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Gulf States avoid sub-prime blues

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Having largely avoided direct exposure to US sub-prime mortgages, Standard & Poor’s chief economist David Wyss says that the main impact of the US financial crisis on the Gulf States will be lower interest rates. He predicts an imminent fall in the Fed discount rate to 1.75 per cent, and no move to hike rates up before the middle of next year.

‘The Federal Reserve will not want to repeat its previous mistake of keeping rates low for too long, and so I expect a tightening will come the moment we can see a definite improvement in the economy,’ said the Wall Street economist who was in Dubai for a conference this week.

Risks ahead

‘We think the economy will pick up in the second half of the year but there is a risk that it could fall back into recession in early 2009 after the presidential election. House prices should bottom out in the middle of 2009 and that is when we would expect to see rates starting to rise again.’

Falling interest rates – courtesy of the UAE dirham’s peg to the US dollar -have been the main effect of the ongoing US financial crisis on the Gulf States. Direct losses due to exposure to sub-prime mortgages have not exceeded $2 billion, although there are rumors that some sovereign wealth funds have made large undeclared losses but we will never know for sure.

Deutsche Bank has also highlighted an estimated $400 billion in losses to sovereign wealth funds due to the fall in global stock markets as a result of the crisis. But clearly these are book losses from markets trading at all-time highs last October.

In addition, there has been an impact in sukuk issues which are down by a half in the first quarter of 2008 on the same period a year earlier. These are basically corporate bonds issues structured to be Shariah-compliant but the impact of the US financial crisis on yields has been the same as for conventional bond issues.

Standard & Poor’s now expects sukuks to start to pick up by the end of 2009. ‘Actually the floodgates could open as soon as one corporate goes ahead with a sukuk, as there are a great many new projects that need funding,’ said S&P regional managing director Jan Willem Plantagie.

Thus it is arguable that a few regional projects are not proceeding as fast as they might have done without the US financial crisis. However, this impact is undoubtedly being more than offset by the availability of funds at much cheaper rates of interest in the GCC’s dollar-pegged economies.

Does this mean that low interest rates are going to turbo charge an already accelerating local economy? And could that end in a nasty accident with real estate becoming overvalued as it has in the United States and European economies like the UK, Ireland, Spain, France and the Netherlands?

‘It does remind me a bit of Texas in the early 1980s when I advised a bank there on its exposure to oil. They had one-third Houston commercial property, one-third residential and one-third corporate loans,’ said Dr. Wyss. ‘The problem was that all three lending categories depended on the oil price, and that particular bank is no longer with us.

‘However, I find it hard even in the worst scenario to see the oil price going below $91-a-barrel, and that will still mean massive liquidity in the Gulf States. OPEC has a $400 billion surplus and that will leave room for solid growth in the Gulf even with a slowdown.

‘On the other hand, the European Central Bank is doing just the opposite of what I think is appropriate for its economy right now, and you could argue that unsustainable bubbles are emerging.’

Dr. Wyss said that the present financial crisis reminds him most of 1991-2, although in the US that was more a commercial than residential property driven crisis.

‘We built too many houses at too higher price because of the persistence of very low interest rates,’ he said. ‘And the financial markets miss-priced mortgage risk with loan-to-value ratios falling to 98 per cent for first-timers, so when house prices fell they just walked away from the loans.’

Sub-prime costs

S&P’s chief economist thinks that the IMF’s figure of $1 trillion as the total cost of sub-prime mortgage write-offs to the banking sector may be too high, and believes write-offs are about half done: ‘Writing loans down to a market value of 80 cents in the dollar is overdoing it, as I reckon the real write-down will not be more than 95 cents. But markets have to correct to value and that is what is happening.’

All the same Dr. Wyss believes that most of the bad news is now out in the marketplace, and that sets the scene for a recovery. The not so good news is that the effect on continuing business has been dramatic and huge job losses look inevitable in the US banks with the best and brightest heading to places like Dubai which are so far immune from this global crisis.

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Written by Peter Cooper

April 14, 2008 at 11:56 am

Posted in Banking, UAE Stocks

2 Responses

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  1. There has come winter 😦
    It became cold and cloudy!
    Mood very bad 😦
    Depression Begins

    DDDepressionnn

    November 20, 2008 at 8:28 pm

  2. […] Gulf States avoid sub-prime blues Having largely avoided direct exposure to US sub-prime mortgages, Standard & Poor’s chief economist David Wyss says that the main impact of the US financial crisis on the Gulf States will be lower interest rates. He predicts an imminent fall in the Fed discount rate to 1.75 per cent, and no move to hike rates up before the middle of next year.   ‘The Federal Reserve will not want to repeat its previous mistake of keeping rates low for too long, and so I expect a tightening will come the […]


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