As oil languishes at around US$30 a barrel and with no rebound in sight, Mena banks and businesses are having to adapt to a new environment that throws up challenges and opportunities. Sarah Rundell reports.
Given that banks in the Middle East and North Africa (Mena) derive an estimated two-thirds of their revenue from oil-related exports, it’s no surprise they are feeling the bite of low oil prices. These are forcing the region’s oil producers to slash government spending, tightening bank liquidity and increasing the cost of borrowing. In a vicious circle, the low price cycle is also starting to hurt the very corporate clients that banks depend on.
The financial crisis and the Arab Spring saw many of the region’s governments pump money into their economies to stimulate growth and diversify away from oil. Now that they are being forced to trim capital expenditure, liquidity is tightening and the price of borrowing is creeping up. “Banks rely on government spending and the region’s governments are allocating less from an expenditure perspective,” says Krishnakumar Duraiswamy, head of trade finance at Abu Dhabi Commercial Bank (ADCB).
The slowdown in infrastructure spend, a key driver of the region’s economic activity, encapsulates the trend. Big infrastructure projects around Expo 2020 and the World Cup in Qatar shouldn’t be affected but other projects are starting to fall by the wayside. In the UAE, Etihad Rail, the company responsible for developing and operating the country’s national rail network, has suspended tendering for the second phase of its project, and in Saudi Arabia, where the government is reportedly renegotiating already late payments with infrastructure contractors, a raft of smaller road and petrochemical plants are being quietly shelved. In fact, Standard & Poor’s forecasts that Saudi spending on transport and infrastructure will fall 63% in 2016 as the country tries to trim next year’s deficit.
Elsewhere, British engineering company Atkins has just announced job cuts in its UAE property and infrastructure teams. “We are hearing from clients across the region that certain projects aren’t going ahead. It will have an impact on sub-contractors and the broader downstream economy,” says Motasim Iqbal, head of transaction banking, UAE and Mena at Standard Chartered.
This means that banks will have to venture further afield for opportunities, likely following the UAE construction groups bidding on contracts in Egypt and on Chinese-backed projects around the China-Pakistan Economic Corridor. The ambitious trade development initiative concentrated in Pakistan’s southern Gwadar port on the Arabian Sea and China’s western Xinjiang region, has been billed as a future route for GCC oil and gas exports into China. Marco Ferioli, Italian ECA Sace’s Mena area manager and head of the new Dubai office, sees a silver lining in the tighter market, arguing it will bring more rigour to infrastructure projects, in turn ushering in efficiency, added value and profitability to national economies.
Tighter lending conditions
The fall in government spending is starting to affect bank lending. “If bank liquidity decreases, the cost of accessing finance increases,” explains Kwabena Ayirebi, regional head of global trade and receivables finance for HSBC Mena.
Although credit is available for “names with history and balance sheets in the country” it is harder “for trading companies, real estate and retail names to find new banks or finance facilities”, explains Emre Karter, head of treasury and trade solutions, Mena, Pakistan and Turkey at Citi.
Tightening liquidity is affecting the region’s SMEs in particular, most of which can’t survive for long when banks restrict lines of credit and customers stop paying. “Receivable cycles are getting longer; payments are not happening on time and this is bad for SMEs,” says Duraiswamy. The Central Bank of the UAE’s latest Credit Sentiment Survey notes a “reduced willingness to extend business loans, especially to SMEs, with changes in credit standards suggesting a higher degree of risk aversion”. Although the trade volumes are still there, the value of trade transactions has reduced. “The volumes are still routed to us but the total values are smaller. A deal we’d have done six months ago up for maturity and going for replacement today, would now be for a much smaller amount,” says Standard Chartered’s Iqbal.
It means banks will earn less from trade finance, adding to the pain some of them are already feeling. Particularly struggling are those that have large exposures to SMEs, due to strategies encouraged and supported by the government when it stipulated that its agencies give at least 10% of their contracts to local smaller businesses. Sharjah-based United Arab Bank reported a 2015 loss of Dh166mn (US$45.2mn), and Union National Bank and National Bank of Fujairah have also reported sharp drops in quarterly profits. “The number of non-performing loans will increase going forward,” predicts Duraiswamy.
“Banks are starting to de-risk from certain segments as they become a lot more cautious and review their strategies,” says Standard Charterd’s Iqbal. Bank caution is already creating opportunities for other players to venture forth, like Beehive, the region’s first online market place for peer-to-peer lending.
