The Gulf has dealt with successive crises in the last three years, from Dubai’s financial implosion, to political unrest in Bahrain and Oman. Now, analysts fear that European and American debt troubles will reduce oil demand, and consequently Gulf country revenues. Borrowings have to be repaid, even rescheduled; in Dubai, repayments will peak in 2014. Other Gulf countries still need to economically diversify. Qatar plans to invest massively in stadiums and housing for the 2022 World Cup: Around US$57 billion, according to Moody’s.

"We are now in the second round of recession, with cascading effects," says N. Bulent Gultekin, associate professor of finance at the Wharton business school. "Volatility is hitting every country; all financial markets and government bonds are affected. However, I do not have a specific worry about Gulf bonds. Although the GCC [Gulf Cooperation Council] must still diversify, they do have better fundamentals in that region."

Direct impacts of the West’s economic problems have been relatively limited in the Gulf. A falling U.S. dollar has made imports more expensive and enhanced inflation, but most of the GCC currencies remain pegged to the dollar. Despite the risk, Gulf investments in Europe continue. Roubini Global Economics estimates that of US$2 trillion in GCC foreign assets, 25-30% is invested in Europe. "Eurozone debt will have more effect on tourism and export than on the banking system," says Ghassan Chehayeb, associate director of MENA research at Exotix, an investment bank boutique specialised in illiquid bonds and debt. "European countries have traditionally been long-term lenders to the United Arab Emirates [UAE] and Kuwait, not the other way around."

Meanwhile, analysts carry optimism for some Gulf countries after Standard & Poor’s cut America’s rating in August. Qatar, Saudi Arabia and Abu Dhabi bonds are seen as havens amid global downturn. In August, Qatari and Abu Dhabi CDS (credit default swap) protection cost under 100bps (basis points, 1/100th of one percent). Bahrain’s five-year CDS pricing touched above 320bps, its peak since political trouble arose earlier this year. Dubai’s five-year CDS reached 500bps, their highest since November 2010, after months of decrease thanks to major restructuring.

Government Bonds, Not Corporate

Due to government guarantees, government and corporate bonds are often considered equivalent in the Gulf. So, when Credit Suisse estimated Dubai debt at US$130 billion, (US$113 billion per the International Monetary Fund), this included all state-linked companies’ debts. Samba financial group calculated US$31.5 billion outstanding direct debt for Dubai’s government, thus 38% of Dubai’s GDP. Counting some guarantees, direct debt rises to 47%, while government related entities [GREs] such as the developer Nakheel, borrowed over 70% of Dubai’s GDP.

Some GREs made a significant effort to restructure debt and increase profitability. Holding company Dubai World restructured US$25 billion in 2010; Nakheel started with US$13 billion this summer. Soaring confidence has allowed Dubai to issue US$500 million in bonds in June.

"Is market confidence sustainable? Dubai’s government will probably be able to raise the additional US$1.5 billion it needs over the next year," says Andrew Gilmour, Senior Economist, Dubai and Gulf, at Samba Financial Group. "There is a slight chance of government default with its limited US$8 billion a year fiscal revenues. And GREs still need to refinance substantial amounts. It’s hard to tell if they will pay by selling assets." Dubai has no rating, but Moody’s rates the UAE’s federation of states Aa2.

"Dubai has a huge advantage on other Gulf countries by having built its infrastructure. The Emirate does not need to go to capital markets anymore," says Rami Sidani, head of MENA Investment at Schroder. Notes Wharton’s Gultekin, "Having infrastructure does not mean the bonds are good. But infrastructure could help the country to be more productive, and so, reduce the debt in the long term. A wise investment is a capital stock."

According to the IMF, Dubai still has two main risks. Firstly, re-scheduled debt creates a peak of repayment in 2014-2015. "The debt schedules of Dubai and its GREs are more manageable. But the market is still weak and the banking system still is burdened," adds Exotix’ Chehayeb. Secondly, the IMF estimates that Dubai’s property sector remains a risk which might affect the sovereign balance sheet. "Investment in housing boosts the short-term economy, but only creates a long-term consumption product," Gultekin says. "If Dubai can reallocate housing oversupply to the tourism sector, these assets will generate income."

