertaintiespersisting regarding rising unemployment and recovery in house prices has resulted in sharp movements in energy prices.


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The use of crude oil as a hedge against uctuations in the US Dollar has been another factor behind the volatility in oil this

year. This marks a return to the pattern last observed in 2008 when the depreciating greenback was one of the chief drivers

of record high oil prices. In our view, oil prices are expected to average around USD60p.b in 2009 and would continue to

rise at a moderate pace over the medium term, rising to USD75p.b in 2010 with the weak pace of global GDP growth and

ample spare capacity precluding a rapid rise in oil prices.

A prolonged global slowdown or a double-dip recession could slow non-hydrocarbons growth further by reducing the scope

for government scal stimulus through much lower oil revenues. Also, consumer and investor condence could weaken

further. Continued weak demand and tighter nancial conditions could lead to an increase in corporate distress that could

feed back into banks in the region. Beyond the short-term, the fear is that many expatriates who left the UAE, Qatar, and

Kuwait will not return before the end of this year. The sharp slowdown in credit growth may expose problem loans that

have been masked by the generally favourable economic conditions in the region. Any further worsening of asset prices

could lead to a deterioration of banks balance sheets, leading to a further reduction in credit, impacting on overall growth.

However, we believe governments in the region have the capacity and have shown willingness to act to mitigate the impact

of any emerging nancial sector stress.

Considering the faster-than-expected turnaround in oil prices, which are likely to average USD60 p.b in 2009 and USD75 p.b in 2010, the prospects for a sustained recovery are indeed becoming brighter, even if they remain vulnerable to

swings in sentiment elsewhere. The current account and scal surpluses will remain sizable. The current account surplus is

expected to shrink from USD245bln in 2008 to USD47bln in 2009, and then recover to USD80.2bln in 2010. Foreign assets

of the GCC will increase to USD1.55 tln by end-2010 (excluding asset valuation changes). The scal situation for 2009

already looks much stronger than estimates suggested during the beginning of the year. The countercyclical scal policy

pursued in several GCC countries in response to the crisis is expected to be maintained (especially in Saudi Arabia and the

United Arab Emirates), with a focus on large public investment projects. For GCC, scal surpluses are projected to decline

in 2009, and then recover in 2010. Given the uncertainty regarding the pace of global recovery and in light of the anticipated

increase in oil prices, continued spending in 2010 is both warranted and feasible in countries with ample scal space.

Current Account Surplus as % of GDP

-10

0

10

20

30

40

50

2007 2008 2009F 2010F

%


Source: IMF, KFHR

Despite the increase in counter-cyclical spending by Saudi Arabia, the Kingdom might end the year with a marginal budget

surplus of around 1.5% of GDP, in stark contrast to the IMF forecast of 4.7% decit. Qatar, Kuwait and the UAE, which

have budget break-even oil prices of lower than USD 50 p.b are also set to post surpluses. The least hydrocarbon-sensitive

economies in the GCC, Bahrain and Oman, will likely post the highest decits, which will be met with accumulated reserves

and new debt issuances.


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GCC Fiscal Surplus % of GDP

-10

0

10

20

30

40

2007 2008 2009F 2010F

%


Source: IMF, KFHR

Ination in the GCC is expected to decline to 3% this year before rising slightly to 4% in 2010. Cost-push pressures from

a more-than-expected weakening of the dollar against major currencies over the next few months, and a modest recovery

in nonfuel commodity prices would add limited inationary pressures next year. Weak domestic demand, the correction in

housing-related prices, and the fall in global commodity prices have brought down the 12-month ination rate from over

13% in July 2008 to 3% in July 2009. Continued slack in the GCC economies will dampen domestically driven ination

pressures in 2010.

Consumer prices in the GCC are on a downtrend, primarily because of the deep correction in housing markets, weaker

global food prices and the strengthening in the US Dollar. This will likely support private consumption demand and also

bodes well for the external competitiveness of the region. Besides, the absence of price pressures will enable policy-

makers to maintain an expansionary monetary and scal policy environment, critical for the economic revival.

GCC Ination Trend

0

2

4

6

8

10

12

14

16

2007 2008 2009F 2010F

%


Source: IMF, KFHR

Ination in them UAE stood at 3.4%y-o-y (0.03%y-o-y in June09) in 1H-09, after averaging 12.3%y-o-y during 2008.The

decline has been even sharper in Qatar, where consumer prices dipped to -2.9% y-o-y in 2Q-09, down from 13.2%y-o-y

in 4Q-08. In Saudi Arabia, ination fell from a peak of 11.1% y-o-y in July 2008 to about 4.1% y-o-y in August 2009.Saudi

Arabia and Kuwait are likely to experience further disination, but end the year with positive ination gures. Rental price

in the two economies are still rising on a year-on-year basis, but at a subdued rate.

The UAE and Qatar are likely to experience a period of deation in the coming months due to a fall in housing prices.

However, we do not forecast to see a sustained deationary environment developing or a deation spiral. While we are

expecting to see deation in both Qatar and the UAE, the economic realities on the ground are diametrically opposite. Qatar

will continue to see solid non-oil economic activity, while the UAE is seeing a structural correction. In Qatar, the fall in the

rental prices are mostly due to a marked increase in housing supply entering the market in 2009. In the UAE, it will be a

result of both the correction in the property sector along with the increased supply in housing. Both Saudi Arabia and Kuwait

are likely to see positive ination rates, although slowing sharply, with rental price growth decelerating and not contracting.


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Again, Saudi Arabia and Kuwait have different economic outlooks with Kuwait forecast to see a contraction in non-oil GDP

growth, while Saudi Arabia continues to have a solid outlook supported by government spending.

Credit Default Swap (CDS) suggest that signs of recovery and stability started shadowing over the GCC region. This

optimism was backed by rising commodity prices such as Gold & Oil in addition to recent activities in xed income markets

(large number of sovereign bonds issued globally). Credit default swap (CDS) spreads on sovereign debt which widened in

the region in the rst half of the year, largely on account of local factors. Higher risk premium were recorded for Dubai and

Bahrain. Dubais CDS spreads widened to around 900 basis points (bps) in March 2009, but have since declined to 305 bps

and 96bps in Abu Dhabi in Oct09 on the strength of the federations support. Further, while Bahrain CDS stood at 175 bsp,

Qatar recorded 85 bsp, a level lower than emerging markets CDS which ranges from 100 bsp to 137 bsp. In general, the

GCCs CDS spreads are lower than the average for emerging economies. International market perceptions of the GCCs

CDS spreads narrowed in recent months, indicating signs of recovery from the impact of the global nancial crisis and in

line with modest recovery in oil prices.

