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The US subprime crisis has hammered the global financial markets and brought them to their knees. After several months of turmoil, financial institutions are still reeling from the squeeze in money markets and access to credit has tightened.
But in the Middle East, the meltdown has had a mixed impact. Banks and Islamic financial institutions have by and large remained insulated from the shakedown, but how long would they remain unscathed if the crisis prolongs?
Experts feel suggestions that Islamic financial institutions would always be insulated from the mortgage crisis are just wishful thinking as all financial institutions will be affected by the higher price of borrowing, regardless of the level of liquidity in the GCC.
Already, some sukuk issues have been delayed or are fetching softer prices, Islamic banks say. But the credit squeeze is not entirely to blame for that.
The sagging US dollar is also giving sukuk issuers cause for concern. In the GCC, companies issue sukuk in dollars as a hedge against their dollar-based assets, but investors now want local currencies instead.
Analysts contend that these days the sukuk has too many ties to the regular credit markets to ever insulate it from a sustained global credit squeeze.
The major investors in sukuk are also the big buyers of conventional debt. In Malaysia, where there is more of a secondary market for Islamic paper, sukuk buyers include pension funds. In the Middle East, where secondary trading is scarce, the investors are banks.
On the other hand, Middle Eastern investors are using the opportunity to buy into giant Western companies. UBS became the latest Western bank to seek a financial lifeline from the cash-rich East, selling a more than 10 per cent stake to investors from Singapore and the Middle East, as it wrote down a further $10 billion in the value of mortgage-backed assets.
The two investors - the Government of Singapore Investment Corporation and an unidentified Middle Eastern investor - will inject $9.7 billion and $1.8 billion into the troubled Swiss bank.
Citigroup recently agreed to sell a $7.5 billion stake to the Abu Dhabi Investment Authority, shoring up its capital base after announcing charges of $8 billion to $11 billion related to bad subprime investments. Dubai World has taken a $5 billion stake in MGM Mirage.
The Qatar Investment Authority, a $60 billion fund, says it saw "tremendous opportunities" to invest in US financial services firms hurt by the credit crisis.
On the flip side, London-based Barclays bank had put on hold a $937 million loan to DAE Aviation, the Washington DC subsidiary of Dubai Aerospace Enterprises. The region's biggest property developer, Emaar Properties, is also taking a hit.
Emaar, which also has operations in the US, says those operations were taking a hit on Emaar's bottom line, leading to a fall in Emaar's share prices.
The retail-investor-dominated stock markets of the Middle East have traditionally shown low levels of correlation with global markets. So they are not expected to be directly affected by the crisis in any significant manner.
However, banks, institutions and high net worth individuals, who have long positions in the global markets will incur losses on their exposure to the collateralised debt obligations, hedge funds and leverage buyout activities.
The risk to banks from the region may be negligible, but some private equity firms will be affected. Most Arab banks have little exposure to the US subprime instruments and the risk for those holding subprime related assets could be manageable.
Banks in the region can easily cope with whatever losses they may have incurred because of the crisis as their financial profiles are strong exhibiting good asset quality, robust capitalisation and high profitability.
According to a recent survey by Standard & Poor's, the aggregate exposure of Middle Eastern banks to the US subprime instruments is less than one per cent of their total assets, with the bulk of exposure concentrated in structured products of high investment grade. Nevertheless, the widespread de-leveraging taking place at the global scene will undoubtedly impact Middle Eastern markets as well. The credit risk aversion being witnessed these days has made banks more selective in financing leverage buyout activities.
The biggest risk to the region is the prospect of a major slowdown in world economic growth. Falling housing and other asset prices in the US, coupled with credit squeeze will undoubtedly have an impact on the highly indebted American consumer. A crisis in credit card finance could follow together with rising corporate defaults, analysts predict.
Slower growth in the US would put downward pressure on oil prices. With most of the region's currencies pegged to the dollar, monetary authorities here would have to follow the US lead and lower domestic interest rates to protect their currencies from market speculation.
This will increase credit expansion and add to rising inflationary pressures. The weaker exchange rates of the dollar and the currencies of the region will further aggravate imported inflation.
