WILL IT HIT HOME?
The worst financial crisis in the world since the Great Depression is having a visible impact on the countries in the GCC region. Mayank Singh and Akshay Bhatnagar report

In September 2008, 11 months after the financial storm struck, the US government made its most dramatic interventions in financial markets since the 1930s. In two tumultuous weeks the Federal Reserve and Treasury between them nationalised the country’s two mortgage giants – Fannie Mae and Freddie Mac; took over AIG, the world’s largest insurance company; extended government deposit insurance to $3.4trn in money-market funds; temporarily banned short-selling in over 900 mostly financial stocks and most dramatic of all pledged to take up to $700bn of toxic mortgage-related assets on to its books. The landscape of the US finance industry has been radically changed. Lehman brothers has gone bust, Bear Stearns and Merrill Lynch have been swallowed by commercial banks themselves. In little more than three weeks America’s government, had expanded its gross liabilities by more than $1trn. In late September the turmoil spread and intensified. Money markets seized up across the globe as banks refused to lend each other. Five European banks failed and European Union governments fell over themselves to prop up their banking systems with rescues and guarantees.

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Tracing its roots
The crisis has its roots in the biggest housing and credit bubble in history. House prices in the US are on average down by almost a fifth since their peak in 2007. The credit losses on the mortgages that financed these houses and on the pyramids of complicated debt products built on top of them are still mounting. In its latest calculations the IMF reckons that worldwide losses on debt originated in the US will reach $1.4trn, up by almost half of its previous estimate of $945bn in April 2008.
 
Globally banks alone have reported just under $600bn of credit related losses and have raised some $430bn in new capital. It is clear that many more write downs lie ahead. According to IMF estimates, without government action along the lines of the US’ $700bn plan, credit could shrink by 7.3 per cent in America, 6.3 per cent in Britain and 4.5 per cent in the rest of Europe. Much of the rich world is already in recession, partly because of tighter credit and partly because of the surge in oil prices earlier this year. Output is falling in Britain, France, Germany and Japan.

Closer home
The contagion effect seems to have arrived at the shores of the Middle East as well. Though the region may avoid the worst case scenario, it is sure to feel the heat. And the signs are already there. The capital markets across the region have been in free fall. Saudi Arabia’s Tadawul Index is down by over 48 per cent since its high of 2008 (see Box). The MSM index has fallen by over 41 per cent since its high of 12,164 points on 12 June 2008. The total value of erosion on the MSM from June 12 to October 23 has been worth RO3,779.79mn. Says Rajeev Singh, partner, transaction advisory services, Ernst & Young, “The biggest concern at the moment is liquidity. And it is not about liquidity at the retail level, but rather the big ticket financing on infrastructure development.”

UAE’s Central Bank in September announced the setting up of a Dhs50bn (RO5bn) emergency lending fund for the country’s banks to tap into. Central banks in Saudi Arabia, Kuwait and Oman have also pledged their support to their respective banks in case of a funding shortfall. Says Singh, “The important thing here is for investors to remain confident about the economy and the government should do all it can to maintain and improve investor confidence. This sentiment is more important than ever.” In the following pages we zero in on the impact of the meltdown on a number of frontline sectors in Oman and see how they are copying with the situation.

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Banking
Robust liquidity situation
The credit squeeze is having an insignificant impact on domestic banks due to their limited exposure to global finance

If you look at the certificate of deposit (CD) interest rates of the Central Bank of Oman (CBO), it still stands at one per cent, this indicates that there is no concern about liquidity in Oman,” says H V Sheshadri, senior deputy general manager – risk, Bank Sohar. CD’s are instruments used by the CBO to maintain liquidity levels in banks. The fact that the CBO has not revised CD’s interest rates shows that it does not feel the need to inject more rials into the market. Commercial banks held CBO’s CD’s and government development bonds worth RO770mn at the end of September 2008. Banks can repo (borrow from CBO) this amount from the CBO at any time and add to their liquidity. Macro numbers too underline the health of the industry. At the end of September 2008 the core capital and reserves of the banking system stood at RO1.54bn. Profits stood at RO209.3mn as against RO145.4mn during the corresponding period in 2007.

