May 2, 2016
- IMF worries about downside risks in GCC but recovery in oil helps to reduce concerns
- Opportunities amidst challenges– A silver lining for SME growth in the GCC
FAST FINANCE
The Federal Reserve did not raise rates last week, as expected, but did point to weaker outlook on inflation at the same time as its removed some of its language expressing concern about the outlook for global growth. The remainder of the week saw oil prices continue to recover while the dollar weakness continued which is supportive for the MENASEA region where commodities (and oil in particular) make up a large share of government budgets. The dovish outlook on US interest rates should continue to support adjustment in the region by removing the primary soures of volatility in the years since the Taper Tantrum of May 2013, a stronger dollar and weaker commodity prices.
In its Middle East Regional Economic Outlook, the IMF highlighted the downside risks facing financial systems in the future as futures markets indicate a rise only to $50 per barrel by the end of the decade. This would represent a big threat to the GCC countries that are already facing challenges of developing the non-oil sector to provide economic diversification.
One of the sectors most influenced by the changing oil prices that is also key to supporting the non-oil growth is the banking sector which is in a relatively good position to manage a moderate oil price environment but which has other risks that may be more pressing.
In order to disentangle the impact of oil from other impacts, we created a simple estimate using data from the UAE of the impact of oil prices on domestic banking liquidity to estimate the relationship between Brent oil prices and the 3-month Emirates Interbank Offered Rate (EIBOR) Between May 2013 and April 2016.
Source: The State of Small & Medium Enterprises in (SMEs) in Dubai, Presentation by Dubai SME, govt. of Dubai
Using this sample to create a projected EIBOR rate—labeled as EIBOR(p)—for the full sample from May 2011 to April 2016 highlights two periods when factors other than oil were significant influences on interbank liquidity to highlight he risks other than oil which may not be as closely watched but which may have significant impacts on banks and, by extension, on the wider economy.
The first period where there is a divergence is at the start of the data sample when the effects of Dubai’s debt crisis was still affecting the interbank rates even as oil prices had recovered from their financial crisis lows. The second period was in December 2015 when the US Federal Reserve made its first interest rate hike.
The risk of a return of a debt crisis is unlikely, not because all of the underlying issues have been resolved but from the stronger global economy which itself is not facing the enormous retrenchment that it was undergoing in the wake of the global financial crisis. The other risk—from Federal Reserve rate hikes—is more of a concern despite the (direct non-oil) effects mostly dissipating.
The Federal Reserve is likely to hike rates one or two times during 2016 which will be transmitted into the UAE’s interbank market by the currency peg. The level of disruption—and the degree to which it persists—will depend on the amount of adjustment within the banking system to rebalance the current discrepancy between (slower) deposit growth and continued (faster) growth of credit (both to the government and to the private sector).
Relative to the baseline of oil prices (estimated to be $35/barrel in 2016 and $41/barrel in 2017), a rise in oil prices will contribute to slightly faster growth which will go part of the way towards narrowing the gap between deposit and loan growth. The UAE Central Bank’s survey of senior credit officers found that loan demand was expected to continue to be solid but that banks were restrained in the amount of actual loan growth they would provide as they were expecting to continue tightening lending conditions through the remainder of the year.
While this adjustment takes place, the banking sector remains well capitalized and slower loan growth (particularly at conventional banks) will limit the pressures on capital. All of this could change significantly if either oil prices have a sharp drop or China growth worries resurface, but at the moment the outlook (at least in the UAE) likely remains more sanguine than the IMF outlook presents.
Small and Medium Size enterprises (SMEs) contribute significantly to the development and growth of efficiency, particularly to innovation, job generation, and international competitiveness. They are therefore the main drivers for growth and economic diversification. Despite the presence of strong entrepreneurial roots and traditions in the GCC, the growth of SME sector in the region has been dismal.
This is in part due to the fact that data on SMEs in the GCC are often limited and different countries in the region categorize companies falling into the SME category slightly differently, and partly the incubation space provided to budding entrepreneurs has been low along with a lack of developed framework which check marks the SME development. Information contained in SME surveys in OECD countries, such as profitability, survival rate, or turnover, are generally not yet available in the Gulf.
Source: The State of Small & Medium Enterprises in (SMEs) in Dubai, Presentation by Dubai SME, govt. of Dubai
Globally, the lack of transparency has been cited as a major factor deterring the growth of SMEs. This problem is rather more acute in this region due to the lack of credit registries. There is very little information on the credit worthiness and the credit histories are not well documented. The absence of credit scores and credit bureaus has been a major bottleneck in SME lending. Moreover, the absence of bankruptcy law specifically is also a major hurdle. However the authorities in the region, have been taking steps to foster the growth of the SME sector in order to diversify the economies dependency on hydrocarbon revenues. Although a ripple effect of a drop in oil revenues is going to hit all sectors going forward, the authorities want to step up in rejuvenating the SME sector so that economic activities stay afloat.
Since the beginning of this year Qatar, Bahrain and UAE have engaged with the Organization for Economic Co-operation and Development (OECD) to implement benchmarking policies for SMEs. Benchmarking of policies will help in implementing successful policies of one country in another and countries will be able to learn from each other. Taking the example of the SMEs that have been setup in Dubai, it is observed that Dubai SMEs are ranked more highly towards internalization and low towards innovation and scalability potential.
Source: “What is an SME? – Small and medium sized enterprises (SME) – Enterprise and Industry”; ec.europa.eu
One lesson that can be learned from the small economies in the eastern European countries is to grow their SME sector through connecting to large global corporations from developed countries such as Germany and France. Countries like Slovakia, Slovenia, and Romania have seen their SME sector has become an integral part of the global value chain and they are innovating and learning from these relationship with multinational companies.
Another welcoming step was the announcement of the establishment of an equity market by the Saudi Stock Exchange that would be targeting Small and Medium Enterprises (SMES) by early next year. The benefits of being listed in this markets will give SMEs access to capital. Another advantage of having SMEs listed on the exchange will be to force them to be more transparent and adequate disclosures will bode well for the creditors and investors which has been the one of the worries of investors and banks in the region.
Learning from the experience of other markets is an important part of charting the path forward towards more diversified economies and the efforts like those from the OECD can be an important partner in accelerating SME development.
Source: The State of Small & Medium Enterprises in (SMEs) in Dubai, Presentation by Dubai SME, govt. of Dubai