Supply chain finance’s time to shine
Tightening liquidity doesn’t mean means banks can’t offer clients other trade finance solutions. “In a liquidity-constrained environment, corporations are looking to optimise their working capital and this presents an opportunity for banks,” says HSBC’s Ayirebi. Banks are working with clients to help extend payment terms with suppliers and accelerate access to receivables, which will allow them to increase liquidity and invest.
Similarly, Citi’s Karter notes increased interest from clients for supply chain finance and receivables discounting services to meet short-term financing needs. The service is particularly sought after by SMEs needing to get paid more quickly and have access to funding that is currently expensive or in limited supply in the commercial banking market.
Banks are also finding opportunities from large corporates looking to shift supplier and distributor risk off their balance sheets, says Karter. Many corporates want to improve the efficiency of their working capital to reduce the challenges they face in accessing debt from banks. One Doha-based expert has noticed increased efficiency amongst importer clients, working to better manage their inventories and slow down their import cycles in response to market liquidity and pricing.
Return of the public sector
In another trend, experts expect global suppliers to the region’s public-sector infrastructure projects to begin to leverage bank finance off the back of their own balance sheets, notes Standard Chartered’s Iqbal. Large companies are increasingly exploring alternative finance options with the region’s multilateral banks and ECAs, and using the insurance market to help structure deals and reduce cost financing costs, he says.
ECAs found few opportunities in the region for a long period during which they were squeezed out by the robust commercial bank market. But ECA demand rises in an anti-cyclical trend with real economies, which will mean more opportunities in the current market, believes Sace’s Ferioli. “If a country is facing problems like an economic slowdown or lack of liquidity and budget constraints, in order to satisfy its needs for funding projects that are strategic, sensitive and that cannot be postponed, ECAs remain an essential resource and a key player in the scenario.”
Egypt is a prime example of the trend. A decade ago the commercial bank market soaked up most of the financing of big projects in Egypt but now political and economic instability has made ECA support essential in financing investment throughout the economy. ECAs from the US, South Korea and Italy are all expected to be involved in the financing of Egypt’s US$6.9bn Tahrir petrochemical plant and last year, Siemens signed an €8bn deal with Egypt to supply gas and wind power plants aimed at boosting electricity generation by 50%, backed by Danish and German ECAs. ECAs will also play a role in enhancing SME finance in the region by supporting domestic buyers to secure better payment terms for the purchase of goods and services, under export contracts covered by their schemes.
The drop in the oil price could see banks, and the region’s governments, become more creative in how they fund infrastructure going forward, particularly encouraging more public-private partnerships (PPPs). Qatar already has a PPP framework in place and Dubai introduced new PPP laws at the end of last year which will broaden PPPs’ application beyond the water and power sectors. Oman is currently in the process of preparing similar legislation. The Qatar-based banker, who wished to remain anonymous, expects to see more government borrowing in the debt capital markets, which will kick-start infrastructure spending again. “This will feed into improved trade volumes as governments contribute more to the economics in the region,” he says.
It is not a uniform downturn across the region. The liquidity crisis isn’t biting as hard in the UAE, which has a more diversified economy compared to other parts of the region. Some countries’ banks are also more robust than others, explains Sace’s Ferioli. “Non-GCC Mena oil exporters present a higher risk because they have smaller buffers and weaker macro-prudential frameworks,” he explains, highlighting banks in Algeria and Iraq as particularly vulnerable to liquidity and credit issues. These countries’ banks are dependent on oil-related deposits, and are also exposed to oil-dependent state-owned enterprises, he says.
Although the region’s oil importers, like Jordan and Egypt, are benefiting from the lower oil prices at the moment, they could feel a “negative spillover” from their oil-dependent trading partners, which would eventually offset the benefits of lower energy prices, Ferioli adds.
Banks in Saudi Arabia, Bahrain and Oman are particularly hurting because of their heavy dependence on the oil sector. The oil price is less of an issue in Kuwait because of lower production costs and stronger reserves, and Qatari banks are insulated by the country’s LNG exports and large investments outside the region.
Things could get worse before they get better. So far, large financial buffers have allowed governments to avoid sharp cuts in public spending, especially in public salaries, supporting consumer and investor confidence and the broader banking sector. Now HSBC’s Ayirebi predicts that a drop in consumer spending could further impact trade flows.
GCC countries are also talking about introducing VAT as governments begin to look at alternative financing sources in a strategy that will cut further into consumer spending.
Experts predict that aftershocks in the corporate sector will be felt in the year ahead. Historically, corporate defaults in the energy sector have tended to follow falling oil prices with a lag of about a year in reflection of the typical one-year hedging horizon used by producers.