Local accruals
“We have not been impacted because banks in Oman have predominately local cash deposits,” says Sheshadri. Bank Sohar achieved an operating profit of RO3.35mn for the first nine months of 2008 with an operating profit of RO1.79mn for the third quarter ended 30 September 2008, a 167 per cent jump over the corresponding period last year. Its customer loans and advances reached RO562.2 mn – a growth of 85 per cent while customer deposits increased to RO496.05mn a growth of 104 per cent during the year. The risk of non-performing assets has been kept at bay largely due to the good quality of lending. For large scale projects like Sohar Aluminium, a number of banks come together and lend as a consortium. The inability of a single bank to fund such dollar denominated loans has proved to be a blessing in disguise as it limits the exposure of each bank.

Regulatory intervention
The CBO has been taking a pre-emptive stance to mitigate any visible impact of the slowdown. It has reduced the cash reserve ratio (CRR) for banks by allowing CBO’s CD’s and cash portfolio of banks under the eight per cent reserve requirement upto three per cent. This is expected to inject RO270mn into the banking system allowing banks to meet their short term liquidity needs. The lending ratio norms (how much a bank can lend) which was supposed to be tightened from 85 per cent to 82.5 per cent from November 2008 to contain the fast growth of credit in the banking system, has been deferred till restoration of normal conditions in the international markets.

The results speak for itself. Domestic inter-bank interest rates which touched a high of about 2.6 per cent on October 2007, dropped to two per cent in the second week of October, indicating a softening of the liquidity situation. Credit growth in the banking system was a healthy 51.4 per cent higher than last year. The CBO avers that banks may find it difficult to access external funding for sometime due to the severe global credit squeeze and increasingly restricted access to international money markets. Since this is a global problem no single country can do much to improve the international market conditions.

Construction
What Slowdown?
For the construction and engineering industry it is business as usual with a few minor pinpricks

We have won projects worth RO50mn in the last six months, the amount and projects in the market are at an all time high and we have a long list of projects that we are tendering for in the coming months,” says Hans Erlings, CEO, Galfar Engineering and Contracting. The Muscat Highway, a gas plant in Harweel, an ODC contract in northern Oman for Petroleum Development Authority (PDO) are some of the projects being executed by Galfar. The swagger in Erlings claims is proof that the construction and engineering sector has remained largely unscathed by the crisis.

Flip side
There are others who would like to strike a more cautious note – Says John Steele, general manager, Douglas OHI, “If the mortgage situation worsens then the question is will the clients fulfill their contracts. A company has to be cautious whether the client has the money as in such situations payments can get delayed.” Steele points out that one of the projects that the company was expecting to work on has got delayed. The big question being raised in the construction and engineering industry is whether the mega leisure and tourism projects like Yiti, Muriya etc will get delayed due to the crisis. It is common knowledge that a number of integrated tourism complexes saw a number of speculators picking up properties to resell them at a premium, but with hardening interest rates, it is going to be difficult for them to get buyers. “I would like to know as to how many of these properties are back in the market,” says Steele. The fall in tourist numbers may also encourage some of these projects to go slow.

Douglas OHI is partly owned by Interserve from the UK, as the situation in Europe worsens it may have an impact on the company’s operations in the Middle East. “If the UK and Ireland go into recession, then it will put more pressure on us (in Qatar, Dubai and Oman) to perform,” says Steele. The industry though has not had any visible impact till now with banks more than willing to fund the capital expenditure of construction companies. Douglas OHI has recently purchased a 70,000 sqmtrs plot of land near Naseem Gardens to set up a plant yard and a permanent labour camp.

Commodity concerns
The erratic supply of some commodities is a definite concern area for the industry. Erratic supply of cement and plastic pipes are forcing companies to resort to novel measures. To ensure a steady supply of plastic pipes for an off-plot facility in Qarn Alam, Galfar purchased the entire caché of pipes needed for the project in 2007 at much higher prices. Says Erlings, “My objective is not to gain money by speculating on material but to deliver projects at a given budget.”

The erosion in commodity prices has come as some relief to the industry. For example the price of steel has fallen from RO620 per tonne in 2007 to RO350 per tonne his year. Copper and Bitumen prices have also followed suit. A strengthening dollar is inadvertently helping construction companies. “The Indian rupee-rial exchange rate is at an eight times high and since Galfar has 19,000 employees from India, for them it is a welcome salary increase,” says Erlings.