GCC Capital Markets -Improved Investor Sentiment

GCC Equities Performance 3Q 2009GCC Indices Performance

Closing Value Performance

Q209 Q309 Q-o-Q% YTD%

Kuwait SE (Kuwait) 8080.3 7817.3 -3.3 0.4

Tadawul (Saudi) 5596.46 6322.04 13.0 31.63

DFM GI (UAE) 1784.45 2191.03 22.8 33.90

ADX GI (UAE) 2631.32 3124.22 18.7 30.72

DSM 20(Qatar) 6491.65 7414.25 14.2 7.67

BHSE All Share (Bahrain) 1581.67 1554.51 -1.7 -13.83

MSM 30 Index 5612.21 6572.25 17.1 20.79

Source: Various Stock Exchange,KFHR

Gulf markets ended the 3Q 2009 sustaining a rally that began in March. A surge in risk appetite, coupled with a rebound

in oil prices and the rally in international markets restored investors condence. Moreover, news of an expected global

economic recovery also boosted condence in the international and regional equities. Dubais benchmark index emerged

as the best performing market during the rst 9 months of 2009 posting YTD gains of 33.9% despite the slump in the real

estate market. Despite the troubles in family owned groups such as the Saad and Al Gosaibi, Saudi Arabias TASI came

in second with gains of 31.63% during the same period. The Saudi benchmark index has suffered the lowest losses of

15.2% in the region since the nancial crisis hit the GCC between 4Q 2008 and 3Q 2009. This may be attributed to the

governments efforts to promote the manufacturing sector in order to diversify its economy. However, the kingdom still

remains heavily reliant on oil revenues but to a lesser extent than most of the other GCC countries. ADX bagged the third

position with gains of 30.72% followed by Omans MSM and Qatar with gains of 15.14% and 7.67% respectively. Qatars

strong economic background and the governments support to the banking sector kept the sentiment positive. Kuwaitsbenchmark index almost ended at with marginal gains of 0.45%. The troubled investment companies remain an issue

in Kuwait, however, the banking rescue bill, which was approved in April, has improved the market sentiment. Bahrains

BHSE was the only regional index to end the rst nine months of 2009 with losses of 13.83% as the bourse is heavily

weighted towards the nancial sector.


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GCC Equity Market Indices Performance YTD (3Q 2009)

-20

-10

0

10

20

30

40

Saudi

Arabia(TASI)

UAE

(DFM)

UAE

(ADX)

Kuwait

(KWSE)

Qatar

(DSM)

Bahrain

(BHSE)

Oman

(MSM)

%

Source: Various Stock Exchanges, KFHR

On a quarter on quarter basis, DFM was the best performer among GCC markets with gains of 22.78% on the back of

renewed foreign institutional buying. ADX followed suit and bagged the second place with gains of 18.73% closely followed

by Omans MSM with gains of 17.11%. Qatar and Saudi index posted gains of 14.21% and 12.96% respectively. Meanwhile,

Bahrain and Kuwait benchmark indices were the only GCC markets to incur losses of 1.72% and 3.25% respectively on a

quarter on quarter basis. On the liquidity front, the average daily traded value in 3Q 2009 was slightly lower as the trading

activity remained subdued due to the holy month of Ramadan and subsequent holidays.

GCC: Equities Returns and Liquidity Analysis (3Q 2009 vs. 2Q 2009)

TASI

DFM

ADX

KSE

QE

BHSE

MSM

-5

0

5

10

15

20

25

0 0.2 0.4 0.6 0.8 1 1.2 1.4

Liquidity Ratio

Returns%

Q-o-Q

Series1

Source: Zawya, KFHR

Chart Analysis: The above chart depicts the 3Q 2009 performance (on a Q-o-Q basis) of GCC equities on y-axis and the Periods Liquidity Ratio

(PLR) on the x-axis. The PLR is the average daily traded value in 3Q 2009 divided by the average daily traded value in 2Q 2009. The gure exhibits

that all GCC markets (except Bahrains BHSE and Kuwaits KSE) posted positive returns in 3Q 2009 but their liquidity was slightly lower than the

average of 2Q 2009.

Volatility indices of the GCC equity markets have returned to their pre-September 2008 levels, with markets showing

evidence of stabilisation and investors re-entering the market. GCC equities are expected to take their positive performance

into the nal quarter of 2009, although at a slow pace. All GCC stock are currently undervalued while the DJIA, Eurostoxx

50 and FTSE are all viewed as overvalued.


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GCC: Equities Volatility (2Q 2008-3Q 2009)

0

20

40

60

80

Saudi

Arabia

(TASI)

UAE (DFM)UAE (ADX) Kuwait

(KSE)

Qatar

(QE/DSM)

Bahrain

(BHSE)

Oman

(MSM)

%

1Q 2008 2Q 2008 3Q 2008 4Q 2008 1Q 2009 2Q 2009 3Q 2009

Source: Zawya, KFHR

Nevertheless, the regional markets still remain reliant on movements in international markets and economic indicators

both regional and international. The stability of the international nancial markets and the global economic recovery will

translate into higher energy demand which will have a positive impact on GCC stocks. Going forward into the fourth quarter,

the nancial markets in the GCC region should be able to continue its positive performance, but at a lesser degree. The

stability of the international nancial markets and the recovery of world economy will result directly in improving energy

demand, and this will be reected on GCC stock markets. However, any discouraging economic news or fall in oil prices

will adversely impact the GCC equities, going forward. The exposure of regional banks to troubled Saad and Al Goasaibi

groups also remains a concern.

Consumer Sentiment ImprovingDespite the weakness in asset classes such as real estate and equities, consumer sentiment in the GCC has been

improving. There is increasing perception among individuals in the region that the worst of the current crisis has passed.

The slowing in the pace of the fall in real estate prices, for example, and reviving energy markets will contribute positively

to consumer sentiment. The most poignant example of this revival is in the UAE where a sizeable number of consumersexpect the economy to emerge from current market corrections by the middle of 2010. The UAE ranks as the seventh most

optimistic country in the world in the second quarter of 2009, according to a Nielsen Global Consumer Condence Survey

conducted in June09. In the UAE, 34% of consumers rate job security as a top concern (36% in March09), followed by the

state of the economy at 17% (previously 23%).The survey indicates a 13% increase in consumer condence in June 2009,

compared with a previous survey in March09 when it reached record lows.

Consumer Condence Reviving in GCC

0

20

40

60

80

100

120

July'07 Oct'07 Jan'08 May'08 Jul'08 Nov'08 Feb'09 May'09 Aug'09

Kuwait Qatar Saudi Arabia UAE

Source: Bayt, KFHR

Despite this new evidence of optimism in the GCC, the global and regional economic malaise is likely to continue to

overshadow spending habits of individuals, thereby ruling out a sharp revival. Retail sales, for example, remain weak. This

is evident from point-of-sale transactions data, a close proxy to retail sales. In Saudi Arabia, transactions fell 0.9% y-o-y

in July this year, though this was a sharp improvement on the 11.7% fall recorded in June. This was the third consecutive


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month of decline in sales. However, August growth could have turned positive as economic and business outlook improved

in the Kingdom and the high base effect of June and July toned down. Other countries in the region also seem to be

suffering from a slump in retail sales. Kuwait saw a mere 4.8% y-o-y rise in sales in 2Q-09 versus 15.7% in 2008.

Although, consumption suffered as a result of dwindling expatriate population and incomes, it is expected to resume once

the recovery begins a positive externality of labour market exibility. With the deleveraging process in the Gulf likely to

be over sooner than in advanced economies, and with oil prices stabilizing around the USD75 p.b level, global funds in the

form of syndicated loans and institutional and direct investments may return to the region, albeit more cautiously than in

the past.

Risks To The Recovery

Doubts persist over the sustainability of the global economic recovery, which remains fragile and subject to at least

temporary reversals. Oil price are rising on the recent positive momentum and are not entirely supported by fundamentals

either in the economy or in the oil market itself. Moreover, what is expected in the GCC, is not a rebound but a lesser

normal contraction than previously expected. Real GDP in the region is primarily determined by oil output, which is limited

by OPEC quotas. No positive surprises in real GDP are expected as all GCC countries are expected to comply with the

quotas in the coming year.

Another risk, at least in the short term, to the regions prospects is linked to the troubles of the Saad and Al Gosaibi

family groups. Concerns inspired by it have clearly held back bank lending to the private sector and delayed any recovery

that otherwise might have materialized. Together the conglomerates are tentatively estimated to owe a host of Saudi

and international banks as much as USD20bln. The companies debt restructuring talks have been complicated by the

allegations of foul play. Legal proceedings, which look set to increase in complexity, could now take many years to work

through and resolve. Fears that the incident is merely representative of broader problems may return to dent investor

condence in the GCC region.

