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Despite the rise in oil prices, credit conditions continue to be tight in the UAE and this is standing in the way of economic recovery.

Outstanding loans are still higher than deposits by Dh37 billion as of July and this shows banks are faced with a funding gap, according to Standard Chartered economists. The latest figures from the UAE central bank show that total loans, advances, and overdrafts contracted by 0.2 per cent month on month in July, with outstanding loans remaining higher than deposits by Dh37 billion as of July 2009.

The funding gap is also leading to higher deposit rates as banks compete for deposits to bridge the gap, bank’s Dubai-based economists Marios Maratheftis  and Mary Nicola say in a report. Marios is Regional Head of Research, MEPNA, and Mary Nicola, the bank’s MENA Economist.

Saudi Arabia is also placed in a similar situation, with the prevailing credit conditions hampering economic recovery, they said.

With oil prices rebounding, the global economic outlook is improving and markets are now beginning to focus on the nature of the recovery. UAE and Saudi Arabia benefit significantly from higher prices, both countries having enjoyed estimated budget surpluses of 22 per cent and 33 pre cent of GDP respectively in 2008.

Higher revenues in 2009 as oil prices continue to recover will help both governments continue comfortably with their expansionary budgets – especially considering that the hydrocarbon sector contributes 81 per cent and 90 per cent, respectively, to government revenues in the UAE and Saudi Arabia. Despite the benefits of higher oil prices and their positive impact on government spending and revenues, liquidity in both countries is tight, and credit growth remains flat, although the reasons behind the two countries’ credit crunches are quite different, the economists point out.

They feel that the growing oil revenue should help to replenish deposits and gradually improve credit conditions.

Credit growth in Saudi Arabia in July was only 0.1 per cent month on month and they feel that the credit crunch in Saudi Arabia is primarily a confidence problem.

“Deposits are higher than loans. Yet while Saudi banks have the liquidity and the ability to resume lending, they are instead opting to increase their deposits with the Saudi Arabian Monetary Agency (SAMA). July data showed a 9 per cent increase in deposits held with SAMA. Here, more efforts are needed to boost business confidence,” they said.

Saudi Arabia and the UAE have the lowest costs of hydrocarbon production among the oil-producing countries (currently estimated at $20 per barrel for Saudi Arabia and $22 for the UAE).

Government revenues have fluctuated tremendously over the course of the year, as is typical for countries that rely heavily on commodities. In July 2008, when the Saudi Arabia Light Spot price (which is used in the OPEC reference basket) was at $132 per barrel, Saudi revenues reached close to $1 billion per day. In the UAE, 2008 production reached 2.567 million barrels per day and the Abu Dhabi Murban Spot Price reached $140 per barrel; as a result, revenues peaked at $304 million per day.

It is interesting to compare these numbers to February 2009, when both production and prices fell to the lowest levels seen in 2008-09. Saudi Arabia produced an average of 7.86 million barrels per day and prices averaged $38.5 per barrel; revenues were only $145 million per day. For the UAE, production fell to 2.223mbpd and prices declined to $44.68 per barrel, causing revenues to fall to $50 million per day. Assuming constant production at current levels, the bank estimates that the UAE and Saudi Arabia gain roughly $3 million and $ 8 million in revenues per day, respectively, for every $1 increase in oil prices.

The report notes that when it comes to real versus nominal GDP growth, the level of oil production has a bigger direct effect on real output than on nominal output. The impact of prices is indirect, felt through the wealth effect and potentially higher government spending and investment. The report refers to a strong correlation between year-on-year changes in oil production and real GDP growth. The relationship is stronger in Saudi Arabia, given that the hydrocarbon sector makes up almost 50 per cent of GDP, versus a 35 per cent direct contribution to UAE GDP.

Oil production is highly correlated with oil prices, with OPEC reducing production when oil prices drop in order to stabilise them, and vice versa. The rebound in oil prices could have implications for production. The report notes that further production cuts are unlikely, especially as WTI prices approach $75, the level cited by Saudi Arabian Oil Minister Ali Al-Naimi as the fair value of oil. Potential oil production increases in 2010 could be another catalyst for a strong rebound in the GCC next year, the analysts say.

Asian recovery

The Standard Chartered report notes that most Asian economies saw acceleration in growth or a narrowing economic contraction during the second quarter of this year. The report asserts that the numbers confirm the bank’s long-held view that large, domestically driven economies are set to outperform small, export-oriented economies. China and Indonesia, where output never contracted in year or year terms, have clearly maintained stronger growth momentum than Singapore, Hong Kong, and Taiwan. Vietnam, despite its relatively high exports-to-GDP ratio, also sustained positive GDP growth due to relatively stable domestic demand. Taiwan and Thailand, where export exposure is high and domestic demand is weak, underperformed in both year or year and quarter to quarter growth terms.

Among the key GDP contributors in the second quarter, gross fixed capital formation, or fixed asset investment, was a drag on growth across Asian economies. Excluding public investment, the negative contribution from investment would have been more severe. This implies that a rebound in business confidence is critical in order for the recovery to be sustainable. While the global economic environment seems to be on the mend, the corporate sector is still very cautious about the business outlook. Order lead times have shortened, as overseas buyers are only willing to commit to orders for the very near term.

This implies that manufacturers and exporters still need to manage their cash flow and working capital carefully, which is deterring fresh capital investment, the bank points out. For companies with exposure to commodities, the volatility in commodity prices is further limiting investment confidence. Investment is likely to remain weak until business confidence sees a sustained recovery. To support the still-nascent recovery, governments need to reinforce public investment and boost business confidence, the bank cautions.

Central banks in the region have already cut policy rates aggressively and supplied ample liquidity to the business sector. These loose monetary conditions are likely to persist until there is a sustained turnaround in business confidence and investment. China, Indonesia, India, and South Korea may choose to tighten first, but they are only likely to take action once they see firm signs of an economic recovery, including a sustained improvement in business confidence, the report says.

At the same time, current levels of economic growth across Asia are still below trend. A full recovery to trend growth or above, and a subsequent removal of the output gap, will probably have to wait until 2010 or later. This implies that demand-pull inflation is unlikely to surface for some time, the report asserts.

“Of course, many have argued that Asian central banks should look to limit the risk of asset bubbles via monetary tightening, but this runs the risk of choking the recovery in its infancy, in our view. Hence, alternative measures to ring-fence the impact of financial market volatility on the real economy should be considered. In our view, hiking policy rates too soon would have a negative impact on both the general economy and the financial markets,” the report said.