Brokerage & Capital Market
Best of the bad deal
The meltdown on the MSM is not just impoverishing investors but is also taking a toll on brokerage companies

June 12, 2008 is a date that Sankar Kailasam, senior vice president, asset management, Gulf Baader Capital Markets (GBCM) remembers vividly, it was the day when the MSM index touched a high of 12,164 points and then started its great fall in which the index has broken one resistance level after another to reach a low of 6587.93 on 8 October, 2008. As the global meltdown continues unabated, there seems to be little respite in sight. Says Kailasam, “Even if the market has to catch up with January 2008 levels of 9035 it will have to jump 27 per cent from its present levels.” In financial terms this translates into moving up from the current market capitalisation of RO7 to RO11bn. Generating this additional RO4bn seems like a distant sign post right now.

Liquidity squeeze
As foreign institutional investors in the US and Europe got hit by the sub prime crisis, they started withdrawing their funds from global markets. Foreign investment on the MSM made up 27 per cent of the total traded volumes in April 2008. Out of this GCC players made up 20-21 per cent and foreign funds constituted six percent. A back of the envelope calculation shows that six per cent of the April 2008 market capitalisation of RO10bn comes to RO600mn or the equivalent of three months of trading on the MSM based on an average daily turnover of RO12-15mn. “From June to September whatever was being sold by FII’s was being picked up by GCC players, but from September GCC funds started withdrawing due to problems in their home markets,” says Kailasam. This double whammy proved to be the proverbial last straw on MSM’s back. A liquidity problem in the market has exacerbated the capital markets problem. Market sources have told OER that around August as FII’s starting withdrawing funds from Oman, interbank lending from foreign and regional banks stopped and FDI dried up most banks were faced with a glut of dollars.

Facing the brunt
Broking companies have been the first ones to get hit by the market meltdown. Brokerages earn their income from three sources. One, investment income earned on their own proprietary fund; second, brokerage income earned from carrying out transactions in the market and third, fee based income from managing portfolios of clients. The falling volume on the MSM has affected the fee and brokerage income of firms and has led to an erosion of its assets.

GBCM on its part has tried to weather the storm by being prudent. “As a company we are under-leveraged and well capitalised. But smaller companies which are not well capitalised and more leveraged will be impacted,” says Kailasam. GBCM was aggressive till April 2008, but as values started getting impacted it became defensive. “Sensing the mood of the market we cut our positions in high-beta stocks and invested in defensive stocks,” he adds. The company which was growing at 35-40 per cent per annumn in the last few years expects a lower growth in Qtr3, 2008. Though no one is sure as to how long the international financial turmoil will continue, in Oman analysts expect a recovery from Qtr4 or early next year.

Hospitality
A good time to check-in
Oman being a niche tourism destination, hotels like Shangri-La’s Barr al Jissah Resort and Spa expect to remain largely unscathed by the financial crisis

When people do not have discretionary income the first thing that they cut down is leave or leisure activity,” says Arbind K Shrestha, general manager, Shangri-La’s Barr Al Jissah Resort & Spa. Going by the logic there is bound to be some adverse impact on tourist arrivals in the sultanate, but the hospitality industry has so far had little cause for concern. The Shangri-La saw 99 per cent occupancy in October 2008. Its average room rates have also gone up by 35 per cent this year.

So what are the reasons behind this paradox – one, the severity of a financial crisis differs from country-to-country based on the quality of tourists that it attracts. There are mass tourist destinations like Dubai, Phuket or Bali which attract the high, mid and low income travellers and there are niche or boutique destinations like Oman or Abu Dhabi which attract the well-heeled tourist. As incomes erodes the mid and low end customers stop taking a vacation altogether affecting mass tourism, but a boutique destination continues attracting its clients.

Second, Oman has around 1800 room nights compared to upwards of 7000 room nights in Dubai. And two-thirds of this capacity is in Muscat. The demand for room nights far exceeds the supply giving the hospitality industry a much needed cushion during a downturn. Third, since in-house guests comprise 90-95 per cent of people dining out at restaurants in a hotel like Shangri-La, the impact on the food and beverage (F&B) segment is next to negligible. Lastly, with a 30 per cent growth in tourists from GCC countries in 2008, the hospitality industry is sure that the downturn in the western hemisphere will pass without much of a hiccup. The Shangri-La attracts 40 per cent guests from the UK, 18 per cent from Germany, 15 per cent from the rest of Europe and the remaining from the GCC countries.

Survival strategy
The industry though is keeping a keen eye on the turmoil. Says Shrestha, “Any hotel that cuts costs or compromises on service during a downturn will not survive in the long run.” So contrary to expectations the best way to negotiate a slowdown in the hotel business is by improving the quality of service that one offers.