The continued woes in the real estate sector in Dubai and issues with nancial sector in Kuwait will likely hamper their

economic recoveries. Similarly, the Bahraini government requires oil prices to average USD75 p.b to balance its budget.

Given its limited reserves and high dependence on the oil sector for government revenues, no GCC country is more

vulnerable to oil price sensitivity than Bahrain. In such a scenario, economic activity is unlikely to bounce back rapidly on

the basis of scal and monetary push provided by the government.

Nonetheless, inherent fundamental strengths such as a young growing population that provides huge customer base to

increase domestic consumption, low debt-to-GDP ratios, and years of accumulated surplus, will ensure that the region is

among the rst to come out of the recessionary spell. In addition, the recent revival in oil prices to around USD70-75 p.b has

improved local sentiment which will play a key role in improving the regions economic dynamics in the coming quarters.

The introduction of a single currency for the region, planned for 2010, is expected to be delayed. Progress has been made

in regional economic integration. The GCC economies have largely unrestricted intraregional mobility of goods, labour, and

capital. Key convergence criteria for establishing the monetary union have been largely achieved. However, little progresshas been made in putting the institutional arrangements in place for a functioning single currency (including harmonization

of statistics, and the development of an efcient payments system). While four of the six GCC countries except Oman and

the UAE have signed the Monetary Union agreement, the option is open for these two countries to join at a later stage.

Financial Sector Concerns Looms

Central banks in the region have also been proactive during the crisis. When money markets dried up in 4Q-08, leading to

sharp rises in interbank offered rates, the central banks stepped in by cutting policy rates and offering discount windows

to banks. Some countries also ploughed back reserves from their SWFs into the local economy. In Qatar, for example,

the Qatar Investment Authority (QIA) bought stakes (10-20%) in local banks. Deposit guarantees were also offered in a

number of countries (KSA, Kuwait, UAE and Bahrain). As a result of a host of such measures, short term money market

liquidity eased, reected by reduction in interbank offered rates from their highs of 4Q-08.These policy actions are aimedat restoring condence, stabilizing the banking system, and supporting demand to avoid an adverse downward spiral. A

key issue is the interaction of policies, with the effectiveness of monetary and scal policies dependent on a restoration of


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Selected Indicators for GCC Islamic Banks and the Banking System

Saudi Arabia Kuwait UAE Bahrain Qatar

Islamic All Islamic All Islamic All Islamic All Islamic All

Capital Adequacy

Ratio

22.1 16.0 21.7 16.0 12.8 13.3 24.5 18.1 17.9 15.6

Change in

Protability(1H09-

1H08)

2.9 -11.9 -71.9 -65.3 -34.2 -19.5 -46.5 -33.7 0.0 5.1

Return on Assets 3.7 2.1 1.6 3.2 1.7 2.2 2.6 1.3 6.6 2.6

Exposure to Real

Estate as % of total

loans*

5.6 7.3 22.1 31.4 25.7 12.9 11.3 26.2 38.3 18.4

Source: National Authorities, Zawya, IMF, KFHR

Note: The analysis for Saudi Islamic banks does not include Islamic windows in conventional banks

*: It is not clear from the published data whether exposures to real estate and construction include household mortgages. Exception is Islamic

bank data for Qatar, where it is clear that household mortgages are included, and banking sector data for Kuwait, which do not include

household mortgages. This renders the comparability of exposures difcult.

Credit to the private sector broadly stagnated from end-November 2008 to end-August 2009. Until the real

estate sector and investment companies show improved operating environments, credit risk concerns are likely to

weigh negatively on many banks nancial proles over the months ahead. A number of factors contributed to the

sluggish private sector lending in the rst eight months of 2009. First, banks were cautious about corporate growth prospects

in an environment of weak domestic demand. Second, the global nancial crisis has generally encouraged most banks

around the world to refocus on risk management. Third, new private sector projects coming to the market dwindled this

year, as a number of projects were put on hold or cancelled.

Private Sector Credit Growth as % of GDP

0

10

20

30

40

50

60

2007 2008E 2009F 2010F

%

UAE Qatar Bahrain Saudi Kuwait Oman

Source: IIF, KFHR

In the second half of this year we expect several major banks in the region to show further prot declines or even some

losses following the recent increase in provisions against growing level of NPLs. Several banks in the region with loan-to-

deposit ratios exceeding 100 have had to deleverage to protect their capital base and meet central banks guidelines. This

has already curtailed banks capacity to expand credit.

Loan-to-Deposit Ratio

2006 2007 2008 June'09

Bahrain 0.82 0.81 0.97 0.95

Kuwait 1 1.1 1.13 1

Oman 1.13 1.06 1.22 1.25

Qatar 0.76 0.81 0.97 1.1

UAE 1.11 1.09 1.37 1.2Saudi 0.81 0.81 0.87 0.79

Source: IIF, KFHR


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Financial soundness indicators constructed from aggregate country data suggest that GCC banks remain solvent and

protable with system-wide capital and liquidity cushions that are helping them weather nancial turmoil . This is largely

due to solid economic performance over recent years, that helped strengthen balance sheets, stronger regulation (Saudi

Arabia and Oman), and high government participation in banks (UAE). While banks remained protable in the rst half of

2009, consolidated net prots have fallen notably in stark contrast to the strong growth in prots over recent years. The ratio

of nonperforming loans (NPLs) to total loans remains below 4 percent.

Selected Banking Soundness Indicators-2008

0

20

40

60

80

100

120

140

160

NPLs CapitalAdequacy

ProvisioningRatio

Return onEquity

%

Saudi Arabia UAE Kuwait Qatar Om an Bahrain

Source: IIF, IMF, KFHR

There has been a pronounced rise in provisioning and bad assets in the regional banking sector. In 2Q-09, the provisions of

the ve leading UAE banks (Emirates NBD, NBAD, Abu Dhabi Commercial Bank, First Gulf Bank and Union National Bank)

which account for 65-70% of the aggregate loan book, increased by 86% over 1Q-09. Saudi banks were no exception and

their provisions for bad loans increased 70% q-o-q to SAR1.5bln in 2Q-09. Further, one-off factors such as the defaults by

Al Gosaibi and Saad Groups of companies pushed up bank losses and delayed the recovery process by casting a cloud on

all banking activity in the country. Concerns have been further fuelled by the reluctance of banks to disclose their exposures

to the two groups, something that for instance no Saudi bank has yet done. This has once again increased risk aversionand loans to the private sector have all but dried up. Additional anxiety has been caused by worries that other family groups

might run into similar difculties.

Although reassuring, nancial soundness indicators have limitations, including that they often are backward looking. In

addition, system data can mask the deterioration in nancial conditions of individual banks. Overexposure to real estate and

highly leveraged companies has eroded asset quality. Uncertainty over the true state of balance sheets, especially in light

of revealed exposures of two large Saudi conglomerates compounded by inadequate transparency, will likely persist over

coming months, restraining bank funding and credit growth, although we judge the risks to be manageable.

The crisis has revealed some vulnerability in the regions nancial sector: weak risk management systems and overleveraged

institutions. Measures to strengthen nancial regulation and supervision already being instituted in some countries

will remain crucial for safeguarding the nancial system against future shocks. In the medium term, nancial market

development including diversication beyond a bank-based system will remain a priority, as will efforts to improve the

business climate to support economic diversication and generate employment.

