By Masood Ahmed Middle East oil exporters are squarely facing the worst financial crisis since the Great Depression head on. Despite the sharp drop in oil prices last year, the oil exporters rightly decided to maintain spending by drawing upon reserves amassed during the boom years. High public spending and exceptional anticrisis financial measures have not only cushioned oil exporters’ own economies but are also contributing to sustaining global demand. They have also helped the interlinked economies of neighboring oil importers. Facing this boom-bust cycle Between 2004 and 2008, Middle East oil-exporting countries grew by about 6 percent a year and accumulated $1.3 trillion in foreign assets. With the striking drop in oil prices—from a peak of $147 per barrel in mid-2008 to around $30 per barrel at the beginning of 2009—the countries of the Gulf Cooperation Council (GCC) have been hardest hit. Iraq and Saudi Arabia are expected to see the most pronounced drops in oil GDP growth—8 and 15 percentage points, respectively—this year.
During the precrisis boom years, banks had lent substantial amounts for real estate and equity purchases and made large profits. With the onset of the crisis, asset values fell sharply and the global deleveraging led to a severe tightening of credit conditions, especially in the GCC. Banks’ balance sheets have come under pressure credit growth has slowed sharply—up to 40 percentage points in Qatar.
Now—that is, during this downturn—the foreign assets accumulated during the boom years are being used for countercyclical fiscal spending. Witness Saudi Arabia, which announced the largest fiscal stimulus package (as a share of GDP) among the G-20 for 2009–10, and a $400 billion investment plan over five years. Governments have also directly injected capital into stressed financial institutions and central banks have provided liquidity support to stabilize financial systems. These anticrisis measures have taken the sting out of the impact of the crisis. The non-oil sector is now projected to grow by 3.2 percent in 2009 (see the IMF’s latest outlook for the Middle East), with overall growth slowing only to 1.4 percent. Imports are being maintained at precrisis levels—at $700 billion in 2009—and helping the global economy weather the downturn. Looking to the future The flip side of continued public spending is that room for pursuing countercyclical policies falls if the crisis is prolonged. Some major oil exporters—like the GCC countries, Algeria, and Libya—have sufficient reserves to sustain spending over a longer period. Others—like Iraq, Iran, Sudan, and Yemen—have less fiscal space and will need to prioritize or cut back government spending and subsidies. The banking systems have so far absorbed the stress and banks have remained solvent and profitable, although at a lower level. Deposit growth and capital inflows are beginning to regain strength, yet private sector credit has remained sluggish: instead, banks are opting to build up reserves in the central bank. Could the asset price bubble and excessive borrowing and lending by banks have been prevented? Given that the global outlook is improving and oil prices are rising again, what can be done to offset procyclical behavior on the part of banks? These questions are of particular importance for oil exporting countries since oil price swings are very large and, therefore, business cycles are particularly severe. Of course, not all oil exporting countries have had the same boom-bust experience, given that prudential measures and supervision were stronger in some countries than in others. One way to dampen the cyclicality of bank borrowing and lending would be to introduce dynamic loan loss provisioning—that is, to build up cushions during good times to be used during bad times. While this may cut into banks’ profits, it could ensure continued lending during economic slumps and reduce the ultimate fiscal cost when tail risks materialize. Looking further ahead, there may be value in developing alternatives to bank financing, such as local private debt markets. This would allow banks to concentrate more on financing small and medium-size enterprises that create private sector jobs and help diversify economies.