Differentiation between sovereign and corporate bonds should also be done for Kuwait. Kuwaiti direct debt is quite low, roughly 10% of its 2010 GDP. Moreover its fiscal balance is the highest in the GCC, at 22.3% of the GDP. Sovereign finances and wealth funds are not endangered, but Kuwait’s banks have difficulties from non-performing lending. "Kuwait companies invested a lot during the boom," Chehayeb notes. "Illiquid assets were bought at a high price. With the financial crisis, a lot of local banks were in default and had to restructure."

Recently, Kuwaiti investment firms Global Investment House and Noor Financial Investment received extensions for debt repayment. The IMF expected Kuwaiti GDP to grow by 5.7% in 2011. "We are greatly positive for Kuwait, thanks to the 205% government surplus," says Standard & Poor’s Credit Analyst Kai Stukenbrock. "The upgraded notation, to AA from AA-, is only due to a methodology change, since we give more value to stock assets."

Bahrain has similar indebtedness to Dubai. Bahrain already was among the highest in Gulf direct indebtedness, accounting for 32% of 2010 GDP. Since the Arab Spring, debt levels increased sharply further, while other Gulf states have direct debt below 20% of GDP. "Local banks have strong appetite for additional government debt in Saudi Arabia," notes James Reeve, senior economist for Saudi Arabia, at Samba Financial Group. "Foreign debt is miniscule, while net foreign assets are officially worth US$500 billion, or 100% of GDP."

Unrest Spurs Spending

In response to the Arab Spring, Gulf countries opened their wallets — US$150 billion worth of social welfare spending in the region since the unrest began, according to a report by Merrill Lynch Bank of America. For instance, only days after the collapse of former Egyptian president Hosni Mubarak’s regime in February, Saudi Arabia announced a social welfare package worth US$10.7 billion, featuring pay raises for government employees, new jobs and loan forgiveness schemes. By the end of the month, the handouts totaled US$37 billion. In March, the spending incredulously continued, as Saudi Arabia’s King Abdullah heralded an additional US$93 billion in social spending. But the Kingdom can afford to, analysts say. "Increases in public spending will not really affect the debt of Gulf countries, due to their huge oil income revenues. If Saudi Arabia increases public spending, it raises its oil production as needed," says S&P’s Stukenbrock.

The two GCC members who have needed help from their neighbors because of the Arab Spring urest are Oman and Bahrain, receiving aid pledges of US$5 billion each. Financial help would not be spent immediately, to repay debt for instance, but to boost both economies over the next 10 years. But despite a US$16.5 billion rise in public spending, Bahraini GDP decreased by 20.5 % in first quarter 2011. The head of Bahrain’s chamber of commerce estimated the country’s civil violence cost roughly US$2 billion. At the end of the year, Bahrain’s fiscal balance will be negative by 7.7% of GDP, estimated Arabia Monitor.

The unrest has hurt Bahrain’s financial sector, which accounts for 25% of its GDP and tourism, Bahrain’s second source of revenues, as hotel occupancy fell by about 30%. According to Reuters, Bahrain has seen an estimated US$20 billion in capital outflows in the first quarter of this year, with a portion of that captured by Dubai. "Besides tourism and finance, property costs have increased while values dropped," says Exotix’s Chehayeb. "The situation is critical for the small kingdom. Moreover, recent protests showed that the political issue has not been solved."

Bahrain’s rating has been downgraded three times by S&P since the beginning of protests, to BBB/Baa1. "Bahrain can still be downgraded in the long term. Besides political and economic concerns, we are worried about public finance. How will Bahrain deal with increasing public spending?" asks S&P’s Stukenbrock. Bahrain planned a 44% rise in public spending over two years in order to boost its economy, which will cost 7% of GDP per year. But the country already has one of the highest direct debt percentages in the Gulf, while GDP was expected to decrease by 1.5% in 2011.