For example the Shangri-La has introduced a butler service for all its guests staying at the Al Husn Hotel. Thus Innovative service, a better value proposition and rewarding customers is the way to go. “In a business it is essential to understand what adds value (like food) and what does not (expensive flower arrangements). One can cut down on the latter but not on the former,” he adds.

Instead of cutting room rates and discounts the hotel is looking at offering customers value added packages for example it may throw in an additional spa treatment for free or a dinner for two for tourists. Cost cutting goes hand-in-hand. Says Shrestha, “With three properties in operations we can look at improving our services and cutting on wastages like utilities at the same time.”

Real Estate
Realty bites
The real estate sector expects to swim through the crisis without much of an impact, but the going may get tougher in the months ahead

The Real estate sector in a tizzy? The question that is bothering stakeholders and investors alike is – will the global crisis have an adverse impact on the real estate sector in the region. It may be difficult to say in which direction the sector will move for now. The real estate developers are maintaining a brave front that all is well and the global meltdown will have a minimal impact on Oman.

Nick Smith, CEO of The Wave, Muscat says on an optimistic note, “The real estate markets in US and Europe have been severely affected due to the sub-prime crisis. There is no sub-prime market in Oman. The circumstances in this country are incredibly favourable. Oman has a substantial income from the oil and the market is well regulated. Compared to other GCC countries, the real estate market in Oman is relatively new. There is a huge demand here. There are many Omanis and expatriates based in Oman who have a healthy appetite for quality real estate products.”

Issues lurking below
Others take a more balanced view taking into account the prevailing market conditions Richard Russell, Managing Director and CEO, The Blue City Company 1 echoes similar views as he says, “While it isn’t reasonable to expect the region to be totally immune to the current global financial shock, for Oman, the risks to the economy and financial system appear to be manageable. Current indicators suggest that the Omani national economy will be able to weather this downturn and that there will not be a significant impact on the performance of the Sultanate’s overall economy.” So is it all honky-dory? Doesn’t seem so. There are issues which the industry needs to sort out or is going to face in the coming months.

Credit crunch
The credit squeeze is expected to make it difficult for developers who are yet to secure funding for their projects. Even if they find investors willing to take the risk, the cost of borrowing will shoot up to put pressure on their margins. To make matters worse, if the government follows Dubai in introducing an escrow account it may make developers scout for alternate sources of funding. Those who have the funding in place may face investors exercising redemption options in large numbers if they don’t achieve their targets in a stipulated period.

Overall, expectations are that the kind of price escalation that has been seen in the primary market in the last one-two years will be arrested and that developers will be more prudent in their pricing strategy.

Some of the new big-ticket projects that are still on the drawing board stage will get deferred. In the secondary market, the buyers at a premium will be hard to get, impacting sales. However, the rental market is not expected to be affected due to the steep gap in demand and supply. Some analysts claim that there has been a 15-20 per cent of a correction in real estate prices and that more may be in the offing. This is largely the result of a slowdown in off-take of properties in the market as propspective buyers postpone their purchase.

Manufacturing
Hitting where it hurts
The manufacturing sector in Oman has been hit by eroding export markets and wild fluctuations in commodity prices

The manufacturing sector in Oman is dependent on exports so anything that happens in the international markets has an adverse impact. We are not as decoupled from the rest of the world as a Saudi Arabia,” says S Gopalan, CEO, Reem Batteries and Power Appliances. With over 90 per cent of the company’s products being exported, the company is echoing a genuine concern. The company supplies batteries to original equipment manufacturers (OEM) in 45 countries. Around 20 per cent of its production of 1.75mn batteries (350,000 batteries) a year goes to the South American and European markets.

The ongoing credit crisis and growing job losses in the US and Europe is having an adverse impact on automobile production. Over 159,000 jobs were lost in September 2008 in the US, the highest number of losses in the last five years. Ford Motor Company cut automobile production by 15 per cent during the second quarter of 2008 and will follow this with a 15-20 per cent cut in Qtr3, 2008 and a 2-8 per cent cut in Qtr4, 2008. This is having a cascading effect on companies like Reem Batteries. Says Gopalan, “Our customers and distributors are not in a position to finance their stocks.” The replacement market for batteries has also been hit due to the increasing popularity of mass transport systems in the face of high gasoline prices (oil prices touched an all time high of $147 per barrel in July 2008).

