Saturday, November 7, 2009

A Tale of Two Markets: Saudi Arabia and the UAE

"It was the best of times.  It was the worst of times."

Those who read my previous post (6 November) of the Oliver Wyman/Zogby International poll and saw the stark disparity between business sentiment in the UAE and the Kingdom of Saudi Arabia may be inclined to apply Dickens' description of England and France quoted above to these two GCC states.

What is a key factor which affects and as well reflects business sentiment?  And which might be responsible for the views of Saudi and UAE businessmen?

Liquidity in the market - the availability of lendable /spendable funds: 
  1. So one's customers can buy whatever one is selling.  
  2. So one can borrow to support one's own ongoing business activities (working capital) as well make any needed long term investments in plant, equipment and property.  And perhaps an acquisition or two.  And of course to refinance existing debt as it matures.
The nice folks at Markaz up in Kuwait kindly provide a highly useful tool for exploration of this topic and even "nicer" they do so for free: Their "Daily GCC Fixed Income Report."

Let's take a look at the 4 November 2009 issue.

Look at the "Interbank Rate Section":
  1. The first thing to focus on is the dramatic decline in interest rates from 31 Dec 2008.- save for Oman.  This decrease reflects increased liquidity.  That's a good thing, though too much liquidity can be a bad thing.
  2. Next notice that Libor (the London US Dollar rate) is much much lower than the rates in any of the GCC states.  That gives a relative indication of difference at the macro level in liquidity between the Gulf and Europe. 
  3. Then notice that the UAE ("AEIBOR") has the second highest rates in the GCC - an indication that liquidity is relatively strained.  Only Oman is tighter.
Notes:  
All the rates shown are for local currencies.  Libor is the US Dollar.. Euribor is the Euro.
These rates reflect the interest rate one bank would charge another creditworthy bank to place a deposit with it.
Loans to corporations or less creditworthy banks would have a margin added to this "base" rate.
 
Another interesting bit of  information in the report is the table of  5 Year Credit Default Swap Rates.  These reflect the cost of buying "insurance" on a 5 Year Bond.   The lower the price the better.

Here the takeaway is that Dubai's CDS rate is well above  that of other GCC States and even above Turkey and Lebanon.   Using these rates, one can construct a relative market price based "sovereign risk rating" matrix.  Saudi the "best" credit and Dubai the "weakest" in the GCC.  But note that prices can also be affected by  other factors than just the obligor's credit.  For example, the volume of bonds outstanding and number of "market makers" willing to write  insurance are important factors.
  
Turning back to AEIBOR, it's possible to perform a more detailed in-country liquidity analysis. 

Before we do that, a bit of "tafsir" on AEIBOR or as the Central Bank of the UAE calls it "EIBOR". The rate is determined (in banker-speak "fixed")  by getting quotes from 12 banks in the Emirates.    The two highest and lowest quotes are excluded.   An arithmetic average of the remaining quotes is then computed.  That result is the EIBOR "fixing".

As we ranked liquidity at a country level above by looking at rates, we can do the same with individual banks.    Unfortunately, I couldn't find the CBUAE's report for 4 November on their website.  So let's work with the CBUAE's  current report.   Select "Today's Eibor Rates" for the fixing report.

At first glance, one can draw some quick impressionistic conclusions about relative liquidity.  Those banks with higher prices are less liquid than those with lower prices.

But one big caveat to our study of individual banks.

This is but a single data point.   The rates from a single day.

To really understand the liquidity situation of banks one would have to look over a longer period to see if there was a persistent pattern.

Why?

Bank interest rates reflect not only liquidity but management of their interest rate "books".  Most banks do not match fund assets with liabilities.  An example of match funding would be to take a six month deposit to fund a six month loan made by the bank.  Rather banks deliberately create interest rate mismatches by taking, for example, a one month deposit to fund a six month loan.  At the end of the one month when the deposit was due, the bank would then take another deposit.  The tenor it would take would depend on its existing interest rate gap book and its gapping strategy.  The result is (in banker-speak) interest rate "gaps".  If you take a look at the notes to your favorite bank's financials, you'll see an interest rate risk table which will show the gaps that bank has taken.

The Central Bank of Bahrain has fairly extensive disclosure requirements so let's use Bank of Bahrain and Kuwait's 2008 financials.  Note 28 provides a maturity (but not a repricing gap analysis).   That will be good enough to illustrate the point. Bear in mind that the typical 5 year loan  resets interest every 3 or 6 months.  And the interest rate reset is what drives the interest rate gap.  But close enough for both government work and this blog's purpose.   

The bank's treasurer uses the interest rate on deposits as the tool to achieve the desired gap position. With deposits, he can adjust his bank's bid rate (the rate which the bank will pay another bank or a customer for a deposit placed with it) and his bank's offer rate (the rate at which the bank will place a deposit with another bank) to attract or discourage transactions.

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