Oman has stabilized much quicker. A 20% increase in public spending has slightly affected the Omani US$22 billion budget, but it only had direct debt of 6% of GDP, the lowest in the GCC. Analysts agree that Gulf states, especially Oman, are very cautious in their spending. S&P removed the ‘CreditWatch negative’ in July on Oman’s A/A-1 rating. "The protests were briefer and far smaller than in Bahrain, and not based on a religious issue. Oman is not extremely rich, its GDP per capita around US$17,000, but the Sultanate has gathered a large surplus over the years," Stukenbrock notes. "Sultanate sovereign debt is not in trouble and quite low. In addition, Oman has enough fiscal revenue space to increase spending," adds Samba’s Gilmour. Confirming that unrest has had minimal impact on Oman, Moody’s cited Oman’s expected 2011 GDP at almost 3%.

Oil Demand Falling?

Analysts continue to worry though that oil demand might fall with a double-dip recession in the West, seriously affecting oil exporters’ revenues. According to Bloomberg, crude oil prices have dropped 15% since the end of June, the biggest quarterly loss since the end of 2008. "The oil price will not plunge, as it did in 1998, to US$10 a barrel, when Russia defaulted financially," Wharton’s Gultekin says. "Even if demand slows down in the West, developing countries have a serious appetite. Oil-dependent countries should not index their expenditures to oil prices, something they learned during the 1973 crisis."

GCC countries hold almost 40% of the world oil reserves, and collectively earned US$465 billion from oil revenues in 2010. Over the last eight months, crude oil prices have risen about 30%. If oil prices plummet, GCC revenues would not be affected equally. The most exposed to risk is Kuwait, where 90% of revenues come from oil. Its 2011 outlays were budgeted on US$60 a barrel oil. Although oil and gas count for only 30% of Bahraini GDP, Bahrain is also heavily dependent on oil prices which bring 75% of government income. Bahrain has one of the highest break-even prices in the Gulf, US$72 per barrel, according to the IMF.

The surge of public spending following the Arab Spring will obviously raise budgtary expectations. The break-even price for oil in Saudi Arabia is expected to rise to US$110 a barrel in 2015, while the current break-even price is at US$83 a barrel, according to the Centre for Global Energy Studies (CGES). "Oil prices seem unlikely to fall significantly and stay low for an extended period, given Saudi Arabia’s ability to act as ‘swing producer’ in OPEC," says Samba’s Reeve. Over the next year, the fiscal balance will decrease from 4.9% of GDP to 2.9% in Saudi Arabia, according to Arabia Monitor.

Qatar and Oman have less worry about oil price volatility. Gas exports supports most of the Qatari economy. For Oman, the fiscal break-even point is lower, at US$58 per barrel, while logistics and tourism constituted 54% of GDP in 2010, and will be boosted by a 20% government spending intensification.

Their solid financial reserves, hydrocarbon reserves, and growth forecasts make Qatar, Saudi Arabia and Abu Dhabi the favourite bonds for investors. UAE’s economy may grow 3.3 % in 2011, Saudi Arabia 6.5%, according to the IMF, while Qatar’s growth expectations are revised to 18.7% for 2011. Kuwait’s growth in 2011 is expected at 5.7%, Oman’s at 4.4%.

Although oil production remains their primary income source, the GCC economies are trying to diversify, with some success. Other factors play a role in growth forecasts: High inflation; lack of employment opportunities amid growing numbers of youth; and unclear leadership succession in some countries. "Energy revenues have created wealth but no jobs," says Schroder’s Sidani. This is one of the biggest threats when 60% of the population is below 30 years old." Wharton’s Gultekin says the direct approach will be to increase the pool of skilled native Gulf workers. "Their challenge is to replace the large expatriate community with locals, especially on the management level," he says. "But that requires a change of attitude."