Signicant progress in prudential regulation and banking supervision has been made in the region, but there is still scope

for further improvement. More robust management systems, close monitoring of high-frequency data and early warning

systems are needed to detect and correct problems that could become systemic. The importance of this issue stems

from the lack of transparency against the backdrop of the prevalence of large family-afliated conglomerates, offshore

and regional banking. This requires enlarging the information set available to supervisors, including off-balance-sheet

operations of banks, household indebtedness, real estate prices, and gathering information on the health of corporates.

Besides regular on-site inspections, stress tests can provide early warning signals.


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Financial Regulations in GCC

UAE Saudi Arabia Qatar Kuwait Bahrain

Lending

Lending to the

public sector


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UAE Saudi Arabia Qatar Kuwait Bahrain

Capital

Adequacy

Total capital/ total

risk asset ratio >10%

Minimum capital

adequacy ratio

required is 10%

Minimum capital

adequacy ratio

required is 10%

Minimum capital

adequacy ratio

required is 12%

Minimum capital

adequacy ratio

required is 12%Tier 1 ratio >6%;

Tier 2 ratio < 67%

of tier 1

Reserve

Req.

The reserve

requirement is 14%

on current, savings

and call accounts,

and 1% on time

deposits

The reserve

requirement is 2%

in savings and time

deposits and 7%

on current account

deposits

The reserve

requirement is

3.75% of deposits

The reserve

requirement is 5%

of deposits

Ownership

Individual

shareholder may

not hold >20% of

the banks shares

(amt exceeding

that requires prior

approval

Securities

Securities (govt.

securities exempt)


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Saudi ArabiaCatching Up

Although the Saudi economy was well positioned to whether the extreme economic and nancial conditions due to its

petrodollar wealth accumulated over the years and limited exposure to global nancial markets, the plummeting of oil

prices from record highs of USD147pb and the volatility in the stock markets were bound to have serious implication on the

Kingdoms economic growth. After registering a stellar average growth rate of 5% between 2003 and 2007, Saudi Arabia

could not remain insulated from the global nancial turmoil contagion woes.

Real GDP growth is estimated to fall to 1.5% in 2009 from 4.5% in 2008 which was largely driven by strong private and

public investment expenditure on the back of record oil prices and abundant liquidity. However, despite being less affected

by the nancial crisis, the indirect impact on the kingdoms real economy has been signicant. Substantially lower oil price

from the 2008 peak is shrinking the main source of government revenue. Weaker global demand for oil has motivated

drastic OPEC production cuts and tighter credit and investor risk aversion in international markets have led to a shortage

of foreign capital, a massive decline in local asset prices and lower investment in the kingdom.

Nevertheless, as we approach 2010 with an expected recovery in global demand conditions and a higher oil production

level, Saudi Arabias real GDP growth rate is forecast to increase to 3% in 2010. The Saudi stock market has recovered

considerably recording YTD gains of 31.63% (as at the end of 3Q09) and may suggest that the conditions for planned IPOs

and sukuk issues are improving and oil prices are steadying in the range of USD65-70pb. Saudi Arabia accounted for 48%

of the proceeds and 8 out of the 13 issues till the end of the 3Q09.

Saudi Arabia: Real GDP Growth Rate (2004-2010F)

0

1

2

3

4

5

6

2004 2005 2006 2007 2008E 2009F 2010F

%

Source: SAMA, KFHR

We believe Saudi government spending and investment will keep growth positive in both 2009 and 2010 with the average

oil price forecast of USD60pb for 2009 and USD75pb for 2010. As far as private-sector growth is concerned, much will

depend on bank lending which has been affected due to risk aversion in the wake of the Saad and Al Gosaibi crisis. The

struggle of the private sector to get nancing and stay aoat might have adverse effects on the labour market which is

already suffering from asymmetries created by the wealthy public sector.

A positive fall out from the global crisis has been easing of ination in the kingdom. After climbing to one of its highest levels

of 9.9% in 2008 the average annual ination in the kingdom is expected to recede to 5% in 2009 due to the easing of the

rate of increase for rent and food prices.

Sitting atop 25% of the worlds oil, Saudi Arabia is the worlds leading oil producer and exporter. Oil accounts for approximately

85% of its revenues and more than 90% of the countrys exports. The kingdoms oil sector ended a ve-year booming era,

with oil prices slashed by half and output as a result of OPECs lower quotas for the last quarter of 2008 and early 2009.

Saudi Arabia pumped an average 9.2mln bpd in 2008 but supplies are projected to dive to only 8mln bpd year in line withOPECs reductions.


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Saudi Arabia: Contribution to GDP

Oil Revenues

85%

Non Oil

Revenues

15%

Oil Revenues Non Oil Revenues

Source: SAMA, KFHR

The external sector in 2008 witnessed its most favourable historical performances, benetting from the oil bonanza during

the rst three quarters of the year. However, in the nal quarter of 2008 the sector was hit hard by the nancial turmoil and

slump in oil demand and prices. In terms of foreign trade, 2008 recorded a current account surplus of USD139bln and trade

surplus of USD212.3bln respectively. Imports amounted to USD100.6bln in 2008, rising by 23.5% y-o-y. The growth was

due to increase in industrial imports that make up more than half of total imports, with the Kingdom rmly heading towardsa non oil economic expansion led by construction, infrastructure development and manufacturing activity. Meanwhile, total

exports amounted to USD313.3bln in 2008, up 34.4% from 2007. The increase in exports was mainly due to a 36.9% yearly

surge in oil exports. However, in 2009 we estimate current account balance to drop drastically to approximately USD16bln

due to a sharp decline in oil prices from the highs of 2008 while the trade balance will reduce to USD100bln.

Saudi Arabia: Current Account Balance (2004-2010F)

0

50

100

150

2004 2005 2006 2007 2008E 2009F 2010F

USDb

ln

0

10

20

30

40

%

Current Account Balance % of GDP

Source: SAMA, KFHR

Saudi Arabia: Trade Balance (2004-2010F)

0

50

100

150

200

250

300

350

2005 2006 2007 2008E 2009F 2010F

USDb

ln

0

50

100

150

200

250

USDb

ln

Export Import Surplus

Source: SAMA, KFHR

The Saudi government remains committed to increasing spending and providing the much needed boost to domestic

demand despite the projected decline in oil revenues. Equipped with its massive overseas assets built up during the oil

boom of 2002-2008, Saudi Arabia approved a record high budget for 2009 to mitigate the impact of lower crude output


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and prices on its economy. The government budgeted USD126.67bln for total expenditure in 2009, out of which USD60bln

was allocated to capital expenditure. The budget prioritises capital spending in key areas, such as education, healthcare

and infrastructure, which is consistent with the governments objectives to create job opportunities and support economic

growth and development in the medium-term.

Saudi Arabia: Fiscal Balance (2004-2010F)

0

100

200

300

400

2004 2005 2006 2007 2008 2009P

USDb

ln

-50

0

50

100

150

200

USDb

ln

Revenue Expenditure Surplus/Deficit

Source: SAMA, KFHR

2008 proved an unprecedented bumper year for Saudi scal policy, highlighting the Kingdoms position as a key beneciary

of the global imbalances of recent years. Revenue for the year stood at USD293.33bln while expenditure was estimated to

be USD136bln. This left a surplus of USD157.33bln (32.5% of GDP). However, in 2009 the Saudi budget is set to plunge

into decit, in the nance ministrys own estimation. The government estimates a decit of USD17bln which is likely to push

up debt (which is all domestic) unless the government opts to utilise its sovereign wealth fund assets, which is an open

possibility and in that case the balance may not even show up as a decit. It is also worth mentioning that Saudi Arabia like

other Arab oil-producing countries has traditionally presented conservative government budget estimates based on lower

oil prices.