Competition comes knocking
The loss of markets in the US and Europe has led manufacturers from the Far Eastern countries to train their sights on the Middle East market. Korean and Chinese companies have been giving regional companies a tough time with rock bottom prices. “In Syria which was a big market for us, we have started facing competition from Turkish companies, which play on price points,” says Gopalan. The company’s sales volume has gone down by 20 per cent.

The fluctuation in commodity prices is proving to be another major headache for the company. Lead and polypropylene are the two biggest inputs which go into making batteries. Lead which was trading at $3800 per tonne in October 2007 fell to $3000 per tonne in April 2008 and has further slipped to $1560 per tonne in October 2008. The company buys lead based on the average monthly price of the commodity on the London Metal Exchange (LME). If the price of lead falls below the average LME price during a particular month, then customers are not willing to pay for the batteries at higher prices, forcing the company to incur a loss. “Whether it is $1000 or $3000 per tonne, the industry likes to have stable prices,” says Gopalan. The behaviour of the commodity market is linked to the fate of other markets like stocks, energy and currencies. If a fund manager feels that he can earn better returns from investing in an alternative financial instrument then he shifts his money. Thus money flows from stocks to currencies to commodities creating volatility. As the financial crisis bites harder the flow of currency has multiplied enormously leading to price fluctuations.

Taking corrective steps
Reem Batteries has been working on improving efficiencies by implementing a lean management initiative (borrowed from Toyota’s management system). Cost control is being brought in through a better utilisation of resources. The silver lining to the situation is that there is no liquidity problem in Oman and well capitalised companies like Reem Batteries have banks that are ready and willing to lend. The company has recently got a term loan from Oman Development Bank (ODB) at three per cent interest rates. The diverse nature of its market from US to Europe to Libya and Nigeria will also help the company to tide over the downturn.

Investing
Vanishing options
Investors across income segments are looking for credible options to invest their savings and making a decent return

The high net worth individuals (HNIs) are in a fix these days world over, more so in Oman. With the financial meltdown in all the markets, their wealth has gone down drastically. Many of them have exposures in western markets apart from the local and regional markets. They have been hammered from all sides. Sankar Kailasam, vice president – asset management, Gulf Baader Capital Markets summarises the plight of HNIs as he says, “Everyone has been affected. Many people in the top-end band have exposure to global markets. When you have multi-market exposure especially in hedge funds, you are bound to get affected in such circumstances.”

Double-whammy
What about the not so sophisticated HNIs? He replies, “In many cases, they have over leveraged themselves to a very high degree. They have to service interest rates as high as seven per cent whereas the collaterals’ value has gone down drastically. They are forced to sell them or defer the payment.”

Those who have the capacity to withstand the turmoil are holding back their investments and are not going for redemption. They can hold it for a period as long as next two years if required. “My investments in Muscat Securities Market have depreciated by almost 30 per cent but I’m not going to sell my stocks. I’m here for long term gains and confident that the market will recover and my shares’ value will go up again. So in a sense it is a notional loss only,” says Mohamed Ali A. Amir Sultan, Director, W.J. Towell & Co.

Many of the HNIs are smart and doing bottom fishing with their spare cash. Some are busy repatriating their investments from overseas markets and ploughing it back in the Sultanate or the region. But the buzzword wherever you go is ‘be liquid – though you may not earn on your spare cash but you won’t lose either’. An Arab co-founder of a US-based company with major interests in Oman confided that he sold most of his investments sometime back before the spread of the sub-prime crisis and has not re-invested his liquid money anywhere.

Despite the temptation of acquiring assets that are grossly undervalued due to the market bloodbath to make up for their losses, most of the HNIs are adopting the strategy of ‘security first and gains later on’.

Retail worries
An HNI may have deep pockets to live through the turmoil, but small and medium investors have been hit hard by vanishing investment options. The safety of their savings has been a paramount concern for them. With Inflation in the 11 per cent range and the cost of funds being around five per cent, small investors are caught between the devil and the deep sea. Says Kailasam, “They have to be invested in equities either through a mutual fund or directly.” As valuations of shares have fallen investors can go in for a systematic investment plan (SIP) or investments at regular intervals. The MSM has over the last ten years given an average return of 13.2 per cent every year. But for investors who have burnt their fingers these numbers may be of little comfort.
 

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