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Bank credit has been very slow to pickup in the six nations of the Gulf Cooperation Council (GCC). How big a problem is this for their economic recovery?
Sluggish credit growth in the post-crisis period was hardly a unique development, as indicated in our latest Regional Economic Outlook. More than a dozen countries in the Middle East and Central Asia region, and countless more outside the region, shared this experience. But while there are clearer signs of recovery in some countries, credit to the private sector is still barely growing in the GCC, notwithstanding policy efforts to revive it.
It might seem easy to ring the alarm bells. After all, won’t the prospect of weak credit growth restrain economic activity in the short-term? Perhaps. But we believe the negative impact of credit growth may not be quite so severe.
Why not? In part, that answer lies in how we arrived at the current situation.
Causes of the credit slowdown
In the five years before the crisis, the GCC countries—Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the U.A.E.—experienced significant increases in credit, spurred by favorable macroeconomic conditions. At its peak, credit growth exceeded 30 percent year-on-year.
The crisis reversed the situation. Credit growth quickly fell and has remained anemic so far during 2010.
Factors affecting both the supply of, and demand for, credit played a role in this slowdown.
- On the supply side, while funding strains have been overcome, higher risk aversion and stricter lending policies by banks have stifled credit growth. The decline in credit growth may also reflect banks in all GCC countries reconsidering their lending practices, which had sometimes relied more on the reputation of the borrower (so called ‘name lending’), rather than credit analysis.
- In most countries in the GCC, demand for credit appears to have dropped in association with the decline in real estate prices, the slowdown in construction activities and non-oil growth, and the corresponding weakness in investor and consumer confidence.
Silver lining in the credit slowdown
There are a number of reasons why we are not as concerned about the slowdown in credit growth.
1. The adjustment in credit growth reflects a much needed correction from very high—perhaps unsustainable—rates of credit growth witnessed during the boom years.
2. There are already some signs of a rebound in credit growth—albeit modest—in Bahrain, Oman and Saudi Arabia.
3. Banking system health is generally satisfactory. Capital adequacy ratios—in loose terms a bank’s ability to absorb losses—remain strong. And stress tests conducted by IMF staff indicate that banks are generally resilient to severe shocks. Moreover, there was significant progress in financial and corporate restructuring during 2010, helping to shore up market confidence. The underlying conditions are therefore in place to support a resumption of credit growth, although this might be gradual.
4. The overall numbers for banking sector credit growth mask important underlying trends. We are seeing a positive trend of credit growth away from volatile sectors (like real estate and household equity purchases) toward more stable sectors such as industry, trade, and services. Credit growth to these sectors has been healthy in a number of countries.
5. Bank credit growth numbers don’t tell the whole story. The private sector is getting some credit through alternative channels of financing:
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- Some governments are guaranteeing foreign debt issued by government-related entities (Qatar and Abu Dhabi).
- Some governments are increasing their advance payments to contractors (Qatar and Saudi Arabia), thus lowering the need to seek bank credit to cover their working capital.
- Specialized credit institutions, especially in Saudi Arabia, have significantly increased their credit to domestic sectors.
6. In general, corporates in the GCC appear to have adequate cash balances and can finance their operations from these cushions in the short term.
So, is policy action still needed?
While fiscal and monetary policies have been geared to support the GCC to emerge from the impact of the global crisis, this isn’t an open-ended option. Ultimately, the private sector will have to play a more active role and, for that, reviving private sector credit growth will be instrumental.
Just as supply and demand factors were at work in the credit slowdown, so should policies aim to address those factors:
- On the demand side, we believe it is appropriate for country authorities to maintain fiscal stimulus—if there is fiscal space—and quantitative easing in 2010, and possibly into 2011. These policies would need to be revisited at signs of a pickup in inflation, which remains relatively muted.
- To improve credit supply: Corporate governance and financial disclosure and transparency will be key. And banks will need to build up their capacity to assess credit risk. Additionally, there is a need to develop alternative domestic sources of corporate funding, primarily domestic or regional debt markets. This will not only help with diversifying the economy’s financing channels, but also improve standards for financial disclosure.