Although the Kingdom forecasts 2009 budgeted decit of USD17bln, the expenditure for the year shows a marginal decline

of 7% as against 2008. Under normal circumstances such a drastic drop in revenues would necessitate a similar reduction

in spending. However, despite the decline in oil price since record highs of 2008, the Saudi Arabias 2009 budget indicates

the Kingdoms continued commitment to focus on optimising the use of available resources and giving priority to projects

that ensure sustainable and balanced development as well as more employment opportunities and job creation.

Large scal surpluses over the past six years have enabled the Saudi government to build up ofcial reserves and to reduce

its outstanding debt levels. Domestic government debt, having peaked at 119% of GDP in 1999, continued its downward

course from 18.7% in 2007 to 15.8% of GDP in 2008. However, we believe, in 2009 government debt will amount to 30%

to GDP before subsiding slightly to 20% in 2010.

Saudi Arabia: Fiscal Balance vs. Domestic Debt (2002-2010F)

-50

0

50

100

150

2002 2003 2004 2005 2006 2007 2008 2009F 2010F

%o

fGDP

Fiscal Balance as a % of GDP Government Debt as % of GDP

Source: SAMA, KFHR


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Moreover, the conservative management of governments petrodollar wealth has shielded the Saudi government from the

adverse developments in global equity markets till 2008. Nonetheless, the investment income earned on these assets is

expected to fall in 2009 compared to 2008 due to lower interest rates on foreign deposits and securities.

The Kingdom of Saudi Arabia needs to create about 160,000 jobs to eliminate unemployment and cater to new entrants.

Saudi economy particularly needs foreign investments in industries capable of generating employment for the locals. Strong

FDI inows over the years have helped in overcoming unemployment among nationals and strengthening the kingdoms

competitiveness. The rate of unemployment in the Kingdom fell from 11.5% in 2005 to 9.8% in 2008.

Saudi Arabia: Unemployment Rates (2001-2010F)

0

2

4

6

8

10

12

14

2001 2002 2003 2004 2005 2006 2007 2008 2009F 2010F

%

Source: SAMA, KFHR

The World Bank has ranked the Kingdom of Saudi Arabia as the 13th most competitive country in the world in its annual

Doing Business report, thus ensuring the Kingdom is well poised to achieve its goal of becoming one of the top 10 most

competitive countries by 2010. Saudi Arabia has shown signicant improvements in the Doing Business rankings over the

last 5 years, leaping from 67th position in 2004, to 38th in 2006, 16th in 2007 and to this years ranking of 13th.

For the fth consecutive year, the report ranks Saudi Arabia as the best place to do business in the entire Middle East

and Arab World, ahead of Bahrain (20th), the UAE (33rd) and Qatar (39th). The report also ranks Saudi Arabia ahead of

advanced economies such as Japan, Germany, France, and Switzerland. Whilst Saudi Arabia holds the lead position,

improvements in the region generally indicate it is a global hot-spot for major investors.

The World Bank recognised several of Saudi Arabias recent reforms which drove the countrys increased ranking this

past year. These reforms made it easier to do business in Saudi Arabia by reducing the required complexity, time, and

cost to start a business and obtain construction permits in the Kingdom. Moreover, the Kingdom has encouraged domestic

and foreign investment by enacting a new foreign investment law, establishing SAGIA, privatizing public companies, and

achieving membership in the WTO.

Saudi Arabias consistent improvement in the Doing Business rankings has been matched by FDI inows to the Kingdom.

The kingdoms inward FDI ows of USD24.3bln in 2007 recorded an annual increase of 33%, and FDI to GDP ratio of 6.4%.

However, in 2008, FDI to Saudi Arabia amounted to USD22.5bln, a 6.5% decline from a year earlier. Foreign investments

in the Kingdom mainly targeted the real estate sector (21% of FDI), petrochemicals (16%), and the mining industry (10%).

Outlook for foreign investment inows in the country will moderate further in 2009 (forecast: USD18bln) due to the ongoing

global nancial crisis before a slight recovery by the end of 2010 (forecast: USD20bln).


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Saudi Arabia: Foreign Direct Investment Inows (2004-2010F)

0

5

10

15

20

25

30

2004 2005 2006 2007 2008E 2009F 2010F

USDb

ln

Source: WIR, KFHR

Economic reforms in the kingdom are behind the growing inow of foreign direct investment in Saudi Arabia. FDI allows

long-term commitments, as opposed to investments in stock markets. The extraordinary progress is a result of on-going

economic reforms, kick-started with the drive to join the World Trade Organisation in December 2005 following decade-longnegotiations. Credit must be extended to Foreign Investment Law enacted in April 2000.

The law allows foreign rms to own a majority stake in companies in the kingdom. The maximum income tax rate for

foreign rms came down from 45% in 2000 to 20%. Saudi Arabian General Investment Authority (Sagia), which looks after

foreign investments, has put in place a one-stop-shop process besides a 30-day deadline for decisions on investment

applications.

Conversely, the law barred foreign investments in 22 areas including exploration, drilling and production of oil, and thereby

dubbed as negative list. However, ofcials have since eased the restrictions, granting foreign investors the opportunity to

invest in such sectors including insurance services, wholesale and retail trade, air and train transport, and communications.

The Supreme Economic Council has eased the restrictions and currently the list includes only 13 activities. SEC forms andoversees the kingdoms economic policies.

As part of WTO accession, Saudi authorities agreed to grant 60% foreign equity shareholding for joint projects. Also, foreign

banks were permitted in the form of locally incorporated joint stock companies or as branches of international nancial

institutions.

Box: Saudi Arabias 10x10 Vision

SAGIA and the Kingdom of Saudi Arabia as a whole are fully committed towards the Kingdoms ambitious project of 10

x 10, which aims at positioning Saudi Arabia amongst the top ten most competitive nations by 2010.

The realisation of 10x10 vision will require substantial steps and effective initiatives, which are facilitated through a series

of development plans that have reached Eighth Developmental Plan (2005-09).

The Eighth Plan marks a new phase in a development process that has spanned more than three decades. Although the

oil sector remains a dominant contributor to the Kingdoms GDP, its contribution may come down in coming years as the

government takes on various plans to enhance its economic diversication.

In the ve years (200509), the Eighth Development Plan aims at increasing real GDP from around USD192.59bln in

2004 to around USD238.7bln in 2009. The Plan also envisages that by the end of 2009, the share of the non-oil sector

in GDP would also increase.

Source: KFHR


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However, due to the difcult borrowing environment at home and abroad, projects are facing delays in the Kingdom. With

the government playing a more extensive role in investment expenditure, focus will remain on strategic or vital infrastructure

projects to meet consumer and industrial demand and sustain economic growth. The global economic slowdown and the

accompanying slide in project costs is prompting Saudi Arabia to make further revisions to its multi-billion dollar downstream

and upstream expansion programs. Three agship projects the Saudi Aramco/Dow Chemical joint venture integrated

renery and petrochemicals project at Ras Tanura, and Saudi Aramcos 400,000 b/d joint venture export reneries with

Total and ConocoPhillips are all delayed, as the partners reassess costs.

