Sluggish Credit Growth in the Gulf: Cause for Concern?
A Commentary by Masood Ahmed, Director, Middle East and Central Asia Department, International Monetary Fund
Published online in Asharq Alawsat, January 11, 2011
Aided by rising oil prices and production, economic prospects for the six nations of the Gulf Cooperation Council (GCC)—Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the UAE—are gaining momentum. But could the slow pick up in bank credit to the private sector witnessed across the region cloud this positive outlook?
While there are clear signs of recovery in some countries, private-sector credit is still barely growing in the GCC, despite policy efforts to revive it. During the five years prior to the crisis, the GCC countries experienced significant increases in credit, spurred by favorable macroeconomic conditions. At its peak in 2005, credit growth in the GCC exceeded 30 percent year-on-year.
With the onset of the crisis, global deleveraging led to severe credit tightening in the GCC, as elsewhere in the world. Credit growth slowed sharply, and has remained anemic so far during 2010.
Factors affecting both the supply of, and demand for, credit have played a role in this slowdown. On the supply side, while funding strains have been overcome, higher risk aversion, stricter lending policies, and lower willingness by banks to rely on so called “name lending” have all served as a brake on new credit.
On the demand side, in most countries in the GCC, demand for credit appears to have dropped in association with the decline in real estate prices, the slowdown in construction activities and non-oil growth, and the corresponding weakness in investor and consumer confidence.
To what extent will weak credit growth stifle economic activity in the short term? For a number of reasons, the negative impact of slow credit growth may not be as worrisome as it appears.
First, the adjustment in credit growth reflects a much-needed correction from very high—perhaps unsustainable—rates of credit growth witnessed during the boom years. Moreover, there are already some signs of a rebound in year-on-year credit growth—albeit modest—in Bahrain (4.7 percent), Oman (7.3 percent) and Saudi Arabia (4.6 percent).
And banking system health is generally satisfactory: capital adequacy ratios remain strong, and stress tests conducted by IMF staff indicate that banks are generally resilient to severe shocks. In addition, significant progress in financial and corporate restructuring during 2010 helped shore up market confidence. The underlying conditions are therefore in place to support a resumption of credit growth, although this may be gradual.
At the same time, the overall numbers for banking sector credit growth mask important underlying developments. Credit growth is displaying a positive trend away from volatile sectors, such as real estate and household equity purchases, toward more stable sectors, such as industry, trade, and services. Credit growth to these sectors has been healthy in a number of countries.
Finally, bank credit growth numbers don’t tell the whole story. The private sector is receiving some credit through alternative channels of financing: some governments are guaranteeing foreign debt issued by government-related entities (Qatar and Abu Dhabi) and are increasing their advance payments to contractors (Saudi Arabia and Qatar), thus lowering the need to seek bank credit to cover their funding needs; and specialized credit institutions, especially in Saudi Arabia, have significantly increased their credit to domestic sectors. In general, corporates in the GCC appear to have adequate cash balances and can finance their operations from these cushions in the short term.
Is policy action still needed? While fiscal and monetary policies have been geared to support the GCC to emerge from the impact of the global crisis, this is not an open-ended option. Ultimately, the private sector will have to play a more active role, for which a revival in private-sector credit growth will be instrumental.
Just as supply and demand factors were at work in the credit slowdown, so should policies aim to address them. On the demand side, it is appropriate for country authorities to maintain fiscal stimulus—where there is fiscal space—and quantitative easing in 2010, and possibly into 2011. These policies would need to be revisited with signs of a pickup in inflation, which remains relatively muted.
To improve credit supply, corporate governance and financial disclosure and transparency will be key. In addition, banks will need to build up their capacity to assess credit risk. Alternative domestic sources of corporate funding—primarily domestic or regional debt markets—will need also to be developed. This will not only help diversify the economy’s financing channels, but also improve standards for financial disclosure.
Ultimately, a revival in credit growth will be essential for GCC countries to deepen economic diversification—the greatest challenges for all natural resource-intensive countries. It is critical not only for moderating the impact of external shocks and disruptive boom-and-bust cycles, but also for creating employment opportunities for the region’s growing young population.