Gulf states need a more co-ordinated response
Despite strong economic growth and adequate liquidity, the financial markets of GCC countries have not been immune from the global volatility in recent weeks. GCC stock markets have experienced unprecedented volatility since early last month. Investors still have fresh memories of the 2006 decline which eroded nearly 60 per cent of the share values in the Saudi and UAE stock markets. Additionally, credit costs have risen in step with international developments and potentially threaten the burgeoning project finance market in the Gulf.
GCC governments are clearly concerned about the health of their financial markets and have already taken individual steps to restore confidence. What they have failed to do so far, however, is to co-ordinate their responses. This failure will diminish the effectiveness of their national responses to this common financial crisis. All Gulf states have tried to increase liquidity and restore confidence in their banks and stock markets, but they have chosen different policies for this purpose. The Central Bank provided an additional facility of Dh70 billion (US$19.06bn) to commercial banks in the UAE last Wednesday after an earlier Dh50bn short-term facility proved insufficient.
In contrast, the Kuwaiti central bank took a more immediate approach and injected liquidity directly into the banking system in the form of deposits. Additionally, it cut its benchmark discount rate from 5.75 per cent to 4.5 per cent on Sept 29 and, contrary to the UAE, interbank lending rates have been declining since Oct 5. The Saudi Arabian Monetary Agency (SAMA) equally cut its repo rate - equivalent to the Fed discount rate - to 5.5 per cent for the first time since 2007 and reduced the reserve requirements for commercial banks from 13 per cent to 10 per cent on Oct 12. Nevertheless, the Saudi discount rate remains higher than those of other GCC countries.
In addition to these monetary measures, the GCC governments are taking several other steps to strengthen their stock markets. These include easing the restrictions on share buybacks by listed companies, indirect support for property prices, revised limits on daily share price fluctuations and stronger bank deposit insurance coverage. The Kuwait Investment Authority and Qatar Investment Authority are also supporting their respective stock markets by large quantities of share purchases.
There is no doubt that these measures will have a positive effect on GCC financial markets. But if their governments do not co-ordinate their policies, this can lead to large flows of money across GCC markets and cause more instability. The GCC stock markets and banks are highly interconnected and as one Gulf state takes the lead in restoring confidence in its financial markets, investors might switch their assets from other GCC markets.
For example, divergence of deposit rates can encourage investors to move their savings to the countries with higher rates, causing liquidity shortages in neighbouring countries. The Gulf states will need to address this, otherwise some governments may be tempted to impose restrictions on capital flows to prevent capital flight. The necessity of a multilateral approach is best demonstrated by what happened in European financial markets recently. Without prior co-ordination with other EU members, the Irish government augmented its deposit insurance policy to insure all bank deposits without any size limit.
In response to this policy, nervous investors in many European countries moved their savings to Irish banks, causing liquidity shortages in other EU member countries. This unilateral Irish policy forced other EU governments to raise their own deposit insurance ceilings. Furthermore, the Irish government's unilateral policy drew considerable criticism from other EU governments and weakened the EU's ability to offer a co-ordinated response to the crisis. Fortunately, the EU governments have been able to co-ordinate their policies in recent weeks.
Since there are no restrictions on the flow of capital among GCC financial markets, these governments must follow the example of the EU and co-ordinate their responses to this global crisis. Nader Habibi is Henry J Leir Professor of Middle East Economics at Brandeis University, US Eckart Woertz is Programme Manager Economics at Gulf Research Center in Dubai firstname.lastname@example.org