Saudi Arabia: Delayed or Cancelled Projects

Project Name Sector

Project Value

USD Status

Completion

Date Owner

ADC - Al Ahsa Cement Plant Industry 320,000,000 Delayed NA Al Ahsa Development

Company

ADC - Jubail Aluminum Chip

Manufacturing Facility

Industry 220,000,000 Delayed NA Al Ahsa Development

Company

Arabian Cement Company/

Italcementi - Cement Plant inLabuna

Industry 600,000,000 Delayed 2011 JV of Arabian Cement

Company and Italcementi

Aramco - Dammam Oil Field

Development

Oil and Gas 250,000,000 Delayed NA Saudi Arabian Oil

Company

Aramco - Ras Tanura

Renery

Oil and Gas 8,000,000,000 Delayed Q1 2012 Saudi Arabian Oil

Company

Grand Real Estate Projects -

Marriland Leisure Park

Real Estate 3,000,000,000 Delayed Q3 2012

Kinan - Al Basateen Real Estate 93,000,000 Delayed Q4 2010 Kinan International for

Real Estate Development

Company

SWCC - Shuaibah Water

Transmission System

(Package 2)

Power and

Water

265,000,000 Delayed Feb-09 Saline Water Conversion

Corporation

Safco 5 - Urea and Ammonia

Plant

Petrochemicals 500,000,000 Delayed 2011 Saudi Arabian Fertilizer

Company

Saudi - Egypt Causeway Infrastructure 3,000,000,000 Delayed NA Ministry of Transport -

Egypt and Ministry of

Transport - Saudi Arabia

Saudi Maaden - Aluminum

Complex - Alumina Renery

Industry 2,000,000,000 Delayed 2015 Saudi Arabian Mining

Company

Sipchem - Jubail Ammonia

Plant

Petrochemicals Delayed 2011 Saudi International

Petrochemical Company

Al Ittefaq Steel Products

Company - Dammam Steel

Plant

Industry 400,000,000 Cancelled NA Al Ittefaq Steel Products

Company

Al Watan Cement Company -

Jalajil Cement Plant

Industry 300,000,000 Cancelled NA Al Watan Cement

Company

Aramco - Yanbu Renery

Expansion

Oil and Gas 500,000,000 Cancelled 2014 Saudi Arabian Oil

Company

Delta Oil - Ethane/Propane

Cracker

Petrochemicals 2,000,000,000 Cancelled NA Delta Oil Company

Mabani - Yanbu Steel Plant Industry 40,000,000 Cancelled NA Mabani Steel Company

Petrokemya -

Debottlenecking/Expansion

of Cracker Units 1 and 3

Petrochemicals Cancelled NA Arabian Petrochemical

Company

Petrokemya - VCM Plant

Expansion Project

Petrochemicals Cancelled 2010 Arabian Petrochemical

Company

Source: Zawya, KFHR


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Liquidity has been an important issue in Saudi Arabia since September 2008, and the regulation of the market by the

government was done to keep the economy from succumbing to complete illiquidity. In a way, the regulation of the national

economy has made the Saudi Arabia much safer from recession; by keeping credit and other cash circuits active, they are

one rung safer from domestic collapse.

Saudi Arabia: Policy Actions to Boost Investor Condence (October 2008- To Date)

16th Jun 2009 Saudi Arabian Monetary Agency (SAMA) halved the interest rate it pays to commercial banks for

deposits, but kept its benchmark repurchase rate unchanged.

14th Apr 2009 SAMA cut its reverse repurchase rate by 25 basis points to 0.5%. It had reduced the rate in January

and December by a total of 125 basis points.

19th Jan 2009 SAMA cut benchmark repurchase rate by 50 basis points to 2%, having lowered it by 50 basis points

in December. In ve moves since October, the repo has been lowered by a total of 350 basis points.

23rd Nov 2008 SAMA lowered bank reserve requirements to 7% from 10%. Since October, it has reduced the reserve

ratio from 13%.

21st Oct 2008 SAMA poured USD3bln in long-term bank deposits, its rst direct injection of U.S. dollars in a

decade.

17th

Oct 2008 Saudi Arabia's top economic body, the Supreme Economic Council, promised to guarantee bankdeposits.

Source: Various, KFHR

Saudi Arabias Dollar peg came under considerable pressure during 2008 as the monetary policy stance of the US Federal

Reserve proved entirely inappropriate for the Saudi business cycle. With the domestic economy running into a multitude

of bottlenecks due to its rapid expansion, SAMA was nonetheless repeatedly forced to follow the Feds interest rate cuts.

Repo rates declined 300 bps during the year to 2.5% in December 2008. The reverse repo rates were slashed from 4.25%

in December 2007 to 1.5% at the end of 2008. In the latest move, on 16th June 2009 the Saudi Arabian Monetary Agency

reduced its benchmark reverse repurchase rate for the fourth time since December 2008 to 0.25% from 0.5%, while

keeping its repo rate constant at 2%.

Saudi Arabia: Key Rate Cuts (Dec 2007-Jun 2009)

0

1

2

3

4

5

6

Endof

2007

23-Jan

-08

1-Fe

b-08

19-Mar

-08

3-M

ay-08

12-Oct-

08

30-Oct-

08

23-Nov

-08

16-Dec

-08

19-Jan

-09

14-Apr

-09

16-Jun

-09

%

Repo Rate Reverse Repo Rate

Source: SAMA, KFHR

In early 2008, strong macro environment, cheap credit and increased food and rental prices fueled ination in the Kingdom.

Saudi Arabias General Wholesale Price Index (WPI) registered annual growth (i.e. WPI ination) of 11.8% at the end of

3Q08. In a bid to control the situation, SAMA was left desperately casting about for alternative policy instruments. As a key

step, it hiked the reserve requirement for banks from 9% in January 2008 to 13% in May 2008.

These steps have now given the Saudi monetary authorities additional ammunition to confront the economic softness,

especially at a time when inationary pressures are once again abating (2009F: 5%). Ination pressures in Saudi Arabia,

which were perceived as a major concern until the rst half of 2008, have eased considerably with the onset of the global

economic crisis. Recent data show that ination in Saudi Arabia fell to 5.2% in June 2009, down from a peak of 11.1% inJuly last year.


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Oil GDP vs. Total GDP (% Change)

-10

-5

0

5

10

2004 2005 2006 2007 2008E 2009F%C

hangey-o

-y

Oil GDP Total GDP

Source: SAMA, KFHR

Despite this slowdown the kingdom is pressing ahead with investments to expand upstream oil capacity. Saudi Arabia is

considering the second phase of capacity expansion to achieve a total capacity of 15mln bpd after the rst phase target of

12.5mln bpd is achieved by 2009 end. The target capacity expansion aims to prepare for a foreseen rebound in demandin the next few years.

Oil and Gas Fields in Saudi Arabia

Source: Saudi Aramco

Downstream projects (reneries and petrochemicals) are also underway but at a slower pace as these require more foreign

borrowings and investments whereas crude capacity expansion is to be nanced by the state oil company. Rening capacity

of the existing seven plants was estimated to be 2.1mln bpd at the end of 2008. The Kingdom aims to invest USD20bln to

increase the rening capacity to 3mln bpd to meet the requirement of the fast growing Asian region.

The collapse in oil prices is one of the clearest and most immediate impacts of the nancial crisis on Saudi economy. Saudi

Arabias oil export revenues are forecast to fall 41% to USD172bln in 2009 due to lower production and prices. Exceptionally

high oil prices in early 2008 had already slowed demand growth and the onset of nancial crisis and recession in much of

the world will further dent demand.


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Saudi Oil Revenues and Oil Export Price

0

100

200

300

400

2002 2003 2004 2005 2006 2007 2008E 2009F

USDb

ln

0

20

40

60

80

100

USDp

b

Oil Export Revenues Saudi Oil Export Price

Source: SAMA, KFHR

The worlds largest oil exporters average daily production is expected to shrink 8.7% to 8.4mln bpd in 2009 down from

an average 9.2mln bpd in 2008. Saudi production peaked at 9.7mln bpd in July 2008. However, ofcial gures reveal

that Saudi Arabia raised its oil production by nearly 300,000 bpd in March 2009 in spite of a collective agreement by theOrganisation of Petroleum Exporting Countries to cut crude supplies to support prices. The country produced 8.358mln bpd

in March 2009, compared with around 8.056mln bpd in February 2009.

The March 2009 production is also in excess of 300,000 bpd above its output target set by the oil exporter group under a

series of production cuts totaling 4.2mln bpd by January 2009. Under the cartels latest accord, Saudi Arabia was allocated

a quota of 8.051mln bpd.

The oil sector holds primary signicance in Saudi Arabia, despite an oil price slump last year and OPECs decision to cut

output. The upward price correction witnessed since the 2Q09 should return liquidity to enable the government to support

Saudi Arabias investment programs in the oil sector.

Banking

The banking sector in Saudi Arabia consists of eleven publicly listed banks and National Commercial Bank (NCB). Five of

the eleven listed banks (namely Riyad Bank, SAMBA, Al Rajhi Bank, Al Bilad Bank and Alinma Bank) and NCB are local

whereas the rest have foreign participation with SABB, Saudi Hollandi Bank, Banque Saudi Fransi and Arab National

Bank having substantial foreign ownership. In the last one decade, SAMA has offered licenses to a number of regional

and international players to operate in The Kingdom. Gulf International Bank of Bahrain was the rst to acquire the license

in 2000. The regional and foreign banks having operations in The Kingdom currently include Gulf International Bank of

Bahrain, National Bank of Kuwait, Emirates Bank and Bank Muscat.

The increase in economic activity is funded by the growth in credit from banking institutions. The total assets of commercial

banks in the Kingdom increased at a CAGR of 18.5% which is in line with the GDP growth of 17.1% during 2003 to 2008.

However, Saudi banking sector could not remain insulated from the implications of the global nancial distress even though

the well provisioned balance sheet of the Saudi banking sector (with the NPL coverage of above 100%) signals the overall

good health quality of the Kingdoms banking assets. In the second quarter of 2009, Saudi Arabia faced the defaults by

two high prole families. SAMA froze the bank accounts of Mr. Maan Al Sanea, the founder of Saad group, and his family.

Apart from those mentioned above, there have not been any further threats of signicant defaults. In a recent interview, Mr.

Al-Jasser, governor of SAMA expressed his views on the two families and mentioned that there are no systemic risks on

the Saudi banking system from their debt; however, he said the protability of banks might get affected. He also mentioned

about the setting up of a special committee which will investigate the two rms and take appropriate actions. He also ruled

out the moves to buy the debts of the two troubled families.

The total assets of commercial banks in The Kingdom grew at a CAGR of 19% from 2003 to 2008 and by only 2.7% in 1H

2009. The growth was mainly fuelled by the inow of petrodollars in the last ve years but is expected to be sluggish for2009; however, from 2010 onwards we expect healthy growth.


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Saudi Arabia: Commercial Banks Total Assets Composition (2006-1H 2009)

0

100000

200000

300000

400000

2006 2007 2008 1 H 2009

USDm

ln

Cash in Vault Deposits with SAMA

Foreign Assets Total Claims

Fixed Assets Other Assets

Source: SAMA, KFHR

The foreign assets and liabilities grew at a CAGR of 14% and 23% respectively from 2003 to 2008 causing the net foreign

assets to increase slightly at a CAGR of 0.2%. However, in rst half 2009, the foreign assets increased by 16% and foreign

liabilities declined by 31% causing the net foreign assets to boost by 143%.

The loans and advances to the private sector increased at a CAGR of 27% from 2003 to 2008, however, in 1H 2009 the

loans have declined by around 1% due to banks preference towards holding cash which is evident from the increase in

cash and deposits with SAMA. We expect the lending to start growing by the end of 2009 as the global markets recover

and the economic activity in The Kingdom picks up.

The deposits grew at CAGR of 18.5% from 2003 to 2008, however, in H1 2009 the deposits increased at a slower pace of

8%. Though demand deposits and quasi monetary deposits (mainly foreign currency reserves) recorded increase in value,

time & savings deposits decreased in H1 2009.

Saudi Arabia: Commercial Banks Total Liabilities Composition (2006-1H 2009)

0

100000

200000

300000

400000

2006 2007 2008 1H 2009

USD

mln

Total Deposits Foreign Liabilities Capital Accounts

Interbank Liabilities Repos Other Liabilities

Source: SAMA, KFHR

The investments by banks in the private sector and government sector increased at a CAGR of 24% and 7% respectively

from 2003 to 2008. However, in 1H 2009, the investments in private sector and government sector declined by 2% and

13% respectively. The decline in govt. sector securities might be because of buyback of securities by SAMA in the open

market to inject liquidity.

SAMA undertook a number of measures to pump in liquidity into the local market and spur lending by the commercial banks;

the regulator cut the ofcial repo and reverse repo rates to 2% and 0.25% respectively since October 2008, decreased

the reserve requirement on demand deposits from 13% to 7%, injected liquidity into the banking sector through demand

deposits and provided guarantees for deposits at commercial banks. The average interbank lending rate in The Kingdom

has declined signicantly from September 2008 levels suggesting increasing liquidity and rising condence in the bankingsector.


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All these positive efforts by SAMA have helped the banking sector in The Kingdom to weather the global crisis relatively

well. However, lately the banks in The Kingdom are feeling some pain related to credit problems. Decline in international

trade the private sector lending related to imports and exports in The Kingdom are expected to grow at a slower pace than

historical Levels due to depressed global demand. However, our outlook remains positive for 2010 as the global economy

starts to recover.

KSAs strong macro-economic outlook offers future optimism for the nancial institutions that can capitalise on the growing

nancing appetite and deposit base in the Kingdom. Dependant on the stability of global stock markets in 2009, the

Kingdom holds signicant potential to attract investments. The Kingdoms continued commitment towards the projects to

ensure sustainable and balanced economic development along with banks restructuring plans and to lower dependence

on revenues from equity markets, provide a window for stable banking sector performance. Going forward, to tap the

potential mortgage market, mortgage laws need to be designed to protect the interest of both lenders and borrowers.

Real Estate

Real estate plays an important role in the Kingdoms relatively small non-oil economy, which remains focused on the

governments effort for economic diversication. Despite a global recession and declining property markets across the

world the real estate activity in KSA is estimated to increase at an average annual rate of 5.8%, with its contribution to GDPincreasing from 6.8% in 2004 to a forecast 7% in 2009.

Real Estate Sector Contribution to GDP

6.6

6.7

6.8

6.9

7

7.1

7.2

7.3

1999 2004 2009F

%

Real Estate to GDP

Source: SAMA, KFHR

In recent years, Saudi Arabia has undertaken many economic reform measures that added further clarity to laws and

regulations and are aimed at attracting foreign investments and providing direct impetus to the real estate sector. Kingdom

of Saudi Arabia, the largest amongst the GCC economies, has managed to maintain its grip on economic factors even in

the current scenario. The reason behind this is the larger domestic investor base in comparison to foreign investors.

The projects in pipeline to date are worth more than USD500bln. With no more projects likely to be announced in 2009, the

outlook is not expected to change much in 2010. The current real estate investments, which are of the order of USD300bln,

making KSA one of the biggest construction markets, are conjectured to reach USD400-450bln levels by 2010. The demand

for real estate is expected to continue optimistically, owing to reasons such as highest population growth rates in the region

and an ever increasing foreign workforce inux. Furthermore, the lowered prices of cement (lower by 1/4); steel (lower by

1/2) and other construction materials suggest better protability for construction businesses.


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Saudi Arabia: Population Growth Trend (2004-2010F)

0 5 10 15 20 25 30 35

2004

2005

2006

2007

2008E

2009F

2010F

mln

Source: EIU, KFHR

KSA is projected to have one of the more resilient, safest and robust real estate markets in the GCC. Residential prices

which increased at a rate of 10% p.a. during 2002-2005, will continue an upward momentum once the current economic

slowdown is over. The growth of real estate sector is forecast to moderate to 5% during 2009 (owning to the overall globalslowdown), but the moderation is believed to be transient.

With only one half of the total residential facilities in KSA (approximately 4.3mln), estimated to be occupied by owners

and the rest rented out; and an unmet demand of 250,000 houses residential rental alone is expected to show a 10%

acceleration in 2009.

Having approximately 60% population between the working age group of 15-64 years indicates a strong demand in all

categories of daily households in years to come.

Saudi Arabia: Population Distribution

Above 64 Years

3%

Under 30 Years

61%

Between 30 to

64 Years

36%

Above 64 Years Under 30 Years Between 30 to 64 Years

Source: EIU, KFHR

With less than 50% of the population having home ownership, while 60% of the population being under 30 years of age and

a signicant inow of labour force migration into the Kingdom indicates substantial housing demand in the country.

Saudi Arabia is witnessing an escalating demand from young middle income Saudis. Thus, if Saudi is to meet such demand

it will need to build 1.5mln new homes by 2015. Saudi Arabia being one of the largest construction markets in the Middle

East is estimated to have the total real estate investments of around USD300bln, which are expected to cross USD400bln

mark in near future.


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Saudi Arabia: Housing Demand by Region (2005-2009F)

0

Ritadh

Makkah

Almadina

Qassim

EastRe

gion

Assir

Tabu

kHa

il

North

Borde

rsJiz

an

Najra

nBa

haJour

5

10

15

20

30

25

%

Source: Ministry of Economy & Planning, KFHR

A moderation in property and rentals in the 1H 2009 was witnessed as the global economic sentiment and a correction in

oil prices took a toll on investor sentiment. Property prices have showed excessive increment of as much as 80% in early

2008 (given oil windfalls and demand) in the capital city of Riyadh.

Despite this, it is our conservative estimate that only half of the Saudi residents own their properties, and with approximately

60% of the population under 30 years of age. This translates as a signicant demand of about 200,000 homes per year,

across various echelons of society. The current infrastructural developments show promise to provide for this demand.

KSA is expected to witness a moderate but sustained growth of 5% in the real estate prices in 2009; rental prices are also

forecast to grow by 10-15%. This is primarily due to the increasing per-capita income and the resulting rise in standards of

living, coupled with the rising population. Further, KSA provides an environment conducive for and attractive to business

and investment as government reforms remain committed. This has enhanced the demand for both residential as well as

commercial space much beyond supply.

KSAs real estate sector is still one of the most promising and resilient in the GCC. We remain optimistic on investment

prospects with sustained demand and incremental increase in rental and overall prices despite the gloomy global economic

backdrop. Moreover, oil prices stabilising in the range of USD6507-pb will protect the real estate market of the kingdom

from faltering by keeping a check on the liquidity issues.


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KuwaitBuilding blocks

Kuwaits real GDP came in at 6.3% in 2008 as against 3.8% in 2007, underpinned by record high oil prices in the third

quarter of 2008 and a resultant increase in government expenditure. Although oil prices corrected by the end of December

by more than 50% since reaching USD147pb in July, the windfall surplus was enough to sustain growth at a stellar pace

in 2008. However, the global economic downturn has impacted Kuwait across all sectors. The Kuwaiti bourse fell and the

collapse of investment rms have in turn fed a decline in the real estate market and a drop in commodity prices.

The decline in oil prices from their 2008 peak has changed the outlook for oil revenues and for economic growth in Kuwait

in 2009. The growth for 2009 is expected to moderate to 1% on account of our oil price forecast of USD55pb but is forecast

to recover to 2% in 2010.

Kuwait: Real GDP Growth Rate Trend (2004-2010F)

0

2

4

6

8

10

12

2004 2005 2006 2007 2008E 2009F 2010F

%C

hangey-o-y

Source: CBK, KFHR

To contain the crisis, Kuwaits government has launched a series of initiatives aimed at shoring up investor condence,

bolstering the bourse and rescuing failing rms. From sending a bourse regulator bill to parliament and setting up a USD7.3bln

bailout fund to suggesting that troubled nancial rms consider mergers, the government is putting its considerable weight

and nancial heft into managing the economic crisis. Kuwait approved a USD5.15bln economic stimulus bill to underwrite

fresh bank loans and assist troubled investment rms impacted by the regional credit crisis. In the GCC, Kuwait is the only

country that has approved a comprehensive economic stimulus package to guarantee and assist banks and investment

companies. However, the manner in which these plans are perceived and implemented will greatly affect their chances for

success.

In a survey initiated in March 2009, Moodys recognised that Kuwaits scal and economic strengths remain superior

compared to most peers despite some adverse fallout from the global crisis. Moodys has also taken into consideration

improvement in policy environment with the recent election of a new parliament and the formation of a new government

in Kuwait. Kuwaits country ceiling for foreign currency bonds remains at Aa2 with a stable outlook while its local currency

ceilings also remain at Aa2. Kuwaits local and foreign currency government bond ratings and its country ceiling for foreign

currency bank deposits, which were also conrmed at Aa2.


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Contribution to GDP in 2008

Oil

Revenues

90%

Non Oil

Revenues

10%

Oil Revenues Non Oil Revenues

Source: CBK, KFHR

Kuwait boasts the worlds fourth-largest oil reserves and its oil GDP constitutes 90% of its overall GDP. In 2008, Kuwaits

trade balance reached USD62.24bln as against USD41.9bln in 2007, primarily fuelled by trade surpluses on account of

increasing oil prices earlier in the year. Despite a decline in oil output in 2009, export earnings should remain reasonablystrong as the prices have stabilised in the range of USD65-70pb. As a result, the current account is expected to maintain

a surplus (although not as high as in 2008) of USD10.14bln in 2009-10 while the trade surplus is forecast to be USD17bln.

We expect the current account balance to improve to USD22.1bln in 2010-11 and trade balance to climb to USD20bln in

2010-11 on account of an increase in oil exports as the global economy recovers.

Kuwait: Trade Balance Trend (2004-2010F)

0

20

40

60

80

100

2004 2005 2006 2007 2008E 2009F 2010F

USDb

ln

0

20

40

60

80

USDbl

n

Exports Imports Trade Surplus

Source: CBK, KFHR

Kuwait: Current Account Trend (2004-2010F)

0

20

40

60

80

2004 2005 2006 2007 2008E 2009F 2010F

USDbln

0

20

40

60

%

Current Account Balance % of GDP

Source: CBK, KFHR


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On the scal front, Kuwaits scal surplus came in at USD2.1bln in 2008-09 as against USD31.62bln in 2007-08. The

steep fall may be attributed to a fall in oil prices from their July 2008 peak. Although Kuwaits budgetary projections have

historically been very conservative we caution that Kuwaits surplus in 2009-10 may also be hampered by the lagged

impact of a drop in oil prices and lower earnings this year. This will in turn cause the government to revisit some of the

planned mega projects. We forecast that the scal surplus will narrow sharply to USD6.1bln in 2009-10, due to the crude

oil production cuts by OPEC in order to stabilise the prices.

Nonetheless, we expect Kuwait to be able to invest in the economy in times of economic weakness, given the governments

co

gcc economic outlook 011209

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